Chapter 20
Accounting for
Postemployment
Benefits
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.
2
Defined Contribution Plans
 The employer contributes a defined sum to a third party
plan trust.
 Amounts to be funded are determined by the plan.
 The plan invests the contributed assets, which earn
income, and makes distributions to retirees.
 There is no promise for specific future benefits.
 Market risk is borne by the employee.
 Accounting for the firm is relatively straightforward.
 For profit companies contribute to 401(k) plans and nonprofit organizations contribute to 403(b) plans.
3
Characteristics of a Pension Plan
A pension plan
requires that a
company provide
income to its retired
employees in return
for services they
provided during their
employment.
4
Defined Benefit Plans
The retirement income,
normally paid monthly,
usually is determined on
the basis of the
employees earnings and
length of service with
the company.
$50,000 average salary X 2.5% per year X 30 years
= $37,500 pension per year
Internal Revenue
Qualifications
Most companies design their pension plans to meet
the Internal Revenue Code qualifications, which
state that:
1. Employer contributions are deductible for
income tax purposes when paid.
2. Pension fund earnings are exempt from income
taxes.
3. Employer contributions to the pension fund are
not taxable to the employees until they receive
their pension benefits.
5
6
Defined Benefit Plans
 The employee is promised a certain amount of benefits
at retirement.
 The amount received is based upon variables such as
-Years of service
-Ending salary or average of best (three) years
-Multiplier, such as 2.5% per year of service
-Age, if retiring early, a deduction will be made
 The employer remains liable for the benefits and bears
the market risk.
 The employer is the trust-beneficiary.
 The accounting by the firm is complex.
7
Projected Benefit Obligation
The projected benefit
obligation is the actuary’s
estimate of the present value of
benefits attributed to date
based on future salary levels.
8
Accumulated Benefit Obligation
The accumulated benefit
obligation is the actuary’s
estimate of the present value of
benefits attributed to date
based on current salary levels.
9
Components of
Pension Expense
1.
2.
3.
4.
5.
+Service cost for the year. Increases pension expense.
+Interest on projected benefit obligation (liability).
Beginning PBO times the discount or settlement rate.
Increases pension expense.
-Expected return on plan assets during the year. Fair
value of plan assets at beginning of year times expected
long-term rate of return on plan assets. Generally
decreases pension expense.
+Amortization of prior service cost = Present value of
additional benefits/modification of the plan amortized
over the remaining service lives of active employees.
Generally increases pension expense.
+Gain or loss = Amortization of the cumulative
unrecognized net gain or loss from previous periods in
excess of the corridor.
10
Service Cost
Service cost is the
actuarial present value
of the benefits attributed
by the pension benefit
formula to service
rendered by the
employees during the
current period.
11
Interest Cost
Interest cost is the
increase in the
projected benefit
obligation due to the
passage of time.
12
Expected Return on Assets
The expected return on
plan assets is the
expected increase in plan
assets due to investing
activities.
The expected return on
plan assets, if positive,
will decrease pension
expense.
13
Prior Service Cost
When a defined benefit plan is either
initiated or amended, credit is often given
to employees for years of service
provided before the date of initiation or
amendment.
14
Unrecognized Prior Service Cost
The retroactive benefit Prior service cost is not
to a pension plan is the recorded in the accounts in
prior service cost. the period granted. Instead,
it is amortized and included
in the computation of pension
expense.
15
Methods of Amortization
Prior service cost may be amortized over
future service periods of employees active
at the time of the plan amendment using
either the straight-line or years-of-service
method.
16
Straight-line Method
The average remaining service life of employees
expected to receive benefits is calculated by
dividing the total future service years by the
number of employees.
Total future service years = average remaining service life
Number of employees expected
to receive benefits
17
Years-of-Service Method
The Board prefers a years-of-service
amortization method where
unrecognized prior service cost is
divided by the number of future
service years to be worked by
participating employees, to obtain a
cost per service-year. This cost per
service-year is multiplied by the
number of service years consumed
each year.
18
Gain or Loss
A gain or loss in plan assets arises
because of changes in the stock market
and because of changes in actuarial
assumptions.
19
Gain or Loss
The gain or loss is not recognized in
the period in which it occurs, so it is
called an unrecognized net gain or loss.
20
Amortization of Gain or Loss
The minimum amortization required is computed
by dividing the total unrecognized gain or loss
subject to amortization at the beginning of the year
by the average remaining service period of active
employees expected to receive benefits.
The amount subject to amortization is the excess
of 10% of the larger of the beginning balances of
the projected benefit obligation and the marketrelated asset value. Use absolute values.
21
Amortization of Gain or Loss
1. Amortization of any unrecognized net
loss from previous periods is added to
compute pension expense, or
2. Amortization of any unrecognized net
gain from previous periods is deducted
to compute pension expense.
22
Computation of Net Gain or Loss
Use January 1 cumulative gain or loss for computation.
