Accounting Accounting for for Pensions Pensions and and Postretirement Postretirement Benefits Benefits Chapter 20 Intermediate Accounting 12th Edition Kieso, Weygandt, and Warfield Chapter 20-1 Prepared by Coby Harmon, University of California, Santa Barbara Learning Learning Objectives Objectives Distinguish between accounting for the employer’s pension plan and accounting for the pension fund Identify types of pension plans and their characteristics Explain alternative measures for valuing the pension obligation List the components of pension expense Use a worksheet for employer’s pension plan entries Describe the amortization of unrecognized prior service costs Explain the accounting procedure for recognizing unexpected gains and losses Explain the corridor approach to amortizing unrecognized gains and losses Explain the recognition of a minimum liability 10 Describe the requirements for reporting pension plans in financial statements Chapter 20-2 Accounting Accounting for for Pensions Pensions and and Postretirement Postretirement Benefits Benefits Nature of Pension Plans Defined contribution plan Definedbenefit plan Role of actuaries Chapter 20-3 Accounting for Pensions Alternative measures of liability Capitalization versus noncapitalization Components of pension expense Using a Pension Worksheet 2006 entries and worksheet Amortization of prior service cost 2007 entries and worksheet Gain or loss 2008 entries and worksheet Minimum Liability Minimum liability computation Financial statement presentation Worksheet example Reporting Pension Plans in Financial Statements Within the financial statements Within the notes to the financial statements 2009 entries and worksheet —a comprehensive example Special issues Nature Nature of of Pension Pension Plans Plans A Pension Plan is an arrangement whereby an employer provides benefits (payments) to employees after they retire for services they provided while they were working Pension PensionPlan Plan Administrator Administrator Employer Employer Retired Employees Chapter 20-4 Contributions Benefit Payments Assets & Liabilities LO Distinguish between accounting for the employer’s pension plan and accounting for the pension fund Nature Nature of of Pension Pension Plans Plans Some pension plans are: 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 Chapter 20-5 LO Distinguish between accounting for the employer’s pension plan and accounting for the pension fund Types Types of of Pension Pension Plans Plans Defined-Contribution Plan Employer contribution determined by plan (fixed) Risk borne by employees Benefits based on plan value Defined-Benefit Plan Benefit determined by plan Employer contribution varies (determined by Actuaries) Risk borne by employer Actuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc Statement of Financial Accounting Standard No 87, “Employers’ Accounting for Pension Plans,” 1985 Chapter 20-6 LO Identify types of pension plans and their characteristics Accounting Accounting for for Pensions Pensions 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? Chapter 20-7 LO Explain alternative measures for valuing the pension obligation Accounting Accounting for for Pensions Pensions 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 Alternative measures of the Liability Illustration 20-3 FASB’s choice Chapter 20-8 LO Explain alternative measures for valuing the pension obligation Accounting Accounting for for Pensions Pensions Capitalization versus Noncapitalization FASB Statement No 87 represents a compromise that combines some of the features of capitalization with some of the features of noncapitalization Companies not capitalize some elements of the pension plan in the accounts and the financial statements Chapter 20-9 LO Explain alternative measures for valuing the pension obligation Accounting Accounting for for Pensions Pensions Components of Pension Expense Effect on Expense Service Costs + Interest on Liability + Actual Return on Plan Assets +- Amortization of Unamortized Prior Service Costs + Gain or Loss +- Chapter 20-10 LO List the components of pension expense Using Using aa Pension Pension Work Work Sheet Sheet P20-2 Pension Journal Entry for 2008 Dec 31 Pension expense Cash Chapter 20-35 16,000 16,000 LO Explain the corridor approach to amortizing unrecognized gains and losses Using Using aa Pension Pension Work Work Sheet Sheet P20-2 Pension Work Sheet for 2009 Items Bal Jan 1, 2009 GENERAL JOURNAL ENTRIES Prepaid/ Pension Accrued Expense Cash Costs Prior service costs Projected Benefit Obligation (222,000) (160,000) Bal Jan 1, 2009, revised (382,000) Service costs 19,000 (19,000) Interest 38,200 (38,200) Return on assets Amort of PSC (21,900) 54,400 Contributions Benefits paid Journal entry Dec 31, 2009 Chapter 20-36 MEMO RECORD Prior Plan Service Assets Costs 219,000 * (40,000) 160,000 219,000 160,000 3,000 21,900 (54,400) (40,000) 89,700 Unrecognized Gain/Loss 3,000 16,400 40,000 (16,400) (422,800) 264,500 (49,700) (49,700) 105,600 3,000 * Actual return = Expected Return ($49,700) net liability LO Explain the corridor approach to amortizing unrecognized gains and losses Using Using aa Pension Pension Work Work Sheet Sheet P20-2 Pension Journal Entry for 2009 Dec 31 Chapter 20-37 Pension expense 89,700 Prepaid/Accrued Costs 49,700 Cash 40,000 LO Explain the corridor approach to amortizing unrecognized gains and losses Using Using aa Pension Pension Work Work Sheet Sheet P20-2 Pension Work Sheet for 2010 Items Bal