Pension Plans
Defined contribution plans require the employer and also
normally the employee to contribute an amount, usually a
percentage of salary, to a third party. This amount
accumulates for the employee and provides the employee
with retirement benefits. Employee bears the risk of the
investments. Employer simply expenses contributions.
Defined benefit plan requires the employer to provide a
defined benefit upon retirement of qualified employees.
Usually a function of ending salary, and years of service.
Employer pays a trustee but is ultimately responsible to the
employee for benefits earned
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Defined Benefit Plan
Assets
Beg bal
+Contributions
+Actual Return
- Distributions
= Ending Balance
Liabilities
Projected Benefit Obligation
+Service cost
+Interest cost
- Distributions
= Ending Balance
If the liabilities exceed the assets, the plan is underfunded. The
accounting issues involve how much of the net or gross position
of the plan should go on the company's financials.
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The Basic Accounting
The basic accounting from FAS No. 87 keeps the pension
off the balance sheet for the most part. The portion of
pension expense that is not funded each year (or
overfunded) shows as a pension liability (or asset).
Items that are not capitalized include:
Projected benefit obligation
Pension plan assets
Unrecognized prior service cost
Unrecognized net gain or loss
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Vocabulary
Vested benefit obligation - the benefits employees have
earned even if they quit now.
Accumulated benefit obligation - the benefits employees are
expected to receive based on current salaries
Projected benefit obligation - the benefits employees are
expected to receive based on their anticipated future salaries
FASB elected to base pension expense on the projected
benefit obligation
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Pension Expense
The amount of pension expense consists of the following:
Service cost - the increase in PBO as a result of employees
working this year
+ Interest cost - the increase in the liability because it is
carried at present value
-Actual return on plan assets - the earnings and unrealized
gains and losses on the portfolio of assets held by the fund
+ Amortization of unrecognized prior service costs - the
cost of benefits given to employees for work already
performed
+- Gain or Loss - adjust actual return on plan assets to
expected return and amortization of unrecognized
losses/gains from prior periods
Ex 2, 3
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Service Cost
This comes from the actuary, and is based on the increase in
PBO from the year's work.
Interest Cost
Since the liability is carried at present value, it increases by the
amount of interest each year. The interest cost is the beginning
of year PBO times the settlement rate. The settlement rate is the
rate at which an insurance company would settle the obligations.
Actual Return on Plan Assets
The plan is holding investments to pay future benefits. This is
the amount earned on them during the year.
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Amortization of Unrecognized Prior Service Cost
When benefits are initially granted or amended to increase
them, an immediate liability is created.
It is not recorded on the company's books.
It is amortized to pension expense over the average remaining
service life of employees receiving the benefit or on years of
service method
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Gains/Losses
Part One is the difference between actual return on plan assets
and expected return. It adjusts pension expense so that expected
return on plan assets is the true component of expense. If actual
return is greater than expected return, you will recognize a loss
(to reduce the return to actual), if actual return is less than
expected return, you will recognize a gain.
The difference between the actual and expected returns are
called unexpected gains and losses or asset gains and losses.
The same can happen on the liability side of the plan, and these
are called liability gains and losses.
Asset and liability gains and losses are accumulated off balance
sheet until they get outside the "corridor".
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Corridor Amortization
The FASB believed that these gains and losses should be able
to "ride" unless they get too large, as they often reverse
themselves from one year to the next.
Must amortize the unrecognized net gain or loss balance when
it exceeds 10% of the larger of the beginning balance of the
projected benefit obligation or the market-related value of plan
assets at the beginning of the year.
Amortization is the difference between the corridor and the
unrecognized net gain/loss divided by the average remaining
service life of all active employees.
Ex 8, 9
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Minimum Pension Liability
Because so much is off balance sheet, the FASB decided that
there are situations in which additional liability must be
booked on the balance sheet.
Minimum liability must be recorded equal to the excess of the
accumulated benefit obligation over the fair value of plan
assets.
Increase the existing liability to this amount, and record a debit
first to "Intangible Asset - Deferred pension cost" to the extent
that unrecognized prior service costs exist, then put any excess
to "Excess of additional pension liability over unrecognized
prior service cost" which is a contra equity account.
Ex 14, 15, Pb 7
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