INTERMEDIATE
ACCOUNTING
Seventh Canadian Edition
KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA
Northern Alberta Institute of Technology
CHAPTER
20
Pensions and Other Employee
Future Benefits
Learning Objectives
1. Distinguish between accounting for the employer’s
pension costs and accounting for the pension fund.
2. Identify types of pension plans and their
characteristics.
3. Identify the accounting and disclosure requirements
for defined contribution plans.
4. Explain alternative measures for valuing the pension
obligation.
5. Identify the components of pension expense.
6. Identify transactions and events that affect the
projected benefit obligation.
Learning Objectives
7. Identify transactions and events that affect the
balance of the plan assets.
8. Explain the usefulness of—and be able to complete—
a work sheet to support the employer’s pension
expense entries.
9. Explain the pension accounting treatment of past
service costs.
10. Explain the pension accounting treatment of
actuarial gains and losses, including corridor
amortization.
Learning Objectives
11. Identify the differences between pensions and postretirement health care benefits.
12. Identify the financial reporting and disclosure
requirements for defined benefit plans.
13. Identify the financial accounting and reporting
requirements for defined benefit plans whose
benefits do not vest or accumulate.
14. Explain the basics of what current service cost, the
projected benefit obligation and past service cost
represent. (Appendix 14A)
Pensions and Other
Employee Future Benefits
Introduction
and
Terminology
Nature of
pension
plans
Defined
contribution
plans
Defined
benefit plans
The role of
actuaries
Defined Benefits
that Vest or
Accumulate Basics
Alternative
measures of the
liability
Capitalization vs.
non-capitalization
Major components
of pension
expense
Projected benefit
obligation and
plan assets
Basic Illustration
Defined Benefits
that Vest or
Accumulate Complexities
Past service costs
Actuarial gains and
losses
Corridor
amortization
Other benefits that
vest or accumulate
Comprehensive
illustration
Reporting defined
benefit plans
Perspectives
Plan complexities
Defined
Appendix ABenefits Example of a
that do not One Person
Vest or
Plan
Accumulate
Current
Postservice cost
employment Projected
benefits
benefit
and
obligation
compenPast
sated
Service
absences
Cost
Pension Plans
• A pension plan provides benefits to retirees for
services provided during employment
• Employer sponsors and contributes to fund,
and incurs the cost of the pension plan
– Accounting for the employer
• Pension plan receives the contributions,
administers pension assets, and makes
pension payments to the beneficiaries
– Accounting for the pension plan
Pension Fund Stream
TRUST
COMPANY
Pension Expense
Cash paid to pension
plan (funding)
Accrued pension
asset/liability
$
Plan
Assets
Projected Benefit
Obligation
Employees (pension benefits)
Pension Terminology
• Contributory
– Employee and employer make contributions to the
plan
• Non-contributory
– Employers bear the full cost of the pension plan
– No contributions made by employee
• Vested
– Amounts in the plan become the legal property of
the employee
• Employee is entitled to receive benefits even after
leaving the employ of the corporation
– Governed by provincial law
Defined Contribution Plans
• Employer contributes a defined sum to a third
party – plan trustee
– Ownership of plan assets assumed by trustee
• Employee assumes the economic risk
– No guarantee made by employer as to benefits
paid
• Cost of the plan in the current year is known
with certainty
Defined Contribution Plans
• Liability reported if contribution (funding) is
less than required
• Asset reported if the amount contributed is
more than required for the period
• Disclosure requirements:
– Annual pension expense amount
– Nature and effect of matters affecting
comparability
Defined Contribution Plans:
Employers’ Journal Entries
Contribution made
is less than
the pension expense
Contribution made
is more
than pension expense
Pension Expense Dr
Cash
Cr
Accrued Pension
Liability
Cr
Pension Expense Dr
Accrued Pension
Asset
Dr
Cash
Cr
Liability
Asset
Exercise 20-1: LinDu Limited
Given: Defined Contribution Plan
Employee Contribution:
5% of gross pay
Employer Contribution:
Equal amount
November 30, 2005:
$25,500 combined
employee and employer contribution owing
December 2005:
$274,300 gross pay
Exercise 20-1: LinDu Limited
Requirement a)
December 10, 2005 Journal Entry:
Pension Liability
Cash
25,500
25,500
To record payment to pension trustee
Exercise 20-1: LinDu Limited
Requirement b)
5% of December gross pay =
$274,300
x .05
Employer Contribution Expense
13,715
Exercise 20-1: LinDu Limited
Requirement c)
Current liability:
Pension Contributions Payable
($13,715 + $13,715)
$ 27,430
This assumes amounts for previous months
were remitted as required each month. At
December 31st all that remains as payable is the
amount withheld from employees in December
and the required employer matching amount.
