INTERMEDIATE ACCOUNTING
TENTH CANADIAN EDITION
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER 19
Pensions and Other
Employee Future
Benefits
Prepared by:
Lisa Harvey, CPA, CA
Rotman School of Management,
University of Toronto
CHAPTER 19
PENSIONS AND OTHER EMPLOYEE FUTURE BENEFITS
After studying this chapter, you should be able to:
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Understand the importance of pensions from a business perspective.
Identify and account for a defined contribution benefit plan.
Identify and explain what a defined benefit plan is and the related accounting issues.
Explain what the employer’s benefit obligation is, identify alternative measures for this obligation,
and prepare a continuity schedule of transactions and events that change its balance.
Identify transactions and events that change benefit plan assets, and calculate the balance of the
assets.
Explain what a benefit plan’s funded status is, calculate it, and identify what transactions and
events change its amount.
Identify the components of pension expense, and account for a defined benefit pension plan under
the immediate recognition approach.
Account for defined benefit plans with benefits that vest or accumulate other than pension plans.
Identify the types of information required to be presented and disclosed for defined benefit plans,
prepare basic schedules, and be able to read and understand such disclosures.
Identify differences between the IFRS and ASPE accounting for employee future benefits and what
changes are expected in the near future.
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Pensions and Other Employee Future
Benefits
Introduction
and Benefit
Plan Basics
Defined Benefit
Pension Plans
•Overview of
pensions and
their
importance
from a
business
perspective
•The employer’s obligation
Presentation,
Disclosure, and
Analysis
•Plan assets
•Presentation
•Comparison of
IFRS and ASPE
•Funded status
•Disclosure
•Looking ahead
•Defined benefit cost
components and the
immediate recognition
approach
•Analysis
•Defined
contribution
plans
IFRS/ASPE
Comparison
•Other defined benefit
plans
•Defined
benefit plans
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Benefit Plans
• Three examples of benefit plans:
1. Pension and other post-retirement plans (e.g.
health care and life insurance)
2. Post-employment benefit plans (e.g.
severance benefits and long-term disability
benefits)
3. Compensated absences (e.g. parental leaves,
unrestricted sabbatical leaves)
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Nature of Pension Plans
• A pension plan provides benefits (payments) to
retirees for services provided during
employment
• The employer sponsors and contributes to the
fund and incurs the cost of the pension plan
– Requires accounting for the employer
• The pension plan receives the contributions,
administers pension assets and makes pension
payments to the beneficiaries
– Requires accounting for the pension plan
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Pension Fund Stream
PENSION
FUND
EMPLOYER
Cash paid to pension
plan (contributions)
$
Fund
Assets
Pension recipients (benefits)
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Pension Terminology
• Funded
– Employer sets aside money for future pension
benefits in a separate legal entity
• Contributory
– Employee and employer make contributions to the
plan
• Non-contributory
– Employers bear the full cost of the pension plan
– No contributions made by employee
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Pension Plans
• The two most common types of pension plans
are:
1. Defined contribution (DC) plans
2. Defined benefit (DB) plans
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Defined Contribution Plans
• Employer contributes a defined sum (either a
fixed sum or related to salary) to a third party
– Ownership of plan assets assumed by plan trustee
– Trustee is responsible for investment and distribution
of plan assets
• Employee assumes the economic risk
– No guarantee made by employer as to benefits paid
– Plan does not specify the benefits the employees will
receive or the method used to determine benefits
• Cost of the plan in the current year is known with
certainty
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Defined Contribution Plans
• Accounting is straightforward:
– Liability reported if contributions for the period have
not been made in full
– Asset reported if the amount contributed is more than
required for the period
– The benefit cost (pension expense) is the amount the
company is required to contribute to the plan
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Defined Contribution Plans
• When plan is first established or when
there is an amendment to the plan, the
employer may be obligated to make
contributions for previous employee
services
– Called prior or past service cost
– Under IFRS, these costs are generally
recognized immediately as an expense
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Defined Benefit Pension Plans
• Pension benefits received by employee after retiring are
specified (i.e. defined)
– Pension benefits are based on a formula with key variables such as
years of service and expected salary level at retirement
– The trust’s main goal is to ensure there will be enough pension
assets to pay the employer’s obligation to employees when they
retire
• The employer assumes the economic risk
– Assets are legally owned by the trust but in substance belong to the
employer (the beneficiary of the trust)
– The employer is responsible for making the defined benefit
payments no matter what happens in the trust
• Cost of plan not known with certainty, as it depends on
uncertain future variables (e.g. employee turnover, mortality,
inflation)
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Defined Benefit Pension Plans
• Can be vesting or non-vesting
– Vested amounts plan become the legal property of the
employee
– Employees are entitled to receive vested benefits even after
leaving the employ of the corporation
• Accounting for defined benefit plans is not easy to
measure:
– The pension expense is not same as cash funding contribution
– Actuarial assumptions must be used extensively
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Pensions and Other Employee Future
Benefits
Introduction
and Benefit
Plan Basics
Defined Benefit
Pension Plans
•Overview of
