20-1 7.Explain the accounting for unexpected gains and losses. 8. Explain the corridor approach to...

20-1

After studying this chapter, you should be able to:

LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES

1. Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. (SELF-STUDY)

2. Identify types of pension plans and their characteristics. (SELF-STUDY)

3. Explain alternative measures for valuing the pension obligation.

4. List the components of pension expense.

5. Use a worksheet for employer’s pension plan entries.

6.6. Describe the amortization of prior service Describe the amortization of prior service

costs.costs.

Accounting for Pensions and Postretirement Benefits2020

20-2

PREVIEW OF CHAPTERPREVIEW OF CHAPTER 2020

20-3

6. Describe the amortization of prior service costs.

7. Explain the accounting for unexpected gains and losses.

8. Explain the corridor approach to amortizing gains and losses.

9. Describe the requirements for reporting pension plans in financial statements.



1. Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

2. Identify types of pension plans and their characteristics.





20-4

An arrangement whereby an employer provides benefits (payments) to

retired employees for services they provided in their working years.

Pension PlanAdministrator

Pension PlanAdministrator

ContributionsEmployerEmployer

Retired Employees Benefit Payments Assets &

Liabilities

Nature of Pension Plans

LO 1

20-5

Pension plans can be:

Contributory: employees voluntarily make payments to

increase their benefits.

Noncontributory: employer bears the entire cost.

Qualified pension plans: offer tax benefits.

Pension fund should be a separate legal and accounting

entity.


LO 1

20-6


LO 1

Illustration 20-2Pension Funds andPension Expense

The two most common types of pension plans are defined

contribution plans and defined benefit plans.

20-7













20-8

Defined-Contribution PlanDefined-Contribution Plan Defined-Benefit Plan

Employer contribution

determined by plan (fixed)

Risk borne by employees

Benefits based on plan

value

Benefit determined by plan

Employer contribution

varies (determined by

Actuaries)

Risk borne by employer

Actuaries make predictions (called actuarial assumptions) of mortality

rates, employee turnover, interest and earnings rates, early retirement

frequency, future salaries, and any other factors necessary to operate a

pension plan


LO 2

20-9













20-10

Two questions:

1) What is the pension obligation that a company should

report in the financial statements?

2) What is the pension expense for the period?

Accounting for Pensions

LO 3

20-11

Employer’s pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan.

Alternative Measures of the Liability


Illustration 20-3

FASB’s choice

LO 3

20-12

Recognition of the Net Funded Status of the Pension Plan

Companies must recognize on their balance sheet the

full overfunded or underfunded status of their defined

benefit pension plan.


LO 3

The overfunded or

underfunded status is

measured as the difference

between the fair value of the

plan assets and the

projected benefit obligation.

20-13













20-14


Illustration 20-4Components of AnnualPension Expense

LO 4

20-15

Service Costs ++1.1.


Components of Pension Expense

Actuarial present value of benefits attributed by the pension

benefit formula to employee service during the period

Effect on Expense

LO 4

20-16

Interest on the Liability ++2.2.



Interest for the period on the projected benefit obligation

outstanding during the period

The interest rate use is referred to as the settlement rate.

Effect on Expense

LO 4

20-17

Actual Return on Plan Assets +-+-3.3.



Increase in pension funds from interest, dividends, and

realized and unrealized changes in the fair value of the plan

assets.

Illustration 20-5

Effect on Expense

LO 4

20-18



Plan amendments often include provisions to increase

benefits for employee service provided in prior years.

Company allocates the cost (prior service cost) of providing

these retroactive benefits to pension expense in the future,

specifically to the remaining service-years of the affected

employees.

Amortization of Prior Service Costs ++4.4.

Effect on Expense

LO 4

20-19

Gain or Loss +-+-5.5.


Components of Pension Expense Effect on Expense

Volatility in pension expense can result from sudden and

large changes in the fair value of plan assets and by changes

in projected benefit obligation.

