Chapter 20-1 CHAPTER 20 ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITS Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 20-2 Learning Objectives 1. Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. Identify types of pension plans and their characteristics. 3. 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. 6. Describe the amortization of unrecognized prior service costs. 7. Explain the accounting procedure for recognizing unexpected gains and losses. 8. Explain the corridor approach to amortizing unrecognized gains and losses. 9. Describe the requirements for reporting pension plans in financial statements. Chapter 20-3 Accounting for Pensions and Postretirement Benefits Nature of Pension Plans Accounting for Pensions Defined contribution plan Alternative measures of liability Defined-benefit plan Role of actuaries Recognition of net funded status Components of pension expense Using a Pension Worksheet 2010 entries and worksheet Amortization of prior service cost 2011 entries and worksheet Gain or loss 2012 entries and worksheet Chapter 20-4 Reporting Pension Plans in Financial Statements Within the financial statements Within the notes to the financial statements Pension note disclosure 2013 entries and worksheet—a comprehensive example Special issues Nature of Pension Plans A Pension Plan is an arrangement whereby an employer provides benefits (payments) to employees after they retire for services they provided while they were working. Pension Plan Administrator Employer Retired Employees Chapter 20-5 Benefit Payments Assets & Liabilities LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. Nature of Pension Plans Some pension plans are: 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. Chapter 20-6 LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. Types 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 estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc. Chapter 20-7 LO 2 Identify types of pension plans and their characteristics. 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? Chapter 20-8 LO 3 Explain alternative measures for valuing the pension obligation. Accounting for Pensions The employer’s pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan. Alternative measures of the Liability Illustration 20-3 FASB’s choice Chapter 20-9 LO 3 Explain alternative measures for valuing the pension obligation. Accounting for Pensions Recognition of the Net Funded Status 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. Chapter 20-10 LO 3 Explain alternative measures for valuing the pension obligation. Accounting for Pensions Components of Pension Expense 1. Service Costs 2. Interest on the Liability 3. Actual Return on Plan Assets 4. Amortization of Prior Service Costs 5. Gain or Loss Chapter 20-11 Effect on Expense + + ++ +- LO 4 List the components of pension expense. 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. Chapter 20-12 LO 4 List the components of pension expense. Accounting for Pensions Components of Pension Expense 2. Interest on the Liability Effect on Expense + Interest for the period on the projected benefit obligation outstanding during the period. The interest rate (settlement rate) should reflect the rate at which companies can effectively settle pension benefits. Chapter 20-13 LO 4 List the components of pension expense. Accounting for Pensions Components of Pension Expense 3. Actual Return on Plan Assets Effect on Expense +- The actual return on plan assets is the increase in pension funds from interest, dividends, and realized and unrealized changes in the fair-market value of the plan assets. Chapter 20-14 LO 4 List the components of pension expense. Accounting for Pensions Components of Pension Expense 4. Amortization of Prior Service Costs Effect on Expense + Plan amendments often increase benefits for service provided in prior years. The cost (prior service cost) of providing these retroactive benefits is allocated to pension expense over the remaining service-years of the affected employees. Chapter 20-15 LO 4 List the components of pension expense. 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 market value of plan assets and by changes in the projected benefit obligation. Chapter 20-16 LO 4 List the components of pension expense. Pension Items Not Recognized Companies do not recognize two main items in the accounts and in the financial statements: Projected benefit obligation. Pension plan assets. A company must disclose in notes to the financial statements, but not in the body of the financials. Some items are recognized in other comprehensive income; changes in these items are amortized into expense through smoothing techniques. Prior service costs. Actuarial gains and losses. Chapter 20-17 LO 5 Use a worksheet for employer’s pension plan entries. Using a Pension Work Sheet Pension Work Sheet Items 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. Chapter 20-18 MEMO RECORD Pension Asset / Liability Projected Benefit Obligation Plan Assets The “Memo Record” columns maintain balances for the unrecognized pension items. LO 5 Use a worksheet for employer’s pension plan entries. Using a Pension Work Sheet BE20-3: At January 1, 20100, KRC