Accounting for Post Employment Benefits

1
Chapter

• Accounting for Post Employment Benefits

2
Chapter Objectives
3
Accounting for Post Employment Benefits

• A pension plan is an agreement between a company
  and its employees that the company promises to
  provide benefits to its retired employees in
  return for the services that were provided by the
  employees during their employment.

4
Types of Pension Plans

• a. Defined contribution plan the employers
  contribution to the plan is defined by the terms
  of the plan. Future benefits (for the employees)
  are limited to those that can be provided by the
  contributions and the returns earned on the
  investment of those contribution. (Note
  Investment decision are made by employees).

5
Types of Pension Plans (contd.)

• b. Defined benefit plan a pension plan that
  states either the benefits to be received by
  employees after retirement or the method of
  determining such benefit (i.e., annual retirement
  income is Average of last 5 years salary
  number of years of service 0.0257)

6
Types of Pension Plans (contd.)

• For a defined benefit plan, most of the risks lie
  with the company because the payments to the
  employees have been defined and the company has
  the responsibility for the payment. While for the
  defined contribution plan, most the risks lie
  with the employees because the company
  responsibility end when the required periodic
  contribution has been made. This chapter focus on
  the complex accounting issues of a defined
  benefit plan.

7
Defined Benefit Plans

• A defined benefit plan may be funded or unfunded.
  
• Under a funded plan, the company typically makes
  periodic payments to a funding agency which
  assumes the responsibilities for safeguarding,
  investing the pension assets (to earn returns on
  the investments for the pension plan) and making
  payments to the recipients of benefits.

8
Defined Benefit Plans (contd.)

• For an unfunded plan, no periodic payments are
  made to an external agency and the pension
  payments to retired employees are made from
  current company resources.

9
Defined Benefit Plans (contd.)

• (Note the Pension Reform Act of 1974 has
  eliminated unfunded plans for companies. However,
  some plans are underfunded.)
• The amounts needed to fund a pension plan are
  estimated by actuaries. In addition, a defined
  benefit plan can be contributory or non
  contributory.

10
Contributory Plans

• Under a contributory plan, an employee bornes
  part of the cost and makes contributions from
  his/her salary into the pension fund. For the
  noncontributory plans, the entire cost is borne
  by the employer.The chapter is concerned with the
  non contributory plan.

11
Contributory Plans (contd.)

• For a qualified plan, the Internal Revenue Code
  allows
• 1. Employers contribution are tax deductible
• 2. Pension fund earnings are tax exempt.
• 3. Employers contribution to the pension fund not
  to be taxable to the employees until pension
  benefits are actually received.
• 4. Employees contributions to the pension fund
  not to be taxable until benefits are actually
  received.

12
Historical Prospective of Pension Plans

• 1. Accounting Research Bulletin no. 47
• recommending accrual basis rather than cash
  basis (I.e., recognize pension expenses, when
  benefits are paid). However, ARB No. 47 is not
  mandatory. Many companies were still using cash
  basis.

13
Historical Prospective of Pension Plans (contd.)

• 2. APB No. 8 Accounting for the cost of Pension
  Plans required the use of accrual method but
  allowing flexibility in calculating pension
  expense through the use of various actuarial
  methods.
• 3. FASB statement No. 35 (1980) Accounting for
  reporting by Defined Benefit Pension Plans which
  defines the disclose principles for the funding
  agencies.

14
Historical Prospective of Pension Plans (contd.)

• 4. FASB statement No. 36 (1980) Disclosure of
  Pension Benefit information requires certain
  disclosures but superseded by SFAS No. 87 (1985)
  Employers Accounting for Pensions.

15
FASB No. 87

• The discussion of pension accounting in this
  chapter is based FASB No. 87.
• The Pension liability (obligation)
• Pension obligation the deferred compensation
  obligation that companies have promised to their
  employees for their service under the terms of
  pension plan.

16
Other Alternative Measures of Pension Obligation

• a. Vested Benefits
• The benefits that the employee is entitled even
  if the employee leaves the company today. This
  benefit is computed based on current salary
  level.
• b. Accumulated benefit obligation
• Vested benefits plus nonvested benefits (Computed
  based on current salary level)

17
Other Alternative Measures of Pension Obligation
(contd.)

• c. Projected benefit obligation (FASBs choice)
• Vested benefit nonvested benefit (computed
  based on future salary level)
• c. is FASBs choice of pension obligation.

18
Capitalization vs. Non Capitalization

• Capitalization Pension liability is recognized
  in the balance sheet.
• Non capitalization Pension liability is only
  reported in the footnote (off-balance-sheet
  financing)
• Prior to FASB No. 87, the accounting for Pension
  Plan was a non capitalization approach. FASB No.
  87 adopts a partial capitalization approach.

