17
Pensions and Other
Postretirement Benefits
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
2.
3.
Distinguish between accounting for the
employer’s pension plan and accounting
for the pension fund.
Identify types of pension plans and their
characteristics.
Explain alternative measures for valuing
the pension obligation.
4.
List the components of pension expense.
5.
Use a worksheet for employer’s pension
plan entries.
20-1
6.
Describe the amortization of prior service
costs.
7.
Explain the accounting for unexpected
gains and losses.
8.
Explain the corridor approach to
amortizing gains and losses.
9.
Describe the requirements for reporting
pension plans in financial statements.
Nature of Pension Plans
An arrangement whereby an employer provides benefits (payments) to
retired employees for services they provided in their working years.
Pension Plan
Administrator
Employer
Retired
Employees
20-2
Benefit Payments
Assets &
Liabilities
LO 1
Nature of Pension Plans
Pension plans can be:

Contributory: employees voluntarily make payments to
increase their benefits.

Noncontributory: employer bears the entire cost.

Qualified pension plans: offer tax benefits.
Pension fund should be a separate legal and accounting
entity.
20-3
LO 1
Nature of Pension Plans
Illustration 20-2
Pension Funds and
Pension Expense
The two most common types of pension plans are defined
contribution plans and defined benefit plans.
20-4
LO 1
Nature of Pension Plans
Defined-Contribution Plan

Employer contribution
determined by plan (fixed)

Risk borne by employees

Benefits based on plan
value
Defined-Benefit Plan

Benefit determined by plan

Employer contribution
varies (determined by
Actuaries)

Risk borne by employer
Actuaries make predictions (called actuarial assumptions) of mortality
rates, employee turnover, interest and earnings rates, early retirement
frequency, future salaries, and any other factors necessary to operate a
pension plan
20-5
LO 2
Accounting for Pensions
Two questions:
1) What is the pension obligation that a company should
report in the financial statements?
2) What is the pension expense for the period?
20-6
LO 3
Accounting for Pensions
Alternative Measures of the Liability
Employer’s pension
obligation is the deferred
compensation obligation it
has to its employees for
their service under the
terms of the pension plan.
FASB’s
choice
Illustration 20-3
20-7
LO 3
Accounting for Pensions
Recognition of the Net Funded Status of the
Pension Plan
 Companies must recognize on their balance sheet the
full overfunded or underfunded status of their defined
benefit pension plan.
 The overfunded or
underfunded status is
measured as the difference
between the fair value of the
plan assets and the
projected benefit obligation.
20-8
LO 3
Accounting for Pensions
Illustration 20-4
Components of Annual
Pension Expense
20-9
LO 4
Accounting for Pensions
Components of Pension Expense
1.
Service Costs
Effect on
Expense
+
Actuarial present value of benefits attributed by the pension
benefit formula to employee service during the period
20-10
LO 4
Accounting for Pensions
Components of Pension Expense
2.
Effect on
Expense
Interest on the Liability
+
Interest for the period on the projected benefit obligation
outstanding during the period
The interest rate use is referred to as the settlement rate.
20-11
LO 4
Accounting for Pensions
Components of Pension Expense
3.
Actual Return on Plan Assets
Effect on
Expense
+-
Increase in pension funds from interest, dividends, and
realized and unrealized changes in the fair value of the plan
assets.
Illustration 20-5
20-12
LO 4
Accounting for Pensions
Components of Pension Expense
4.
Amortization of Prior Service Costs
Effect on
Expense
+
Plan amendments often include provisions to increase
benefits for employee service provided in prior years.
Company allocates the cost (prior service cost) of providing
these retroactive benefits to pension expense in the future,
specifically to the remaining service-years of the affected
employees.
20-13
LO 4
Accounting for Pensions
Components of Pension Expense
5.
Gain or Loss
Effect on
Expense
+-
Volatility in pension expense can result from sudden and
large changes in the fair value of plan assets and by changes
in projected benefit obligation.
20-14
LO 4
Using a Pension Worksheet
Pension Work Sheet
Items
Annual
Pension
Expense
GENERAL JOURNAL ENTRIES
Other Comprehensive Income
(OCI)
Prior
Service
Cash
Costs (PSC)
Gain/Loss
The “General Journal Entries” columns
determine the journal entries to be recorded
in the formal general ledger.
20-15
MEMO RECORD
Pension
Asset /
Liability
Projected
Benefit
Obligation
Plan
Assets
The “Memo Record”
columns maintain balances
for the unrecognized
pension items.
LO 5
Using a Pension Work Sheet
Illustration: On January 1, 2014, Zarle Company provides the
following information related to its pension plan for the year 2014.
Plan assets, January 1, 2014, are $100,000.
Projected benefit obligation, January 1, 2014, is $100,000.
Annual service cost is $9,000.
Settlement rate is 10 percent.
Actual return on plan assets is $10,000.
Funding contributions are $8,000.
Benefits paid to retirees during the year are $7,000.
Prepare the pension worksheet for 2014.
20-16
LO 5
Using a Pension Work Sheet
Prepare a pension worksheet for 2014.
Illustration 20-8
GENERAL JOURNAL ENTRIES
OCI
Items
Jan. 1, 2014
Pension
Expense
Service costs
9,000
Interest costs
10,000
Actual return
(10,000)
Contributions
Cash
PSC
MEMO RECORD
Gain/Loss
Pension
Asset /
Liability
0
($100,000 x 10%)
(10,000)
10,000
(8,000)
8,000
Dec. 31, 2014
7,000
9,000
Plan
Assets
100,000
(9,000)
Benefits paid
Journal entry
Projected
Benefit
Obligation
(100,000)
(8,000)
(7,000)
(1,000)
-
-
(1,000)
(112,000)
111,000
($1,000) net liability
20-17
LO 5
Pension Journal Entry
Illustration 20-8
GENERAL JOURNAL ENTRIES
OCI
Items
Jan. 1, 2014
Pension
Expense
Cash
PSC
MEMO RECORD
Gain/Loss
Pension
Asset /
Liability
0
Projected
Benefit
Obligation
(100,000)
Service costs
9,000
(9,000)
Interest costs
10,000
(10,000)
Actual return
(10,000)
Contributions
10,000
(8,000)
8,000
Benefits paid
Journal entry
7,000
9,000
(8,000)
Dec. 31, 2014
Pension Expense
Cash
Pension Asset/Liability
20-18
Plan
Assets
100,000
(7,000)
(1,000)
-
-
(1,000)
(112,000)
111,000
9,000
8,000
1,000
LO 5
Prior Service Cost
Amortization of Prior Service Cost
Company should not recognize the retroactive benefits as
pension expense in the year of amendment.
Employer should recognize the pension expense over the
remaining service lives of the employees who are expected to
benefit from the change in the plan.
Amortization Method:

