CHAPTER 20 Accounting for Pensions and Postretirement Benefits ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Basic definitions and concepts related to pension plans Brief Questions Exercises Exercises 1, 2, 3, 4, 5, 6, 7, 8, 9, 12, 24, 30 Worksheet preparation Problems 16 Concepts for Analysis 1, 2, 3, 4, 5, 3, 4, 7, 10, 14, 15, 18 1, 2, 4, 7, 8, 9, 10, 11, 12 1, 2, 1, 2, 3, 6, 11, 13, 14, 15, 16, 17, 18 1, 2, 3, 4, 5, 6, 9, 11, 12 Balance sheet recognition, 15, 19, 20, computation of pension 22, 23 expense 6, 10 3, 9, 11, 12, 1, 2, 3, 4, 13, 14 5, 6, 7, 8, 9, 11, 12 2, 5, Corridor calculation 18 8, 13, 14, 16, 17, 18 2, 3, 5, 6, 7, 8, 11, 12 3, 4, 5, 6 Prior service cost 12, 13, 20 5, 6, 1, 2, 3, 5, 9, 11, 12, 13, 14 1, 2, 3, 4, 6, 7, 8, 9, 11, 12 1, Gains and losses 14, 17, 21, 22 7, 8, 9, 13, 14, 1, 2, 3, 4, 5, 6, 16, 17 7, 8, 9, 11, 12 4, 5, Disclosure issues 23 10 9, 11, 12 11, 12 3, Special Issues 25 11, 12 19, 20, 21, 22, 23, 24 13, 14 Income statement recognition, computation of pension expense *10 Postretirement benefits 9, 10, 11, 13, 16, 17 26, 27, 28, 29 4, *This material is dealt with in an Appendix to the chapter Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-1 ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Brief Exercises Learning Objectives Exercises Problems 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 1, 2, 1, 2, 6, 11, 12, 13, 15 Use a worksheet for employer’s pension plan entries 3, 4, 7, 10, 11, 14, 18 1, 2, 4, 7, 8, 9, 10, 11, 12 Describe the amortization of prior service costs 1, 2, 5, 7, 12, 13 1, 2, 3, 4, 6, 7, 8, 9, 10, 11, 12 Explain the accounting for unexpected gains and losses 12, 13 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12 Explain the corridor approach to amortizing gains and losses 8, 12, 13, 16, 17, 18 3, 4, 5, 6, 8, 11, 12 Describe the requirements for reporting pension plans in financial statements 6, 8, 9, 10 9, 11,12, 13 1, 2, 3, 4, 8, 11, 12 *10 Identify the differences between pensions and postretirement healthcare benefits 11, 12 19, 20, 21, 22, 23, 24 13, 14 *11 Contrast accounting for pensions to accounting for other postretirement benefits 11, 12 19, 20, 21, 22, 23, 24 13, 14 20-2 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ASSIGNMENT CHARACTERISTICS TABLE Item E20-1 E20-2 E20-3 E20-4 E20-5 E20-6 E20-7 E20-8 E20-9 E20-10 E20-11 E20-12 E20-13 E20-14 E20-15 E20-16 E20-17 E20-18 *E20-19 *E20-20 *E20-21 *E20-22 *E20-23 *E20-24 P20-1 P20-2 P20-3 P20-4 P20-5 P20-6 P20-7 P20-8 P20-9 P20-10 P20-11 P20-12 *P20-13 *P20-14 Description Pension expense, journal entries Computation of pension expense Preparation of pension worksheet Basic pension worksheet Application of years-of-service method Computation of actual return Basic pension worksheet Application of the corridor approach Disclosures: Pension expense and other comprehensive income Pension worksheet Pension expense, journal entries, statement presentation Pension expense, journal entries, statement presentation Computation of actual return, gains and losses, corridor test, and pension expense Worksheet for E20-13 Pension expense, journal entries Amortization of accumulated OCI (G/L), corridor approach, pension expense computation Amortization of accumulated OCI balances Pension worksheet—missing amounts Postretirement benefit expense computation Postretirement benefit worksheet Postretirement benefit expense computation Postretirement benefit expense computation Postretirement benefit worksheet Postretirement benefit worksheet—missing amounts 2-year worksheet 3-year worksheet, journal entries, and reporting Pension expense, journal entries, amortization of loss Pension expense, journal entries for years Computation of pension expense, amortization of net gain or loss-corridor approach, journal entries for years Computation of prior service cost amortization, pension expense, journal entries, and net gain or loss Pension worksheet Comprehensive 2-year worksheet Comprehensive 2-year worksheet Pension worksheet—missing amounts Pension worksheet Pension worksheet Postretirement benefit worksheet Postretirement benefit worksheet—2 years Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual Level of Time Difficulty (minutes) Simple 15–20 Simple 10–15 Moderate 15–25 Simple 10–15 Moderate 15–25 Simple 10–15 Moderate 15–25 Moderate 20–25 Moderate 25–35 Moderate 20–25 Moderate 20–30 Moderate 20–30 Complex 35–45 Complex Moderate Moderate 40–50 15–20 25–35 Moderate Moderate Moderate Moderate Simple Simple Moderate Moderate 30–40 20–25 5–10 25–30 10–12 10–12 15–20 25–30 Moderate Complex Complex Moderate Complex 40–50 45–55 40–50 30–40 45–55 Complex 45–60 Moderate Complex Moderate Moderate Moderate Moderate Moderate Moderate 35–45 45–60 40–45 25–30 35–45 35–45 30–35 40–45 (For Instructor Use Only) 20-3 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Item CA20-1 CA20-2 CA20-3 CA20-4 CA20-5 CA20-6 CA20-7 20-4 Description Pension terminology and theory Pension terminology Basic terminology Major pension concepts Implications of GAAP rules on pensions Gains and losses, corridor amortization Nonvested employees—an ethical dilemma Copyright © 2011 John Wiley & Sons, Inc Level of Difficulty Moderate Moderate Simple Moderate Complex Moderate Moderate Kieso, Intermediate Accounting, 14/e, Solutions Manual Time (minutes) 30–35 25–30 20–25 30–35 50–60 30–40 20–30 (For Instructor Use Only) SOLUTIONS TO CODIFICATION EXERCISES CE20-1 Master Glossary (a) The actuarial present value of benefits (whether vested or nonvested) attributed, generally