Postemployment Benefits

1
Chapter 16

• Postemployment Benefits

2
Chapter 16--Learning Objectives

• 1. Differentiate between defined-contribution and
  defined-benefit plans

3
Plan Types

• Defined contribution
• Defined benefit

Retirement Plans
4
Defined Contribution Plan

• The amounts of the periodic contributions made by
  the employer to the plan are defined by the plan
• Retirement benefits depend on management of plan
  assets and are not defined

5
Accounting for Defined Contribution Plans

• Contributions to a defined contribution plan are
  expensed as incurred
• Pension Expense xxx
• Cash xxx

6
Defined Benefit Plans

• The retirement benefits are defined by the plan
• Employer contributions are dependent upon
  actuarial estimates of future benefit payments

7
SFAS 87

• Accounting for single employer defined benefit
  pension plans

8
Defined Benefit Plans

• Accounting for defined benefit plans is
  relatively more complex, requiring actuarial
  estimates of future obligations such as
• 1. The effect of pay raises
• 2. The effect of changing interest rates

9
Actuarial Measures Required by SFAS 87

• ABO Accumulated benefit obligation
• PBO Projected benefit obligation

10
Accumulated Benefit Obligation - ABO

• Present value of accumulated benefits

11
Accumulated Benefits

• Future benefits
• Earned to date
• Based upon applying the benefit formula utilizing
  current salary levels

Measure future benefits using todays prices
12
Projected Benefit Obligation - PBO

• Present value of projected benefits

13
Projected Benefits

• Future benefits
• Earned to date
• Based upon applying the benefit formula utilizing
  projected salary levels

Measure future benefits using future prices
14
Defined Benefit ExampleJims Pension Plan

• Employed by Cardinal Corp 1/1/85
• Defined benefit pension plan
• Initiated 1/1/1998
• Benefit formula
• 3 of final salary for each year of service
• To be paid
• at the end of each year of retirement

Jim
15
Actuarial Estimates for Jim

• Retirement in 5 years, from 12/31/98
• Life expectancy after retirement 4 years

16
Salary Information

• 1997 29,000
• 1998 30,000
• Expected Annual Raises 1,000

17
Time Line
R A A A A
97 98 99 00 01 02
03
04 05 06 07
R Retirement A Annuity amount
18
Expected Annuity Amounts
For 1 year of Service
19
Number of Years of Service at Retirement?
13
14 15 16 17 18 19

19 years
20
Expected Annuity Amounts
For 19 years of Service
21
Expected Annuity Amounts?
19,950 19,950 19,950 19,950
22
Taking Care of Future Benefits

• Cardinal Corp. will purchase an annuity when Jim
  retires that will pay 19,950 per year to Jim
  during his retirement
• Amount needed at retirement is the present value
  of the 19,950 annuity payments discounted at a
  rate that will settle their obligation to Jim
• Assume a settlement rate of 10

23
Present Value of Annuity at Retirement?
24
PV of Annuity at Retirement?
PVA present value of an annuity
25
PV of Annuity at Retirement?
26
Some Equalities

• PV of annuity at retirement 63,240
• Expected PBO at retirement 63,240
• Expected ABO at retirement 63,240

27
Funding the Plan

• Cardinal will need 63,240 in the pension fund by
  the end of 1998
• The fund is expected to earn 8
• i.e., Expected return 8
• Cardinal will fund the plan by making 5 equal
  annual installments
• Beginning now (12/31/98)
• Must calculate the amount to fund each year

28
Funding the Plan
Must Grow to 63,240
29
Amount of Each Installment?
30
ABO PBO

• Under SFAS 87, Cardinal must measure and report
  the ABO and PBO each balance sheet date
• Also pension expense is related to the
  measurement of the PBO
• Lets compute the ABO and PBO at the initiation
  of the pension plan (1/1/98)

31
Accumulated Benefits - 1/1/98?
32
Accumulated Benefits - 1/1/98
11,310 11,310 11,310 11,310
33
ABO - 1/1/98?
Present Value _at_ 1/1/98
34
ABO - 1/1/98?
Use Settlement Rate (10)
35
ABO - 1/1/98?
36
Projected Benefits - 1/1/98?
37
PBO - 1/1/98?
13,650 13,650 13,650 13,650
Present Value _at_ 1/1/98
38
PBO - 1/1/98?
Use Settlement Rate (10)
39
PBO - 1/1/98?
40
Prior Service Cost (PSC)?