Defined Benefit Pension Plans
• End benefit received by employees is predefined
– Contributions based on formula:
• Employee’s years of service and expected salary
level at retirement
– Actuarial assumptions used extensively in
accounting for defined benefit plans
– Cost of plan in current year not known with
certainty
• The employer remains liable to ensure benefit
payments
• Employer is the trust-beneficiary
Defined Benefit Pension Plans
•
Pension obligation valuation
1. Vested benefit obligation
– Based on current salary levels
– Includes only vested benefits
2. Accumulated benefit obligation
– Based on current salary levels
– Includes both vested and nonvested service
3. Projected benefit obligation
– Based on future salary levels
– Includes both vested and nonvested service
Pension Liability Measurement
Recommended
method - CICA
Handbook, Section
3461
Pension obligation
Present value of
the estimated
future benefits to
be paid to
employees
Vested benefit obligation
Accumulated benefit
obligation (ABO)
Projected benefit obligation
(PBO)
Pro-rated on salaries Pro-rated on service
Projected Benefit Obligation
(PBO)
• Pro-rated on salaries
• Annual funding based on percentage of
total estimated compensation earned by
the employees over their career
• Pro-rated on services
• Annual funding based on the total
estimated benefit being allocated evenly
over the years of service of the employee
Projected Benefit Obligation
(PBO)
• Defined as the portion of the defined
obligation attributed to services provided to
date
– Based on the present value of vested and
nonvested benefits
• Also referred to as accrued benefit obligation
Capitalization vs.
Noncapitalization
• Capitalization
– Full obligation recognized as liability
– Pension plan assets reported as assets
– Liability and assets reduced by payment of
benefits
• Noncapitalization
– Follows substance of the plan as separate
legal and accounting entity
– Obligation on B/S = amount of expense
recognized less amount funded
– Adopted by Accounting Standards Board
Components of
Pension Expense
Service Cost for
Current Year
+
Interest on the
Liability
+
Expected return on
Plan Assets

Pension Expense
+
Amortized
Past Service Costs
+ or 
Amortized
Net Actuarial Gain
or Loss
+ or 
Amortized
Transitional
Asset or Obligation
Components of
Pension Expense
• Service Cost
– The amount of pension benefit earned in the
current period
• Interest
– Consider PBO as a long-term liability (albeit offbalance sheet) that accrues interest
– Interest rate used is the current yield on highquality debt, or current settlement rate
Components of
Pension Expense
• Expected Return on Plan Assets
– The assets in the pension plan earn income and
this income including any capital appreciation
reduces the eventual cost of the pension
– Long-term rate of return applied to fair value of
plan assets
Components of
Pension Expense
• Amortization of Past Service Costs (PSC)
– PSC are from either the initial adoption of a
pension plan or an amendment to improve the
existing plan
– PSC are the present value of those additional
future benefits
– Amortized over the expected period to full
eligibility of the employee group
Components of
Pension Expense
•
Amortization of Net Actuarial Gains/Losses
–
Two sources for these gains and losses
1. Change in plan’s actuarial assumptions
2. Plan experiences gains and losses
–
Amortized using “corridor approach”
Components of
Pension Expense
• Amortization of Transitional Asset or
Obligation
– Stem from CICA Handbook, Section 3461
(introduced in 2000)
– When Section 3461 is applied prospectively,
any difference between plan assets and PBO
is amortized
– Amortization period is the Expected Average
Remaining Service Life (EARSL)
Notes on EARSL
• EARSL is the expected average remaining
service life of the employee group
• It is another number determined by the
actuary
• Consider the following example
EARSL
Picture a bus full of employees heading for retirement.
Given an EARSL of 10 years in 2005, what is a reasonable
EARSL in 2006?
Are the same employees on the
bus at retirement as were on at
the beginning?
2005
2006
Retirement
Some got on the bus, others got off the bus…
A reasonable estimate for 2006 might be 10 years.