19
Pension Liability

• Pension liability is the pension benefit that
  companies have promised to pay employees (for the
  deferred compensation). When liability occurs
  (but not paid), pension expense should be
  recognized. Pension liability will only be
  reduced when benefits are paid.

20
Pension Liability (contd.)

• Funding of pension plans does not reduce pension
  liability. It (funding) is considered as a
  pledged collateral against pension liability.
• Pension liability is affected by 2 factors
• employers promises
• the benefit payment
• Therefore, the under or overfunding pension plans
  does not affect pension liability at all.

21
Pension Cost

• The determination of Pension Cost (expense) is
  extremely complicated because it is a function of
  the following components
• 1.() Service Cost
• 2.() Interest on the Liability
• 3. (-) Actual Return on Plan Assets
• 4. () Amortization of Unrecognized Prior Service
  Cost
• 5.( or -) Amortization of Unrecognized Net Gain
  or Loss

22
Pension Cost1.() Service Cost

• The present value of the new benefits earned by
  the employees during the year. The service cost
  for the year is provided by actuary. (Effect on
  pension expense increases pension expense)

23
Pension Cost2.() Interest on the Liability

• Interest expense accrues each year or the
  projected benefit obligation using a settlement
  rate. (increases pension expense)

24
Pension Cost3. (-) Actual Return on Plan Assets

• The return earned by the accumulated pension fund
  assets in a particular year. The return includes
  interests, dividends and the changes in the
  market value of the fund assets. (in general,
  decreases pension expense)

25
Pension Cost4. () Amortization of Unrecognized
Prior Service Cost

• The retroactive benefits (earned by employees for
  the service years prior to the adoption of the
  pension plan) are allocated to pension expense in
  the future (i.e., to the remaining service -
  years of the affected employees). (generally
  increases pension expense).

26
Pension Cost5.( or -) Amortization of
Unrecognized Net Gain or Loss

• The gain or loss includes 2 components
• (a) the difference between the actual return on
  plan assets and the expected return
• (b) the amortization of changes in the projected
  benefit obligation (these changes occur when
  actuarial assumptions are modified or when actual
  experience differs from expected experience) from
  previous period.

27
Pension Cost5.( or -) Amortization of
Unrecognized Net Gain or Loss (contd.)

• The amount of unrecognized net gain or loss from
  (b) is amortized over the future years and this
  amortization is included in the pension expense
  of a gain or loss from previous periods exceeds
  10 of the greater of the actual projected
  benefit obligation or the fair value of the plan
  assets.

28
Pension Cost5.( or -) Amortization of
Unrecognized Net Gain or Loss (contd.)

• The purpose of the amortization of net gain or
  loss is to smooth out the effect of changes and
  reduce the volatility of the pension expense
  reported annually. The amortization of net gain
  is subtracted from pension expense computation,
  and the amortization of net loss is added.

29
The components of pension expense are exhibited
in the diagram below.
30
Accounting for Pension (FASB No. 87) Example 1

• To illustrate the use of a work sheet and how it
  helps in accounting for a pension plan, assume
  that on January 1, 1992, Zarle Company adopts
  FASB Statement No. 87 to account for its defined
  benefit pension plan. The following facts apply
  to the pension plan for the year 1992

31
Example 1 (contd.)

• Plan assets, January 1, 1992, are 100,000.
• Projected benefit obligation, January 1, 1992, is
  100,000.
• Annual service cost for 1992 is 9,000.
• Settlement rate for 1992 is 10.
• Actual return on plan assets for 1992 is 10,000.
• Contributions (funding) in 1992 are 8,000.
• Benefits paid to retirees in 1992 are 7,000.

32
Example 1 (contd.)

• Using the data presented above, the work sheet
  presents the beginning balances and all of the
  pension entries recorded by Zarle Company in
  1992.
• The beginning balances for the projected benefit
  obligation and the pension plan assets are
  recorded on the first line of the work sheet in
  the memo record. They are not recorded in the
  formal general journal and, therefore, are not
  reported as a liability and an asset in the
  financial statements of Zarle Company.

33
Example 1 (contd.)

• These 2 significant pension items are
  off-balance-sheet amounts that affect pension
  expense but are not recorded as assets and
  liabilities in the employers book.

34
Example 1 (contd.)
34
Accounting for Post Employment Benefits
35
Example 1 (contd.)

• Entry (a) records the service cost component,
  which increases pension expense 9,000 and
  increase the liability (projected benefit
  obligation)9,000.
• Entry (b) accrues the interest expense component,
  which increases both the liability and the
  pension expense by 10,000 (the beginning
  projected benefit obligation multiplied by the
  settlement rate of 10).

36
Example 1 (contd.)

• Entry (c) records the actual return on the plan
  assets, which increases the plan assets and
  decreases the pension expense.
• Entry (d) records Zarle Companys contribution
  (funding) of assets to the pension fund cash is
  decreased 8,000 and plan assets are increased
  8,000.
• Entry (e) records the benefit payments made to
  retirees, which results in equal 7,000 decrease
  to the plan assets and the projected benefit
  obligation.