Board prefers a years-of-service method.

Employers may use straight-line amortization over the
average remaining service life of the employees.
20-19
LO 6
Using a Pension Work Sheet
E20-7: The following defined pension data of Rydell Corp. apply to the year
2014.
Projected benefit obligation, 1/1/14 (before amendment)
Plan assets, 1/1/14
Pension liability
On January 1, 2014, Rydell Corp., through plan amendment,
grants prior service benefits having a present value of
Settlement rate
Service cost
Contributions (funding)
Actual (expected) return on plan assets
Benefits paid to retirees
Prior service cost amortization for 2014
$560,000
546,200
13,800
120,000
9%
58,000
65,000
52,280
40,000
17,000
Instructions: For 2014, prepare a pension work sheet for Rydell Corp. that
shows the journal entry for pension expense.
20-20
LO 6
Using a Pension Work Sheet
E20-7
Items
Dec. 31, 2014
GENERAL JOURNAL ENTRIES
OCI
Annual
Prior
Pension
Pension
Service Gain /
Asset /
Expense
Cash
Cost
Loss
Liability
(13,800)
PSC
120,000
MEMO RECORD
Projected
Benefit
Obligation
(560,000)
(120,000)
Bal. Jan. 1, 2014
(680,000)
Service costs
58,000
(58,000)
Interest costs
61,200
(61,200)
Asset Return
(52,280)
Amort. PSC
(17,000)
(65,000)
65,000
Benefits paid
Journal entry
AOCI -12/31/2013
Dec. 31, 2014
20-21
83,920
546,200
52,280
17,000
Contributions
Plan
Assets
546,200
(65,000)
103,000
40,000
(40,000)
(759,200)
623,480
(121,920)
103,000
-
(135,720)
($135,720) liability
Using a Pension Work Sheet
E20-7: Pension Journal Entry for 2014.
Dec. 31
Pension Expense
Other Comprehensive Income (PSC)
Pension Asset/Liability
Cash
20-22
83,920
103,000
121,920
65,000
LO 6
Gains and Losses
Gain or Loss
Unexpected swings in pension expense can result from:
1. Sudden and large changes in the fair value of plan assets,
and
2. Changes in actuarial assumptions that affect the amount of
the projected benefit obligation.
20-23
LO 7
Gains and Losses
Question: What is the potential negative impact on net
income of these unexpected swings?
Volatility
The profession decided to
reduce the volatility with
smoothing techniques.
20-24
LO 7
Gains and Losses
Smoothing Unexpected Gains and Losses
on Plan Assets