LO 4

20-20













20-21

Pension Work SheetGENERAL JOURNAL ENTRIES MEMO RECORD

Annual Prior Pension ProjectedPension Service Asset / Benefit Plan

Items Expense Cash Costs (PSC) Gain/Loss Liability Obligation Assets

Other Comprehensive Income (OCI)

The “General Journal Entries” columns

determine the journal entries to be

recorded in the formal general ledger.

The “Memo Record”

columns maintain balances

for the unrecognized

pension items.

Using a Pension Worksheet

LO 5

20-22

Illustration: On January 1, 2014, Zarle Company provides the

following information related to its pension plan for the year 2014.

Plan assets, January 1, 2014, are $100,000.

Projected benefit obligation, January 1, 2014, is $100,000.

Annual service cost is $9,000.

Settlement rate is 10 percent.

Actual return on plan assets is $10,000.

Funding contributions are $8,000.

Benefits paid to retirees during the year are $7,000.

Prepare the pension worksheet for 2014.

Using a Pension Work Sheet

LO 5

20-23

Pension Projected Pension Asset / Benefit Plan

Items Expense Cash PSC Gain/Loss Liability Obligation Assets

Jan. 1, 2014 0 (100,000) 100,000

Service costs 9,000 (9,000)

Interest costs 10,000 (10,000)

Actual return (10,000) 10,000

Contributions (8,000) 8,000

Benefits paid 7,000 (7,000)

Journal entry 9,000 (8,000) (1,000)

Dec. 31, 2014 - - (1,000) (112,000) 111,000

MEMO RECORD GENERAL JOURNAL ENTRIES

OCI


Prepare a pension worksheet for 2014.

($100,000 x 10%)($100,000 x 10%)

($1,000) net liability($1,000) net liability

LO 5

Illustration 20-8

20-24

Pension Projected Pension Asset / Benefit Plan

Items Expense Cash PSC Gain/Loss Liability Obligation Assets

Jan. 1, 2014 0 (100,000) 100,000



Actual return (10,000) 10,000



Journal entry 9,000 (8,000) (1,000)

Dec. 31, 2014 - - (1,000) (112,000) 111,000


OCI

Pension Journal Entry

LO 5

Illustration 20-8

Pension Expense 9,000

Cash 8,000

Pension Asset/Liability 1,000

20-25













20-26

Amortization of Prior Service Cost

Company should not recognize the retroactive benefits as

pension expense in the year of amendment.

Employer should recognize the pension expense over the

remaining service lives of the employees who are expected to

benefit from the change in the plan.

Prior Service Cost

Amortization Method:

Board prefers a years-of-service method.

Employers may use straight-line amortization over the

average remaining service life of the employees.

LO 6

20-27

E20-7: The following defined pension data of Rydell Corp. apply to the year 2014.


Projected benefit obligation, 1/1/14 (before amendment)

$560,000Plan assets, 1/1/14

546,200Pension liability

13,800On January 1, 2014, Rydell Corp., through plan amendment, grants prior service benefits having a present value of

120,000Settlement rate

9%Service cost

58,000Contributions (funding)

65,000Actual (expected) return on plan assets

52,280Benefits paid to retirees

40,000Prior service cost amortization for 2014

17,000

Instructions: For 2014, prepare a pension work sheet for Rydell Corp. that shows the journal entry for pension expense.

LO 6

20-28

E20-7

Annual Prior Pension Projected Pension Service Gain / Asset / Benefit Plan

Items Expense Cash Cost Loss Liability Obligation Assets Dec. 31, 2014 (13,800) (560,000) 546,200

PSC 120,000 (120,000)

Bal. Jan. 1, 2014 (680,000) 546,200



Asset Return (52,280) 52,280

Amort. PSC 17,000 (17,000)



Journal entry 83,920 (65,000) 103,000 (121,920)

AOCI -12/31/2013 -

Dec. 31, 2014 103,000 - (135,720) (759,200) 623,480


OCI


($135,720) liability($135,720) liability

20-29


Other Comprehensive Income (PSC) 103,000


Cash65,000


E20-7: Pension Journal Entry for 2014.