by the pension benefit formula, to employee service rendered before a specified date and based on employee service and compensation (if applicable) before that date The accumulated benefit obligation differs from the projected benefit obligation in that it includes no assumption about future compensation levels For plans with flat-benefit or non-pay-related pension benefit formulas, the accumulated benefit obligation and the projected benefit obligation are the same (b) A plan that defines postretirement benefits in terms of monetary amounts (for example, $100,000 of life insurance) or benefit coverage to be provided (for example, up to $200 per day for hospitalization, or 80 percent of the cost of specified surgical procedures) Any postretirement benefit plan that is not a defined contribution postretirement plan is, for purposes of Subtopic 715–60, a defined benefit postretirement plan (Specified monetary amounts and benefit coverage are collectively referred to as benefits) (c) The value, as of a specified date, of an amount or series of amounts payable or receivable thereafter, with each amount adjusted to reflect the time value of money (through discounts for interest) and the probability of payment (for example, by means of decrements for events such as death, disability, or withdrawal) between the specified date and the expected date of payment (d) The cost of retroactive benefits granted in a plan amendment Retroactive benefits are benefits granted in a plan amendment (or initiation) that are attributed by the pension benefit formula to employee services rendered in periods before the amendment CE20-2 According to FASB ASC 715-30-35-43 (Defined-Benefit Plans – Pension – Discount Rates): Assumed discount rates shall reflect the rates at which the pension benefits could be effectively settled It is appropriate in estimating those rates to look to available information about rates implicit in current prices of annuity contracts that could be used to effect settlement of the obligation (including information about available annuity rates published by the Pension Benefit Guaranty Corporation) In making those estimates, employers may also look to rates of return on high-quality fixed-income investments currently available and expected to be available during the period to maturity of the pension benefits Assumed discount rates are used in measurements of the projected, accumulated, and vested benefit obligations and the service and interest cost components of net periodic pension cost Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-5 CE20-3 According to FASB ASC 715-30-35-4 (Defined-Benefit Plans – Pension – Components of Net Periodic Cost): All of the following components shall be included in the net pension cost recognized for a period by an employer sponsoring a defined-benefit pension plan: (a) Service cost (b) Interest cost (c) Actual return on plan assets, if any (d) Amortization of any prior service cost or credit included in accumulated other comprehensive income (e) Gain or loss (including the effects of changes in assumptions), which includes, to the extent recognized (see paragraph 715-30-35-26), amortization of the net gain or loss included in accumulated other comprehensive income (f) Amortization of any net transition asset or obligation existing at the date of initial application of this Subtopic and remaining in accumulated other comprehensive income CE20-4 According to FASB ASC 715-20-50-6 (Defined-Benefit Plans – General – Interim Disclosure Requirements for Publicly Traded Entities): A publicly traded entity shall disclose the following information for its interim financial statements that include a statement of income: (a) The amount of net benefit cost recognized, for each period for which a statement of income is presented, showing separately each of the following: (b) The total amount of the employer’s contributions paid, and expected to be paid, during the current fiscal year, if significantly different from amounts previously disclosed pursuant to paragraph 71520-50-1(g) Estimated contributions may be presented in the aggregate combining all of the following: 20-6 The service cost component The interest cost component The expected return on plan assets for the period The gain or loss component The prior service cost or credit component The transition asset or obligation component The gain or loss recognized due to a settlement or curtailment Contributions required by funding regulations or laws Discretionary contributions Noncash contributions Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ANSWERS TO QUESTIONS **1 A private pension plan is an arrangement whereby a company undertakes to provide its retired employees with benefits that can be determined or estimated in advance from the provisions of a document or from the company’s practices In a contributory pension plan the employees bear part of the cost of the stated benefits whereas in a noncontributory plan the employer bears the entire cost **2 A defined-contribution plan specifies the employer’s contribution to the plan usually based on a formula, which may consider such factors as age, length of service, employer’s profit, or compensation levels A defined-benefit plan specifies a determinable pension benefit that the employee will receive at a time in the future The employer must determine the amount that should be contributed now to provide for the future promised benefits In a defined-contribution plan, the employer’s obligation is simply to make a