37
Example 1 (contd.)

• The formal journal entry on 12/31/92 is
• Pension Expense 9,000
• Cash 8,000
• Prepaid/Accrued Pension Cost 1,000
• The 1,000 of accrued pension cost represents the
  different between the pension expense and the
  funded amount. This represents a liability
  because the plan is underfunded by 1,000. Both
  the projected benefit obligation (112,000) and
  plan assets (111,000) are off-balance-sheet
  items.

38
Example 1 (contd.)

• The reconciliation of the off-balance-sheet items
  and the prepaid/accrued pension cost account is
  shown below
• Projected benefit obligation(Cr.) (112,000)
• Plan Assets at fair value(De.) 111,000
• Prepaid/accrual pension cost (Cr.) (1,000)

39
Example 2 with unrecognized prior service cost
(PSC)

• When a defied benefit plan is adopted (or
  amended), credit (PSC) is often given to
  employees for years of service provided before
  the date of adoption or amendment. As a result of
  PSC, the projected pension obligation is greater
  than before.

40
Example 2 (contd.)

• The PSC (represent the retroactive benefit) is
  not recognized as pension expense entirely in the
  year of adoption (or amendment) but is recognized
  during the service period of those employees who
  are expected to receive benefits under the plan
  (PSC is amortized over the remaining service life
  of the covered active employees)

41
Example 2 (contd.)

• The Board prefers a years-of-service method in
  amortizing the PSC. To illustrate the
  amortization of the unrecognized PSC under the
  year-of-service-method, assume Zarle Company
  defined benefit pension plan covers 170
  employees. Zarle amends its pension plan on
  1/1/93 and grants 80,000 of PSC to its
  employees. The employees are grouped as follows
  according to expected years of retirement

42
Example 2 (contd.)

• Number of Expected
• Group Employees Retirement on 12/ 31
• A 40 1993
• B 20 1994
• C 40 1995
• D 50 1996
• E 20 1997
• ____________
• 170

43
Example 2 (contd.)

• The computation of the service-year per year and
  the total service-years is shown as follows
• Computation of Service-Years
• Service-Years
• Year A B C D E Total
• 1993 40 20 40 50 20 170
• 1994 20 40 50 20 130
• 1995 40 50 20 110
• 1996 50 20 70
• 1997 20 20
• 40 40 120 200 100 500

44
Example 2 (contd.)

• Computed on the basis of a prior service cost of
  80,000 and a total of 500 service-year for all
  years, the cost per service-year is 160 (80,000
  / 500). The annual amount of amortization based
  on a 160 cost per service-year is computed as
  follows

45
Example 2 (contd.)Computation of Annual Prior
Service Cost Amortization

• Total Cost Per Amount
• Year Service-Year ? Service-Year Amortization
• 1993 170 160 27,200
• 1994 130 160 20,800
• 1995 110 160 17,600
• 1996 70 160 11,200
• 1997 20 160 3,200
• 500 80,000

46
??

• FASB Statement No. 87 allows an alternative
  method of computing amortization of unrecognized
  prior service cost employers may use
  straight-line amortization over the average
  remaining service life of the employees.
• In this case, with 500 service years and 170
  employees, the average would be 2.94 years (500 /
  170). Using this method, the 80,000 cost would
  be charged to expense at 27,211 (80,000/2.94)
  in 1993, 27,211 in 1994, and 25,578 (27,211 ?
  .94) in 1995.

47
??

• If the Board had adopted full capitalization of
  all elements of the pension plan, the prior
  service cost would have been capitalized as an
  intangible asset -- pension goodwill--and
  amortized over its useful life. The intangible
  asset (goodwill) comes from the assumption that
  the cost of additional pension benefits increases
  loyalty and productivity (and reduce turnover)
  among the affected employees.
• However, prior service cost is accounted for
  off-balance-sheet and is called unrecognized
  prior service cost. Although not recognized on
  the balance sheet, prior service cost is a factor
  in computing pension expense.

48
??

• Continuing the Zarle Company illustration into
  1993, the amendment on 1/1/93 grants employees
  PSC with a present value of 80,000. In addition,
  the following facts also apply to pension plan of
  Zarle for the year of 1993
• Annual service cost for 1993 is 9,500.
• Settlement rate for 1993 is 10.
• Actual return on plan assets for 1993 is
  11,000.
• Annual contributions (funding) are 20,000.
• Benefits paid to retires in 1993 are 8,000.
• Amortization of prior service cost (PSC) using
  the years-of -service method is 27,200.