• The actuarially determined present value of
  projected benefits at the inception of the plan
• Represents retroactive credit given for service
  prior to the initiation of the plan
• PSC PBO at the inception of the plan
• PSC PBO 24,425

41
Chapter 16--Learning Objectives

• 2. Understand the theoretically correct
  pension-related journal entries for
  defined-benefit pension plans and understand the
  practical compromises of SFAS No. 87

42
SFAS 87

• Pension expense measurement
• Must reflect benefit formula
• i.e., .projected benefits
• Must use the settlement rate

43
Components of Pension Expense

• Service cost
• Interest
• Return
• Amortization of PSC
• Amortization of transition amount
• Amortization of gains/losses

44
Service Cost

• Actuarial present value of projected benefits
  earned during the current accounting period
• Measured at balance sheet date

Add to Pension Expense
45
Interest

• The growth in the PBO due to the passage of time
• Beginning PBO x Settlement Rate

Add to Pension Expense
46
Return

• Pension expense includes either
• Actual return
• Expected return

Subtract from Pension Expense
47
Prior Service Cost - PSC

• Cost of providing retroactive benefits when
• Plan is initiated
• Benefits are increased
• Amortize over
• Service lives of employees receiving retroactive
  benefits
• May use their average service lives

Add to Pension Expense
48
Transition Amount

• Unrecorded funded status of the plan when SFAS 87
  was adopted
• Amortize over
• Average service lives
• May elect 15 years, if longer

49
Gains/Losses

• Actuarial gains/losses
• Experience gains/losses
• Use corridor approach, at a minimum

50
1998 Pension Expense for Jim

• Components to consider
• Service cost
• Interest
• Return
• Amortization of PSC

Jim
51
1998 Service Cost

• End of 1998 Þ 5 years from retirement
• 3 x 35,000
• x PVA,10, 4 yrs x PV, 10, 5yrs
• 1,050 x 3.1699 x 0.6209 2,067

52
1998 Interest

• Beginning PBO x Settlement rate
• 24,425 x 10 2,443

53
1998 Return

• None
• Nothing in fund until the end of the year

54
Amortization of PSC
6 years

• Jims Service Period
• 24,425 / 6 4,071

55
1998 Pension Expense

• Service cost 2,067
• Interest 2,443
• Return -0-
• Amortization of PSC 4,071
• Pension expense 8,581

56
Funding at 12/31/98

• Amount funded 9,981
• Pension Expense 8,581
• Prepaid 1,400

Funding Credit cash
57
Journal Entry - 1998

• Pension Expense 8,581
• Prepaid/Accrued Pension Cost 1,400
• Cash 9,981

58
Change in PBO

• 24,425
• 2,067
• 2,443
• 28,935

• PBO at 1/1/98
• Service cost for 1998
• Interest for 1998
• PBO at 12/31/98

59
1999 Pension Expense for Jim

• Components to Consider
• Service Cost
• Interest
• Return
• Amortization of PSC

Jim
60
Timing

• Years to Retirement?
• 4 years
• Years during Retirement?
• 4 years
• Settlement Rate
• 10

4 years
61
Known Values

• Final salary 35,000
• Beginning PBO 28,935
• PSC 24,425
• Amortization period 6 years
• Beginning fund balance 9,981
• Expected rate of return on fund 8
• Amount funded each 12/31 9,981

62
1999 Service Cost

• 3 x 35,000
• x PVA,10, 4 yrs x PV, 10, 4 yrs
• 1,050 x 3.1699 x 0.6830 2,273

63
1999 Interest

• 28,935 x 10 2,894

Beginning PBO x Settlement rate
64
1999 Return

• 9,981 x 8 798

Beginning fund balance x Expected rate of return
65
Amortization of PSC

• 24,425 / 6 4,071

66
1999 Pension Expense

• Service cost 2,273
• Interest 2,894
• Return ( 798)
• Amortization of PSC 4,071
• Pension expense 8,440

Report in Income Statement
67
Journal Entry - 1999

• Pension Expense 8,440
• Prepaid/Accrued Pension Cost 1,541
• Cash 9,981

68
Prepaid/Accrued Pension Cost Account
Prepaid/Accrued Pension Cost
Dr 1,400 12/31/98 Dr 1,541
2,941 12/31/99
69
PBO - 12/31/99

• Beginning balance
• Service cost
• Interest
• Ending balance

• 28,935
• 2,273
• 2,894
• 34,102

70
Fund Balance - 12/31/99

• Beginning balance
• Return
• Funding
• Ending balance

• 9,981
• 798
• 9,981
• 20,760

71
Effects of Increasing Benefits

• Increases cost for employer
• PBO
• Interest
• Service cost

72
Jim - 2000

• Benefits Increase!!