Dec. 31

LO 6

20-30













20-31

Gain or Loss

Unexpected swings in pension expense can result from:

1. Sudden and large changes in the fair value of plan assets,

and

2. Changes in actuarial assumptions that affect the amount of

the projected benefit obligation.

Gains and Losses

LO 7

20-32

Question: What is the potential negative impact on net

income of these unexpected swings?

Volatility

The profession decided to reduce the volatility with smoothing techniques.

Gains and Losses

LO 7

20-33

Smoothing Unexpected Gains and Losses on Plan Assets

Companies include the expected return on the plan assets

as a component of pension expense, not the actual return in

a given year.

Companies record asset gains and asset losses in an

account, Other Comprehensive Income (G/L), combining

them with gains and losses accumulated in prior years.

Gains and Losses

LO 7

20-34 LO 7

20-35

Smoothing Unexpected Gains and Losses on the Pension Liability

Companies report liability gains and liability losses in Other

Comprehensive Income (G/L).

Companies combine the liability gains and losses in the

same Other Comprehensive Income (G/L) account.

They accumulate the asset and liability gains and losses in

Accumulated Other Comprehensive Income and report on

the balance sheet in the stockholders’ equity section.

Gains and Losses

LO 7

20-36













20-37

Corridor Amortization

FASB invented the corridor approach for amortizing

the accumulated net gain or loss balance when it gets

too large. How large is too large?

10% of the larger of the beginning balances of the

projected benefit obligation or the market-related

value of the plan assets.

Any Accumulated OCI net gain or loss balance above

the 10% must be amortized.

Gains and Losses

LO 8

20-38

Illustration: Data for Callaway Co.’s projected benefit

obligation and plan assets over a period of six years.

Gains and Losses

LO 8

Illustration 20-14Computation of the Corridor

20-39

Gains and Losses

LO 8

Illustration 20-15Graphic Illustration of the Corridor

20-40

BE20-7: Shin Corporation had a projected benefit obligation of

$3,100,000 and plan assets of $3,300,000 at January 1, 2014.

Shin also had a net actuarial loss of $465,000 in accumulated

OCI at January 1, 2014. The average remaining service period of

Shin’s employees is 7.5 years.

Instructions: Compute Shin’s minimum amortization of the

actuarial loss.

Gains and Losses

LO 8

20-41

BE20-7: Compute Shin’s amortization of the loss.

Gains and Losses

Amortization

Projected benefit obligation (3,100,000)$

Plan assets 3,300,000 3,300,000$

Corridor percentage 10%

Corridor amount 330,000

Accumulated loss 465,000

Excess loss subject to amortization 135,000

Average remaining service 7.5

Amortized to pension expense 18,000$

÷

LO 8

20-42


P20-2: Jackson Company adopts acceptable accounting for its defined benefit pension plan on January 1, 2013, with the following beginning balances: plan assets $200,000; projected benefit obligation $250,000. Other data are as follows.

2013 2014 2015

Annual service cost 16,000$ 19,000$ 26,000$

Settlement rate and expected rate of return 10% 10% 10%

Actual return on plan assets 18,000 22,000 24,000

Annual funding (contributions) 16,000 40,000 48,000

Benefits paid 14,000 16,400 21,000

Prior service cost (plan amended, 1/1/14) 160,000

Amortization of prior service cost 54,400 41,600

Change in actuarial assumptions, Dec. 31 PBO 520,000

Average remaining service life 15 years 15 years 15 years

LO 8

20-43

Annual Prior Pension ProjectedPension Service Gain / Asset / Benefit Plan

Items Expense Cash Cost Loss Liability Obligation AssetsBal. Jan. 1, 2013 (50,000) (250,000) 200,000


Interest 25,000 (25,000)