contribution to the plan each year based on the plan formula The benefit of gain or risk of loss from assets contributed to the plan is borne by the employee In a defined-benefit plan, the employer’s obligation is to make sufficient contributions each year to provide for the promised future benefits Therefore, the employer is at risk to the extent that contributions will not be adequate to meet the promised benefits **3 The employer is the organization sponsoring the pension plan The employer incurs the costs and makes contributions to the pension fund Accounting for the employer involves: (1) allocating the cost of the pension plan to the proper accounting periods, (2) measuring the amount of pension obligation resulting from the plan, and (3) disclosing the status and effects of the plan in the financial statements The pension fund or plan is the entity which receives the contributions from the employer, administers the pension assets, and makes the benefit payments to the pension recipients Accounting for the fund involves identifying receipts as contributions from the employer sponsor, income from fund investments, and computing the amounts due to individual pension recipients Accounting for the pension costs and obligations of the employer is the topic of this chapter; accounting for the pension fund is not **4 When the term “fund” is used as a noun, it refers to assets accumulated in the hands of a funding agency for the purpose of meeting pension benefits when they become due When the term “fund” is used as a verb, it means to pay over to a funding agency (as to fund future pension benefits or to fund pension cost) **5 An actuary’s role is to ensure that the company has established an appropriate funding pattern to meet its pension obligations, to make predictions and assumptions about future events and conditions that affect pension costs, and to assist the accountant in measuring facets of the pension plan that must be reported (costs, liabilities and assets) In order to determine the company’s pension obligation, the actuary must first determine the expected benefits that will be paid in the future To accomplish this requires the actuary to make actuarial assumptions, which are estimates of the occurrence of future events affecting pension costs, such as mortality, withdrawals, disablement and retirement, changes in compensation, and changes in discount rates to reflect the time value of money **6 In measuring the amount of pension benefits under a defined-benefit pension plan, an actuary must consider such factors as mortality rates, employee turnover, interest and earnings rates, early retirement frequency, and future salaries Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-7 Questions Chapter 20 (Continued) **7 One measure of the pension obligation is the vested benefit obligation This measure uses only current salary levels and includes only vested benefits; that is, benefits the employee is already entitled to receive even if the employee renders no additional services under the plan A company’s accumulated benefit obligation is the actuarial present value of benefits attributed by the pension benefit formula to service before a specified date and is based on employee service and compensation prior to that date The accumulated benefit obligation differs from the projected benefit obligation in that it includes no assumption about future compensation levels The projected benefit obligation is based on vested and nonvested services using future salaries **8 Cash-basis accounting recognizes pension cost as being equal to the amount of cash paid by the employer to the pension fund in any period; pension funding serves as the basis for expense recognition under the cash basis Accrual-basis accounting recognizes pension cost as it is incurred and attempts to recognize pension cost in the same period in which the company receives benefits from the services of its employees Frequently, the amount which an employer must fund for pension purposes during a particular period is unrelated to the economic benefits derived from the pension plan in that period Cashbasis accounting recognizes the amount funded as periodic pension cost and the amount funded may be discretionary and vary widely from year to year Funding is a matter of financial management, based on working capital availability, tax considerations, and other matters unrelated to accounting considerations **9 The five components of pension expense are: (1) Service cost—the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period (2) Interest cost—the increase in the projected benefit obligation as a result of the passage of time (3) Actual return on plan assets—the reduction in pension cost for actual investment income from plan assets and the change in the market value of plan assets (4) Amortization of prior service cost—the cost of retroactive benefits granted in a plan amendment (including initiation of a plan) (5) Gains and losses—a change in the value of either the projected benefit obligation or the plan assets resulting from experience different from that assumed or expected or from a change in an actuarial assumption Note to instructor: Regarding return on plan assets, the final component is expected rate of return We are assuming above that an adjustment is made to the actual return to determine expected return 10 The service cost component of net periodic pension expense is determined as the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period The plan’s benefit formula