49
The following work sheet presents all of the
pension entries and information recorded by Zarle
Company in 1993.
50
??

• The first line of the work sheet shows the
  beginning balances of the Prepaid/Accrued Pension
  Cost account and the memo accounts. Entry (f)
  records Zarle Companys granting of prior service
  cost by adding 80,000 to the projected benefit
  obligation and to the unrecognized
  (noncapitalized)prior service cost. Entries (g),
  (h), (i), (k),(l) are similar to the
  corresponding entries in 1992. Entry (j) records
  the 1993 amortization of unrecognized prior
  service cost by debiting Pension Expense by
  27,200 and crediting the new Unrecognized Prior
  Service Cost account by the same amount.

51
??

• The journal entry on 12/31/93 is
• Pension Expense 44,800
• Cash 20,000
• Prepaid/accrued Pension Cost 24,800

52

• The reconciliation of prepaid/accrued pension
  cost and the off-balance-sheet items is in the
  following schedule
• Reconciliation Schedule--December 31,1993
• Projected benefit obligation (Credit) (212,700)
• Plan assets at fair value (Debit) 134,100
• Funded status (78,600)
• Unrecognized prior service cost (Debit)
  52,800
• Prepaid/accrued pension cost (Credit) (25,800)
• The reconciliation is the formula that makes the
  work sheet work. It relates the components of
  pension accounting, recorded and unrecorded, to
  one another.

53
Gain or Loss

• A. Smoothing unexpected gains and losses on plan
  assets returns ( Asset gains losses).
• B. Smoothing unexpected gains and Losses in the
  pension liability (Liability gains and Losses).

54
A. Smoothing unexpected gains and losses on plan
assets returns ( Asset gains losses)

• The actual return on plan assets reduces pension
  expense (assuming a positive return). A large
  change in the actual return are affect pension
  expense for a year. The funding amount estimated
  by the actuaries is based on the expected return
  on plan assets (not based on the actual return to
  avoid the fluctuations. As a result, pension
  expense needs to be adjusted for the difference
  between the expected return and the actual
  return. This difference is referred to as the
  unexpected gain (when the actual return is
  greater than the expected return) or unexpected
  loss (when the actual return is less than the
  expected return).

55
A. Smoothing unexpected gains and losses on plan
assets returns ( Asset gains losses) (contd.)

• An unexpected gain will increase pension expense
  and an unexpected loss will decrease pension
  expense (to adjust the pension expense to include
  the expected return rather than the actual
  return).

56
Example

• Assume that Shierer Company in 1994 has an actual
  return of 16,000 when the expected return is
  13,410 (the expected rate of return ? plan
  assets at the beginning of the year). The
  unexpected gain of 2,590 is debited to pension
  expense and increases the unrecognized net gain
  or loss account (an off-balance-sheet item). The
  unrecognized net gain or loss is a cumulative
  from period to period off-balance-sheet account.

57
B. Smoothing unexpected gains and Losses in the
pension liability (Liability gains and losses)

• In estimating the projected pension obligation
  (the liability), the actuaries make assumptions
  about items such as rate, retirement rate,
  turnover rate, disability rate, and salary
  amount. Any change in these actuarial assumptions
  changes the amount of projected pension
  obligation.
• The unexpected gains or losses from changes in
  the projected pensions obligation are called
  liability gains and losses.

58
B. Smoothing unexpected gains and Losses in the
pension liability (Liability gains and losses)
(contd.)

• Liability gains (resulting from unexpected
  decreases in the liability balance) and liability
  losses (unexpected increase in the liability) are
  deferred (unrecognized). The liability gains and
  losses are combined in the same unrecognized net
  gain or loss account (an off-balance-sheet item)
  used for asset gains and losses discussed
  earlier. They are accumulated from year to year,
  off-balance-sheet, in a memo record account.

59
Corridor Amortization

• Because the asset gains and losses and the
  liability gains and losses can be offsetting, the
  accumulated total unrecognized net gain or loss
  may not grow too large. But, it is possible that
  no offsetting will occur and that the balance in
  the Unrecognized Net gain or Loss account will
  continue to grow.

60
Corridor Amortization (contd.)

• To limit its growth, the FASB invented the
  corridor approach for amortizing the accumulated
  balance in the Unrecognized gain and Loss account
  when it gets too large. The unrecognized net gain
  or loss balance gets too large and must be
  amortized 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.

61
Corridor Amortization (contd.)To illustrate the
corridor approach, assume data on the projected
benefit obligation and the plan assets over a
period of 6 years as shown in the schedule below.

• Projected
  Market-Related
• Beginning-of-the- Benefit Asset Corridor
• Year Balance Obligation Value /-
  10
• 1991 1,000,000 900,000 100,000
• 1992 1,200,000 1,100,000 120,000
• 1993 1,300,000 1,700,000 170,000
• 1994 1,500,000 2,250,000 225,000
• 1995 1,700,000 1,750,000 175,000
• 1996 1,800,000 1,700,000 180,000
• The corridor becomes 10 of the larger (in
  boldface) of the projected benefit obligation or
  the market-related plan asset value.