pensions and
their
importance
from a
business
perspective
•The employer’s obligation
Presentation,
Disclosure, and
Analysis
•Plan assets
•Presentation
•Comparison of
IFRS and ASPE
•Funded status
•Disclosure
•Looking ahead
•Defined benefit cost
components and the
immediate recognition
approach
•Analysis
•Defined
contribution
plans
IFRS/ASPE
Comparison
•Other defined benefit
plans
•Defined
benefit plans
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Defined Benefit Pension Plans
• Three methods of measuring the pension
obligation valuation
1. Vested benefit method
– Based on current salary levels
– Includes only vested benefits
2. Accumulated benefit method
– Based on current salary levels
– Includes both vested and non-vested service
3. Projected benefit method
– Based on future salary levels
– Includes both vested and non-vested service
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Defined Benefit Pension Plans
• Projected benefit method is considered the best
measure for accounting purposes
• Present value of vested and non-vested benefits
earned as at the reporting date (using future
salary levels) is called defined benefit obligation
(DBO)
– Under ASPE, the DBO is known as the accrued
benefit obligation (ABO)
– ASPE also allows the accrued benefit obligation
(ABO) for funding purposes which is based on
different variables.
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Defined Benefit Obligation (DBO)
Defined benefit obligation, beginning
+ Current service cost
+ Interest cost
- Benefits paid to retirees
+/- Past service costs of plan amendments
during period
+/- Actuarial gains (-) or losses (+)
.
= Defined benefit obligation, end of period
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Current Service Cost
• The cost of benefits that will be provided in
the future in exchange for current services
• These costs are prorated on service:
– Annual expense is based on the total
estimated benefit being allocated evenly over
the years of service of the employee
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Interest Cost
• Interest accrues on the DBO as time passes
– Similar to discounted debt
• Current market rate
– Determined by reference to current yield on
high-quality debt instrument (e.g. corporate
bonds)
– Required by IFRS and ASPE
• Settlement rate
– Implied rate on insurance contract that would
effectively settle pension obligation
– Allowed under ASPE
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Benefits Paid to Retirees
• Pension benefits are paid to retirees
(former employees)
– Like all liabilities, the amount owing is
decreased as these payments are made
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Past Service Costs
• Similar to DC plans, when a plan is started
or amended, credit is often given for past
years of service
– This amount is included in the pension benefit
cost on the income statement in the year it is
incurred
• Note that companies can also amend
plans to reduce the benefits received
– Results in a decreased DBO and a past
service benefit
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Actuarial Gains and Losses
• These gains and losses can occur
because of:
– Changes in actuarial assumptions
• A change in assumptions about future events
– Experience gains or losses
• Difference between what actually happened and
the actuarial assumption that was made
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Plan Assets
Plan assets, fair value at beginning
+ Contributions
+/- Actual return
- Benefits paid to retirees
.
= Plan assets, fair value at end of period
* Actual return = Expected return +
remeasurement gain on assets or –
remeasurement actuarial loss on assets
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Contributions
• Contributions are made each year by:
– The employer
– The employees (if applicable)
• Federal and provincial law dictate the
funding requirements
• The Canadian Revenue Agency (CRA)
also dictates regulations as well as what
contributions are tax deductible
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Return on Plan Assets
• The income generated on the assets less
administration costs
– Due to year over year volatility, a long-term
rate of return is estimated
• This is referred to as the expected return
– Under IFRS, rate used must be the same as
the discount rate used to calculate interest
cost
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Funded Status
Defined Benefit Obligation (DBO)
- Fair Value of plan assets
= Funded status
• DBO > Plan assets = underfunded =
funded status liability
• DBO < Plan assets = overfunded = funded
status asset
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Accounting for Pensions
• Pension cost should be accrued and recognized
in accounting periods that benefit from
employees’ service
• Two approaches to accounting for pension
expense
– Immediate recognition approach
•
•
A form of this approach is required by IFRS
Allowed under ASPE
– Deferral and amortization approach
•
Allowed under ASPE
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Immediate Recognition Approach
Statement of Financial Position Presentation
• DBO and fund assets are off-balance
sheet or memo accounts
– Under IFRS, the net employee benefit or
liability is reported
– Under ASPE, the net employee benefit or
liability is reported based on the funded
status of the plan
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Immediate Recognition Approach
Income Statement Presentation
• Pension expense is made up of:
– Current service cost
– Interest cost
– Actual return on plan assets
• Under IFRS, this amount is allocated between net
income (interest amounts) and OCI (remeasurements)
– Past service cost
– Actuarial gains and losses
• Under IFRS, these are included in OCI
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The Pension Worksheet
• Used to accumulate information needed
for the formal journal entries and to keep
track of the relevant pension plan items
and components reported off-balance
sheet
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Immediate Recognition Approach –
Example (2013)
General Journal Entries
Items
Annual
Pension
Expense
Cash
Bal. Jan 1 2013
a) Service cost
b) Interest cost
c) Actual return
d) Contributions
e) Benefits paid
Expense entry, 2013
Contribution entry,
2013
Balance Dec. 31, 2013
Net
Defined
Benefit
Liability/
Asset
0
9,000 Dr.