provides a measure of how much benefit is earned and, therefore, how much cost is incurred in each individual period The FASB concluded that future compensation levels had to be considered in measuring the present obligation and periodic pension expense if the plan benefit formula incorporated them 11 The interest component is the interest for the period on the projected benefit obligation outstanding during the period The assumed discount rate should reflect the rates at which pension benefits could be effectively settled (settlement rates) Companies should look to rates of return on highquality fixed-income investments currently available whose cash flows match the timing and amount of the expected benefit payments 20-8 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) Questions Chapter 20 (Continued) *12 Service cost is the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period Actuaries compute service cost at the present value of the new benefits earned by employees during the year Prior service cost is the cost of retroactive benefits granted in a plan amendment or initiation of a pension plan The cost of the retroactive benefits is the increase in the projected benefit obligation at the date of the amendment *13 When a defined-benefit plan is either initiated or amended, credit is often given to employees for years of service provided before the date of initiation or amendment The cost of these retroactive benefits are referred to as prior service costs Employers grant retroactive benefits because they expect to receive benefits in the future As a result, prior service cost should not be recognized as pension expense entirely in the year of amendment or initiation It is recognized as an adjustment to other comprehensive income It should be recognized during the service periods of those employees who are expected to receive benefits under the plan Consequently, prior service cost is amortized over the service life of employees who will receive benefits and is a component of net periodic pension expense each period *14 Liability gains and losses are unexpected gains or losses from changes in the projected benefit obligation Liability gains (resulting from unexpected decreases) and liability losses (resulting from unexpected increases) are recognized in other comprehensive income The accumulated gains and losses are then amortized, subject to complex amortization guidelines in other comprehensive income *15 If pension expense recognized in a period exceeds the current amount funded, a liability account referred to as Pension Asset /Liability arises; the account would be reported either as a current or long-term liability, depending on the ultimate date of payment If the current amount funded exceeds the amount recognized as pension expense, an asset account referred to as Pension Asset /Liability arises; the account would be reported as a non-current asset Because these assets are used to fund the pension obligation, noncurrent classification is appropriate *16 Computation of actual return on plan assets Fair value of plan assets at end of period Deduct: Fair value of plan assets at beginning of period Increase in fair value of assets Deduct: Contributions to plan during the period Add: Benefits paid during the period Actual return on plan assets $10,150,000 9,500,000 650,000 $1,000,000 1,400,000 400,000 $ 1,050,000 *17 An asset gain occurs when the actual return on the plan assets is greater than the expected return on plan assets while an asset loss occurs when the actual return is less than the expected return on the plan assets A liability gain results from unexpected decreases in the pension obligation and a liability loss results from unexpected increases in the pension obligation *18 Corridor amortization occurs when the accumulated OCI (G/L) balance gets too large The gain or loss is too large when it exceeds the arbitrarily selected FASB criterion of 10% of the larger of the beginning balances of the projected benefit obligation or the market-related value of the plan assets The excess gain or loss balance may be amortized using any systematic method but the amortization cannot be less than the amount computed using the straight-line method over the average remaining service-life of active employees expected to receive benefits Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-9 Questions Chapter 20 (Continued) *19 The amount of the pension asset/liability to be reported on the company’s balance sheet is as follows: Projected benefit obligation Pension plan assets Pension liability $(400,000) 350,000 $ (50,000) In the financial statements, the company will report a pension liability of $50,000 This amount is also referred to as the funded status of the plan *20 The prior service cost arising in the year of the amendment (which increases the projected benefit obligation) is recognized by an offsetting debit to Other Comprehensive Income (PSC) In subsequent periods, the $9,150,000 will be amortized into periodic pension expense over the remaining service lives of the employees This approach is consistent with the treatment for actuarial gains and losses *21 Actuarial gains or losses arise from (1) asset gains or losses (when the expected return is different than the actual return on plan assets) and (2) a liability gain or loss (when actuarial assumptions not coincide with actual experiences related to computation of the projected benefit obligation.) In the period that they arise, these gains and losses are not recognized as part of