FAS 158 and Employee Benefit Plans

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FAS 158 and Employee Benefit Plans

• ACCT 70053
• Spring 2008

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Pensions A Quick Review

• Companies offer two types of retirement benefit
  plans for their employees
• Defined contribution plans the employer
  contributes some amount to a plan. The ultimate
  retirement benefit is uncertain and the employee
  bears the investment risk.
• Defined benefit plans the employer promises to
  pay retirement benefits according to some benefit
  formula.

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Pensions A Quick Review

• Defined contribution plans do not present any
  significant accounting issues the annual cost
  of the plan is simply the amount of the required
  annual contribution
• Defined benefit plans are more complex and are
  accounted for according to
• FAS 87 Employers' Accounting for Pensions
• FAS 88 Employers' Accounting for Settlements and
  Curtailments of Defined Benefit Pension Plans and
  for Termination BenefitsFAS 106 Employers'
  Accounting for Postretirement Benefits Other Than
  Pensions
• FAS 158 Employers' Accounting for Defined
  Benefit Pension and Other Postretirement Plans

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Pensions A Quick Review

• As employees earn retirement benefits, the
  employer incurs an obligation. This obligation
  can be measured several ways
• Vested benefit obligation (VBO) is the present
  value of benefits that have been earned and
  vested.
• Accumulated benefit obligation (ABO) is the
  present value of benefits earned based upon
  current salary levels.
• Projected benefit obligation (PBO) is the present
  value of benefits earned based upon projected
  future salary levels

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Pensions A Quick Review

• The amount that an employer will have to pay for
  retirement benefits is determined by the benefit
  formula.
• For example, BNSF describes its benefit formula
  as follows
• The benefits under these pension plans are based
  on years of credited service and the highest
  consecutive sixty months of compensation for the
  last ten years of salaried employment with BNSF.

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Pensions A Quick Review

• Under most benefit formulas, the amount that will
  ultimately be paid to retirees is uncertain due
  to uncertainty about such factors as
• Mortality
• Employee turnover
• Employee salary progression

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Pensions A Quick Review

• Due to the uncertainty, employers will use
  actuaries to estimate the expected amount of its
  obligation for retirement benefits
• The retirement benefit obligation is the
  actuarially determined present value
• When actual experience differs from the actuarial
  calculations, the result is actuarial
  gains/losses or pension gains/losses

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Pensions A Quick Review

• Most pension plans are required by Federal law to
  be funded to increase the likelihood that funds
  will be available to pay the retirement benefits.
• BNSF describes its funding policy as follows
• BNSFs funding policy is to contribute annually
  not less than the regulatory minimum and not more
  than the maximum amount deductible for income tax
  purposes with respect to the funded plan.

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Pensions A Quick Review

• The Federal government also established the
  Pension Benefit Guarantee Corporation (PBGC),
  funded by premiums paid by employers, to
  guarantee payment of benefits to retirees even if
  the employer is insolvent.

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Pensions A Quick Review

• The amounts funded by the employer are turned
  over to a trustee who will invest the funds until
  they are needed to pay retirement benefits
• Therefore, the rate of return on plan assets will
  affect the amount the employer has to contribute
  to the fund, all else equal
• Higher return on plan assets implies lower
  employer contributions

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Pensions A Quick Review

• Some definitions
• Service cost the increase in the PBO due to the
  incremental retirement benefits earned in a
  period.
• Interest cost the increase in the PBO due to
  the passage of time.
• Prior service cost the increase (or decrease)
  in the PBO due to adoption or amendment of a
  defined benefit retirement plan.

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Pensions A Quick Review

• Some definitions
• Funded status of the plan the excess of plan
  assets over PBO. If the fair value of plan assets
  exceeds the PBO, the plan is said to be
  overfunded. If the PBO exceeds the fair value of
  plan assets, the plan is underfunded. Under FAS
  158, the employer must recognize an asset or
  liability, as appropriate, for the funded status
  of the plan.

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Underfunded pension plans
Companies in the SP 500 with the most
underfunded pension plans (amounts in millions,
2006 data)
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Underfunded pension plans
There are 345 companies in the SP 500 index with
defined benefit pension plans. In the aggregate,
they were underfunded by more than 132 billion
in 2006.
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Pensions A Quick Review

• The annual cost of pension plans is determined as
  the sum of the following
• Service cost
• Interest cost
• /- Amortization of losses/gains
• Amortization of prior service cost
• - Expected return on plan assets

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Pensions A Quick Review

• This calculation was designed to achieve income
  smoothing by
• using the long-term expected return on plan
  assets rather than the actual return
• ignoring pension gains/losses unless they become
  too big to ignore
• recognizing the effects of plan amendments over a
  period of years

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Pensions A Quick Review

• Recognition of pension gains/losses is handled by
  a process known as corridor amortization unique
  to this topic.
• If the cumulative amount of the net gain or loss
  exceeds 10 of PBO or plan assets, it is too big
  to ignore (outside the corridor) and must be
  amortized
• Amortization only continues while the cumulative
  gain/loss is outside the corridor

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Other Post-Employment Benefits

• The accounting for other post-employment benefits
  (OPEBs), is covered by FAS 106 and is virtually
  identical to the accounting for pension plans.
• These plans are not required by law to be funded
  and, therefore, many of them are unfunded.

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Pensions BNSF 2007
Here is BNSFs calculation of annual pension cost
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Pensions BNSF 2007
The following table describes the changes in
BNSFs Pension PBO
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Pensions BNSF 2007
The following table describes the changes in
BNSFs pension plan assets
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Pensions BNSF 2007
BNSFs pension plan is underfunded.
This is not an unusual situation and should not
be a cause for alarm among BNSF employees.
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Pensions BNSF 2007
We can analyze how the pension plan affected
BNSFs financial statements
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Pensions BNSF 2007
We can recreate the entry made by BNSF to record
pension cost
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OPEBs BNSF 2007

• Here is BNSFs calculation of annual OPEB cost

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OPEBs BNSF 2007

• The following table describes the changes in
  BNSFs OPEB PBO

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OPEBs BNSF 2007

• The following table describes the changes in
  BNSFs OPEB plan assets

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OPEBs BNSF 2007
BNSFs OPEB plans are entirely unfunded
This is not uncommon since there is no federal
legislation requiring employers to fund post
retirement benefits other than pensions.
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OPEBs BNSF 2007
We can analyze how the OPEB plans affected BNSFs
financial statements
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OPEBs BNSF 2007
We can recreate the entry made by BNSF to record
OPEB cost
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Effect of Adopting FAS 158