10,000 Dr
10,000 Cr.
Memo Record
Defined
Benefit
Obligation
100,000 Cr.
Plan Assets
100,000 Dr.
9,000 Cr.
10,000 Cr.
7,000 Dr.
10,000 Dr.
8,000 Dr.
7,000 Cr.
112,000 Cr.
111,000 Dr.
8,000 Cr.
9,000 Dr.
9,000 Cr.
8,000 Cr.
8,000 Cr.
1,000 Cr.
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Immediate Recognition Approach –
Example (2013)
To record expense:
Pension Expense
9,000
Net Defined Benefit Liability/Asset
9,000
To record contribution:
Net Defined Benefit Liability/Asset 8,000
Cash
8,000
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Immediate Recognition Approach –
Example (2014)
General Journal Entries
Items
Annual
Pension
Expense
Cash
Bal. Dec. 31 2013
f) Past service cost
Memo Record
Net Defined Defined Benefit
Benefit
Obligation
Liability/
Asset
1,000 Cr.
112,000 Cr.
80,000 Dr.
80,000 Cr.
g) Service cost
9,500 Dr.
9,500 Cr.
h) Interest cost
19,200 Dr
19,200 Cr.
i) Actual return
11,100 Cr.
j) Contributions
Contribution entry, 2014
Balance Dec. 31, 2014
111,000 Dr.
11,100 Dr.
20,000 Cr.
20,000 Dr.
k) Benefits paid
Expense entry, 2014
Plan Assets
97,600 Dr.
8,000 Dr.
8,000 Cr.
212,700 Cr.
134,100 Dr.
97,600 Cr.
20,000 Cr.
20,000 Cr.
78,600 Cr.
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Immediate Recognition Approach –
Example (2014)
To record expense:
Pension Expense
97,600
Net Defined Benefit Liability/Asset
97,600
To record contribution:
Net Defined Benefit Liability/Asset 20,000
Cash
20,000
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Immediate Recognition Approach –
Example (2015: ASPE)
General Journal Entries
Items
Annual
Pension
Expense
Cash
Bal. Dec. 31 2014
Memo Record
Net Defined Defined Benefit
Benefit
Obligation
Liability/
Asset
78,600 Cr.
212,700 Cr.
l) Service cost
13,000 Dr.
13,000 Cr.
m) Interest cost
21,270 Dr
21,270 Cr.
n) Actual return
12,000 Cr.
o) Contributions
24,000 Dr.
p) Benefits paid
10,500 Dr.
28,530 Dr.
Expense entry, 2015
50,800 Dr.
Contribution entry, 2015
Balance Dec. 31, 2015
134,100 Dr.
12,000 Dr.
24,000 Cr.
q) Actuarial loss
Plan Assets
10,500 Cr.
28,530 Cr.
50,800 Cr.
24,000 Cr.
24,000 Cr.
105,400 Cr.
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265,000 Cr.
159,600 Dr.
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Immediate Recognition Approach –
Example (2015: ASPE)
To record expense:
Pension Expense
50,800
Net Defined Benefit Liability/Asset
50,800
To record contribution:
Net Defined Benefit Liability/Asset 24,000
Cash
24,000
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Immediate Recognition Approach –
Example (2015: IFRS)
General Journal Entries
Items
Remeasurement (Gain)
Loss OCI
Annual
Pension
Expense
Cash
Bal. Dec. 31 2014
Memo Record
Net Defined Defined Benefit
Benefit
Obligation
Liability/
Asset
78,600 Cr.
212,700 Cr.
l) Service cost
13,000 Dr.
13,000 Cr.
m) Interest cost
21,270 Dr
21,270 Cr.
n) Expected return
14,610 Cr.
o) Remeasurement loss
2,610 Cr.
24,000 Cr.
