Ch20

Chapter 20-1

Chapter 20-2

C H A P T E R C H A P T E R 2020

ACCOUNTING FOR PENSIONS AND ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITSPOSTRETIREMENT BENEFITS

Intermediate Accounting13th Edition

Kieso, Weygandt, and Warfield

Chapter 20-3

1. Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

2. Identify types of pension plans and their characteristics.

3. Explain alternative measures for valuing the pension obligation.

4. List the components of pension expense.

5. Use a worksheet for employer’s pension plan entries.

6. Describe the amortization of unrecognized prior service costs.

7. Explain the accounting procedure for recognizing unexpected gains and losses.

8. Explain the corridor approach to amortizing unrecognized gains and losses.

9. Describe the requirements for reporting pension plans in financial statements.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

Chapter 20-4

Alternative Alternative measures of measures of liabilityliability

Recognition of Recognition of net funded statusnet funded status

Components of Components of pension expensepension expense

Nature of Nature of Pension PlansPension Plans

Accounting for Accounting for PensionsPensions

Using a Pension Using a Pension WorksheetWorksheet

Reporting Reporting Pension Plans in Pension Plans in

Financial Financial StatementsStatements

Defined Defined contribution plancontribution plan

Defined-benefit Defined-benefit planplan

Role of actuariesRole of actuaries

2010 entries and 2010 entries and worksheetworksheet

Amortization of Amortization of prior service costprior service cost


Gain or lossGain or loss


Within the Within the financial financial statementsstatements

Within the notes to Within the notes to the financial the financial statementsstatements

Pension note Pension note disclosuredisclosure

2013 entries and 2013 entries and worksheet—a worksheet—a comprehensive comprehensive exampleexample

Special issuesSpecial issues

Accounting for Pensions and Postretirement Accounting for Pensions and Postretirement BenefitsBenefits

Accounting for Pensions and Postretirement Accounting for Pensions and Postretirement BenefitsBenefits

Chapter 20-5

A A Pension PlanPension Plan is an arrangement whereby an employer is an arrangement whereby an employer provides benefits (payments) to employees after they provides benefits (payments) to employees after they retire for services they provided while they were working.retire for services they provided while they were working.

Pension PlanAdministrator

Pension PlanAdministrator

ContributionsEmployerEmployer

Retired Employees Benefit Payments Assets &

Liabilities

LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

Nature of Pension PlansNature of Pension PlansNature of Pension PlansNature of Pension Plans

Chapter 20-6

Some pension plans are:

LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

Contributory: employees voluntarily make payments to increase their benefits.

Noncontributory: employer bears the entire cost.

Qualified pension plans: offer tax benefits.Pension fund should be a separate legal and accounting entity.

Nature of Pension PlansNature of Pension PlansNature of Pension PlansNature of Pension Plans

Chapter 20-7

Defined-Contribution PlanDefined-Contribution Plan Defined-Benefit PlanDefined-Benefit Plan Employer contribution Employer contribution

determined by plan (fixed)determined by plan (fixed) Risk borne by employeesRisk borne by employees Benefits based on plan valueBenefits based on plan value

Benefit determined by planBenefit determined by plan Employer contribution varies Employer contribution varies

(determined by Actuaries)(determined by Actuaries) Risk borne by employerRisk borne by employer

Actuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc.

Types of Pension PlansTypes of Pension PlansTypes of Pension PlansTypes of Pension Plans

LO 2 Identify types of pension plans and their characteristics.

Chapter 20-8

Two questions:

(1) What is the pension obligation that a company should report in the financial statements?

(2) What is the pension expense for the period?

Accounting for PensionsAccounting for PensionsAccounting for PensionsAccounting for Pensions

LO 3 Explain alternative measures for valuing the pension obligation.

Chapter 20-9 LO 3 Explain alternative measures for valuing the pension obligation.

The employer’s pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan. FASB’s FASB’s

choicechoice

Alternative measures of the Liability


Illustration 20-3

Chapter 20-10

Recognition of the Net Funded Status

Companies must recognize on their balance sheet the full overfunded or underfunded status of their defined-benefit pension plan.

The overfunded or underfunded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation.


LO 3 Explain alternative measures for valuing the pension obligation.

Chapter 20-11

Service CostsService Costs

Interest on the LiabilityInterest on the Liability

Actual Return on Plan AssetsActual Return on Plan Assets

Amortization of Prior Service CostsAmortization of Prior Service Costs

Gain or LossGain or Loss

++

++

+-+-

++

+-+-


LO 4 List the components of pension expense.

Components of Pension Expense

1.1.

2.2.

3.3.