Company had plan assets of $280,000 and a projected benefit obligation of the same amount. During 2010, service cost was $27,500, the settlement rate was 10%, actual and expected return on plan assets were $25,000, contributions were $20,000, and benefits paid were $17,500. Instructions: Prepare a pension worksheet for KRC for 2010. Chapter 20-19 LO 5 Use a worksheet for employer’s pension plan entries. Using a Pension Work Sheet BE20-3: Prepare a pension worksheet for KRC for 2010. GENERAL JOURNAL ENTRIES MEMO RECORD OCI Items Jan. 1, 2010 Service costs Interest costs Actual return Contributions Benefits paid Journal entry Dec. 31, 2010 Pension Expense 27,500 28,000 (25,000) Cash PSC Gain/Loss Pension Asset / Liability 0 Projected Benefit Obligation (280,000) (27,500) (28,000) ($280,000 x 10%) (20,000) 17,500 30,500 (20,000) - Plan Assets 280,000 - (10,500) (10,500) (318,000) 25,000 20,000 (17,500) 307,500 ($10,500) net liability Chapter 20-20 LO 5 Use a worksheet for employer’s pension plan entries. Using a Pension Work Sheet Note the following about the Work Sheet: The balance in the Pension Asset / Liability column should equal the net balance in the memo record – this is the “net funded position” of the pension plan. If a credit balance, Pension liability; if a debit balance, Pension asset. For each transaction or event, the debits must equal the credits. Chapter 20-21 LO 5 Use a worksheet for employer’s pension plan entries. Prior Service Cost Amortization of Prior Service Cost Company should not recognize the retroactive benefits as pension expense entirely 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. SFAS No. 158 allows use of the straight-line method. Chapter 20-22 LO 6 Describe the amortization of prior service costs. Using a Pension Work Sheet E20-7: The following defined pension data of Rydell Corp. apply to the year 2010. Projected benefit obligation, 1/1/10 (before amendment) Plan assets, 1/1/10 Pension liability On January 1, 2010, 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 2010 $560,000 546,200 13,800 120,000 9% 58,000 65,000 52,280 40,000 17,000 Instructions: For 2010, prepare a pension work sheet for Rydell Corp. that shows the journal entry for pension expense. Chapter 20-23 LO 6 Describe the amortization of prior service costs. Using a Pension Work Sheet – E20-7 GENERAL JOURNAL ENTRIES MEMO RECORD OCI Items Dec. 31, 2009 PSC Pension Expense Cash PSC Gain / Loss Pension Asset / Liability (13,800) 120,000 Bal. Jan. 1, 2010 Service costs Interest costs 58,000 61,200 Asset Return Plan Assets 546,200 (680,000) 546,200 (58,000) (61,200) (52,280) Amort. PSC 52,280 17,000 Contributions Benefits paid (17,000) (65,000) 40,000 Journal entry 83,920 AOCI -12/31/2009 Dec. 31, 2010 Chapter 20-24 Projected Benefit Obligation (560,000) (120,000) (65,000) 103,000 (121,920) 103,000 Solution on notes page 65,000 (40,000) - (135,720) (759,200) 623,480 ($135,720) liability Using a Pension Work Sheet E20-7: Pension Journal Entry for 2010. Dec. 31 Pension Expense OCI - PSC Chapter 20-25 83,920 103,000 Pension Liability 121,920 Cash 65,000 LO 6 Describe the amortization of prior service costs. Gains and Losses Gain or Loss Unexpected swings in pension expense can result from: 1. Changes in the market value of plan assets, and 2. Changes in actuarial assumptions that affect the amount of the projected benefit obligation. Chapter 20-26 LO 7 Explain the accounting for unexpected gains and losses. 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. Chapter 20-27 LO 7 Explain the accounting for unexpected gains and losses. Gains and Losses Question: What happens to the difference between the expected return and the actual return? Answer Recorded in Net Gain or Loss account. Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan. Chapter 20-28 LO 7 Explain the accounting for unexpected gains and losses. Gains and Losses Question: What happens with unexpected gains or losses from changes in the Projected Benefit Obligation (PBO)? Answer Recorded in Net Gain or Loss account. Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan. Chapter 20-29 LO 7 Explain the accounting for unexpected gains and losses. 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 (which may equal fair value) of the plan assets. Any accumulated net gain or loss balance above the 10% must be amortized. Chapter 20-30 LO 8 Explain the corridor approach to amortizing gains and losses. 