Cumulative
Unrecognized
Net Loss
Year
(Gain)
Projected
Benefit
Obligation
Actual
Fair
Value
of Plan
Assets
2007
$13,000
$110,000
$100,000
$11,000
$2,000
$200
2008
(2,300)
135,000
130,000
13,500
----
----
2009
18,700
168,000
170,000
17,000
1,700
170
2010
27,500
230,000
215,000
23,000
4,500
450
Assume the average
remaining service period
is 10 years.
Excess
Unrecognized
Net Loss
Corridor
(Gain)
Divide
By 10 years
Recognized
Net Loss
(Gain)
Component
of pension
expense
23
Pension Expense Equal to
Funding
Facts for the Carlisle Company
1. The company adopts a pension plan on
January 1, 2007. No retroactive benefits were
granted to employees.
2. The service cost each year is: 2007, $400,000;
2008, $420,000; 2009, $432,000.
3. The projected benefit obligations at the
beginning of each year is: 2008, $400,000;
and 2009, $840,000.
Continued
24
Pension Expense Equal to
Funding
4. The discount rate is 10%.
5. The expected long-term rate of return on plan
assets is 10%.
6. The company adopts a policy of funding an
amount equal to the pension expense and
makes a payment at the end of each year.
7. Plan assets are based on the amounts
contributed each year, plus a return of 10%,
less $20,000 to retired employees (beginning
2008).
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Pension Expense Equal to
Funding
December 31, 2007:
Pension Expense
Cash
400,000
400,000
December 31, 2008:
Pension Expense
Cash
Service cost (from actuary)
Interest cost ($400,000 x 10%)
Expected return on plan assets
($400,000 x 10%)
Pension expense
420,000
420,000
$420,000
40,000
(40,000 )
$420,000
26
Balance
Plan Assets
Cash from 2007
400,000
Return 2008
40,000
Cash from 2008
420,000
Bal. 1/1/09
840,000
Paid to
retirees
2008
20,000
27
Pension Expense Equal to
Funding
December 31, 2009:
Pension Expense
Cash
Service cost (from actuary)
Interest cost ($840,000 x 10%)
Expected return on plan assets
($840,000 x 10%)
Pension expense
432,000
432,000
$432,000
84,000
(84,000 )
$432,000
Note that the interest cost and the return on
the plan assets offset each other each year.
28
Pension Expense Greater Than
Funding
Carlisle Company funds $385,000 in 2007,
$400,000 in 2008, and $415,000 in 2009.
December 31, 2007:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
400,000
385,000
15,000
Liability
29
Pension Expense Greater Than
Funding
December 31, 2008:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
(Liability balance now
$15,000 + $21,500)
421,500
400,000
21,500
Service cost (from actuary)
$420,000
Interest cost ($400,000 x 10%)
40,000
Expected return on plan assets
($385,000 x 10%)
(38,500 )
Pension expense
$421,500
30
Pension Expense Greater Than
Funding
December 31, 2009:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
Service cost (from actuary)
Interest cost ($840,000 x 10%)
Expected return on plan assets
($803,500 x 10%)
Pension expense
435,650
415,000
20,650
$432,000
84,000
(80,350 )
$435,650
The balance in the liability account is $57,150
($15,000 + $21,500 + $20,650)
Pension Fund Less Than
Pension Funding and Expected
Return Different From
Discount Rate
Carlisle Company funds $415,000 in 2007,
$425,000 in 2008, and $440,000 in 2009. The
expected and actual return is 11%.
December 31, 2007:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
400,000
15,000
415,000
31
Pension Fund Less Than
Pension Funding and Expected
Return Different From
Discount Rate
December 31, 2008:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
Service cost (assumed)
Interest cost ($400,000 x 10%)
Expected return on plan assets
($415,000 x 11%)
Pension expense
414,350
10,650
425,000
$420,000
40,000
(45,650 )
$414,350
The balance in the asset account is $25,650
32
Pension Fund Less Than
Pension Funding and Expected
Return Different From
Discount
Rate
December 31, 2009:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
Service cost
Interest cost ($840,000 x 10%)
Expected return on plan assets
($9,800 x 11%)
Pension expense
420,322
19,678
440,000
$432,000
84,000
(95,678 )
$420,332
The balance in the asset account is $44,872
33
34
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
Carlisle Company funds $385,000 in 2007,
$400,000 in 2008, and $415,000 in 2009. The
company awarded retroactive benefits to
employees. The unrecognized prior service
costs were estimated to be $2 million. Carlisle
decided to increase its contribution by $290,000
per year. The $2 million is amortized over 20
years.
