1
Chapter 19
Accounting for
Postemployment
Benefits
An electronic presentation
by Douglas Cloud
Pepperdine University
2
Objectives
1. Understand the characteristics of pension
plans.
2. Explain the historical perspective of
accounting for pension plans.
3. Explain the accounting principles for defined
benefit plans, including computing pension
expense and recognizing pension liabilities
and assets.
Continued
4. Account for pensions.
5. Understand disclosures of pensions.
3
Objectives
6. Explain the conceptual issues regarding
pensions.
7. Understand several additional issue related to
pensions.
8. Explain other post-employment benefits.
9. Account for OPEBs.
10. Explain the conceptual issues regarding
OPEBs.
11. Understand present value calculations for
pensions. (Appendix)
4
Characteristics of Pension Plans
A pension plan
requires that a
company provide
income to its retired
employees in return
for services they
provided during their
employment.
5
Characteristics of Pension Plans
The retirement
income, normally paid
monthly, usually is
determined on the
basis of the employees
earnings and length of
service with the
company.
6
Internal Revenue
Code 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.
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.
7
Pension Relationships
Employees
Payments during retirement
Receive rights to pension benefits during
retirement
Provide service during employment
Company
Make payments
(fund) (affected by
ERISA and the Tax
Code)
Funding Agency
(for pension plan)
8
Pension Relationships
Funding Agency
(for pension plan)
Company
Recognize expense (and
perhaps asset or liability)
Financial
Statements
Financial
Statements
Prepared according to GAAP
FASB
Statements No.
87, 88, and 132
FASB
Statement No.
35
9
Service
Key Terms
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.
10
Service Cost
Current
period
Remaining
Expected Period of
Employment
Service Cost = PV of
Payment during
Retirement
Expected
Date of
Retirement
Expected
Date of
Death
Retirement
Payments During
Retirement Years of
Benefits Earned in
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 Plan Assets
The expected return on plan
assets is the expected
increase in plan assets due
to investing activities.
13
Expected Return on Plan Assets
Projected Benefit Obligations
at Beginning of Period =
Present Value of Benefits
Earned to Date
Projected Benefit Obligation
Grows to Equal Expected
Retirement Obligation
Interest = Projected Benefit x Discount
Cost
Obligation
Rate
Expected Return on Plan Assets
During Period
Plan assets at Beginning
of Period at Fair Value
Retirement
Assets Used to Pay
Retirement Benefits
Assets Grow to Equal the
Amounts Needed to Pay
Retirement Benefits
14
Amortization of Unrecognized
Prior Service Cost
Prior service cost is not recorded
it
inWhy
the is
accounts
in the period
The
retroactive
benefit
considered
granted.
Instead,
it is to
included
aunrecognized?
pension
plan and
is the
prior in
amortized
included
serviceofcost.
computation
pension expense.
15
Amortization of Unrecognized
Prior Service Cost
Date of Amendment
or Adoption
Unrecognized Prior = Present Value of Benefit from the
Service Cost
Amendment or Adoption to be
Received During Retirement
Unamortized Prior Service Cost is Amortized Over
Average Remaining Service Life of Employees
16
Gain or Loss
A gain or loss arises because actuaries
make assumptions about many of the
items included in the computation of
pension costs and benefits.
17
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.
18
Gain or Loss
The gain or loss components of pension expense
generally consists of one of the following items:
1. Amortization of any unrecognized net loss from
previous periods (added to compute pension
expense), or
2. Amortization of any unrecognized net gain from
previous periods (deducted to compute pension
expense).
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Components of Pension Expense
Service cost = Present value of benefits earned during
the year using the discount rate
+ Interest expense = Projected benefit obligation at
beginning of the year x Discount rate
– Expected return on plan assets = Fair value of plan
assets at the beginning of the year x Expected longterm rate of return on plan assets
+ Amortization of prior service cost = Present value of
additional benefits/modification of the plan amortized
over the remaining service lives of active employees
- Gain or loss = Amortization of the cumulative
unrecognized net gain or loss from previous periods in
excess of the corridor
20
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.
21
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
22
Additional Pension Liability
The additional pension liability
“adjusts” the company’s existing
pension liability or asset to the
amount of the unfunded
accumulated obligation.