Summary of Pension Expense
Components and Methods
Pension expense
component
Method used to Effect on pension
determine cost
expense
1 Service Cost
Present Value
+
2 Interest Expense
Current Rate
+
3 Expected Return
on Plan Assets
Long-Term Expected Rate
of Return
-
4 Prior Service Cost
Amortize
+
5 Actuarial Gains
and Losses
Corridor method
(amortize excess)
+/-
6 Transition Gains
and Losses
Amortize over EARSL
+/-
PBO Transactions
PBO, beginning of period
+ Current Service Cost
+ Interest Cost
+ PSC during period
 Benefits paid to retirees
 Actuarial Gains
+ Actuarial Losses
= PBO, end of period
• The PV of pension
benefits earned to date
by employees
• Most information
relating to PBO
provided by actuaries
Plan Assets Transactions
Plan assets (FV) beginning
of period
+ Employer/employee
funding
 Actual return
 Benefits paid out
= Plan assets (FV) end of
period
Actual return
= expected return
+ experience gain or
 Experience loss on assets
Funded Status
• Funded status = PBO  FV of plan assets
• PBO > Plan assets = underfunded
• PBO < Plan assets = overfunded
Notes on Pension
• CICA Handbook, Section 3461 recommends the
noncapitalization approach
– Pension amounts recorded by the company (most
are disclosed in notes)
• PBO
• Plan Assets
• Unrecognized Past Service Costs (PSC)
• Unrecognized Net Actuarial Gains/Losses
• Unrecognized Net Transitional Asset/Liability
The Pension Worksheet
• Used to accumulate information needed to
record both the formal journal entries and
the memo entries to keep track of the
relevant pension plan items and
components
The Pension Worksheet
General Journal Entries
Items
Annual
Pension
Cash
Expense
Accrued
Pension
A/L
Memo Record
Projected
Benefit
Obligation
Plan
Assets
Beginning Balances recorded here
An ending credit
An ending debit
balance here is
balance is
reported with
reported with
Long-term
other Deferred
Liabilities
Charges
Pension transactions are recorded through the worksheet,
using debits and credits (all entries must therefore balance)
The Pension Worksheet Example
General Journal Entries
Items
Annual
Pension
Cash
Expense
Bal.
a)
b)
c)
d)
e)
Accrued
Pension
A/L
Memo Record
Projected
Benefit
Obligation
Plan
Assets
100,000 Cr. 100,000 Dr.
9,000 Dr.
10,000 Dr.
10,000 Cr.
9,000 Cr.
10,000 Cr.
8,000 Cr.
7,000 Dr.
9,000 Dr.
10,000 Dr.
8,000 Dr.
7,000 Cr.
9,000 Cr.
8,000 Cr. 8,000 Cr.
1,000 Cr. 112,000 Cr. 111,000 Dr.
Pension Entries
To record:
Pension Expense
9,000
Accrued Pension/Liability
To record contribution:
Accrued Pension Liability 8,000
Cash
9,000
8,000
Actuarial Gains and Losses
• Caused by:
1.
2.
3.
Actual return on plan assets differing from
expected return
Changes in actuarial assumptions affecting the
PBO
Actual experience in PBO differing from expected
experience
• If changes large enough, including full amount of the
gains or losses in expense results in substantial
fluctuations in reported pension expense
• Amortization allows for “smoothing” the impact of
these changes
Actuarial Gains and Losses
• Over time, accumulated effect of the changes (net
gains/losses) may even out
• Corridor approach adopted to allow for
circumstances where no accumulating offset occurs
• Amortization used only when the opening
unrecognized gains/losses are greater than 10% of
the larger of the opening balance of the PBO and the
FV of Plan Assets
• Amount calculated under the Corridor Approach
uses Beginning Balances only
Corridor Approach - Example
Opening Balance 2004
$400,000 2005
PBO, JanuaryLess:
1
Corridor $2,100,000
280,000 $2,600,000
$120,000 2,800,000
FV Plan Assets, Jan. 1
2,600,000
Amortized
–
Net Actuarial Loss
(gain) over 5.5 years
400,000
300,000
average remaining service life
$678,182280,000
Corridor –Opening
10% of theBalance
larger of
260,000
(400,000
– 21,818 + 300,000)
the PBO or
PA
Less:
Corridor
Cumulative
Net Actuarial
Loss
(Beginning of Year)
290,000
0
400,000
$388,182
2006
$2,900,000
2,700,000
(170,000)
290,000
678,182
Amount to be Amortized
0
120,000
388,182
Current Year Amortization
0
21,818
70,579
Disclosure Requirements –
Defined Benefit Plans
• All enterprises must disclose:
– Amounts recorded in the financial statements
– Off-balance sheet accounts
– Underlying assumptions
• Financial institutions and public enterprises have
additional disclosure requirements
– Reconciliation of PBO and Plan Assets beginning
and ending balance
– Unamortized balances of PSC, Net actuarial
Gains/Losses, Net Transitional amounts; and
amortization amount for each
Defined Benefit Plans
• E.g. parental leave plans (in excess of what
government provides), some long-term
disability plans
• No basis on which to accrue expense –
benefits not related to service provided.
Entitlement comes with being an employees
Defined Benefit Plans
• Therefore use “event accrual” method to
accrue full cost
• When event occurs that obligates entity:
Benefit Expense
xx
Benefit Liability
xx
Defined Benefit Plans
• When the compensated absence is taken
event occurs that obligates entity:
Benefit Liability
xx
Cash
xx
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