Return on assets (18,000) 18,000

Unexpected loss (2,000) 2,000



Journal entry 21,000 (16,000) 2,000 (7,000)

AOCI - 12/31/12 -

Dec. 31, 2013 - 2,000 (57,000) (277,000) 220,000

OCI

GENERAL JOURNAL ENTRIES MEMO RECORD


P20-2: Pension Work Sheet for 2013

($57,000)($57,000)* Expected Return on Plan Assets $200,000 x

10% = $20,000

**

LO 8

20-44


P20-2 Pension Journal Entry for 2013


OCI – Gain/Loss 2,000


Cash 16,000

Dec. 31

LO 8

20-45

Annual Pension ProjectedPension Gain / Asset Benefit Plan

Items Expense Cash PSC Loss Liability Obligation AssetsBal. Jan. 1, 2014 2,000 (57,000) (277,000) 220,000

Prior service costs 160,000 (160,000)

Adj Bal., 1/1/14 (437,000) 220,000


Interest 43,700 (43,700)


Amort. of PSC 54,400 (54,400)



Journal entry 95,100 (40,000) 105,600 (160,700)

AOCI - 12/31/13 2,000

Dec. 31, 2014 105,600 2,000 (217,700) (483,300) 265,600

GENERAL JOURNAL ENTRIESOCI

MEMO RECORD



($217,700) liability($217,700) liability* Actual return = Expected Return

**

LO 8

20-46


Other Comprehensive Income (PSC) 105,600


Cash40,000

Dec. 31



LO 8

20-47

Annual Pension ProjectedPension Gain / Asset / Benefit Plan

Items Expense Cash PSC Loss Liability Obligation AssetsBal. Dec. 31, 2014 105,600 2,000 (217,700) (483,300) 265,600


Interest 48,330 (48,330)


Unexpected loss (2,560) 2,560

Amort. of PSC 41,600 (41,600)



Liability gain (16,630) 16,630

Journal entry 89,370 (48,000) (41,600) (14,070) 14,300

AOCI - 12/31/14 105,600 2,000

Dec. 31, 2015 64,000 (12,070) (203,400) (520,000) 316,600

GENERAL JOURNAL ENTRIESOCI

MEMO RECORD



($203,400) liability($203,400) liability* Plug * Plug

**

LO 8

20-48





Other Comprehensive Income (G/L) 14,070

Other Comprehensive Income (PSC)41,600

Cash48,000

Dec. 31

LO 8

20-49 LO 8

20-50 LO 8

20-51













20-52

Within the Financial Statements

Recognition of the net funded status of the plan

Classification of pension asset or pension liability

Aggregation of pension plans

Actuarial gains and losses/prior service cost

Reporting Pension Plans in Financial Statements

LO 9

20-53

Within the Notes to the Financial Statements


LO 9

1. Major components of pension expense.

2. Reconciliation showing how the projected benefit obligation

and the fair value of the plan assets changed.

3. A disclosure of the rates used in measuring the benefit

amounts (discount rate, expected return on plan assets, rate

of compensation).

20-54

4. A table indicating the allocation of pension plan assets by

category (equity securities, debt securities, real estate, and

other assets), and showing the percentage of the fair value to

total plan assets.

5. The expected benefit payments to be paid to current plan

participants for each of the next five fiscal years and in the

aggregate for the five fiscal years thereafter. Also required is

disclosure of a company’s best estimate of expected

contributions to be paid to the plan during the next year.



LO 9

20-55

6. The nature and amount of changes in plan assets and benefit

obligations recognized in net income and in other

comprehensive income of each period.

7. The accumulated amount of changes in plan assets and benefit

obligations that have been recognized in other comprehensive

income and that will be recycled into net income in future

periods.



LO 9

20-56

8. The amount of estimated net actuarial gains and losses and

prior service costs and credits that will be amortized from

accumulated other comprehensive income into net income over

the next fiscal year.



