Defined Benefit Plans Part 2

1
Defined Benefit Plans Part 2

• A discussion adapted from Bline and Skekel,
  Accounting for Postretirement Benefits,
  Corporate Accounting Deskbook 1991, New York
  Executive Enterprises Publications Co., Inc.

2
Basic Facts 2004

• 1. On January 2, 2004, Printing, Inc. negotiated
  a new contract with its labor union. Part of the
  agreement included a change in the pension plan
  benefit formula. The plan amendment increased the
  January 2, 2004 PBO by 325,000.

3
Basic Facts 2004

• 1. On January 2, 2004, Printing, Inc. negotiated
  a new contract with its labor union. Part of the
  agreement included a change in the pension plan
  benefit formula. The plan amendment increased the
  January 2, 2004 PBO by 325,000.

Look at the date. The PBO will change at the
beginning of 2004 to reflect the change.
4
Basic Facts 2004

• 1. On January 2, 2004, Printing, Inc. negotiated
  a new contract with its labor union. Part of the
  agreement included a change in the pension plan
  benefit formula. The plan amendment increased the
  January 2, 2004 PBO by 325,000.

How will this amendment affect interest cost for
2004?
5
Basic Facts 2004

• 2. The rate of return on plan assets for 2004 was
  not as great as anticipated, resulting in an
  asset loss of 83,750.

6
Basic Facts 2004

• 2. The rate of return on plan assets for 2004 was
  not as great as anticipated, resulting in an
  asset loss of 83,750.

What might cause this asset loss?
7
Basic Facts 2004

• 3. It was also determined that the discount rate
  used in the PBO calculations was too large. The
  rate was decreased from 9 to 8.5, effective
  December 31, 2004. This change resulted in an
  168,750 increase (liability loss) in the
  actuarys calculation of the PBO.

8
Basic Facts 2004

• At December 31, 2004, the following information
  relating to the PBO, the ABO, the VBO, and the
  market value of plan assets was obtained from the
  actuary and the trustee

9
PBO Information (from actuary)

• Beginning PBO 1,060,000
• Adjustment due to plan
• amendments 325,000
• Service cost (add) 75,000
• Interest cost (add) 124,650
• Benefits paid to retirees (deduct) (93,400)
• Expected ending PBO 1,491,250

10
PBO Information (from actuary)

• Actual ending PBO 1,660,000
• Ending ABO 1,200,000
• Ending VBO 804,000

11
PBO Information (from actuary)

• Beginning PBO 1,060,000
• Adjustment due to plan
• amendments 325,000
• Service cost (add) 75,000
• Interest cost (add) 124,650
• Benefits paid to retirees (deduct) (93,400)
• Expected ending PBO 1,491,250

Computation
12
PBO Information (from actuary)

• Interest Cost
• Beginning PBO 1,060,000
• Adjustment 325,000
• Base for interest cost 1,385,000
• Interest Rate 9
• Interest Cost 124,650

13
PBO Information (from actuary)

• Difference in expected and actual ending PBO
• Actual PBO 1,660,000
• Expected PBO 1,491,250
• Difference 168,750
• The change is due to the decrease in the discount
  rate.

14
Market Value of Plan Assets (from trustee)

• Beginning market value 977,000
• Actual return 13,950
• Contribution to plan 102,450
• Benefits paid (93,400)
• Ending market value 1,000,000

15
Market Value of Plan Assets ending

• At the date of transition in 2003, market and
  market-related asset values were equal.
• Because the firm experienced an asset gain or
  loss in 2004, the two values will no longer be
  equal.

16
Market-Related Asset Value for 2005

• Beginning market value 977,000

17
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return

18
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return
• 977,000 10 97,700

19
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return 97,700

20
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return 97,700
• Contribution to plan 102,450

21
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return 97,700
• Contribution to plan 102,450
• Benefits paid (93,400)

22
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return 97,700
• Contribution to plan 102,450
• Benefits paid (93,400)
• Asset gain (loss) amortization

23
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return 97,700
• Contribution to plan 102,450
• Benefits paid (93,400)
• Asset gain (loss) amortization

The market-related asset value absorbs asset
gains and losses gradually over not more than
five (5) years.
24
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return 97,700
• Contribution to plan 102,450
• Benefits paid (93,400)
• Asset gain (loss) amortization
• (97,700 - 13,950)/5 16,750

25
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return 97,700
• Contribution to plan 102,450
• Benefits paid (93,400)
• Asset gain (loss) amortization (16,750)

26
Market-Related Asset Value for 2005

• Beginning market value 977,000
• Expected return 97,700
• Contribution to plan 102,450
• Benefits paid (93,400)
• Asset gain (loss) amortization (16,750)
• Ending market value 1,067,000