62
Graphic Illustration of the Corridor
63
???

• If the balance of the Unrecognized Net gain or
  Loss account stays within the upper and lower
  limits of the corridor, no amortization is
  required-- the unrecognized net gain or loss
  balance is carried forward unchanged.

64
???

• If amortization is required, the minimum
  amortization shall be the excess divided by the
  average remaining service period of active
  employees expected to receive benefits under the
  plan. Any systematic method of amortization of
  unrecognized gains and losses may be used in lieu
  of the minimum, provided it is greater than the
  minimum, is used consistently for both gains and
  losses, and is disclosed.

65
???

• Illustration. In applying the corridor, the
  Board decided that amortization of the excess
  unrecognized net gain or loss should be included
  as a component of pension expense only if, as of
  the beginning of the year, the unrecognized net
  gain or loss exceeded the corridor. That is, if
  no unrecognized net gain or loss existed at the
  beginning of the period, no recognition of gains
  or losses can result in that period.

66
??

• To illustrate the amortization of unrecognized
  net gains and losses,m assume the following
  information for Soft-White, Inc.
• 1992 1993 1994
• (beginning of the year)
• Projected benefit
• obligation 2,100,000 2,600,000 2,900,000
• Market-related
• asset value 2,600,000 2,800,000 2,700,000
• Unrecognized
• net loss -0- 400,000 300,000

67
??

• If the average remaining service life of all
  active employees is 5.5 years, the schedule to
  amortize the unrecognized net loss is as follows
• Corridor Test and gain/Loss Amortization
  schedule

a. All as of the beginning of the period b. 10
of the greater of projected benefit obligation or
plan market-related value. c. 400,000 - 280,000
120,000 / 5.5 21,818 d. 400,000- 21,818
300,000 678,182 678,182 - 290,000
388,182 388,182 / 55 70,579.
68
??

• As indicated from the schedule, the loss
  recognized in 1993 increased pension expense by
  21,818. This amount is small in comparison with
  the total loss of 400,000 and indicates that the
  corridor approach dampens the effects (reduces
  volatility) of these gains and losses on pension
  expense.

69
??

• The rationale for the corridor is that gains and
  losses result from refinements in estimates as
  well as real changes in economic value and that
  over time some of these gains and losses will
  offset one another. It therefore seems reasonable
  that gains and losses should not be recognized
  fully as component of pension expense in the
  period in which they arise.

70
??

• However, gains and losses that arise from a
  single occurrence not directly related to the
  operation of the pension plan and not in the
  ordinary course of the employers business should
  be recognized immediately. A gain or loss that is
  directly related to a plant closing, a disposal
  of a segment or a similar event that greatly
  affects the size of the employee work force,
  shall be recognized as a part of the gain or loss
  associated with that event.

71
??

• At one time, Bethlehem Steel reported a
  third-quarter loss of 477 million, one of the
  largest quarterly deficits ever recorded by a
  U.S. corporation. A great deal of this loss was
  attributable to future estimated benefits payable
  to workers who were permanently laid off. In this
  situation, the loss should be treated as an
  adjustment to the gain or loss on the plant
  closing and should not affect pension cost for
  the current or future periods

72
Summary Gain and Loss Adjustment

• After considering the unexpected gain or loss on
  assets, it is really the expected return on plan
  assets (not the actual return) that determines
  current pension expense.

73
Summary Gain and Loss Adjustment(contd.)

• The amortization of cumulative unrecognized net
  gain or loss at the beginning of the year is
  subject to the corridor limitation. Only if the
  cumulative unrecognized net gain or loss
  exceeding the corridor, these net gains or losses
  are subject to amortization. This amortization is
  computed by dividing the net gains or loses over
  the average service period.

74
Summary Gain and Loss Adjustment(contd.)

• When the unexpected gain or loss or assets is
  combined with the amortization of the cumulative
  unrecognized net gains or losses, the combined
  amount is referred to simply as gain or loss.
• Note Amortized net gain will reduce pension
  expense while amortized net loss will increase
  pension expense. Unexpected gain or asset return
  will increase pension expense while unexpected
  loss or asset return will reduce pension expense.
• The summary is illustrated graphically on next
  page

75
Graphic Illustration
76
Example 3 With Unrecognized Net Gain or Loss

• Continuing the Zarle company illustration into
  1994, the following facts apply to the pension
  plan
• Annual service cost for 1994 is 13,000.
• Settlement rate is 10expected earnings rate is
  10.
• Actual return on plan assets for 1994 is
  12,000.
• Amortization of prior service cost (PSC) in 1994
  is 20,800.
• Annual contributions (funding) are 24,000
• Benefits paid to retirees in 1994 are 10,500.
• Changes in actuarial assumptions establish the
  end-of-year projected benefit obligation at
  265,000.