pension expense, but are recognized as increases or decreases in other comprehensive income In subsequent periods, these amounts are amortized into periodic pension expense over the remaining service lives of the employees, using corridor amortization *22 (a) Other Comprehensive Income for 2013 is as follows: Actuarial liability gain Asset loss Other comprehensive loss $10,000 14,000 $ 4,000 (b) The computation of comprehensive income for 2013 is as follows: Net income Other comprehensive loss Comprehensive income $25,000 4,000 $21,000 *23 Multiple plans may be combined and shown as one amount on the balance sheet, only if they are in the same under or overfunded position For example, if the company has two or more underfunded (overfunded) plans, the underfunded (overfunded) plans are combined and shown as one amount as a liability (asset) on the balance sheet The FASB rejected the alternative of combining all plans and representing the net amount as a single net asset or net liability The rationale: A company does not have the ability to offset the excess of one plan against underfunded obligations of another plan Furthermore, netting all plans is inappropriate because offsetting assets and liabilities is not permitted under GAAP unless a right of offset exists *24 (a) (b) (c) (d) 20-10 A contributory plan is a pension plan under which employees contribute part of the cost In some contributory plans, employees wishing to be covered must contribute; in other contributory plans, employee contributions result in increased benefits Vested benefits are benefits for which the employee’s right to receive a present or future pension benefit is no longer contingent on remaining in the service of the employer Retroactive benefits are benefits granted in a plan amendment (or initiation) that are attributed by the pension benefit formula to employee services rendered in periods prior to the amendment The years-of-service method is used to allocate prior service cost to the remaining years of service of the affected employees Each year receives a fraction of the original cost with the fraction depicting the number of service-years received out of the total service-years to be worked by the affected employees Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ACCOUNTING, ANALYSIS, AND PRINCIPLES Accounting Balance in PBO at 12/31/2013 Balance at 1/1/2013 Interest cost: ($820.5 X 0.10) = Service cost Increase from actuarial assumptions Benefits paid Amount of plan assets at 12/31/2013 Balance at 1/1/2013 Actual dollar return in 2013 Contributions in 2013 Benefits paid in 2013 Corridor test and amortization of net gain/loss Corridor limit: 10% times greater of $820.5 and $476.5 = Excess of net G/L over corridor limit = $92.0 – $82.1 = Amortization = $9.9 ÷ 15 = Pension expense: Interest cost = ($820.5 X 0.10) = Service cost Amortization of unamortized prior service cost = Amortization of unamortized net loss Expected return on plan assets: ($476.5 X 0.12) = Balance in pension liability Projected benefit obligation Plan assets Pension liability Balance in Unamortized Prior Service Cost at 12/31/2013 Balance at 1/1/2013 Amortization in 2013 20-84 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual $820.5 82.1 42.0 0.0 (40.0) $904.6 $476.5 10.4 70.0 (40.0) $516.9 $ 82.1 9.9 0.7 $ 82.1 42.0 15.0 0.7 (57.2) $ 82.6 $904.6 (516.9) $387.7 ($150.0) 15.0 ($135.0) (For Instructor Use Only) ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) Balance in Unamortized Net Gain or Loss at 12/31/2013 Balance at 1/1/2013 Gain (loss) due to actual return on plan assets below expected return Amortization ($ 92.0) (46.8) 0.7 ($138.1) Journal entry: Pension Expense Other Comprehensive Income (G/L) Pension Asset/Liability Other Comprehensive Income (PSC) Cash 82.6 46.1 43.7 15.0 70.0 PENCOMP, INC Income Statement for the year ended Dec 31, 2013 Revenues: Sales Expenses: Cost of goods sold Salary expense Pension expense Depreciation expense Interest expense Total expenses and losses Net income Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual $3,000.0 $2,000.0 700.0 82.6 80.0 100.0 2,962.6 $ 37.4 (For Instructor Use Only) 20-85 ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) PENCOMP, INC Statement of Financial Position at Dec 31, 2013 Assets: Cash Inventory Plant and equipment Accumulated depreciation $ 368.0 1,800.0 2,168.0 $2,000.0 (320.0) Total Assets 1,680.0 $3,848.0 Liabilities: Note payable Pension liability Total Liabilities $1,000.0 387.7 1,387.7 Equity: Common stock Retained earnings Accumulated other comprehensive income Total Equity Total Equity & Liabilities $2,000.0 733.4 (273.1) 2,460.3 $3,848.0 Plant and equip = no change from previous statement of financial position Accumulated depreciation = [$240 + ($2,000 ÷ 25)] = $320 Inventory = $1,800 given Cash = $438 – $700 + $3,000 – $2,000 –$100 – $200 – $70 = $368 Note payable = no change from previous statement of financial position Pension liability = $387.7 per above analysis Capital stock = no change from previous statement of financial position Retained earnings = $896.0 + $37.4 –$200 = $733.4 Accumulated other comprehensive income = $135.0 + $138.1 = $273.1 20-86 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) Analysis ROE = $37.4 ÷ $2,460.3 = 0.0152 or 1.52% In this example, the unexpected return on plan assets ‘skipped’ the income statement and went to other comprehensive income Had this item been included in income, ROE would have been = ($37.4 –$46.8) ÷ $2,460.3 = –0.0038 or –0.38 percent Whether