27
Computation of Pension Expense

• Using the information provided, the components of
  pension expense are

28
Computation of Pension Expense

• Service cost (from actuary) 75,000

29
Computation of Pension Expense

• Service cost (from actuary) 75,000
• Interest on BPO (from actuary) 124,650

30
Computation of Pension Expense

• Service cost (from actuary) 75,000
• Interest on BPO (from actuary) 124,650
• Expected return on plan assets

31
Computation of Pension Expense

• Expected return on plan assets
• Beginning market value 977,000
• Expected return x .10
• Expected return on plan assets 97,700

32
Computation of Pension Expense

• Service cost (from actuary) 75,000
• Interest on BPO (from actuary) 124,650
• Expected return on plan assets (97,700)

33
Computation of Pension Expense

• Service cost (from actuary) 75,000
• Interest on BPO (from actuary) 124,650
• Expected return on plan assets (97,700)
• Prior service cost amortization

34
Computation of Pension Expense

• Prior service cost is amortized over the total
  expected future years of service of the existing
  workforce benefiting from the amendment.
• Prior service cost 325,000
• Expected service years 32,500
• Allocation per expected service year 10
• Employee service years for 2004 2,500
• Amortization 25,000

35
Computation of Pension Expense

• Service cost (from actuary) 75,000
• Interest on BPO (from actuary) 124,650
• Expected return on plan assets (97,700)
• Prior service cost amortization 25,000

36
Computation of Pension Expense

• Service cost (from actuary) 75,000
• Interest on BPO (from actuary) 124,650
• Expected return on plan assets (97,700)
• Prior service cost amortization 25,000
• Gain/Loss amortization -0-

37
Computation of Pension Expense

• Service cost (from actuary) 75,000
• Interest on BPO (from actuary) 124,650
• Expected return on plan assets (97,700)
• Prior service cost amortization 25,000
• Gain/Loss amortization -0-
• Transition amount amortization 10,000

38
Computation of Pension Expense

• Service cost (from actuary) 75,000
• Interest on BPO (from actuary) 124,650
• Expected return on plan assets (97,700)
• Prior service cost amortization 25,000
• Gain/Loss amortization -0-
• Transition amount amortization 10,000
• Pension expense 136,950

39
Journal Entry

• Pension Expense 136,950
• Ppd/accrued pension cost 34,500
• Cash 102,450

40
Minimum Liability

• An employer must report a pension liability at
  least equal to the amount by which its ABO
  exceeds its plan assets under SFAS No. 87.
• Note This is the minimum liability that can be
  reported.

41
Computation of Minimum Liability

• ABO 1,200,000
• Market value of plan assets 1,000,000
• Minimum pension liability 200,000

42
Maximum value of intangible asset-deferred
pension cost
Prior service cost 325,000 Less
amortization (25,000) Transition
amount 130,000 Less amortization
(20,000) Maximum intangible asset 410,000
43
Minimum Liability to be Journalized

• There are 3 balance sheet accounts affected by
  pensions
• Prepaid (accrued) pension cost
• Intangible asset-deferred pension cost
• Excess of additional pension liability over
  unrecognized prior service cost

44
Minimum Liability to be Journalized

• Existing balance sheet accounts
• Prepaid pension cost 2,500
• Intangible asset-deferred
• Pension cost -0-
• Excess of additional pension
• liability over unrecognized
• prior service cost -0-

45
Minimum Liability to be Journalized
37,000
2,500
200,000
0
Asset
Liability
(34,500)
(202,500)
46
Journal Entry

• Intangible asset-deferred
• pension cost 202,500
• Additional pension
• liability 202,500

47
Footnote Disclosure

• Two schedules are included in the footnotes to
  the financial statements
• The computation of pension expense for 2004
• The reconciliation of the funded status of the
  plan and the amounts recorded on the balance
  sheet.

48
Pension Cost Disclosure

• Pension expense for 2004 includes the following
  components
• Service cost-benefits earned
• during the period 75,000

49
Pension Cost Disclosure

• Pension expense for 2004 includes the following
  components
• Service cost-benefits earned
• during the period 75,000
• Interest on PBO 124,650

50
Pension Cost Disclosure

• Pension expense for 2004 includes the following
  components
• Service cost-benefits earned
• during the period 75,000
• Interest on PBO 124,650
• Actual return on plan assets (13,950)

51
Pension Cost Disclosure

• Pension expense for 200 includes the following
  components
• Service cost-benefits earned
• during the period 75,000
• Interest on PBO 124,650
• Actual return on plan assets (13,950)

Remember that estimated and actual return on
assets were not equal in this scenario.
52
Pension Cost Disclosure

• Pension expense for 2004 includes the following
  components
• Service cost-benefits earned
• during the period 75,000
• Interest on PBO 124,650
• Actual return on plan assets (13,950)
• Net amortization and deferral