77
Example 3 (contd.)

• The 1994 pension work sheet of Zarle is presented
  as follows

78
Example 3 (contd.)

• Entries (m), (n), (o), (q), (r), and (s) are
  similar to the corresponding entries preciously
  explained in 1992 or 1993.
• Entries (o) and (p) are related. Recording the
  actual return in entry (o) has been illustrated
  in both 1992 and 1993 it is recorded similarly
  in 1994. In both 1992 and 1993 it was assumed
  that the actual return on plan assets was equal
  to the expected return on plan assets.

79
Example 3 (contd.)

• In 1994 the expected return of 13,410 (the
  expected rate of return of 10 times the
  beginning-of-the-year plan assets balance of
  134,100) is higher than the actual return of
  12,000. To smooth pension expense, organized net
  gain or loss account and crediting Pension
  Expense. As a result of this adjustment, the
  expected return on the plan assets is the amount
  actually used to compute pension expense.

80
Example 3 (contd.)

• Entry (t) records the changes in the projected
  benefit obligation resulting from a change in
  actuarial assumptions. As indicated, the actuary
  has now computed the ending balance to be
  265,000. Given that the memo record balance at
  December 31 is 236,470 (212,700 13,000
  21,270 -10,500), a difference of 28,530
  (265,000 - 236,470) is indicated. This 28,530
  increase in the employers liability is an
  unexpected loss that is deferred by debiting it
  to the Unrecognized Net gain or Loss account.

81
Example 3 (contd.)

• The journal entry on December 31 to formally
  record pension expense for 1994 is as follow
• Pension Expense 41,660
• Cash 24,000
• Prepaid/Accrued
• pension cost 17,660

82
Example 3 (contd.)

• As illustrated in the work sheets of 1992 and
  1993, the balance of the Prepaid/Accrued pension
  Cost account at December 31, 1994 of 43,460 is
  equal to the net of the balances in the memo
  accounts as shown below

83
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• Record an asset if the fair value of plan assets
  exceeds the accumulated benefit obligation.

84
Example of Minimum Liability Computation

• If a liability for accrued pension cost is
  already reported, only an additional liability to
  equal the required minimum liability (unfunded
  accumulated benefit) is recorded. To illustrate,
  assume that Largent Inc. amends its pension plan
  on December 31, 1992, giving retroactive benefits
  to its employees.
• Project benefit obligation 8,000,000
• Accumulated benefit obligation 7,000,000
• Plan assets (at fair value) 5,000,000
• Market-related asset value 4,900,000
• Unrecognized prior service cost 2,500,000
• Accrued pension cost 500,000

85
Example of Minimum Liability Computation (contd.)

• The unfunded accumulated benefit is computed as
  follows
• Accumulated benefit obligation 7,000,000
• Plan assets (at fair value) 5,000,000
• Unfunded accumulated benefit
• obligation (minimum liability) 2,000,000

86
Example of Minimum Liability Computation (contd.)

• Note that the fair value of the plan assets is
  used, not the market-related asset value to
  compute the unfunded accumulated benefit
  obligation. In this case, an additional
  1,500,000 is required to be recorded as a
  liability and reported on the financial
  statements. The computation is as follows
• Unfunded accumulated benefit
• (minimum liability) 2,000,000
• Accrued pension cost
• (balance at December 31, 1992) 500,000
• Additional liability required 1,500,000

87
Example of Minimum Liability Computation (contd.)

• Largent Inc. would combine the accrued pension
  cost and the additional liability into one amount
  and report it in the balance sheet as accrued
  pension cost or pension liability in the amount
  of 2,000,000.

88
Example of Minimum Liability Computation (contd.)

• If Largent Inc. had a prepaid pension cost of
  300,000 instead of an accrued pension cost of
  500,000, an additional liability of 2,300,000
  would be recorded as follows
• Unfunded accumulated benefit
• (minimum liability) 2,000,000
• Prepaid pension cost 300,000
• Additional liability required 2,300,000

89
Example of Minimum Liability Computation (contd.)

• The existing balance in the prepaid pension cost
  (debit) is combined with the additional liability
  (credit) into one amount and reported as accrued
  pension cost or pension liability in the net
  amount of 2,000,000.

90
Financial Statement Presentation

• When it is necessary to adjust the accounts to
  recognize a minimum liability, the debit should
  be to an intangible asset that is called
  Intangible Asset -- Deferred Pension Cost. The
  entry to record the liability and related
  intangible asset for Largent Inc. (first case)
  is
• Intangible Asset --
• Deferred Pension Cost 1,500,000
• Additional Pension Liability 1,500,000

91
Financial Statement Presentation (contd.)

• One exception to the general rule of reporting an
  intangible asset is when the additional liability
  exceeds the amount of unrecognized prior service
  cost. In this case, the excess is debited to
  Excess of Additional Pension Liability Over
  Unrecognized Prior Service Cost.
• The excess should report as a contra account in
  the stockholder equity auction.