Companies include the expected return on the plan assets
as a component of pension expense, not the actual return in
a given year.

Companies record asset gains and asset losses in an
account, Other Comprehensive Income (G/L), combining
them with gains and losses accumulated in prior years.
20-25
LO 7
20-26
LO 7
Gains and Losses
Smoothing Unexpected Gains and Losses
on the Pension Liability

Companies report liability gains and liability losses in Other
Comprehensive Income (G/L).

Companies combine the liability gains and losses in the
same Other Comprehensive Income (G/L) account.
 They accumulate the asset and liability gains and losses in
Accumulated Other Comprehensive Income and report on
the balance sheet in the stockholders’ equity section.
20-27
LO 7
Gains and Losses
Corridor Amortization
 FASB invented the corridor approach for amortizing
the accumulated net gain or loss balance when it gets
too large. How large is too large?
 10% of the larger of the beginning balances of the
projected benefit obligation or the market-related
value of the plan assets.
 Any Accumulated OCI net gain or loss balance above
the 10% must be amortized.
20-28
LO 8
Gains and Losses
Illustration: Data for Callaway Co.’s projected benefit
obligation and plan assets over a period of six years.
Illustration 20-14
Computation of the Corridor
20-29
LO 8
Gains and Losses
Illustration 20-15
Graphic Illustration
of the Corridor
20-30
LO 8
Gains and Losses
BE20-7: Shin Corporation had a projected benefit obligation of
$3,100,000 and plan assets of $3,300,000 at January 1, 2014.
Shin also had a net actuarial loss of $465,000 in accumulated
OCI at January 1, 2014. The average remaining service period of
Shin’s employees is 7.5 years.
Instructions: Compute Shin’s minimum amortization of the
actuarial loss.
20-31
LO 8
Gains and Losses
BE20-7: Compute Shin’s amortization of the loss.
Amortization
Projected benefit obligation
$
Plan assets
(3,100,000)
3,300,000
$
Corridor percentage
10%
Corridor amount
330,000
Accumulated loss
465,000
Excess loss subject to amortization
135,000
Average remaining service
Amortized to pension expense
20-32
3,300,000
÷
7.5
$
18,000
LO 8
Using a Pension Work Sheet
P20-2: Jackson Company adopts acceptable accounting for its defined
benefit pension plan on January 1, 2013, with the following beginning
balances: plan assets $200,000; projected benefit obligation $250,000.
Other data are as follows.
2013
Annual service cost
Settlement rate and expected rate of return
$
2014
2015
16,000 $
19,000 $
10%
10%
26,000
10%
Actual return on plan assets
18,000
22,000
24,000
Annual funding (contributions)
16,000
40,000
48,000
Benefits paid
14,000
16,400
21,000
Prior service cost (plan amended, 1/1/14)
160,000
Amortization of prior service cost
54,400
Change in actuarial assumptions, Dec. 31 PBO
Average remaining service life
20-33
41,600
520,000
15 years
15 years
15 years
LO 8
Using a Pension Work Sheet
P20-2: Pension Work Sheet for 2013
GENERAL JOURNAL ENTRIES
MEMO RECORD
OCI
Items
Bal. Jan. 1, 2013
Annual
Pension
Expense
Cash
Prior
Service
Cost
Gain /
Loss
Pension
Asset /
Liability
(50,000)
Projected
Benefit
Obligation
(250,000)
Service costs
16,000
(16,000)
Interest
25,000
(25,000)
Return on assets
(18,000)
Unexpected loss
(2,000)
Contributions
Benefits paid
Journal entry
18,000
*
2,000
(16,000)
21,000
Plan
Assets
200,000
(16,000)
2,000
AOCI - 12/31/12
14,000
16,000
(14,000)
(277,000)
220,000
(7,000)
-
Dec. 31, 2013
-
* Expected Return on Plan Assets $200,000
2,000
x
(57,000)
($57,000)
10% = $20,000
20-34
LO 8
Using a Pension Work Sheet
P20-2 Pension Journal Entry for 2013
Dec. 31
Pension Expense
21,000
OCI – Gain/Loss
2,000
Pension Asset/Liability
Cash
20-35
7,000
16,000
LO 8
Using a Pension Work Sheet
P20-2: Pension Work Sheet for 2014
Items
Bal. Jan. 1, 2014
Prior service costs