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
December 31, 2007:
Pension Expense
Cash ($385,000 + $290,000)
Prepaid/Accrued Pension Cost
Service cost
Interest cost ($2,000,000 x 10%)
Amortization of unrecognized
prior service cost
Pension expense
700,000
675,000
25,000
$400,000
200,000
100,000
$700,000
35
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
December 31, 2008:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
Service cost (assumed)
Interest cost ($2,600,000 x 10%)
Expected return on plan assets
($675,000 x 11%)
Amortization of unrecognized
prior service cost
Pension expense
705,750
685,000
20,750
$420,000
260,000
(74,250 )
100,000
$705,750
36
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
December 31, 2009:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
Service cost
Interest cost ($3,260,000 x 10%)
Expected return on plan assets
($1,421,000 x 11%)
Amortization of unrecognized
prior service cost
Pension expense
701,690
700,000
1,690
$432,000
326,000
(156,310 )
100,000
$701,690
37
38
Additional Pension Liability
The accumulated benefit obligation
in excess of the fair value of the
plan assets is a measure of the
obligation of the company based on
the legal concept of a liability.
39
Additional Pension Liability
The additional pension liability
“adjusts” the company’s existing
pension liability or asset to the
amount of the unfunded
accumulated obligation.
40
Recognition of Additional
Pension Liability
Assume the following facts for the Devon
Company at the end of 2007:
Projected benefit obligation
Accumulated benefit obligation
Plan assets (fair value)
Prepaid/accrued pension cost
(liability)
Unrecognized prior service cost
$2,000,000
1,200,000
1,000,000
50,000
300,000
41
Additional Pension Liability
–
=
–
or +
=
Accumulated benefit obligation
Fair value of plan assets
Unfunded Accumulated Benefit
Obligation
Prepaid/accrued pension cost
(credit balance)
Prepaid/accrued pension cost (debit
balance)
Additional Pension Liability
42
Recognition of Additional
Pension Liability
Remember that the difference
between the two benefit obligations
is that the PBO includes assumed
future pay increase, whereas the
ABO is based on current pay levels.
Accumulated benefit obligation $1,200,000
Plan assets (fair value)
(1,000,000)
Unfunded accumulated benefit
obligation
$ 200,000
43
Recognition of Additional
Pension Liability
The unfunded accumulated
benefit obligation of $200,000
is the minimum liability that
the company must recognize.
Accumulated benefit obligation $1,200,000
Plan assets (fair value)
(1,000,000)
Unfunded accumulated benefit
obligation
$ 200,000
44
Recognition of Additional
Pension Liability
Unfunded accumulated benefit obligations
Prepaid/accrued pension cost (liability)
Additional pension liability
$ 200,000
(50,000)
$150,000
December 31, 2007
Deferred Pension Cost (intangible asset) 150,000
Additional Pension Liability
150,000
45
Recognition of Additional
Pension Liability
The intangible asset cannot
exceed the unrecognized
prior service cost.
Assume Devon Company
has an unrecognized prior
service cost of $120,000.
Continued
46
Recognition of Additional
Pension Liability
December 31, 2007
Deferred Pension Cost (intangible asset) 120,000
Excess of Additional Pension
Liability Over Unrecognized Prior
Service Cost (contra equity)
30,000
Additional Pension Liability
150,000
Continued
47
Recognition of Additional
Pension Liability
Stockholders’ Equity
Common stock
$600,000
Additional paid-in capital
230,000
Retained earnings
170,000
Accumulated other comprehensive income
(loss):
Excess of additional pension liability over
unrecognized prior service cost
(30,000)
Total stockholders’ equity
$970,000
Continued
48
Recognition of Additional
Pension Liability
Assume the following facts for the Devon
Company at the end of 2008:
Accumulated benefit obligation
Plan assets (fair value)
Prepaid/accrued pension cost
(liability)
Unrecognized prior service cost
Continued
1,300,000
1,220,000
60,000
110,000
49
Additional Liability
Unfunded ABO
Minimum Liability
(not a real account)
80,000
Prepaid/Accrued
Additional Liability
130,000
60,000
150,000
20,000
50
Recognition of Additional
Pension Liability
Accumulated benefit obligation
$1,300,000
Plan assets (fair value)
1,220,000
Unfunded accumulated benefit obligations 80,000
Prepaid/accrued pension cost (liability)
(60,000)
Additional pension liability (balance)
$20,000
December 31, 2008:
Additional Pension Liability
130,000
Deferred Pension Cost (intangible asset) 100,000
Excess of Additional Liability Over
Unrecognized Prior Service Cost
30,000
51
Recognition of Additional
Pension Liability
Since the additional liability is less
than the unrecognized prior service
cost, the company does not include
any reduction in its accumulated
other comprehensive income for the
year.
52
Recognition of Additional
Pension Liability
If the fair value the plan assets is
more than the accumulated benefit
obligation. No further calculations
are needed.
53
Disclosures
According to FASB Statement No.
132R, a company must disclose
specific information about a
defined benefit pension plan.
54
Other Postemployment Benefits
Many companies offer
additional benefits to former
employees after their
retirement--widely referred to
as OPEB.
What are the major
differences between
postretirement healthcare
benefits and pensions?
55
Interaction with
Deferred Income Taxes
The change in the deferred tax
rules from FASB Statement No. 96
to FASB Statement No. 109, which
made it easier for a company to
recognize deferred tax assets.
56
Chapter 20
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