Pension Plans

1
Pension Plans Defined contribution plans require
the employer and also normally the employee to
contribute an amount, usually a percentage of
salary, to a third party. This amount
accumulates for the employee and provides the
employee with retirement benefits. Employee
bears the risk of the investments. Employer
simply expenses contributions. Defined benefit
plan requires the employer to provide a defined
benefit upon retirement of qualified employees.
Usually a function of ending salary, and years of
service. Employer pays a trustee but is
ultimately responsible to the employee for
benefits earned
2
Defined Benefit Plan Assets Liabilities Beg
bal Projected Benefit Obligation Contributions
Service cost Actual Return Interest cost -
Distributions - Distributions Ending Balance
Ending Balance If the liabilities exceed the
assets, the plan is underfunded. The accounting
issues involve how much of the net or gross
position of the plan should go on the company's
financials.
3
The Basic Accounting The basic accounting from
FAS No. 87 keeps the pension off the balance
sheet for the most part. The portion of pension
expense that is not funded each year (or
overfunded) shows as a pension liability (or
asset). Items that are not capitalized
include Projected benefit obligation Pension
plan assets Unrecognized prior service
cost Unrecognized net gain or loss
4
Vocabulary Vested benefit obligation - the
benefits employees have earned even if they quit
now. Accumulated benefit obligation - the
benefits employees are expected to receive based
on current salaries Projected benefit obligation
- the benefits employees are expected to receive
based on their anticipated future salaries FASB
elected to base pension expense on the projected
benefit obligation
5

• Pension Expense
• The amount of pension expense consists of the
  following
• Service cost - the increase in PBO as a result of
  employees working this year
• Interest cost - the increase in the liability
  because it is carried at present value
• Actual return on plan assets - the earnings and
  unrealized gains and losses on the portfolio of
  assets held by the fund
• Amortization of unrecognized prior service
  costs - the cost of benefits given to employees
  for work already performed
• - Gain or Loss - adjust actual return on plan
  assets to expected return and amortization of
  unrecognized losses/gains from prior periods
• Ex 2, 3

6
Service Cost This comes from the actuary, and is
based on the increase in PBO from the year's
work. Interest Cost Since the liability is
carried at present value, it increases by the
amount of interest each year. The interest cost
is the beginning of year PBO times the settlement
rate. The settlement rate is the rate at which
an insurance company would settle the
obligations. Actual Return on Plan Assets The
plan is holding investments to pay future
benefits. This is the amount earned on them
during the year.
7
Amortization of Unrecognized Prior Service
Cost When benefits are initially granted or
amended to increase them, an immediate liability
is created. It is not recorded on the
company's books. It is amortized to pension
expense over the average remaining service life
of employees receiving the benefit or on years of
service method
8
Gains/Losses Part One is the difference between
actual return on plan assets and expected return.
It adjusts pension expense so that expected
return on plan assets is the true component of
expense. If actual return is greater than
expected return, you will recognize a loss (to
reduce the return to actual), if actual return is
less than expected return, you will recognize a
gain. The difference between the actual and
expected returns are called unexpected gains and
losses or asset gains and losses. The same can
happen on the liability side of the plan, and
these are called liability gains and losses.
Asset and liability gains and losses are
accumulated off balance sheet until they get
outside the "corridor".
9
Corridor Amortization The FASB believed that
these gains and losses should be able to "ride"
unless they get too large, as they often reverse
themselves from one year to the next. Must
amortize the unrecognized net gain or loss
balance when it exceeds 10 of the larger of the
beginning balance of the projected benefit
obligation or the market-related value of plan
assets at the beginning of the year. Amortization
is the difference between the corridor and the
unrecognized net gain/loss divided by the average
remaining service life of all active
employees. Ex 8, 9
10
Minimum Pension Liability Because so much is off
balance sheet, the FASB decided that there are
situations in which additional liability must be
booked on the balance sheet. Minimum liability
must be recorded equal to the excess of the
accumulated benefit obligation over the fair
value of plan assets. Increase the existing
liability to this amount, and record a debit
first to "Intangible Asset - Deferred pension
cost" to the extent that unrecognized prior
service costs exist, then put any excess to
"Excess of additional pension liability over
unrecognized prior service cost" which is a
contra equity account. Ex 14, 15, Pb 7