Pensions

1
Pensions Other Post Employment Benefits after
SFAS No. 158

• Includes certain slides provided by authors of
  Skousen, Stice Stice and Kieso, Weygandt
  Warfield Intermediate Accounting textbooks, as
  modified and adapted by Teresa Gordon

2
Types of plans

• Contributory Plan
• Non-Contributory Plan
• Defined Contribution Plan
• Defined Benefit Plan

3
Defined contribution plans

• A plan that provides benefits based solely on
  what has been contributed and the earnings
  thereon lt 401(k) gt
• Amounts to be funded are determined by the plan
• No promise for specific future benefits.
• Independent third party holds assets
• Risk borne by employee
• Accounting relatively straightforward

4
Defined benefit plans

• A pension plan that determines the amount of
  benefit to be provided
• Contributions based on estimated amounts needed
  to meet expected payments
• Form versus substance of trust
• Risk borne by employer
• Accounting by employer is complicated

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Defined Benefit Pension Plan
Employer
Current Employees
6
Pension Approaches

• Before FASB 87 88
• pay as you go or noncapitalization
• FASB 87 88
• Capitalization approach
• Full obligation reported only in notes
• FASB 158
• Pension post-retirement benefit cost is same as
  FASB 87
• Full obligation is now reported on balance sheet
• Additional items now on statement of
  comprehensive income

7
Capitalization approach to pensions

• Employer has full liability for benefits related
  to service already rendered by employee
• Expense is recognized as employees work (service
  cost) and this increases the liability
• Liability balance increases every year since
  present value of future benefits is larger (less
  time remains to cash outflow)
• Liability is reduced through payments to retirees
• Assets of the plan are considered pledged,
  collateral against a liability
• Liability less designated assets reported on
  balance sheet (net presentation)

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Measures of Pension Liability
Benefits for vested and nonvested employees at
future salaries
Benefits for vested and non- vested employees at
current salaries
Accumulated Benefit Obligation
Projected Benefit Obligation
Benefits for vested employees at current salaries
Vested Benefit Obligation
(GAAP)
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Interest/return rates

• Discount rate
• Rates on high-quality fixed-income investments
  with maturities consistent with expected payments
  to retirees
• Generally equivalent to a portfolio of
  zero-coupon bonds with appropriate maturities
• Expected rate of return
• Based on long-term rate of return anticipated
  given investment of plan assets

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What happens when

• Interest rates increase?
• Interest rates decrease?

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A working paper for pensions
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Accounts on Employers Books

• Net Periodic Pension Cost (Expense)
• Amount recognized by the employer on the income
  statement
• Pension expense includes six basic elements (more
  later)
• Other comprehensive income
• Up to three amounts reported for changes in
  balance of AOCI amounts (see next slide)

13
Working Paper Pension Expense
14
A working paper for pensions
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Accounts on Employers Books

• On balance sheet Net funded position
• When PBO gt Plan Assets, reported as noncurrent
  liability (with current liability if there are
  inadequate plan assets to cover current payments
  to retirees)
• When Plan Assets gt PBO, reported as noncurrent
  asset

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A working paper for pensions
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Accounts on Employers Books

• Accumulated other comprehensive income (AOCI)
• Account appears as part of owners equity section
  of balance sheet
• Three pension related balances
• Transition gain or loss
• Prior service cost
• Actuarial gains or losses

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A working paper for pensions
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Self-checking features
Funded status must equal PBO Plan Assets
Each blue row must add across to ZERO
Balance forwards
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Net Periodic Pension Cost

• Net periodic pension cost (the expense) consists
  of six basic elements
• Service cost
• Interest cost
• Expected return on plan assets
• Amortization (if any) of
• Transition gain or loss
• Prior service cost
• Unrecognized gain or loss