4.4.

5.5.

Effect on Expense

Chapter 20-12

Service CostsService Costs ++1.1.



Components of Pension Expense Effect on Expense

Actuarial present value of benefits attributed by the pension benefit formula to employee service during the period.

Chapter 20-13

Interest on the LiabilityInterest on the Liability ++2.2.




Interest for the period on the projected benefit obligation outstanding during the period.

The interest rate (settlement rate) should reflect the rate at which companies can effectively settle pension benefits.

Chapter 20-14

Actual Return on Plan AssetsActual Return on Plan Assets +-+-3.3.




The actual return on plan assets is the increase in pension funds from interest, dividends, and realized and unrealized changes in the fair-market value of the plan assets.

Chapter 20-15




Plan amendments often increase benefits for service provided in prior years.

The cost (prior service cost) of providing these retroactive benefits is allocated to pension expense over the remaining service-years of the affected employees.

Amortization of Prior Service CostsAmortization of Prior Service Costs ++4.4.

Chapter 20-16

Gain or LossGain or Loss +-+-5.5.




Volatility in pension expense can result from sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation.

Chapter 20-17

Companies do not recognize two main items in the accounts and in the financial statements:

Pension Items Not RecognizedPension Items Not RecognizedPension Items Not RecognizedPension Items Not Recognized

LO 5 Use a worksheet for employer’s pension plan entries.

Some items are recognized in other comprehensive income; changes in these items are amortized into expense through smoothing techniques.

Prior service costs.

Actuarial gains and losses.

A company must disclose in notes to the financial statements, but not in the body of the financials.

Projected benefit obligation.

Pension plan assets.

Chapter 20-18

Pension Work SheetGENERAL JOURNAL ENTRIES MEMO RECORD

Prior Pension ProjectedPension Service Asset / Benefit Plan

Items Expense Cash Costs (PSC) Gain/Loss Liability Obligation Assets

Other Comprehensive Income (OCI)

Using a Pension Work SheetUsing a Pension Work SheetUsing a Pension Work SheetUsing a Pension Work Sheet


The “General Journal Entries” columns determine the journal entries to be recorded in the formal general

ledger.

The “Memo Record” columns maintain

balances for the unrecognized pension

items.

Chapter 20-19

BE20-3:BE20-3: At January 1, 20100, KRC Company had plan assets of $280,000 and a projected benefit obligation of the same amount. During 2010, service cost was $27,500, the settlement rate was 10%, actual and expected return on plan assets were $25,000, contributions were $20,000, and benefits paid were $17,500.

Instructions: Instructions: Prepare a pension worksheet for KRC for 2010.



Chapter 20-20

Pension Projected Pension Asset / Benefit Plan

I tems Expense Cash PSC Gain/Loss Liability Obligation Assets J an. 1, 2010 0 (280,000) 280,000

Service costs 27,500 (27,500)

I nterest costs 28,000 (28,000)

Actual return (25,000) 25,000

Contributions (20,000) 20,000

Benefits paid 17,500 (17,500)

J ournal entry 30,500 (20,000) (10,500)

Dec. 31, 2010 - - (10,500) (318,000) 307,500

MEMO RECORD GENERAL J OURNAL ENTRI ES

OCI


BE20-3: BE20-3: Prepare a pension worksheet for KRC for 2010.


($280,000 x ($280,000 x 10%)10%)

($10,500) net ($10,500) net liabilityliability

Chapter 20-21

Note the following about the Work Sheet:



The balance in the Pension Asset / Liability

column should equal the net balance in the

memo record – this is the “net funded position”

of the pension plan. If a credit balance,

Pension liability; if a debit balance, Pension

asset.

For each transaction or event, the debits must

equal the credits.

Chapter 20-22

Amortization of Prior Service Cost

Company should not recognize the retroactive benefits as pension expense entirely in the year of amendment.

Employer should recognize the pension expense over the remaining service lives of the employees who are expected to benefit from the change in the plan.

LO 6 Describe the amortization of prior service costs.

Prior Service CostPrior Service CostPrior Service CostPrior Service Cost

Amortization Method:

Board prefers a years-of-service method.

SFAS No. 158 allows use of the straight-line method.

Chapter 20-23

E20-7:E20-7: The following defined pension data of Rydell Corp. apply to the year 2010.


Projected benefit obligation, 1/1/10 (before amendment)

$560,000Plan assets, 1/1/10

546,200Pension liability

13,800On January 1, 2010, Rydell Corp., through plan amendment, grants prior service benefits having a present value of

120,000Settlement rate

9%Service cost

58,000Contributions (funding)

65,000Actual (expected) return on plan assets

52,280Benefits paid to retirees

40,000Prior service cost amortization for 2010

17,000

Instructions: For 2010, prepare a pension work sheet for Rydell Corp. that shows the journal entry for pension expense.