53
Computation of Net Amortization and Deferral

• Prior service cost amortization 25,000

54
Computation of Net Amortization and Deferral

• Prior service cost amortization 25,000
• (Gain) Loss amortization -0-

55
Computation of Net Amortization and Deferral

• Prior service cost amortization 25,000
• (Gain) Loss amortization -0-
• Transition amount amortization 10,000

56
Computation of Net Amortization and Deferral

• Prior service cost amortization 25,000
• (Gain) Loss amortization -0-
• Transition amount amortization 10,000
• Difference between actual and
• expected return on plan assets
• (97,700-13,950) (83,750)

57
Computation of Net Amortization and Deferral

• Prior service cost amortization 25,000
• (Gain) Loss amortization -0-
• Transition amount amortization 10,000
• Difference between actual and
• expected return on plan assets
• (97,700-13,950) (83,750)
• Net amortization and deferral (48,750)

58
Computation of Net Amortization and Deferral

• Prior service cost amortization 25,000
• (Gain) Loss amortization -0-
• Transition amount amortization 10,000
• Difference between actual and
• expected return on plan assets
• (97,700-13,950) (83,750)
• Net amortization and deferral (48,750)

Only the net amount is disclosed. This is just
the computation.
59
Pension Cost Disclosure

• Pension expense for 2004 includes the following
  components
• Service cost-benefits earned
• during the period 75,000
• Interest on PBO 124,650
• Actual return on plan assets (13,950)
• Net amortization and deferral (48,750)

60
Pension Cost Disclosure

• Pension expense for 2004 includes the following
  components
• Service cost-benefits earned
• during the period 75,000
• Interest on PBO 124,650
• Actual return on plan assets (13,950)
• Net amortization and deferral (48,750)
• Pension expense 136,950

61
Pension Cost Disclosure

• Pension expense for 2004 includes the following
  components
• Service cost-benefits earned
• during the period 75,000
• Interest on PBO 124,650
• Actual return on plan assets (13,950)
• Net amortization and deferral (48,750)
• Pension expense 136,950

62
Reconciliation Disclosure

• Actuarial present value of benefit obligations

63
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)

64
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)

65
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)

VBO and ABO are reported but not used in the
reconciliation disclosure.
66
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)

67
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)

68
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000

69
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)

70
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss

71
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss
• Liability loss 2004 168,750

72
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss
• Liability loss 2004 168,750
• Asset loss 2004 83,750

73
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss
• Liability loss 2004 168,750
• Asset loss 2004 83,750
• Unrecognized net (gain) loss 252,500

74
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500

75
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500
• Prior service cost not yet recognized in net
  periodic pension cost

76
Unrecognized Prior Service Cost

• Prior service cost at amendment
• date 325,000
• Cumulative amortization 25,000
• Unrecognized prior service cost 300,000

77
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500
• Prior service cost not yet recognized in net
  periodic pension cost 300,000

78
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500
• Prior service cost not yet recognized in net
  periodic pension cost 300,000
• Unrecognized net obligation (asset)
• at December 31, 2004

79
Unrecognized Net Obligation

• Net obligation at adoption 130,000
• Cumulative amortization 20,000
• Unrecognized net obligation 110,000

80
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500
• Prior service cost not yet recognized in net
  periodic pension cost 300,000
• Unrecognized net obligation (asset)
• at December 31, 2004 110,000

81
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500
• Prior service cost not yet recognized in net
  periodic pension cost 300,000
• Unrecognized net obligation (asset) at December
  31, 2004 110,000
• Adjustment required to recognize minimum
  liability (202,500)

82
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500
• Prior service cost not yet recognized in net
  periodic pension cost 300,000
• Unrecognized net obligation (asset) at December
  31, 2004 110,000
• Adjustment required to recognize minimum
  liability (202,500)
• Prepaid pension cost (pension liability)
  recognized on the balance sheet ( 200,000)

83
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500
• Prior service cost not yet recognized in net
  periodic pension cost 300,000
• Unrecognized net obligation (asset) at December
  31, 2004 110,000
• Adjustment required to recognize minimum
  liability (202,500)
• Prepaid pension cost (pension liability)
  recognized on the balance sheet ( 200,000)

84
Reconciliation Disclosure

• Actuarial present value of benefit obligations
• VBO (from actuary) ( 804,000)
• ABO (from actuary) (1,200,000)
• PBO (from actuary) (1,660,000)
• Plan assets at fair market value 1,000,000
• PBO (in excess of) or less than plan assets (
  660,000)
• Unrecognized net (gain) or loss 252,500
• Prior service cost not yet recognized in net
  periodic pension cost 300,000
• Unrecognized net obligation (asset) at December
  31, 2004 110,000
• Adjustment required to recognize minimum
  liability 202,500
• Prepaid pension cost (pension liability)
  recognized on the balance sheet ( 200,000)

Check figure Additional pension liability
(202,500) Prepaid (Accrued) Pension Cost
2,500 Pension liability reported on balance
sheet (200,000)