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Pension Definitions

• Prior Service Cost (PSC)
• Cost of benefits granted for service rendered
  prior to the inception of the plan
• Increases PBO at date of amendment but cost is
  amortized to expense over future years
• Reduces funded status since PBO is higher
• Recognized as charge to OCI at date of plan
  amendment
• Amortization method recommended
• Years of service method
• Straight-line or other methods that amortize PSC
  faster are also acceptable

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Actuarial Gains and Losses

• Actuarial assumptions are subject to inaccuracies
  as time goes by and circumstances change
• There is a materiality provision for determining
  when gains and losses are sufficiently large to
  require amortization (charge to expense)
• 10 Corridor Rule

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Kieso, Weygandt Warfield 11th ed. Illustration
20-14, page 1034
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10 Corridor Amortization

• Amortization is required only on the portion of
  unrecognized net gain or loss that exceeds 10 of
  the greater of
• PBO at beginning ofyear, or
• market-related value of plan assets at the
  beginning of the year.

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Settlements Curtailments

• Additional FASB standards govern major changes in
  pension plans
• Settlements
• No further obligations to some or all employees
• Curtailments
• Results in significant reduction in expected
  years, or
• No further accrual of benefits
• Handling will require further research (primarily
  FASB 88)

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Pension Disclosures FAS 132(R)

• Amount and types of assets held
• Assumptions related to discount rate, rate of
  increase in compensation, expected return on plan
  assets
• Alternative amortization policies
• Past practice or history of regular benefit
  increases

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Pension Disclosures FAS 132(R)

• The details for net periodic pension cost
• the service cost component.
• the interest cost component.
• the expected return on plan assets FAS 132
• the amortization of PSC, transition amount and
  unrecognized gain/loss (separately)
• Gain or loss from settlement or curtailment of
  plan

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Pension DisclosuresReconciliations

• The fair value of plan assets (changes between
  BOY and EOY)
• PBO Obligation (changes between BOY and EOY)

Easily obtained from our work paper!
EoY end of yearBoY beginning of year
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Pension Disclosures

• Employers with multiple plans
• Information can be combined but the computations
  are made for each individual plan
• Net position for over-funded plans would be
  reported in noncurrent assets
• Net position for under-funded plans would be
  reported in liabilities
• Part may be reported as a current liability
• See next slide

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Current portion of liability

• The current portion (determined on a plan-by-plan
  basis) is the amount by which the actuarial
  present value of benefits in PBO that are payable
  in the next 12 months exceeds the fair value of
  plan assets
• As always, the operating cycle might be longer
  than 12 months in which case wed use the
  operating cycle

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Other Postretirement Benefits

• FASB 106 Appendix Material in KWW text
• Also changed by FASB No. 158

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Other Post-retirement Benefits

• The accounting is similar to pension accounting
  EXCEPT that
• the terminology is slightly different
• EPBO
• APBO

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Kieso, Weygandt Warfield 11th ed. Illustration
20A-3, page 1056
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APBO vs EPBO

• Prior to the date on which an employee attains
  full eligibility for the benefits that employee
  is expected to earn
• APBO lt EPBO
• On and after the full eligibility date,
• APBO EPBO
• In other words
• EPBO gt APBO until the employee has earned the
  right to full benefits
• EPBO APBO after the employee has worked long
  enough to earn full eligibility

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Kieso, Weygandt Warfield 11th ed. Illustration
20A-2, page 1056

• Cost attributed to period from hire to
  eligibility (vesting)

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Postretirement Benefit Worksheet

• Would be the same as a pension worksheet with
  modified labels at the top
• Pension Expense becomes Postretirement Benefit
  Expense.
• PBO becomes APBO.

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Working paper for FAS106
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Net periodic postretirement benefit cost.

• The expense basically includes the same elements
  as pension cost
• Service cost -- the actuarial present value of
  benefits attributed to services rendered by
  employees during the period.
• Interest cost -- the interest on the beginning
  balance of the accumulated postretirement benefit
  obligation
• Less expected return on plan assets.
• Amortizations (transition, prior service cost and
  unrecognized gain or loss)

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Comparing FASB 87 106