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• The amount of the additional liability required
  should be evaluated each reporting period along
  with the related intangible asset or contra
  equity account. At each reporting date, these
  items above may be increased, decreased, or
  totally eliminated. Neither the intangible asset
  nor the contra equity account is amortized from
  period to period the balance are merely adjusted
  up or down.

93
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• The minimum liability approach to the Zarle
  Company pension plan for all three years 1992,
  1993 and 1994 is illustrated in the following
  schedule (values are assumed for the accumulated
  benefit obligation).

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95
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• In 1992 the fair value of the plan assets exceeds
  the accumulated benefit obligation therefore, no
  additional liability need be reported. The Board
  does not permit the recognition of a net
  investment in the pension plan when the plan
  assets exceed the pension obligation.

96
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• In 1993, the minimum liability amount (29,900)
  exceeds the accrued pension cost liability
  already recorded (25,800), so an additional
  liability of 44,100 (29,900 - 25,800) is
  recorded as follows
• December 31, 1993
• Intangible Asset --
• Deferred Pension Cost 4,100
• Additional Pension Liability 4,100

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• In 1994, the minimum liability (81,000) exceeds
  the accrued pension cost liability (43,460), so
  an additional liability of 37,540 must be
  reported at the end of 1994. Since a balance of
  4,100 already exists in the Additional Liability
  account, it is credited for 33,440 (37,540 -
  4,100). Also, since the additional liability
  exceeds the unrecognized prior service cost by
  5,540, the excess is debited to the contra
  equity account Excess of Additional Liability
  Over Unrecognized Prior Service Cost.

98
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• The remainder 27,900 (33,440 - 5,540) is
  debited to the Intangible Asset -- Deferred
  Pension Cost. The entry on December 31, 1994 to
  adjust the minimum liability is as follows
• December 31, 1994
• Intangible Asset --
• Deferred Pension Cost 27,900
• Excess of Additional Pension Liability
• Over Unrecognized Prior Service Cost 5,540
• Additional Pension Liability 33,430

99
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• As the additional liability changes, the combined
  debit balance of the intangible asset and contra
  equity accounts fluctuates by the same amount.

100
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101
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102
Work Sheet Illustration

• To illustrate how the pension work sheet is
  affected by the minimum liability computation, a
  revised version of the 1994 work sheet of Zarle
  Company is shown on page 1115. The boldface items
  entry (u) relate to adjustments caused by
  recognition of the minimum liability at the end
  of 1993 and 1994.

103
Work Sheet Illustration (contd.)

• As illustrated in prior work sheets, the balance
  in the Prepaid/Accrued Pension Cost account
  (43,460) equals the net of the balances in the
  memo accounts (265,000 - 159,600 32,000
  29,940). With the Additional Liability amount
  being combined with the Prepaid/Accrued Pension
  Cost amount in order to report the minimum
  pension liability in the balance sheet, the
  reconciliation at December 31, 1994 as shown
  below has an added element in it

104
Reconciliation Schedule -- 1994 (Revised)

• Projected benefit obligation (Credit) (265,000)
• Plan assets at fair value (Debit) 159,600
• Funded status (105,400)
• Unrecognized prior service cost (Debit) 32,000
• Unrecognized net loss (Debit) 29,940
• Prepaid/Accrued pension cost (Credit) (43,460)
• Additional liability (Credit) (37,540)
• Accrued pension cost liability
• recognized in the balance sheet (81,000)

105
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• Reporting Pension Plans in Financial statement
  within the financial statements
• Pension Exp. xxx
• Cash xxx
• Prepaid/Accrued
• Pension Cost xxx

106
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• The prepaid/accrued Pension Cost is a ???? if it
  has a credit balance. The liability is ???? If it
  requires the disbursement of cash within the next
  year. If the prepaid/accrued Pension Cost has a
  debit balance, it is an asset. Also, if the
  accumulated benefit obligation exceeds the ???
  Value of plan assets, an additional Liability is
  recorded and reported. The debit is either to an
  intangible asset account - a deferred Pension
  Cost or to a contra stockholder equity account.

107
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• Within the Notes to the financial statements, the
  general disclosures and rationales are as follows

108
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• 1. A description of the plan including employee
  groups covered, type of benefit formula, funding
  policy, type of assets held, and the nature and
  effect of significant maters affecting
  comparability of information for all periods
  presented.

109
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• Rationale - Because the measurement of pension
  expense is based on the benefit formula, a
  description of the plan and the benefit formula
  is useful. Furthermore, disclosure of funding
  policies and types of assets held helps determine
  future cash flows and their likelihood as well as
  highlights the difference between cash flow and
  pension expense. Finally, significant events
  affecting the plan are disclosed so the reader
  can predict the effect of these events on
  long-term trends of the plan.