LO 9

20-57

The Pension Reform Act of 1974

Pension Terminations

Special Issues


LO 9

20-58 LO 9

20-59

Accounting Guidance

In December 1990, the FASB issued rules on “Employers’

Accounting for Postretirement Benefits Other Than Pensions.”

These rules cover for healthcare and other “welfare benefits”

provided to retirees, their spouses, dependents, and beneficiaries.

Other welfare benefits include life insurance offered outside a

pension plan; medical, dental, and eye care; legal and tax services;

tuition assistance; day care; and housing assistance.

APPENDIXAPPENDIX 20A ACCOUNTING FOR POSTRETIRMENT BENEFITS

LO 10 Identify the differences between pensions and postretirement healthcare benefits.

20-60

Differences Between Pension Benefits and Healthcare Benefits

Illustration 20A-1


LO 10

20-61

Differences Between Pension Benefits and Healthcare Benefits

Measuring the future payments for healthcare benefit plans is so much

more difficult than for pension plans.

1. Many postretirement plans do not set a limit on healthcare benefits.

2. The levels of healthcare benefit use and healthcare costs are

difficult to predict. Increased longevity, unexpected illnesses (e.g.,

AIDS, SARS, and avian flu), along with new medical technologies

and cures, cause changes in healthcare utilization.


LO 10

20-62

Postretirement Benefits Accounting Provisions

Attribution Period - period of time over which the

postretirement benefit cost accrue.Illustration 20A-2


LO 10

20-63


Obligations Under Postretirement Benefits

Expected postretirement benefit obligation (EPBO) is the

actuarial present value as of a particular date of all benefits a

company expects to pay after retirement to employees

and their dependents.

Accumulated postretirement benefit obligation (APBO) is

the actuarial present value of future benefits attributed to

employees’ services rendered to a particular date.


LO 10

20-64


Postretirement Expense

1. Service Cost

2. Interest Cost

3. Actual Return on Plan Assets

4. Amortization of Prior Service Costs

5. Gains and Losses


LO 10

20-65

Illustrative Accounting Entries

LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

2014 Entries and Worksheet

Illustration: The use of a worksheet in accounting for a postretirement benefits plan, assume that on January 1, 2014, Quest Company adopts a healthcare benefit plan. The following facts apply to the postretirement benefits plan for the year 2014.

► Plan assets at fair value on January 1, 2014, are zero.

► Actual and expected returns on plan assets are zero.

► Accumulated postretirement benefit obligation (APBO), January 1, 2014, is zero.

► Service cost is $54,000.

► No prior service cost exists.

► Interest cost on the APBO is zero.

► Funding contributions during the year are $38,000.

► Benefit payments to employees from plan are $28,000.


20-66


Illustration 20A-4

Journal Entry



20-67

Recognition of Gains and Losses


Gains and losses represent changes in the APBO or the value

of plan assets. Gains and losses are recorded in other

comprehensive income.

The Corridor Approach

Amortization Methods


LO 11

20-68


Illustration: The following facts apply to the postretirement benefits plan for

Quest Company for the year 2015.

► Actual return on plan assets is $600.

► Expected return on plan assets is $800.

► Discount rate is 8 percent.

► Increase in APBO due to change in actuarial assumptions is $60,000.

► Service cost is $26,000.

► Funding contributions during the year are $18,000.

► Benefit payments to employees during the year are $5,000.

► Average remaining service to expected retirement: 25 years.



LO 11

20-69


Journal Entry



Illustration 20A-6

LO 11

20-70

Amortization of Gains and Losses in 2016


Illustration 20A-8


2016 CORRIDOR TEST

2016

LO 11

20-71 LO 12 Compare the accounting for pensions under GAAP and IFRS.

RELEVANT FACTS - Similarities

IFRS and GAAP separate pension plans into defined contribution plans and defined benefit plans. The accounting for defined contribution plans is similar.