Chapter 20-24

Pension Projected Pension Gain / Asset / Benefit Plan

I tems Expense Cash PSC Loss Liability Obligation Assets Dec. 31, 2009 (13,800) (560,000) 546,200

PSC 120,000 (120,000)

Bal. J an. 1, 2010 (680,000) 546,200


I nterest costs 61,200 (61,200)

Asset Return (52,280) 52,280

Amort. PSC 17,000 (17,000)


Benefits paid 40,000 (40,000)

J ournal entry 83,920 (65,000) 103,000 (121,920)

AOCI - 12/31/2009 -

Dec. 31, 2010 103,000 - (135,720) (759,200) 623,480

MEMO RECORD GENERAL J OURNAL ENTRI ES

OCI

Using a Pension Work Sheet – E20-7Using a Pension Work Sheet – E20-7Using a Pension Work Sheet – E20-7Using a Pension Work Sheet – E20-7

($135,720) liability($135,720) liabilitySolution on Solution on notes pagenotes page

Chapter 20-25

Pension Expense 83,920

OCI - PSC 103,000

Pension Liability 121,920

Cash65,000


E20-7: E20-7: Pension Journal Entry for 2010.

Dec. 31


Chapter 20-26

Gain or Loss

Unexpected swings in pension expense can result from:

1. Changes in the market value of plan assets, and

2. Changes in actuarial assumptions that affect the amount of the projected benefit obligation.

Gains and LossesGains and LossesGains and LossesGains and Losses

LO 7 Explain the accounting for unexpected gains and losses.

Chapter 20-27

Question:Question: What is the potential negative impact What is the potential negative impact on Net Income of these unexpected swings?on Net Income of these unexpected swings?

VolatilityVolatility

The profession The profession decided to reduce the decided to reduce the volatility with volatility with smoothing techniquessmoothing techniques..



Chapter 20-28

AnswerAnswer

Recorded in Net Gain or Loss account.

Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan.


Question:Question: What happens to the difference What happens to the difference between the expected return and the actual return?between the expected return and the actual return?


Chapter 20-29 LO 7 Explain the accounting for unexpected gains and

losses.


Question:Question: What happens with unexpected What happens with unexpected gains or losses from changes in the Projected gains or losses from changes in the Projected Benefit Obligation (PBO)?Benefit Obligation (PBO)?

AnswerAnswer

Recorded in Net Gain or Loss account.

Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan.

Chapter 20-30

Corridor Amortization

FASB invented the corridor approach for amortizing the accumulated net gain or loss balance when it gets too large. How large is too large?

10% of the larger of the beginning balances of the projected benefit obligation or the market-related value (which may equal fair value) of the plan assets.

Any accumulated net gain or loss balance above the 10% must be amortized.


LO 8 Explain the corridor approach to amortizing gains and losses.

Chapter 20-31

BE20-7:BE20-7: Shin Corporation had a projected benefit

obligation of $3,100,000 and plan assets of

$3,300,000 at January 1, 2010. Shin’s also had a

net pension actuarial loss of $465,000 in

accumulated OCI at January 1, 2020. The average

remaining service period of Shin’s employees is 7.5

years.

Instructions: Instructions: Compute Shin’s minimum

amortization of the actuarial loss.



Chapter 20-32

BE20-7:BE20-7: Compute Shin’s amortization of the loss.



Amortization

Projected benefit obligation (3,100,000)$

Plan assets 3,300,000 3,300,000$

Corridor percentage 10%

Corridor amount 330,000

Accumulated loss 465,000

Excess loss subject to amortization 135,000

Average remaining service 7.5

Amortized to pension expense 18,000$ ÷

Chapter 20-33


P20-2: Jackson Company adopts acceptable accounting for its defined benefit pension plan on January 1, 2009, with the following beginning balances: plan assets $200,000; projected benefit obligation $250,000. Other data are as follows.