GENERAL JOURNAL ENTRIES
OCI
Gain /
Cash
PSC
Loss
2,000
160,000
Annual
Pension
Expense
Pension
Asset
Liability
(57,000)
Adj Bal., 1/1/14
MEMO RECORD
Projected
Benefit
Plan
Obligation
Assets
(277,000)
220,000
(160,000)
(437,000)
Service costs
19,000
(19,000)
Interest
43,700
(43,700)
Return on assets
Amort. of PSC
(22,000)
54,400
Contributions
Benefits paid
Journal entry
*
22,000
(54,400)
(40,000)
95,100
(40,000)
105,600
AOCI - 12/31/13
Dec. 31, 2014
16,400
40,000
(16,400)
(483,300)
265,600
(160,700)
2,000
105,600
* Actual return = Expected Return
20-36
220,000
2,000
(217,700)
($217,700) liability
LO 8
Using a Pension Work Sheet
P20-2 Pension Journal Entry for 2014
Dec. 31
Pension Expense
Other Comprehensive Income (PSC)
Pension Asset/Liability
Cash
20-37
95,100
105,600
160,700
40,000
LO 8
Using a Pension Work Sheet
P20-2: Pension Work Sheet for 2015
Items
Bal. Dec. 31, 2014
Annual
Pension
Expense
GENERAL JOURNAL ENTRIES
OCI
Gain /
Cash
PSC
Loss
105,600
2,000
Pension
Asset /
Liability
(217,700)
MEMO RECORD
Projected
Benefit
Plan
Obligation
Assets
(483,300)
265,600
Service costs
26,000
(26,000)
Interest
48,330
(48,330)
Return on assets
(24,000)
Unexpected loss
(2,560)
Amort. of PSC
Contributions
41,600
24,000
2,560
(41,600)
(48,000)
48,000
Benefits paid
Liability gain
Journal entry
AOCI - 12/31/14
Dec. 31, 2015
* Plug
20-38
21,000
16,630
(16,630)
89,370
(48,000)
(41,600)
(14,070)
105,600
2,000
64,000
(12,070)
14,300
(203,400)
(520,000)
(21,000)
*
316,600
($203,400) liability
LO 8
Using a Pension Work Sheet
P20-2 Pension Journal Entry for 2013
Dec. 31
20-39
Pension Expense
89,370
Pension Asset/Liability
14,300
Other Comprehensive Income (G/L)
14,070
Other Comprehensive Income (PSC)
41,600
Cash
48,000
LO 8
20-40
LO 8
20-41
LO 8
Reporting Pension Plans in Financial
Statements
Within the Financial Statements
20-42

Recognition of the net funded status of the plan

Classification of pension asset or pension liability

Aggregation of pension plans

Actuarial gains and losses/prior service cost
LO 9
Reporting Pension Plans in Financial
Statements
Within the Notes to the Financial Statements
1. Major components of pension expense.
2. Reconciliation showing how the projected benefit obligation
and the fair value of the plan assets changed.
3. A disclosure of the rates used in measuring the benefit
amounts (discount rate, expected return on plan assets, rate
of compensation).
20-43
LO 9
Reporting Pension Plans in Financial
Statements
Within the Notes to the Financial Statements
4. A table indicating the allocation of pension plan assets by
category (equity securities, debt securities, real estate, and
other assets), and showing the percentage of the fair value to
total plan assets.
5. The expected benefit payments to be paid to current plan
participants for each of the next five fiscal years and in the
aggregate for the five fiscal years thereafter. Also required is
disclosure of a company’s best estimate of expected
contributions to be paid to the plan during the next year.
20-44
LO 9
Reporting Pension Plans in Financial
Statements
Within the Notes to the Financial Statements
6. The nature and amount of changes in plan assets and benefit
obligations recognized in net income and in other
comprehensive income of each period.
7. The accumulated amount of changes in plan assets and benefit
obligations that have been recognized in other comprehensive
income and that will be recycled into net income in future
periods.
20-45
LO 9
Reporting Pension Plans in Financial
Statements
Within the Notes to the Financial Statements
8. The amount of estimated net actuarial gains and losses and
prior service costs and credits that will be amortized from
accumulated other comprehensive income into net income over
the next fiscal year.
20-46
LO 9
Reporting Pension Plans in Financial
Statements
Special Issues
20-47