Jim
73
Change in Benefit Formula

• Jim will receive 4 of final salary during each
  year of retirement

74
Immediate Impact?

• Retroactive increase in benefits!!!
• Increase in PBO.

75
Retroactive Effect on PBO

• PBO at 12/31/99 - Old formula 34,102
• PBO at 12/31/99 - New formula?
• 4 x 35,000 x 15
• x PVA, 10 , 4 yrs x PV, 10, 4 yrs
• 1,400 x 15 x 3.1699 x 0.6830 45,466

76
The Additional PSC is?

• PBO - Old formula
• PBO - New formula
• Additional PSC

• 34,102
• 45,466
• 11,364

Cost of Retroactive Benefits
77
Unamortized PSC?

• From initiating Plan
• Amortized - 2 years
• Unamortized initial PSC
• Increase due to plan amendment
• Unamortized PSC

• 24,425
• ( 8,142)
• 16,283
• 11,364
• 27,647

78
2000 Service Cost

• 4 x 35,000
• x PVA,10, 4 yrs x PV, 10, 3yrs
• 1,400 x 3.1699 x 0.7513 3,334

3 years
79
2000 Interest

• Use new beginning PBO
• 45,466 x 10 4,547

Beginning PBO x Settlement rate
80
2000 Return

• 20,760 x 8 1,661

Beginning fund balance x Expected rate of return
81
Amortization of PSC

• 27,647 / 4 6,912

Unamortized PSC Service Period
4 years
82
2000 Pension Expense

• Service cost 3,334
• Interest 4,547
• Return ( 1,661)
• Amortization of PSC 6,912
• Pension expense 13,132

83
Assume Funding 12,000

• Journal entry
• Pension Expense 13,132
• Cash 12,000
• Prepaid/Accrued Pension Cost
  1,132

84
Prepaid/Accrued Pension Cost
Dr 1,400 12/31/98 Dr 1,541
2,941 12/31/99 1,132 Cr
1,809 12/31/00
85
PBO - 12/31/2000

• Beginning balance
• Service cost
• Interest
• Ending balance

• 34,102
• 3,334
• 4,547
• 53,347

86
Fund Balance - 12/31/2000

• Beginning balance
• Return
• Funding
• Ending balance

• 20,760
• 1,661
• 12,000
• 34,421

87
Chapter 16--Learning Objectives

• 3. Measure and account for actuarial gains and
  losses

88
Gains (Losses) - Types

• Actuarial
• Experience

You win some!! You lose some!!
89
Actuarial Gains (Losses)

• Result from a change in actuarial assumptions

Oh! There he goes again. Changing his mind!
90
Actuarial Assumptions

• Settlement rate
• Expected years of employment
• Expected salary levels
• Expected date of death

91
Impact of Change in Assumption

• Beginning PBO changes
• Interest changes
• Service cost changes

What does it all Mean?
92
Calculate Actuarial Gain (Loss)

• Beginning PBO - New assumptions
• Minus beginning PBO - Old assumptions

93
Actuarial Gain?

• New PBO lt Old PBO

Cost Reduction
94
Actuarial Loss

• New PBO gt Old PBO

OOPs! Its going to cost more!!!
95
Experience Gains (Losses)

• When the pension plan earns more or less than
  expected
• Only occur when Pension Expense includes the
  expected return

96
Measurement of Experience Gain (Loss)

• Beginning Expected FMV of Fund
• Minus beginning Actual FMV of Fund

Oh! Well! Things never go according to plan!!
97
Experience Gain

• Actual return gt Expected return
• Beginning FMV of fund gt Expected

Yeah! We made out!!
Lucky guess!!
98
Experience Loss

• Actual return lt Expected return
• Beginning FMV of fund lt Expected

Boo!! We messed up!
99
Recognition - Gains (Losses)

• Minimum recognition
• Use corridor approach
• i.e., at a minimum, recognize the amount of gain
  or loss required using the corridor approach

100
Corridor Defined

• 10 of the greater of either the
• Beginning PBO
• Beginning asset related market value of plan
  assets (We will use FMV)

101
Corridor Approach - Steps

• Calculate corridor
• Calculate excess (if any)
• Cumulative unamortized gains losses minus the
  corridor
• Amortize excess
• over average remaining service lives of plan
  participants
• i.e., divide excess by average remaining service
  lives

102
The Corridor Illustrated
63,000 Cumulative gain
Excess 13,000
50,000
The Corridor
-50,000
103
The Corridor Illustrated
50,000
42,000 Cumulative gain
The Corridor
No Excess
-50,000
104
The Corridor ILlustrated
50,000
The Corridor
-50,000
Excess (11,000)
-61,000 Cumulative loss
105
Pension Expense Adjustment

• Add Amortization of net losses
• Subtract Amortization of net gains

106
Jim Again - 2001

• Assume
• Settlement rate 12

Jim
107
Effect

• Settlement rate goes up
• Costs go?
• Down
• PBO?
• Decreases

Its a Gain
108
Effect on Beginning PBO

• 53,347
• 48,428
• 4,919
• gain

• PBO 12/31/00 - 10
• PBO 12/31/00 - 12
• 16 x 35,000 x 4
• x PVA, 4yrs, 12 x PV, 3yrs, 12
• Cumulative unamortized gain (loss)?