23
Disclosures
According to FASB Statement No.
132, a company must disclose
specific information about a defined
benefit pension plan. These items are
shown in Slide 24.
24
Disclosures
3. The funded status of the5.plan,
the
amounts
not
The
amount
included
1. A reconciliation
2. the
A reconciliation
recognized on the balance sheet,
amounts not
within
other
of the beginning
of the beginning
recognized
on
the
balance
sheet,
including
the amount
6.
The
discount
rate,
the
comprehensive
income
and ending
and
ending
of any rate
unamortized
prior
service
cost,
the in
amount
of
of
compensation
from
a
change
the
balances of the
balances
of the
any unrecognized
net
gain
or
loss,
the
amount
of any
7.
The
amounts
increase,
and
the
additional
pension
4. benefit
The amount of
projected
fair value
of the
remaining
unamortized,
unrecognized
net
obligation
and
types of
expected
long-term
liability.
pension
expense.
obligation.
plan
assets.
or net asset
existing
at
the
adoption
of
rate of return on thesecurities FASB Statement
No. 87,plan
the assets.
net pension prepaid
asset
included
in or
theaccrued
liability; and any intangible
asset
and the related
plan
assets.
amount of accumulated other comprehensive income.
25
Pension Expense Equal to Funding
Facts for the Carlisle Company
1. The company adopts a pension plan on January
1, 2004. No retroactive benefits were granted to
employees.
2. The service cost each year is: 2004, $400,000;
2005, $420,000; 2006, $432,000.
3. The projected benefit obligations at the
beginning of each year is: 2005, $400,000; and
2006, $840,000.
Continued
26
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 2005).
27
Pension Expense Equal to Funding
December 31, 2004:
Pension Expense
Cash
400,000
400,000
December 31, 2005:
Pension Expense
Cash
Service cost (assumed)
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
28
Pension Expense Equal to Funding
December 31, 2006:
Pension Expense
Cash
Service cost (assumed)
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.
29
Pension Expense Greater Than
Pension Funding
Carlisle Company funds $385,000 in 2004,
$400,000 in 2005, and $415,000 in 2006.
December 31, 2004:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
400,000
385,000
15,000
Liability
30
Pension Expense Greater Than
Pension Funding
December 31, 2005:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
Service cost (assumed)
Interest cost ($400,000 x 10%)
Expected return on plan assets
($385,000 x 10%)
Pension expense
421,500
400,000
21,500
$420,000
40,000
(38,500 )
$421,500
31
Pension Expense Greater Than
Pension Funding
December 31, 2006:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
Service cost (assumed)
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
32
Pension Fund Less Than Pension
Funding and Expected Return Different
From Discount Rate
Carlisle Company funds $415,000 in 2004,
$425,000 in 2005, and $440,000 in 2006. The
expected and actual return is is 11%.
December 31, 2004:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
400,000
15,000
415,000
33
Pension Fund Less Than Pension
Funding and Expected Return Different
From Discount Rate
December 31, 2005:
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
34
Pension Fund Less Than Pension
Funding and Expected Return Different
The balance
in
the
asset
account
is
$44,872
From Discount Rate
December 31, 2006:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
Service cost (assumed)
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
35
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
Carlisle Company funds $385,000 in 2004,
$400,000 in 2005, and $415,000 in 2006. 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.