24,000 Dr.
q) Benefits paid
10,500 Dr.
r) Liability loss
28,530 Dr.
.
Expense entry, 2015
31,140 Dr.
19,660 Dr.
Balance Dec. 31, 2015
134,100 Dr.
14,610 Dr.
2,610 Dr.
p) Contributions
Contribution entry, 2015
Plan Assets
10,500 Cr.
28,530 Cr.
50,800 Cr.
24,000 Cr.
24,000 Cr.
105,400 Cr.
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265,000 Cr.
159,600 Dr.
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Immediate Recognition Approach –
Example (2015: IFRS)
To record expense:
Pension Expense
19,660
Remeasurement Loss (OCI)
31,140
Net Defined Benefit Liability/Asset
50,800
To record contribution:
Net Defined Benefit Liability/Asset 24,000
Cash
24,000
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Valuation of Accrued Benefit Asset
• Accrued benefit asset cannot exceed
expected future benefits (valuation
allowance may be necessary to reduce the
value on statement of financial position)
– Referred to as the asset ceiling test
• Change in valuation allowance is generally
recognized through pension expense in
net income
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Other Defined Benefit Plans with
Benefits that Vest or Accumulate
• Accrual accounting is appropriate for post-retirement
benefits, post-employment benefits and long-term
compensated absences
– Example: post-retirement health care benefits
• Since the right to the benefit is earned by rendering
service, the cost and related liability are accrued as
employee provides service
• IFRS generally follows the same approach as for
pension plans, except that actuarial gains/losses and
past service costs are reflected in OCI
• Under ASPE, defined benefit plans where benefits vest
or accumulate based on service are accounted for in
same way as defined benefit pension plans
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Defined Benefit Plans with Benefits
that Do Not Vest or Accumulate
• E.g. parental leave plans (in excess of what
government provides), long-term disability plans
• Use “event accrual” method to accrue full cost
• When event occurs that obligates entity:
Benefit Expense
xx
Benefit Liability
xx
• When the compensated absence is taken:
Benefit Liability
xx
Cash
xx
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Pensions and Other Employee Future
Benefits
Introduction
and Benefit
Plan Basics
Defined Benefit
Pension Plans
•Overview of
pensions and
their
importance
from a
business
perspective
•The employer’s obligation
Presentation,
Disclosure, and
Analysis
•Plan assets
•Presentation
•Comparison of
IFRS and ASPE
•Funded status
•Disclosure
•Looking ahead
•Defined benefit cost
components and the
immediate recognition
approach
•Analysis
•Defined
contribution
plans
IFRS/ASPE
Comparison
•Other defined benefit
plans
•Defined
benefit plans
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Presentation
• Defined benefit assets/liabilities
– Generally reported separately for each benefit
plan (unless all plans result in asset or
liability)
– Generally classified as long-term
• Benefit costs
– Components of benefit costs may be reported
together or separately on the income
statement
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Disclosure Requirements
• Disclosures under ASPE include:
– Description of each plan and any major
changes in terms during the year
– Information on most recent actuarial valuation
for funding purposes
– Funded status at year end (including FV of
plan assets and ABO)
– Explanation of differences between funded
status and amounts recorded on balance
sheet
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Disclosure Requirements
• Additional disclosure requirements under IFRS
include:
– Characteristics of defined benefit plans and related
risks
– Amounts included in statements from the plans
– How the plans help with cash flow management
– Reconciliations of beginning to ending balances of PV
of the net defined benefit liability/asset, plan assets
and DBO
– Amounts included in periodic net income and OCI
– Underlying assumptions and sensitivity information
– Many others such as the estimate of following year’s
expected funding contributions
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Analysis
• Analysis generally focuses on predicting
future cash flow obligations
• It is very important to validate the major
assumptions underlying the fund status
and future cash requirements, especially
– Discount rate used to measure DBO
– Current service cost
– Interest cost
• Small changes in key variables can have a
very significant impact
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Pensions and Other Employee Future
Benefits
Introduction
and Benefit
Plan Basics
Defined Benefit
Pension Plans
•Overview of
pensions and
their
importance
from a
business
perspective
•The employer’s obligation
Presentation,
Disclosure, and
Analysis
•Plan assets
•Presentation
•Comparison of
IFRS and ASPE
•Funded status
•Disclosure
•Looking ahead
•Defined benefit cost
components and the
immediate recognition
approach
•Analysis
•Defined
contribution
plans
IFRS/ASPE
Comparison
•Other defined benefit
plans
•Defined
benefit plans
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Looking Ahead
• Recent changes to IFRS has created
additional differences between IFRS and
ASPE
– Expected replacement of the ASPE pension
section is expected to take these differences
into account
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COPYRIGHT
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