IFRS and GAAP recognize a pension asset or liability as the funded status of the plan (i.e., defined benefit obligation minus the fair value of plan assets). (Note that defined benefit obligation is referred to as the projected benefit obligation in GAAP.)

IFRS and GAAP compute unrecognized past service cost (PSC) (referred to as prior service cost in GAAP) in the same manner. However, IFRS recognizes past service cost as a component of pension expense in income immediately. GAAP amortizes PSC over the remaining service lives of employees.

20-72

RELEVANT FACTS - Differences

IFRS and GAAP include interest expense on the liability in pension expense. Regarding asset returns, IFRS reduces pension expense by the amount of interest revenue (based on the discount rate times the beginning value of pension assets). GAAP includes an asset return component based on the expected return on plan assets.

Under IFRS, companies recognize both liability and asset gains and losses (referred to as remeasurements) in other comprehensive income. These gains and losses are not “recycled” into income in subsequent periods. GAAP recognizes liability and asset gains and losses in “Accumulated other comprehensive income” and amortizes these amounts to income over remaining service lives, using the “corridor approach.”

LO 12

20-73

RELEVANT FACTS - Differences

The accounting for pensions and other postretirement benefit plans is the same under IFRS. GAAP has separate standards for these types of benefits, and significant differences exist in the accounting.

LO 12

20-74

ON THE HORIZON

The IASB and the FASB have been working collaboratively on a postretirement benefit project. The recent amendments issued by the IASB moves IFRS closer to GAAP with respect to recognition of the funded status on the statement of financial position. However, as illustrated in the About the Numbers section above, significant differences remain in the components of pension expense. The FASB is expected to begin work on a project that will reexamine expense measurement of postretirement benefit plans. The FASB likely will consider the recent IASB amendments in this area, which could lead to a converged standard.

LO 12

20-75

At the end of the current period, Oxford Ltd. has a defined benefit

obligation of $195,000 and pension plan assets with a fair value of

$110,000. The amount of the vested benefits for the plan is $105,000.

What amount related to its pension plan will be reported on the

company’s statement of financial position?

a. $5,000.

b. $90,000.

c. $85,000.

d. $20,000.

IFRS SELF-TEST QUESTION

LO 12

20-76

At the end of the current year, Kennedy Co. has a defined benefit

obligation of $335,000 and pension plan assets with a fair value of

$245,000. The amount of the vested benefits for the plan is $225,000.

Kennedy has unrecognized past service costs of $24,000 and an

unrecognized actuarial gain of $8,300. What account and amount(s)

related to its pension plan will be reported on the company’s statement of

financial position?

a. Pension Liability and $74,300.

b. Pension Liability and $90,000.

c. Pension Asset and $233,300.

d. Pension Asset and $110,000.


LO 12

20-77

At January 1, 2014, Wembley Company had plan assets of $250,000

and a defined benefit obligation of the same amount. During 2014,

service cost was $27,500, the discount rate was 10%, actual and

expected return on plan assets were $25,000, contributions were

$20,000, and benefits paid were $17,500. Based on this information,

what would be the defined benefit obligation for Wembley Company at

December 31, 2014?

a. $277,500. c. $27,500.

b. $285,000. d. $302,500.


LO 12

20-78

Copyright © 2013 John Wiley & Sons, Inc. All rights reserved.

Reproduction or translation of this work beyond that permitted in

Section 117 of the 1976 United States Copyright Act without the

express written permission of the copyright owner is unlawful.

Request for further information should be addressed to the

Permissions Department, John Wiley & Sons, Inc. The purchaser

may make back-up copies for his/her own use only and not for

distribution or resale. The Publisher assumes no responsibility for

errors, omissions, or damages, caused by the use of these

programs or from the use of the information contained herein.

Copyright

20-1 7.Explain the accounting for unexpected gains and losses. 8. Explain the corridor approach to...

Documents

Transcript of 20-1 7.Explain the accounting for unexpected gains and losses. 8. Explain the corridor approach to...