2009 2010 2011

Annual service cost 16,000$ 19,000$ 26,000$

Settlement rate and expected rate of return 10% 10% 10%

Actual return on plan assets 18,000 22,000 24,000

Annual funding (contributions) 16,000 40,000 48,000

Benefits paid 14,000 16,400 21,000

Prior service cost (plan amended, 1/1/10) 160,000

Amortization of prior service cost 54,400 41,600

Change in actuarial assumptions, Dec. 31 PBO 520,000

Average remaining service life 15 years 15 years 15 years


Chapter 20-34

Pension ProjectedPension Gain / Asset / Benefit Plan

I tems Expense Cash PSC Loss Liability Obligation AssetsBal. J an. 1, 2009 (50,000) (250,000) 200,000


I nterest 25,000 (25,000)

Return on assets (18,000) 18,000

Unexpected loss (2,000) 2,000 Contributions (16,000) 16,000 Benefits paid 14,000 (14,000)

J ournal entry 21,000 (16,000) 2,000 (7,000)

AOCI - 12/31/08 -

Dec. 31, 2009 - 2,000 (57,000) (277,000) 220,000

OCI

GENERAL J OURNAL ENTRI ES MEMO RECORD


P20-2: P20-2: Pension Work Sheet for 2009

($57,000)($57,000)* * Expected Return on Plan AssetsExpected Return on Plan Assets $200,000 $200,000

x 10% = x 10% = $20,000$20,000

**

Solution on Solution on notes pagenotes page


Chapter 20-35


P20-2 P20-2 Pension Journal Entry for 2009


OCI – Gain/Loss 2,000

Pension Asset/Liability 7,000

Cash 16,000

Dec. 31


Chapter 20-36

Pension ProjectedPension Gain / Asset Benefit Plan

I tems Expense Cash PSC Loss Liability Obligation AssetsBal. J an. 1, 2010 2,000 (57,000) (277,000) 220,000 Prior service costs 160,000 (160,000)

Adj Bal., 1/1/10 (437,000) 220,000


I nterest 43,700 (43,700)


Amort. of PSC 54,400 (54,400)

Contributions (40,000) 40,000 Benefits paid 16,400 (16,400)

J ournal entry 95,100 (40,000) 105,600 (160,700)

AOCI - 12/31/09 2,000

Dec. 31, 2010 105,600 2,000 (217,700) (483,300) 265,600

GENERAL J OURNAL ENTRI ESOCI

MEMO RECORD



($217,700) liability($217,700) liability* * Actual return = Expected Actual return = Expected

ReturnReturn

**



Chapter 20-37




Pension Expense 95,100Dec. 31

Cash

40,000


OCI - PSC 105,600

Chapter 20-38

Pension ProjectedPension Gain / Asset / Benefit Plan

I tems Expense Cash PSC Loss Liability Obligation AssetsBal. Dec. 31, 2010 105,600 2,000 (217,700) (483,300) 265,600


I nterest 48,330 (48,330)


Unexpected loss (2,560) 2,560 Amort. of PSC 41,600 (41,600)


Benefits paid 21,000 (21,000) Liability gain (16,630) 16,630

J ournal entry 89,370 (48,000) (41,600) (14,070) 14,300

AOCI - 12/31/10 105,600 2,000

Dec. 31, 2011 64,000 (12,070) (203,400) (520,000) 316,600

GENERAL J OURNAL ENTRI ESOCI

MEMO RECORD



($203,400) liability($203,400) liability* Plug * Plug

**



Chapter 20-39





OCI - Gain/Loss 14,070

OCI - PSC 41,600

Cash 48,000

Dec. 31


Chapter 20-40

Within the Financial Statements

Pension expense

Pension Asset / Liability

Components of Accumulated Other Comprehensive Income

Reporting Pension Plans in Financial Reporting Pension Plans in Financial StatementsStatements


LO 9 Describe the requirements for reporting pension plans in financial statements.

Chapter 20-41

Within the Notes to the Financial Statements1. Major components of pension expense.

2. Reconciliation showing how the projected benefit

obligation and the fair value of the plan assets

changed.

3. Amounts recognized in accumulated other

comprehensive income that have not yet been

recognized in pension expense, showing separately

the net gain or loss and prior service costs, and the

amounts to be recognized is pension expense in the

next year.




Chapter 20-42

Within the Notes to the Financial Statements4. Disclosure of the rates used in measuring the

benefit amounts (discount rate, expected return on

plan assets, rate of compensation).

5. Table indicating the allocation of pension plan assets

by category (e.g., types of investments).

6. The expected benefit payments to be paid to current

plan participants for each of the next five fiscal

years and in the aggregate for the five fiscal years

thereafter.




Chapter 20-43

Special Issues

The Pension Reform Act of 1974

Pension Terminations




Chapter 20-44

iGAAP and U.S. GAAP separate pension plans into defined-contribution plans and defined-benefit plans. The accounting for defined-contribution plans is similar.

For defined-benefit plans, both iGAAP and U.S. GAAP recognize the net of the pension assets and liabilities on the balance sheet. Unlike U.S. GAAP, which recognizes prior service cost on the balance sheet (as an element of “Accumulated other comprehensive income”), iGAAP does not recognize prior service costs on the balance sheet. Both GAAPs amortize prior service costs into income over the expected service lives of employees.