109
Corridor?

• 10 of Greater of
• Beginning PBO 48,428
• FMV of assets 34,421
• Corridor
• 10 x 48,428 4,843

110
Excess?
4,919 Cumulative Gain
Excess 76
4,843
The Corridor
-4,843
111
Amortization

• Excess?
• 76
• Amortization period?
• 3 years
• Amortization amount?
• 76 / 3 25

3 years
112
Effect on Pension Expense?

• Add or subtract?
• Subtract

Gain Savings Reduces expense
113
2001 Service Cost

• 4 x 35,000
• x PVA,12, 4 yrs x PV, 12, 2yrs
• 1,400 x 3.0373 x 0.7972 3,390

2 years
114
2001 Interest

• 48,428 x 12 5,811

New beginning PBO x New settlement rate
115
2001 Return

• 34,421 x 8 2,754

Beginning fund balance x Expected rate of return
116
Amortization of PSC

• 27,647 / 4 6,912

Same as last year
117
2001 Pension Expense

• Service Cost 3,390
• Interest 5,811
• Return ( 2,754)
• Amortization of PSC 6,912
• Amortization of Gains ( 25)
• Pension Expense 13,334

118
Funding

• At 12/31/96 12,000
• Pension Expense 13,334
• Prepaid/Accrued 1,334 cr
• Pension Expense 13,334
• Prepaid/Accrued Pension Cost
  1,334 Cash 12,000

119
(No Transcript)
120
PBO - 12/31/2001

• New beginning balance
• Service cost
• Interest
• Ending balance

• 48,428
• 3,390
• 5,811
• 57,629

121
Fund Balance - 12/31/2001

• Beginning balance
• Return
• Funding
• Ending balance

• 34,421
• 2,754
• 12,000
• 49,175

122
2002 - New Assumptions

• Expected return 8
• Actual return 2

Its a Loss
123
Effect

• Expected return gt Actual return
• FMV of plan assets lt Expected FMV
• Will have to make it up
• Cost will go up
• Will not account for effect until 2003

124
Expected Fund Balance - 12/31/2002

• Beginning balance
• Return
• Funding
• Ending balance

• 49,175
• 3,934
• 12,000
• 65,109

125
Actual Fund Balance - 12/31/2002

• Beginning balance
• Return
• Funding
• Ending balance

• 49,175
• 984
• 12,000
• 62,159

126
Experience Gain (Loss)

• Expected fund balance
• Actual fund balance
• Experience loss

• 65,109
• 62,159
• 2,950

127
Cumulative Unamortized Gain (Loss)?

• Actuarial 4,919 gain
• Amortized 2001 (25)
• Experience 2,950 loss
• Cumulative 1,944 gain
• Carry over to 2003
• In 2003
• Apply corridor to determine whether there is an
  excess
• If no excess, no gain is amortized

128
The Funded Status of a Defined Benefit Pension
Plan

• A defined benefit pension plan may be
• Overfunded AssetsgtObligation
• Underfunded AssetsltObligation
• Fully funded AssetsObligation

129
Minimum Liability

• Companies must report at least the minimum
  liability in the balance sheet
• The minimum liability is the funded status of the
  plan measured using the ABO
• Minimum liability
• ABO minus FMV of plan assets
• If there is no minimum liability, the company
  need only report the balance in the
  Prepaid/Accrued Pension Cost account in the
  balance sheet

130
Jims ABO - 12/31/98
29,000 30,000

• 30,000 x 3 x 14
• x PVA, 10 , 4 yrs x PV, 10, 5 yrs
• 30,000 x 3 x 14 x 3.1699 x 0.6209
• 24,800

131
Minimum Liability - 12/31/98

• ABO
• FMV of fund
• Minimum liability

• 24,800
• 9,981
• 14,819

132
I have to report a liability of 14,819. But,
its not on my books. My books show a debit to
Prepaid/Accrued Pension Cost.
133
Ill create a new account. Call it Additional
Liability
134
Determine Additional Liability

