Pension Accounting
Chapter 17
Understand the
nature/characteristics/accounting of employer
pension plans:
Defined Benefit Plans.
Professor Vedd
CHAPTER 17: PENSION
Objectives:
 Pension Overview
 Fundamental differences between:
– Defined contribution plans
– Defined benefit plans*

Accounting for Pension:
– Key components: Pension expense

Disclosure/presentation
Professor Vedd
Overview of Pension Plan
A pension plan:
An agreement between an employer/employee
• Government plans: social security
• Individual plans (IRA)
• Employer Plans* 
Emphasis: Pension Plan: for Corporation:
Company set aside funds for employees’ service!
Professor Vedd
Pensions: SFAS 158

SFAS 158 Reporting pension items in
the balance sheet and AOCI

132R: Disclosures

IAS 19 (detail information provided –end of
the lecture)
Professor Vedd
PENSION PLAN: Overview
Employer
Sponsors the plan
Benefits
Plan
Administrator
Contributions
The plan administrator receives
the contributions from the
employer, invests the pension
assets, and makes the benefit
payments.
Professor Vedd
Pension Recipients
TYPES OF PENSION PLANS
TWO TYPES
1
DEFINED
CONTRIBUTION
PLAN
Pension fund
$
promise FIXED ANNUAL
CONTRIBUTIONS
DEFINED
BENEFIT
PLAN
promise FIXED
RETIREMENT BENEFITS
Professor Vedd
2
Defined contribution plans


•
•
Defined Contribution
A plan that provides benefits based solely on what has been
contributed and the earnings thereon
Amounts to be funded are determined by the plan
– No promise for specific future benefits.
– Independent third party holds assets
– Risk borne by employee
– Accounting relatively straightforward
Employer makes no guarantee to the amount of benefits
Employees’ retirement benefits based on the amount of funds
in the plan
Professor Vedd
Defined Benefit Pension Plans
DEFINED BENEFIT PLAN
Plan Characteristics
Employer is
committed to
specified
retirement
benefits.
Retirement
benefits are based
on a formula that
considers years of
service,
compensation
level, and age.
Professor Vedd
Employer bears
all risk of
pension fund
performance.
Accounting for Defined Benefit Plans
 Defined
benefit plans
– Employer’s contribution is based on the expected future
benefits
– Affected by many variables:
 Years of service
 Annual salary at retirement
 Retirement years
– Etc.

Future Obligation for retirement benefits is
based on many estimates/assumptions
Professor Vedd
Actuaries and Pension Accounting
Pension calculations involve
actuarial assumptions.
These are
estimates.
Assumptions involve:
mortality rates, employee turnover, future salaries,
rates of return, etc.
Professor Vedd
Measures of Pension Liability:
Defined Benefit Plan
Pension calculations involve
actuarial assumptions.
Benefits for vested and nonvested
employees at future salaries
Benefits for vested/ nonvested employees at current
salaries
Accumulated
Benefit
Obligation
(AB0)
Professor Vedd
(GAAP)
Projected
Benefit
Obligation
(PBO)
OVERVIEW: PENSION
COMPONENTS
Based On Actuarial Assumptions:
How much to contribute annually for the service provided by
employees
1. SERVICE PROVIDED
Employee
hired
SERVICE COST
PENSION EXPENSE
Professor Vedd
Benefit Period
Employee
Retired
PENSION EXPENSE: INTEREST COST
 Interest
cost : (PENSION EXPENSE)
 – the increase in the pension obligation
(PBO) due to the accrual of an additional
year of interest.
 PV of liability increases as you get closer
to the due date
– Interest cost = discount rate * beginning
balance in PBO
Professor Vedd
INTEREST COST:PENSION
EXPENSE
 PV
of pension Obligation is increased by
the interest cost on the beginning of
PBO
Professor Vedd
OVERVIEW: TIMELINE
COMPONENTS
PRIOR (PAST) SERVICE COST
Past Service Cost
Employee
Hired
SERVICE
COST
Benefit Period
Employee
Retired
Plan
Initiation
Professor Vedd
PENSION EXPENSE: Prior Service Cost

Establishing (or modifying/amended) a plan

Cost of benefits granted for service rendered prior
to the inception of the plan

Increases PBO at date of amendment/
 The entire amount of Past Service Cost is NOT
recognized as expense in the current year
 Instead , Past Service Cost is recognized in the
current period in Other Comprehensive Income
(OCI)
Professor Vedd
Issues in Accounting:
Defined Benefit Plans
Periodic expense (Pension Expense) of having a
pension plan
2. Plan Assets Resources set aside by the employer
from which to pay the retirement in the future
(invested by Trustee)
3. Employer’s Obligation to pay retirement benefits
in the future
1.
Professor Vedd
Pension Plan Assets

Resources with which the obligation will
Satisfy: PLAN ASSETS

Employee contribution in the Pension Fund
(held by Trustee)

Plan Assets are invested -in income producing
assets.