Chapter 20-45

Another difference in defined-benefit recognition is that under iGAAP companies have the choice of recognizing actuarial gains and losses in income immediately or amortizing them over the expected remaining working lives of employees. U.S. GAAP does not permit choice.

The IASB has recently issued a discussion paper on pensions proposing: (1) elimination of smoothing via the corridor approach, (2) a different presentation of pension costs in the income statement, and (3) a new category of pensions for accounting purposes—so-called “contribution-based promises.”

Chapter 20-46

Accounting Guidance

In December 1990, the FASB issued rules on

“Employers’ Accounting for Postretirement Benefits

Other Than Pensions.” These rules cover for

healthcare and other “welfare benefits” provided to

retirees, their spouses, dependents, and

beneficiaries.

Other welfare benefits include life insurance offered

outside a pension plan; medical, dental, and eye

care; legal and tax services; tuition assistance; day

care; and housing assistance.

Chapter 20-47

Differences Between Pension Benefits and Healthcare Benefits

LO 10 Identify the differences between LO 10 Identify the differences between pensions and postretirement healthcare pensions and postretirement healthcare

benefits.benefits.

Illustration 20A-1

Chapter 20-48

Differences Between Pension Benefits and Healthcare Benefits


benefits.benefits.

Measuring the future payments for healthcare benefit plans is

so much more difficult than for pension plans.

1. Many postretirement plans do not set a limit on

healthcare benefits.

2. The levels of healthcare benefit use and healthcare

costs are difficult to predict. Increased longevity,

unexpected illnesses (e.g., AIDS, SARS, and avian flu),

along with new medical technologies and cures, cause

changes in healthcare utilization.

Chapter 20-49

Postretirement Benefits Accounting Provisions


benefits.benefits.

Attribution Period - period of time over which the

postretirement benefit cost accrue.Illustration 20A-2

Chapter 20-50



benefits.benefits.

Obligations Under Postretirement Benefits

Expected postretirement benefit obligation

(EPBO) is the actuarial present value as of a particular

date of all benefits a company expects to pay

after retirement to employees and their

dependents.

Accumulated postretirement benefit obligation

(APBO) is the actuarial present value of future

benefits attributed to employees’ services

rendered to a particular date.

Chapter 20-51



benefits.benefits.

Postretirement Expense

1. Service Cost

2. Interest Cost

3. Actual Return on Plan Assets

4. Amortization of Prior Service Costs

5. Gains and Losses

Chapter 20-52

Illustrative Accounting Entries

LO 11 Contrast accounting for pensions to LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.accounting for other postretirement benefits.

2010 Entries

and

WorksheetIllustration: The use of a worksheet in accounting for a postretirement benefits plan, assume that on January 1, 2010, Quest Company adopts a healthcare benefit plan. The following facts apply to the postretirement benefits plan for the year 2010.

Plan assets at fair value on January 1, 2010, are zero. Actual and expected returns on plan assets are zero. Accumulated postretirement benefit obligation (APBO), January 1,

2010, is zero. Service cost is $54,000. No prior service cost exists. Interest cost on the APBO is zero. Funding contributions during the year are $38,000. Benefit payments to employees from plan are $28,000.

Chapter 20-53

Illustrative Accounting Entries 2010 Entries

and

WorksheetIllustration 20A-4

Journal Journal EntryEntry

Chapter 20-54

Recognition of Gains and Losses



Gains and losses represent changes in the APBO or the

value of plan assets. Gains and losses are recorded in

other comprehensive income.

The Corridor Approach

Amortization Methods

Chapter 20-55



2011 Entries

and

WorksheetIllustration: The following facts apply to the postretirement benefits plan for Quest Company for the year 2011.

Actual return on plan assets is $600. Expected return on plan assets is $800. Discount rate is 8 percent. Increase in APBO due to change in actuarial assumptions is

$60,000. Service cost is $26,000. Funding contributions during the year are $18,000. Benefit payments to employees during the year are $5,000. Average remaining service to expected retirement: 25 years.

Chapter 20-56

Illustrative Accounting Entries 2011 Entries

and

WorksheetIllustration 20A-6

Journal Journal EntryEntry

Chapter 20-57

Amortization of Gains and Losses in 2012



Illustration 20A-8

Chapter 20-58

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Ch20

Education

pension benefits

pension funds

definedbenefit pension

types of pension plans

employers pension plan

qualified pension plans

financial statements

pension benefit formula