• Assets Liabilities

135
Determine Additional Liability

• Assets Liabilities

Prepaid/ Accrued
1,400
136
Determine Additional Liability

• Assets Liabilities

Prepaid/ Accrued
1,400
14,819
137
Determine Additional Liability

• Assets Liabilities

Prepaid/ Accrued 1,400
16,219 A plug
14,819 Minimum liability
138
Determine Additional Liability

• Assets Liabilities

Prepaid/ Accrued 1,400
16,219 Additional liability
14,819 Minimum liability
139
Adjusting Additional Liability

• Additional Liability

-0- Beg balance 16,219 Adjustment
Credit Additional Liability
16,219 Ending balance
140
Adjusting Additional Liability

• Additional Liability

-0- Beg balance 16,219 Credit
16,219 Additional liability
141
What to Debit?

• Unamortized PSC 20,354
• Additional liability 16,219
• Intangible asset 16,219

Call it Unamortized PSC
Debit
142
Journal Entry

• Unamortized PSC 16,219
• Additional Liability 16,219

143
Recap
Additional Liability
Prepaid/Accrued
BB -0- Dr 1,400
-0- B B 16,219 Cr
1,400
16,219
Unamortized PSC
BB -0- Dr 16,219
16,219
144
Balance Sheet Assets Liabilities
Unamortized PSC
145
Pension Liability
146
(No Transcript)
147
The Minimum Liability
148
Chapter 16--Learning Objectives

• 4. Apply the disclosure requirements of SFAS No.
  87

149
SFAS No. 87 requirements

• Description of the plan
• Components of periodic pension expense
• Reconciling schedule
• Critical plan assumptions
• Other information

150
Description of the Plan

• Employee group covered
• Type of benefit formula
• Funding policy
• Types of assets held
• Significant non-benefit liabilities
• Nature and effect of significant matters
  affecting comparability of information for all
  periods presented

151
Components of Periodic Plan Expense

• Amount of net periodic pension cost for the
  period
• And the following elements
• Service cost component
• Interest cost component
• Actual return on assets for the period
• Net total of other components

152
Footnote Disclosure

• Reconcile PBO to
• Prepaid/Accrued Pension Cost

153
Reconciling Schedule Example

• Projected Benefit Obligation
  (100,000)
• Plan Assets at Fair Value
  70,000
• Funded Status
  (30,000)
• Unrecogn. Net Oblig. at Plan Initiation
  40,000
• Unrecogn. Prior Service Cost
  50,000
• Unrecogn. Net (Gain) or Loss
  (20,000)
• (Accrued) / Prepaid Pension Cost
  40,000

154
Include in Reconciling Schedule

• Fair value of plan assets
• Projected benefit obligation
• Accumulated benefit obligation
• Vested obligation
• Amount of unrecognized prior service costs
• Amount of unrecognized net gain or loss
• Amount of any remaining unamortized transition
  amount
• Amount of any additional liability

155
Critical Plan Assumptions

• Weighted average assumed discount rate and rate
  of compensation expense
• Weighted Average expected long-term rate of
  return on plan assets

156
Other Information

• Amounts and types of any securities of the
  employer and related parties included in the plan
  assets
• The approximate amount of annual benefits of
  employees and retirees covered by annuity
  contracts issued by the employer and related
  parties
• Amortization methods used

157
Chapter 16--Learning Objectives

• 5. Explain the general accounting requirements
  for other postretirement benefits

158
Other Post-Employment Benefits

• Post-retirement health care is the most
  significant
• Were initially handled on a cash basis
• FASB statements No. 87 and No. 106 apply

159
SFAS No. 87

• Disclose material annual cash outflows for
  retiree health benefits
• Describe the benefits provided
• Describe the employee groups covered
• Describe the accounting and funding policies

160
SFAS No. 106

• Must recognize periodic post-retirement benefit
  cost in earnings
• Must report the obligation to provided
  post-retirement benefits in balance sheet
• Accounting for post-retirement health benefits
  parallels pension methods

161
Components of Post-Retirement Benefit Costs

• Service cost
• Interest cost
• Amortization of prior service cost
• Actual return on plan assets
• Gain or loss on plan assets, and amortization of
  unrecognized gain or loss
• Amortization of unrecognized transition obligation

162
Definitions

• Service Cost Actuarial present value of the
  benefits attributed to services rendered by
  employees during the period
• Accumulated post-retirement benefit obligation
  Actuarial present value of all future benefits
  attributed to an employees service rendered to
  that date

163
Liability Measurement

• Actuarial assumptions
• Per capita claims cost by age
• Health care cost trends
• Medicare reimbursement rate
• Employee turnover
• Retirement age
• Mortality
• Number of covered dependents