Accumulated balance: Contribution + return
on investment Professor Vedd
Return on Plan Asset
– Expected return on plan assets (FASB)
– *Expected rate of return:
 Based on long-term rate of return anticipated given investment
of plan assets
– Expected return on plan asset decreases the pension cost
and increases plan asset
Professor Vedd
Actuarial Gains and Losses
Actuarial assumptions are subject to
inaccuracies as time goes by and
circumstances change
 The estimate of the PBO also require
revision
 Inc/Dec in PBO is referred to gain/loss

Professor Vedd
NET GAINS/LOSSES
NET GAINS/LOSSES:
1. Gains/Losses from the return on Assets
2. Gains/Losses from changing assumptions
(PBO)
= NET GAINS/LOSSES
• Deferred and reported as OCI
• Amortized using Corridor rule*
Professor Vedd
Corridor Amount
STEPS
1: GREATER OF PBO & PLAN ASSETS
2: 10% OF STEP 1
3…. Next slide…
PBO at
The corridor
amount is 10% of
the greater of . . .
Professor Vedd
the
beginning of the
period.
Or
Fair value of plan
assets at the
beginning of the
period.
Gains and Losses
EXAMPLE
2013 Net Loss Amortization ($ in millions)
2009
PBO
$
400
Fair value of plan assets
300
2013
Net loss for 2009
55
Average service life
15
Apply steps:
1. Greater of PBO & Plan Assets = PBO $400
2. 10% of PBO i.e. 400 x 10% = $40
Professor Vedd
Gains and Losses
STEP 3: FIND THE EXCESS TO BE AMORTIZED
Net loss
Corridor amount ($400 x 10%)
Excess at the beginning of the year
$
$
AMORTIZATION:
$15,000,000 ÷ 15 years = $1,000,000
Professor Vedd
55
40
15
Defined Benefit Plan:
Net Periodic Pension Cost
So far…..
PENSION EXPENSE=
Service Cost
+ Interest Cost
- expected return on plan Asset
+Amortization (if any) of Prior service cost
+/- Amortization (net) Gains/Losses
Professor Vedd
REPORTING:
Employer’s Obligation & Plan Asset

The employer’s obligation and plan assets
are not individually reported in a
company’s primary financial statements:

the difference between the two, the
funded status, is reported as:
a pension liability if underfunded or
Vedd
 a pension assetProfessor
if overfunded.

Funded Status of Pension Plan
Projected Benefit Obligation (PBO)
- Plan Assets at Fair Value
Underfunded / Overfunded Status
This amount is reported in the
balance sheet as a Pension Liability
or Pension Asset.
Professor Vedd
Pension Disclosures

The details for net periodic pension cost
– the service cost component.
– the interest cost component.
– the expected return on plan assets the
amortization of PSC, transition amount and
unrecognized gain/loss (separately)
– Gain or loss from settlement or curtailment of
plan
Professor Vedd
Pension Disclosures
– Amount and types of assets held
– Assumptions related to discount rate,
rate of increase in compensation,
expected return on plan assets
– Alternative amortization policies
– Past practice or history of regular
benefit increases
Professor Vedd
Pension Disclosures

Employers with multiple plans
– Information can be combined but the
computations are made for each individual plan
 Net position for over-funded plans would be
reported in noncurrent assets
 Net position for under-funded plans would be
reported in liabilities
– Part may be reported as a current liability
– See next slide
Professor Vedd
Disclosure of Pension Plans
FASB 132
1. A reconciliation between the beginning and
ending balances for the projected benefit
obligation
2. A reconciliation between the beginning and
ending balances in the fair value of the
pension fund



The fair value of plan assets
(changes between BOY and EOY)
PBO Obligation
(changes between BOY and EOY)
EoY = end of year
BoY = beginning of year
Professor Vedd
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Professor Vedd
(concluded)
Professor Vedd
IAS 19: INFORMATION

The standard covers all employee benefits - not just pensions. This note focuses on pensions
but a later section considers other employee benefits. The key pension points are:
Assets are taken at market value

Liabilities are calculated using an interest rate based on the yield on high quality corporate

bonds at the valuation date (usually taken as AA-rated)

There is a limit to the amount that can be recognized as a prepayment (surplus) in the
company balance sheet

Actuarial gains and losses may be:
recognized in the P&L immediately
– recognized in the P&L on a smoothed basis
– recognized immediately in the statement of recognized income and expense
–

The cost of past service benefit increases is recognized immediately to the extent that the
increases are vested immediately
Professor Vedd