Jan 1, 2010 GENERAL JOURNAL ENTRIES Prepaid/ Pension Accrued Expense Cash Costs (49,700) Projected Benefit Obligation (422,800) Service costs 26,000 (26,000) Interest 42,280 (42,280) Return on assets (24,000) Unexpected loss (2,450) Amort of PSC 41,600 Contributions 24,000 2,450 (41,600) (48,000) 48,000 Benefits paid Unexpected loss Journal entry Dec 31, 2010 Chapter 20-38 * Plug MEMO RECORD Prior Plan Service Unrecognized Assets Costs Gain/Loss 264,500 105,600 3,000 21,000 (21,000) (49,920) * 83,430 (48,000) 49,920 (35,430) (85,130) (520,000) 315,500 64,000 55,370 ($85,130) net liability LO Explain the corridor approach to amortizing unrecognized gains and losses Using Using aa Pension Pension Work Work Sheet Sheet P20-2 Pension Journal Entry for 2010 Dec 31 Chapter 20-39 Pension expense 83,430 Prepaid/Accrued Costs 35,430 Cash 48,000 LO Explain the corridor approach to amortizing unrecognized gains and losses Using Using aa Pension Pension Work Work Sheet Sheet P20-2 (Variation) Would there be any amortization of the gain/loss for 2011? Beg Projected benefit obligation Beg Plan assets Corridor percentage Corridor amount Unrecognized loss Loss subject to amortization Amortization period Amortization to pension expense $ (520,000) 315,500 Amortization $ 520,000 $ 10% 52,000 55,370 3,370 15 225 The amortization would be reported in 2011 as follows Chapter 20-40 LO Explain the corridor approach to amortizing unrecognized gains and losses Using Using aa Pension Pension Work Work Sheet Sheet P20-2 Partial Pension Work Sheet for 2011 Items Bal Jan 1, 2011 GENERAL JOURNAL ENTRIES Prepaid/ Pension Accrued Expense Cash Costs (85,130) Projected Benefit Obligation (520,000) MEMO RECORD Prior Plan Service Unrecognized Assets Costs Gain/Loss 315,500 64,000 55,370 Service costs Interest Return on assets Amort of loss 225 (225) Journal entry Dec 31, 2011 Chapter 20-41 LO Explain the corridor approach to amortizing unrecognized gains and losses Minimum Minimum Liability Liability The Board, requires immediate recognition of a liability (minimum liability) when the accumulated benefit obligation exceeds the fair value of plan assets If a company has already reported a liability for accrued pension cost, it records only an additional liability to equal the required minimum liability Chapter 20-42 LO Explain the recognition of a minimum liability Minimum Minimum Liability Liability BE20-8 Judy O’Neill Corporation provides the following information at December 31, 2007 Accumulated benefit obligation Plan assets at fair value Accrued pension cost Unrecognized prior service cost $2,800,000 2,000,000 200,000 1,100, 000 Compute the additional liability that O’Neill must record at December 31, 2007 Chapter 20-43 LO Explain the recognition of a minimum liability Minimum Minimum Liability Liability BE20-8 Compute the additional liability that O’Neill must record at December 31, 2007 Accumulated benefit obligation Fair value of plan assets Minimum liability Accrued pension cost Additional liability Intangible asset 600,000 Additional pension liability Chapter 20-44 $2,800,000 2,000,000 800,000 200,000 $ 600,000 600,000 LO Explain the recognition of a minimum liability Reporting Reporting Pension Pension Plans Plans in in Financial Financial Statements Statements Within the Financial Statements Pension expense Accrued Pension Cost Prepaid Pension Cost Intangible Asset—Deferred Pension Cost (Minimum Liability test) Chapter 20-45 LO 10 Describe the requirements for reporting pension plans in financial statements Reporting Reporting Pension Pension Plans Plans in in Financial Financial Statements Statements Within the Notes to the Financial Statements Major components of pension expense Reconciliation showing how the projected benefit obligation and the fair value of the plan assets changed The funded status of the plan (difference between the projected benefit obligation and fair value of the plan assets) Chapter 20-46 LO 10 Describe the requirements for reporting pension plans in financial statements Reporting Reporting Pension Pension Plans Plans in in Financial Financial Statements Statements Within the Notes to the Financial Statements Disclosure of the rates used in measuring the benefit amounts (discount rate, expected return on plan assets, rate of compensation) Table indicating the allocation of pension plan assets by category 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 20-47 LO 10 Describe the requirements for reporting pension plans in financial statements Reporting Reporting Pension Pension Plans Plans in in Financial Financial Statements Statements Special Issues The Pension Reform Act of 1974 Pension Terminations Chapter 20-48 LO 10 Describe the requirements for reporting pension plans in financial statements Copyright Copyright Copyright © 2007 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 20-49 ... Statement of Financial Accounting Standard No 87, “Employers’ Accounting for Pension Plans,” 1985 Chapter 20- 6 LO Identify types of pension plans and their characteristics Accounting Accounting for... benefits Pension fund should be a separate legal and accounting entity Chapter 20- 5 LO Distinguish between accounting for the employer’s pension plan and accounting for the pension fund Types Types... Alternative measures of the Liability Illustration 20- 3 FASB’s choice Chapter 20- 8 LO Explain alternative measures for valuing the pension obligation Accounting Accounting for for Pensions Pensions Capitalization