110
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• 2. The components of net periodic pension cost
  (pension expense) for the period.
• Rationale - Information on the components helps
  users better understand how pension expense is
  determined and why it changes from one period to
  the next.

111
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• 3. A schedule reconciling the funded status of
  the plan with amounts reported in the employers
  statement of financial position, showing
  separately
• (a) Plan assets available for benefits (at fair
  value).
• (b) The Projected benefit obligation identifying
  the accumulated benefit obligation and the vested
  benefit obligation.
• (c) The amount of unrecognized prior service cost.

112
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• (d) The amount of unrecognized net gain or loss.
• (e) The amount of any remaining net asset or
  liability existing at transition due to FASB
  Statement No. 87.
• (f) The amount of any additional liability
  recognized.
• (g) The amount of prepaid pension cost or accrued
  pension cost recognized in the balance sheet
  (which is the net result of combining items (a)
  through (f) above).

113
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• Rationale - The components of the pension
  obligation are disclosed, including the funded
  status of the plan. For example, is there an
  unfunded projected benefit obligation ?
  Furthermore, disclosure of vested benefits (for
  which the employees right to receive a present
  of future pension benefit is no longer contingent
  on remaining in the service of the employer),
  identifies the firmness of a companys
  liability. Finally reconciling the plans funded
  status to the amount reported on the balance
  sheet highlights the difference between the fund
  status and balance sheet presentation.

114
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• 4. The weighted-average discount rate, the rate
  of compensation increase used to measure the
  projected benefit obligation, and the
  weighted-average expected long-run rate of return
  on plan assets.
• Rationale - Disclosure of these rates permits the
  reader to determine the reasonableness of the
  assumptions applied to measuring the liability
  and certain components of pension expense.

115
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• In summary, the disclosure requirements are
  extensive, and purposely so. One factor that has
  made pension reporting difficult to understand in
  the past has been the lack of consistent
  terminology. Furthermore, a substantial amount of
  offsetting has been done to arrive at pension
  expense and the related pension liability. These
  disclosures should take some of the mystery of
  pension reporting.

116
Illustration of Pension Note Disclosure

• In addition to the detailed description of the
  pension plan and other disclosures about the
  operation of the plan during the year, the
  employer is required to identify the components
  of pension expense and to reconcile pension plan
  assets and liabilities recorded in the memo
  record with assets or liability amounts reported
  in the financial statements.

117
Components of Pension Expense

• The Board requires disclosure of the individual
  pension expense components - (1) service cost,
  (2) interest cost, (3) actual return on assets,
  and (4) all other costs combined - so that the
  more sophisticated readers can understand how
  pension expense is determined. Using the
  information from the Zarle Company illustration,
  the component cost information, taken from the
  first (left hand) column of the work sheets, for
  each of the three years, is presented in the
  following schedule

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119
Reconciliation Schedule

• The Boards requirement that off-balance-sheet
  assets, liabilities, and unrecognized gains and
  losses be reconciled with the on-balance-sheet
  asset or liability can be confusing, But, some
  consider this reconciling schedule the key to
  understanding FASB Statement No. 87 and pension
  plan accounting. The format of this
  reconciliation schedule, as illustrated in
  Statement No. 87, is shown below.

120

121
Illustration of Pension Note Disclosure

• With the exception of the vested benefit
  obligation and the accumulated benefit obligation
  included in the reconciliation schedule above, we
  have illustrated this reconciliation for each of
  the work sheets presented thus far in the
  chapter. What we called additional liability
  (credit) in the 1994 revised reconciliation on
  page 1116 is called adjustment required to
  recognize minimum liability in Statement No.
  87s disclosure requirements.

122
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• Why is such a detailed listing of these
  unrecognized items necessary?
• The FASB gave the following explanation is its
  Basis of Conclusions section17 The Board
  acknowledges that the delayed recognition
  included in this statement results in excluding
  the most current and most relevant information
  from the employers financial statements of
  financial position. That information is, however,
  included in the disclosures required, and
  certain liabilities previously omitted will be
  recognized.

123
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• The reconciliation schedule for Zarle Company,
  shown below, is prepared from the last line of
  each of the pension work sheets previously
  prepared. Only the actuarially provided amounts
  for vested benefit obligation and accumulated
  benefit obligation need to be obtained outside
  the work sheet (we use assumed values in our
  illustration).

124

125
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• The 1992 column reveals the projected benefit
  obligation to be underfunded by 1,000.
• The 1993 column reveals that the underfunded
  liability of 78,600 is reported in the balance
  sheet at 29,900 because of 52,800 of
  unrecognized prior service cost and 4,100 of
  additional liability.

126
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• The 1994 column reveals that the underfunded
  liability of 105,400 is reported in the balance
  sheet at 81,000 because of 32,000 of
  unrecognized prior service cost, 19,940 of
  unrecognized net loss, and 37,540 of additional
  liability.