36
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
December 31, 2004:
Pension Expense
Cash ($385,000 + $290,000)
Prepaid/Accrued Pension Cost
Service cost (assumed)
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
37
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
December 31, 2005:
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
38
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
December 31, 2006:
Pension Expense
Cash
Prepaid/Accrued Pension Cost
Service cost (assumed)
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
39
Computation of Net Gain or Loss
Cumulative
Unrecognized
Net Loss
Year
(Gain)
Projected
Benefit
Obligation
Actual
Fair
Value
of Plan
Assets
Excess
Unrecognized
Net Loss
Corridor
(Gain)
Recognized
Net Loss
(Gain)
2004
$13,000
$110,000
$100,000
$11,000
$2,000
$200
2005
(2,300)
135,000
130,000
13,500
----
----
2006
18,700
168,000
170,000
17,000
1,700
170
2007
27,500
230,000
215,000
23,000
4,500
450
40
Recognition of Additional
Pension Liability
Assume the following facts for the Devon
Company at the end of 2004:
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
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
Plan assets (fair value)
Unfunded accumulated benefit
obligation
$1,200,000
(1,000,000 )
$ 200,000
42
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
Plan assets (fair value)
Unfunded accumulated benefit
obligations
$1,200,000
(1,000,000 )
$ 200,000
43
Recognition of Additional
Pension Liability
Unfunded accumulated benefit obligations $200,000
Prepaid/accrued pension cost (liability)
(50,000 )
Additional pension liability
$150,000
December 31, 2004:
Deferred Pension Cost
Additional Pension Liability
Continued
150,000
150,000
44
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
45
Recognition of Additional
Pension Liability
December 31, 2004:
Deferred Pension Cost
120,000
Excess of Additional Pension
Liability Over Unrecognized Prior
Service Cost
30,000
Additional Pension Liability
150,000
Continued
46
Recognition of Additional
Pension Liability
Stockholders’ Equity
Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
(loss):
Excess of additional pension liability over
unrecognized prior service cost
Total stockholders’ equity
$600,000
230,000
170,000
(30,000)
$970,000
47
Recognition of Additional
Pension Liability
Assume the following facts for the Devon
Company at the end of 2005:
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
48
Recognition of Additional
Pension Liability
Unfunded accumulated benefit obligations
Prepaid/accrued pension cost (liability)
Additional pension liability
$80,000
(60,000 )
$20,000
December 31, 2005:
Additional Pension Liability
Deferred Pension Cost
130,000
130,000
49
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.
50
Pension Liabilities
Five alternatives for meeting the recognitionmeasurement criteria of a liability that have been
identified as follows:
1. Amount attributed to employee service to
date.
2. Contributions based on an actuarial funding
method.
3. Termination liability.
4. Amount of vested benefits.
5. Amount payable to retirees.
51
Termination Benefits Paid
to Employees
FASB Statement No. 88 requires that a
company record a loss and a liability for
termination benefits when the following two
conditions are met:
1.The employee accepts the offer, and
2.The amount can be reasonably estimated.
52
Other Postemployment Benefits
Many
What
companies
are the major
offer
additional
differences
benefits
between
to
formerpostretirement
employees after
their
healthcare
retirement—widely
benefits and
referredpensions?
to as OPEB.
53
Other Postemployment Benefits
Item
Beneficiary
Benefits
Funding
Pensions
Retired employee (some
residual benefit to
surviving spouse)
Defined, fixed dollar
amount, paid monthly
Healthcare
Retired employee,
spouse, and
dependents
Not limited, paid as
used, varies
geographically
Funding legally required Usually not funded
and tax deductible
because not legally
required and not tax
deductible
54
OPEB Expense
The net postretirement benefit expense includes the
following components:
1. Service cost
2. Interest cost
3. Expected return on plan assets
4. Amortization of unrecognized prior service cost
5. Gain or loss
6. Recognition of the obligation or asset existing at
the date of the initial adoption of the statement
55
Illustration of Accounting
for OPEBS
Livingston Company adopts a healthcare plan for
retired employees on January 1, 2004. At that time
the company has two employees and one retired
employee. The discount rate is 10%, all employees
were hired at age 25 and will become eligible full
benefits at age 55. The retired employee was paid
$1,500 postretirement healthcare benefits in 2004.
The company determines its accumulated
postretirement benefit obligations to be $100,000.
Continued
56
Illustration of Accounting
for OPEBS
Service cost (actuarially determined)
Interest cost ($100,000 x 0.10)
Expected return on plan assets
Amortization of unrecognized prior
service cost ($100,000 ÷ 5)
Gain or loss
Amortization of transition obligation
Postretirement Benefit Expense
Continued
$ 1,100
10,000
0
20,000
0
0
$31,100
57
Illustration of Accounting
for OPEBS
December 31, 2004:
Postretirement Benefit Expense
Accrued Postretirement Benefit
Cost
31,100
31,100
To record the payment of retirement benefits:
Accrued Postretirement Benefit Cost
Cash
1,500
1,500
58
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.
59
Chapter 19
The End
60