The Pension Reform Act of 1974

Pension Terminations
LO 9
20-48
LO 9
RELEVANT FACTS - Similarities
20-49

IFRS and GAAP separate pension plans into defined contribution plans
and defined benefit plans. The accounting for defined contribution plans
is similar.

IFRS and GAAP recognize a pension asset or liability as the funded
status of the plan (i.e., defined benefit obligation minus the fair value of
plan assets). (Note that defined benefit obligation is referred to as the
projected benefit obligation in GAAP.)

IFRS and GAAP compute unrecognized past service cost (PSC)
(referred to as prior service cost in GAAP) in the same manner.
However, IFRS recognizes past service cost as a component of pension
expense in income immediately. GAAP amortizes PSC over the
remaining service lives of employees.
LO 12 Compare the accounting for pensions under GAAP and IFRS.
RELEVANT FACTS - Differences
20-50

IFRS and GAAP include interest expense on the liability in pension
expense. Regarding asset returns, IFRS reduces pension expense by
the amount of interest revenue (based on the discount rate times the
beginning value of pension assets). GAAP includes an asset return
component based on the expected return on plan assets.

Under IFRS, companies recognize both liability and asset gains and
losses (referred to as remeasurements) in other comprehensive income.
These gains and losses are not “recycled” into income in subsequent
periods. GAAP recognizes liability and asset gains and losses in
“Accumulated other comprehensive income” and amortizes these
amounts to income over remaining service lives, using the “corridor
approach.”
LO 12
RELEVANT FACTS - Differences

20-51
The accounting for pensions and other postretirement benefit plans is
the same under IFRS. GAAP has separate standards for these types of
benefits, and significant differences exist in the accounting.
LO 12
ON THE HORIZON
The IASB and the FASB have been working collaboratively on a postretirement
benefit project. The recent amendments issued by the IASB moves IFRS closer
to GAAP with respect to recognition of the funded status on the statement of
financial position. However, as illustrated in the About the Numbers section
above, significant differences remain in the components of pension expense.
The FASB is expected to begin work on a project that will reexamine expense
measurement of postretirement benefit plans. The FASB likely will consider the
recent IASB amendments in this area, which could lead to a converged
standard.
20-52
LO 12
IFRS SELF-TEST QUESTION
At the end of the current period, Oxford Ltd. has a defined benefit
obligation of $195,000 and pension plan assets with a fair value of
$110,000. The amount of the vested benefits for the plan is $105,000.
What amount related to its pension plan will be reported on the
company’s statement of financial position?
a. $5,000.
b. $90,000.
c.
$85,000.
d. $20,000.
20-53
LO 12
IFRS SELF-TEST QUESTION
At the end of the current year, Kennedy Co. has a defined benefit
obligation of $335,000 and pension plan assets with a fair value of
$245,000. The amount of the vested benefits for the plan is $225,000.
Kennedy has unrecognized past service costs of $24,000 and an
unrecognized actuarial gain of $8,300. What account and amount(s)
related to its pension plan will be reported on the company’s statement of
financial position?
20-54
a.
Pension Liability and $74,300.
b.
Pension Liability and $90,000.
c.
Pension Asset and $233,300.
d.
Pension Asset and $110,000.
LO 12
IFRS SELF-TEST QUESTION
At January 1, 2014, Wembley Company had plan assets of $250,000
and a defined benefit obligation of the same amount. During 2014,
service cost was $27,500, the discount rate was 10%, actual and
expected return on plan assets were $25,000, contributions were
$20,000, and benefits paid were $17,500. Based on this information,
what would be the defined benefit obligation for Wembley Company at
December 31, 2014?
20-55
a. $277,500.
c. $27,500.
b. $285,000.
d. $302,500.
LO 12
Copyright
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20-56