this ‘should’ be included in a return on equity calculation is debatable The rationale for excluding this from current period income (and therefore from ROE) is that a defined benefit pension plan is a long-term contract and so it is the long term expected return on the plan’s assets that is relevant to measuring the cost of sponsoring the plan Some people believe that a particularly high or low return in a given year is not indicative of the long-term return Others argue that all returns, high or low, accrue to the plan sponsor and so pension expense should reflect all returns Principles The effects of plan amendments and actuarial gains and losses in a given year can be thought of as fairly transitory items with respect to income In other words, these are items that are not likely to repeat at the same dollar amount year in and year out Including these items in income arguably makes identifying the company’s ‘permanent’ income more difficult Therefore, the FASB (and the IASB) have (so far!) decided to keep those items out of the income statement Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-87 PROFESSIONAL RESEARCH (a) According to FASB ASC 715-30-35: 35-22 Asset gains and losses are differences between the actual return on plan assets during a period and the expected return on plan assets for that period Asset gains and losses include both changes reflected in the market-related value of plan assets and changes not yet reflected in the market-related value (that is, the difference between the fair value of assets and the market-related value) Gains or losses on transferable securities issued by the employer and included in plan assets are also included in asset gains and losses Asset gains and losses not yet reflected in market-related value are not required to be amortized under paragraphs 715-30-35-24 through 35-25 35-24 As a minimum, amortization of a net gain or loss included in accumulated other comprehensive income (excluding asset gains and losses not yet reflected in market-related value) shall be included as a component of net pension cost for a year if, as of the beginning of the year, that net gain or loss exceeds 10 percent of the greater of the projected benefit obligation or the market-related value of plan assets If amortization is required, the minimum amortization shall be that excess divided by the average remaining service period of active employees expected to receive benefits under the plan The amortization must always reduce the beginning-of-the-year balance Amortization of a net gain results in a decrease in net periodic pension cost; amortization of a net loss results in an increase in net periodic pension cost If all or almost all of a plan’s participants are inactive, the average remaining life expectancy of the inactive participants shall be used instead of the average remaining service period 20-88 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) PROFESSIONAL RESEARCH (Continued) (b) According to FASB ASC 715-30-35: Gains and Losses 35-18 As established in the definition of the term, a gain or loss results from a change in the value of either the projected benefit obligation or the plan assets resulting from experience different from that assumed or from a change in an actuarial assumption This Subtopic generally does not distinguish between gains and losses that result from experience different from that assumed or from changes in assumptions Gains and losses include amounts that have been realized, for example by sale of a security, as well as amounts that are unrealized 35-19 Because gains and losses may reflect refinements in estimates as well as real changes in economic values and because some gains in one period may be offset by losses in another or vice versa, this Subtopic does not require recognition of gains and losses as components of net pension cost of the period in which they arise (c) According to FASB ASC 715-30-25: 25-1 If the projected benefit obligation exceeds the fair value of plan assets, the employer shall recognize in its statement of financial position a liability that equals the unfunded projected benefit obligation If the fair value of plan assets exceeds the projected benefit obligation, the employer shall recognize in its statement of financial position an asset that equals the overfunded projected benefit obligation Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-89 Copyright © 2011 John Wiley & Sons, Inc 10 11 12 13 14 15 16 17 18 19 20 21 (a) A Accumulated OCI, Dec 31, 2011 Balance, Dec 31, 2012 Balance, Jan 1, 2012 Service cost Interest cost Actual /Expected return Amortization of PSC Contributions Benefits Liability increase Journal entry for 2012 Items Measurement C D (99,000) (99,000) Cash Formula: (L9*.09)* –1 113,250 90,000 56,250 (52,000) 19,000 Annual Pension Expense B F G 100,000 81,000 (19,000) (19,000) OCI—Prior Service Cost H Kieso, Intermediate Accounting, 14/e, Solutions Manual Formula: L9 + N9 71,000 76,000 71,000 (5,000) OCI— Gain/Loss General Journal Entries E I K Formula: B11* –1 (211,250) (66,250) (145,000) Pension Asset/Liability J M N (762,250) 85,000 (76,000) (625,000) (90,000) (56,250) 551,000 99,000 (85,000) 57,000 480,000 Memo Record Projected Benefit Obligation Plan assets L PROFESSIONAL SIMULATION (For Instructor Use Only) PROFESSIONAL SIMULATION (Continued) (b) Simply change the formula in cell B11 to multiply by 07; change the formula in cell B12 to multiply 10 times (N9* – 1) Journal Entry Other Comprehensive Income (G/L) Pension Expense Pension