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, 2010. Shin’s also had a net pension actuarial loss of $465,000 in accumulated OCI at January 1, 2020. The average remaining service period of Shin’s employees is 7.5 years. Instructions: Compute Shin’s minimum amortization of the actuarial loss. Chapter 20-31 LO 8 Explain the corridor approach to amortizing gains and losses. Gains and Losses BE20-7: Compute Shin’s amortization of the loss. Amortization Projected benefit obligation Plan assets $ (3,100,000) 3,300,000 $ 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 Chapter 20-32 ÷ 7.5 $ 18,000 LO 8 Explain the corridor approach to amortizing gains and losses. Using a Pension Work Sheet P20-2: Jackson Company adopts acceptable accounting for its defined benefit pension plan on January 1, 2009, with the following beginning balances: plan assets $200,000; projected benefit obligation $250,000. Other data are as follows. Annual service cost Settlement rate and expected rate of return 2009 2010 2011 $ 16,000 $ 19,000 $ 26,000 10% 10% 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, 1/1/10) 160,000 Amortization of prior service cost 54,400 Change in actuarial assumptions, Dec. 31 PBO Average remaining service life Chapter 20-33 41,600 520,000 15 years 15 years 15 years LO 8 Explain the corridor approach to amortizing gains and losses. Using a Pension Work Sheet P20-2: Pension Work Sheet for 2009 GENERAL JOURNAL ENTRIES MEMO RECORD OCI Items Bal. Jan. 1, 2009 Pension Expense Cash Pension Asset / Liability (50,000) Gain / Loss PSC Projected Benefit Obligation (250,000) Service costs 16,000 (16,000) Interest 25,000 (25,000) Return on assets Unexpected loss (18,000) (2,000) Contributions Benefits paid Journal entry 18,000 * 2,000 (16,000) 14,000 21,000 (16,000) 2,000 AOCI - 12/31/08 16,000 (14,000) (7,000) - Dec. 31, 2009 - * Expected Return on Plan Assets $200,000 10% = $20,000 Chapter 20-34 Plan Assets 200,000 2,000 x (57,000) Solution on notes page (277,000) 220,000 ($57,000) LO 8 Explain the corridor approach to amortizing gains and losses. Using a Pension Work Sheet P20-2 Pension Journal Entry for 2009 Dec. 31 Pension Expense 21,000 OCI – Gain/Loss 2,000 Pension Asset/Liability Cash Chapter 20-35 7,000 16,000 LO 8 Explain the corridor approach to amortizing gains and losses. Using a Pension Work Sheet P20-2: Pension Work Sheet for 2010 Items Bal. Jan. 1, 2010 Prior service costs Pension Expense GENERAL JOURNAL ENTRIES OCI Gain / Cash PSC Loss 2,000 160,000 Pension Asset Liability (57,000) Adj Bal., 1/1/10 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 (22,000) Amort. of PSC Contributions Benefits paid 54,400 Journal entry 95,100 * 22,000 (54,400) (40,000) 16,400 (40,000) 105,600 AOCI - 12/31/09 Dec. 31, 2010 40,000 (16,400) (160,700) 2,000 105,600 * Actual return = Expected Return Chapter 20-36 220,000 2,000 (217,700) Solution on notes page (483,300) 265,600 ($217,700) liability LO 8 Explain the corridor approach to amortizing gains and losses. Using a Pension Work Sheet P20-2 Pension Journal Entry for 2010 Dec. 31 Pension Expense OCI - PSC Pension Asset/Liability Cash Chapter 20-37 95,100 105,600 160,700 40,000 LO 8 Explain the corridor approach to amortizing gains and losses. Using a Pension Work Sheet P20-2: Pension Work Sheet for 2011 Items Bal. Dec. 31, 2010 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 41,600 Contributions Benefits paid Liability gain Journal entry AOCI - 12/31/10 Dec. 31, 2011 * Plug Chapter 20-38 24,000 2,560 (41,600) (48,000) 21,000 16,630 (16,630) 89,370 (48,000) (41,600) 105,600 64,000 (14,070) 14,300 48,000 (21,000) * 2,000 (12,070) (203,400) Solution on notes page (520,000) 316,600 ($203,400) liability LO 8 Explain the corridor approach to amortizing gains and losses. Using a Pension Work Sheet P20-2 Pension Journal Entry for 2011 Dec. 31 Chapter 20-39 Pension Expense 89,370 Pension Asset/Liability 14,300 OCI - Gain/Loss 14,070 OCI - PSC 41,600 Cash 48,000 LO 8 Explain the corridor approach to amortizing gains and losses. Reporting Pension Plans in Financial Statements Within the Financial Statements Pension expense Pension Asset / Liability Components of Accumulated Other Comprehensive Income Chapter 20-40 LO 9 Describe the requirements for reporting pension plans in financial statements. 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. Amounts recognized in accumulated other comprehensive income that have not yet been recognized in pension expense, showing separately the net gain or loss and prior service costs, and the amounts to be recognized is pension expense in the next year. Chapter 20-41 LO 9 Describe the requirements for reporting pension plans in financial statements. Reporting Pension Plans in Financial Statements Within the Notes to the Financial Statements 4. Disclosure of the rates used in measuring the benefit amounts (discount rate, expected return on plan assets, rate of compensation). 5. Table indicating the allocation of pension plan assets by category (e.g., types of investments). 6. 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. Chapter 20-42 LO 9 Describe the requirements for reporting pension plans in financial statements. Reporting Pension Plans in Financial Statements Special Issues The Pension Reform Act of 1974 Pension Terminations Chapter 20-43 LO 9 Describe the requirements for reporting pension plans in financial statements. iGAAP and U.S. GAAP separate pension plans into definedcontribution plans and defined-benefit plans. The accounting for defined-contribution plans is similar. For defined-benefit plans, both iGAAP and U.S. GAAP recognize the net of the pension assets and liabilities on the balance sheet. Unlike U.S. GAAP, which recognizes prior service cost on the balance sheet (as an element of “Accumulated other comprehensive income”), iGAAP does not recognize prior service costs on the balance sheet. Both GAAPs amortize prior service costs into income over the expected service lives of