Asset /Liability Cash Other Comprehensive Income (PSC) 71,000 113,250 66,250 99,000 19,000 Disclosure Financial Statements Income Statement Pension expense $113,250 Balance Sheet Liabilities Pension liability $211,250 Stockholders’ equity Accumulated other comprehensive loss $152,000* *($81,000 + $71,000) Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-91 IFRS CONCEPTS AND APPLICATION IFRS20-1 When a defined benefit plan is either initiated or amended, credit is often given to employees for years of service provided before the date of initiation or amendment The cost of these retroactive benefits are referred to as past service costs Employers grant retroactive benefits because they expect to receive benefits in the future As a result, past service cost should not be recognized as pension expense entirely in the year of amendment or initiation, but should be recognized during the service periods of those employees who are expected to receive benefits under the plan Consequently, unrecognized past service cost is amortized over the remaining average period to vesting of employees who will receive benefits and is a component of net periodic pension expense each period IFRS20-2 Corridor amortization occurs when the accumulated unrecognized net gain or loss balance gets too large The gain or loss is too large when it exceeds the arbitrarily selected IASB criterion of 10% of the larger of the beginning balances of the defined benefit obligation or the fair value of the plan assets The excess unrecognized gain or loss balance may be amortized using any systematic method but the amortization cannot be less than the amount computed using the straight-line method over the average remaining servicelife of active employees expected to receive benefits IFRS20-3 The IASB allows companies to immediately recognize actuarial gains and losses If a company chooses immediate recognition, the actuarial gain or loss can either adjust net income or other comprehensive income IFRS20-4 No, Bill is not correct Companies may use the corridor approach or the immediate recognition approach to recognize actuarial gains and losses The amount of actuarial gains (losses) recognized under the two approaches will differ 20-92 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) IFRS20-5 Joshua Co would report a pension liability of $74,300 ($335,000 – $245,000 – $24,000 + $8,300) IFRS20-6 2012 PSC amortization: $125,000 ÷ = $25,000 Villa’s 2012 and 2013 pension expense would be decreased by the $25,000 PSC amortization IFRS20-7 (a) (b) Income Statement Revenues Expenses Pension expense ($14,000 + $750) Net income Statement of Comprehensive Income Revenues Expenses Pension expense ($14,750 – $750) Net income Other comprehensive income Actuarial loss on defined benefit plan Total comprehensive income Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual $125,000 85,000 14,750 $ 25,250 $125,000 85,000 14,000 26,000 750 $ 25,250 (For Instructor Use Only) 20-93 20-94 Copyright © 2011 John Wiley & Sons, Inc $59,400 = $660,000 X 09 82,120 Dr 58,000 Dr 59,400 Dr 52,280 Cr 17,000 Dr 55,000 Cr 55,000 Cr 27,120 Cr 40,920 Cr 13,800 Cr 737,400 Cr 40,000 Dr Defined Benefit Obligation 560,000 Cr 100,000 Cr 660,000 Cr 58,000 Cr 59,400 Cr 613,480 Dr 55,000 Dr 40,000 Cr 52,280 Dr Plan Assets 546,200 Dr 546,200 Dr Memo Record 83,000 Dr 17,000 Cr 100,000 Dr 100,000 Dr Unrecognized Past Service Cost *Note: We show actual return on the worksheet to ensure that plan assets are properly reported If expected and actual return differ, then an additional adjustment is made to compute the proper amount of pension expense (c) Items Balance, January 1, 2012 (a) Prior service cost New balance, January 1, 2012 (b) Service cost (c) Interest cost (d) Actual return* (e) Amortization of PSC (f) Contributions (g) Benefits Journal entry, December 31 Balance, December 31, 2012 Doreen Corp Pension Worksheet—2012 General Journal Entries Annual Pension Pension Asset/ Expense Cash Liability 13,800 Cr IFRS20-8 Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) Items Copyright © 2011 John Wiley & Sons, Inc $(762,250) 551,000 (211,250) 81,000 71,000 $ (59,250) Reconciliation Schedule—12/31/12 Defined benefit obligation (Credit) Plan assets at fair value (Debit) Funded status Unrecognized past service cost (Debit) Unrecognized net loss (Debit) Pension Asset/Liability 551,000 Dr (b) 762,250 Cr 85,000 Dr 99,000 Dr 85,000 Cr 57,000 Dr 480,000 Dr $56,250 = $625,000 X 09 Expected return = $52,000 Unexpected gain = Actual return minus expected return; $5,000 = $57,000 – $52,000 14,250 Cr 59,250 Cr 76,000 Cr 625,000 Cr 90,000 Cr 56,250 Cr 81,000 Dr 19,000 Cr 100,000 Dr Memo Record Unrecognized Plan Past Assets Service Cost (b) (d) 99,000 Cr 99,000 Cr 45,000 Cr Buhl Corp Pension Worksheet General Journal Entries Annual Pension Defined Pension Asset/ Benefit Expense Cash Liability Obligation Balance, January 1, 2012 (a) Service cost 90,000 Dr (b) Interest cost 56,250 Dr (c) Actual return 57,000 Cr (d) Unexpected gain 5,000 Dr (e) Amortization of PSC 19,000 Dr (f) Liability increase (g) Contributions (h) Benefits Journal entry 113,250 Dr Balance, December 31, 2012 (a) 71,000 Dr 76,000 Dr 5,000 Cr Unrecognized Net Gain or Loss IFRS20-9 Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-95 IFRS20-10 (a) Actual Return = (Ending – Beginning) – (Contributions – Benefits) Fair value of plan assets, December 31, 2012 $2,620 Deduct: Fair value of plan assets, January 1, 2012 1,700 Increase in fair value of plan assets 920 Deduct: Contributions $800 Less benefits paid 200 600 Actual return on plan assets in 2012 $ 320 (b) Computation of pension liability gains and losses and pension asset gains and losses 20-96 Difference between 12/31/12 actuarially computed DBO and 12/31/12 recorded defined benefit obligation (DBO): DBO at end of year $3,645 DBO per memo records: 1/1/12 DBO $2,800 Add interest (10%) 280 Add service cost 400 (200) (3,280) Less benefit payments Liability loss $365 Difference between actual fair value of plan assets and expected fair value: 12/31/12 actual fair value of plan assets $2,620 Expected fair value 1/1/12 fair value of plan assets $1,700 Add expected return ($1,700 X 10%) 170 Add contribution 800 (200) (2,470) Less benefits paid Asset gain Unrecognized net (gain) or loss Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (150) $215 (For Instructor Use Only) IFRS20-11 (a) According to IAS 19, paragraph 105, “The expected return on plan assets is one component of the expense recognised in profit or loss The difference between the expected return on plan assets and the actual return on plan assets is an actuarial gain or loss; it is included with the actuarial gains and losses on the defined benefit obligation in determining the net amount that is compared with the limits of the 10% ‘corridor’ specified in paragraph 92.” (b) Paragraph 95 states “In the long term, actuarial gains and losses may offset one another Therefore, estimates of post-employment benefit obligations may be viewed as a range (or ‘corridor’) around the best estimate An entity is permitted, but not required, to recognise actuarial gains and losses that fall within that range This Standard requires an entity to recognise, as a minimum, a specified portion of the actuarial gains and losses that fall outside a ‘corridor’ of plus or minus 10% [Appendix A illustrates the treatment of actuarial gains and losses, among other things.] The Standard also permits systematic methods of faster recognition, provided that those methods satisfy the conditions set out in paragraph 93 Such permitted methods include, for example, immediate recognition of all actuarial gains and losses, both within and outside the ‘corridor’ Paragraph 155(b)(iii) explains the need to consider any unrecognised part of the transitional liability in accounting for subsequent actuarial gains.” (c) According to paragraph 54, “The amount recognised as a defined benefit liability shall be the net total of the following amounts: (1) the present value of the defined benefit obligation at the end of the reporting period (see paragraph 64); (2) plus any actuarial gains (less any actuarial losses) not recognised because of the treatment set out in paragraphs 92 and 93; (3) minus any past service cost not yet recognised (see paragraph 96); (4) minus the fair value at the end of the reporting period of plan assets (if any) out of which the obligations are to be settled directly (see paragraphs 102–104).” Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 20-97 IFRS20-11 (Continued) Further, as stated in paragraph 58, “The amount determined under paragraph 54 may be negative (an asset) An entity shall measure the resulting asset at the lower of: (1) the amount determined under paragraph 54; and (2) the total of: (i) any cumulative unrecognised net actuarial losses and past service cost (see paragraphs 92, 93 and 96); and (ii) the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan The present value of these economic benefits shall be determined using the discount rate specified in paragraph 78.” IFRS20-12 (a) M&S provides pension arrangements for the benefit of its UK employees through the Marks & Spencer UK Pension Scheme This has a defined benefit section, which was closed to new entrants with effect from April 2002, and a defined contribution section which has been open to new members with effect from April 2003 M&S also operates a small funded defined benefit pension scheme in the Republic of Ireland Retirement benefits also include a UK postretirement healthcare scheme and unfunded retirement benefits (b) 2010 2009 (c) Impact on 2010 financial statements: pension expense decreased net income by £46.5; actuarial loss of £251.6 on consolidated statement of recognized income and expense; net retirement benefit deficit of £366.5 (d) M&S’s Analysis of assets and expected rates of return portion of its pension footnote details the major categories of assets, which are property partnership interest; UK equities; overseas equities; government bonds; corporate bonds; and cash and other In general, the expected long-term rate of return on these assets increases with an increase in risk for the asset M&S’s overall expected rate of return is 6.5% 20-98 Pension expense Pension expense Copyright © 2011 John Wiley & Sons, Inc £46,500,000 (£199,500,000) Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ... E2 0-1 2 E2 0-1 3 E2 0-1 4 E2 0-1 5 E2 0-1 6 E2 0-1 7 E2 0-1 8 *E2 0-1 9 *E20 -2 0 *E2 0-2 1 *E2 0-2 2 *E2 0-2 3 *E2 0-2 4 P2 0-1 P2 0-2 P2 0-3 P2 0-4 P2 0-5 P2 0-6 P2 0-7 P2 0-8 P2 0-9 P2 0-1 0 P2 0-1 1 P2 0-1 2 *P2 0-1 3 *P2 0-1 4 Description... Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ASSIGNMENT CHARACTERISTICS TABLE Item E2 0-1 E2 0-2 E2 0-3 E2 0-4 E2 0-5 E2 0-6 E2 0-7 E2 0-8 E2 0-9 E2 0-1 0 E2 0-1 1 E2 0-1 2 E2 0-1 3... 35–45 30–35 40–45 (For Instructor Use Only) 2 0- 3 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Item CA2 0-1 CA2 0-2 CA2 0-3 CA2 0-4 CA2 0-5 CA2 0-6 CA2 0-7 2 0- 4 Description Pension terminology and theory