employees. Chapter 20-44 Another difference in defined-benefit recognition is that under iGAAP companies have the choice of recognizing actuarial gains and losses in income immediately or amortizing them over the expected remaining working lives of employees. U.S. GAAP does not permit choice. The IASB has recently issued a discussion paper on pensions proposing: (1) elimination of smoothing via the corridor approach, (2) a different presentation of pension costs in the income statement, and (3) a new category of pensions for accounting purposes—so-called “contribution-based promises.” Chapter 20-45 Accounting Guidance In December 1990, the FASB issued rules on “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” These rules cover for healthcare and other “welfare benefits” provided to retirees, their spouses, dependents, and beneficiaries. Other welfare benefits include life insurance offered outside a pension plan; medical, dental, and eye care; legal and tax services; tuition assistance; day care; and housing assistance. Chapter 20-46 Differences Between Pension Benefits and Healthcare Benefits Illustration 20A-1 Chapter 20-47 LO 10 Identify the differences between pensions and postretirement healthcare benefits. Differences Between Pension Benefits and Healthcare Benefits Measuring the future payments for healthcare benefit plans is so much more difficult than for pension plans. 1. Many postretirement plans do not set a limit on healthcare benefits. 2. The levels of healthcare benefit use and healthcare costs are difficult to predict. Increased longevity, unexpected illnesses (e.g., AIDS, SARS, and avian flu), along with new medical technologies and cures, cause changes in healthcare Chapter 20-48 utilization. LO 10 Identify the differences between pensions and postretirement healthcare benefits. Postretirement Benefits Accounting Provisions Attribution Period - period of time over which the postretirement benefit cost accrue. Illustration 20A-2 Chapter 20-49 LO 10 Identify the differences between pensions and postretirement healthcare benefits. Postretirement Benefits Accounting Provisions Obligations Under Postretirement Benefits Expected postretirement benefit obligation (EPBO) is the actuarial present value as of a particular date of all benefits a company expects to pay after retirement to employees and their dependents. Accumulated postretirement benefit obligation (APBO) is the actuarial present value of future benefits attributed to employees’ services rendered to a particular date. Chapter 20-50 LO 10 Identify the differences between pensions and postretirement healthcare benefits. Postretirement Benefits Accounting Provisions Postretirement Expense 1. Service Cost 2. Interest Cost 3. Actual Return on Plan Assets 4. Amortization of Prior Service Costs 5. Gains and Losses Chapter 20-51 LO 10 Identify the differences between pensions and postretirement healthcare benefits. Illustrative Accounting Entries 2010 Entries and Worksheet Illustration: The use of a worksheet in accounting for a postretirement benefits plan, assume that on January 1, 2010, Quest Company adopts a healthcare benefit plan. The following facts apply to the postretirement benefits plan for the year 2010. Chapter 20-52 Plan assets at fair value on January 1, 2010, are zero. Actual and expected returns on plan assets are zero. Accumulated postretirement benefit obligation (APBO), January 1, 2010, is zero. Service cost is $54,000. No prior service cost exists. Interest cost on the APBO is zero. Funding contributions during the year are $38,000. Benefit payments to employees from plan are $28,000. LO 11 Contrast accounting for pensions to accounting for other postretirement benefits. Illustrative Accounting Entries 2010 Entries and Worksheet Illustration 20A-4 Chapter 20-53 Journal Entry Illustrative Accounting Entries Recognition of Gains and Losses Gains and losses represent changes in the APBO or the value of plan assets. Gains and losses are recorded in other comprehensive income. The Corridor Approach Amortization Methods Chapter 20-54 LO 11 Contrast accounting for pensions to accounting for other postretirement benefits. Illustrative Accounting Entries 2011 Entries and Worksheet Illustration: The following facts apply to the postretirement benefits plan for Quest Company for the year 2011. Chapter 20-55 Actual return on plan assets is $600. Expected return on plan assets is $800. Discount rate is 8 percent. Increase in APBO due to change in actuarial assumptions is $60,000. Service cost is $26,000. Funding contributions during the year are $18,000. Benefit payments to employees during the year are $5,000. Average remaining service to expected retirement: 25 years. LO 11 Contrast accounting for pensions to accounting for other postretirement benefits. Illustrative Accounting Entries 2011 Entries and Worksheet Illustration 20A-6 Chapter 20-56 Journal Entry Illustrative Accounting Entries Amortization of Gains and Losses in 2012 Illustration 20A-8 Chapter 20-57 LO 11 Contrast accounting for pensions to accounting for other postretirement benefits. Copyright Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. 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