Pensions and Other Postretirement Benefits Sid Glandon, DBA, CPA Associate Professor of Accounting...
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Transcript of Pensions and Other Postretirement Benefits Sid Glandon, DBA, CPA Associate Professor of Accounting...
Pensions and Other Postretirement Benefits
Sid Glandon, DBA, CPAAssociate Professor of AccountingUniversity of Texas at El Paso
Qualified Pension Plans
Must cover 70% of employees Can’t discriminate in favor of highly
compensated employees Must be funded through contributions to
an irrevocable trust Benefits must vest within specified period Compliance with restrictions regarding
timing and amount of contributions and benefits.
Types of Pension Plans
Defined Contribution Promise to pay fixed annual contributions to
the pension fund Employee assumes risk of fund performance
Defined Benefits Promise to pay fixed retirement benefit
defined by a designated formula Employer assumes risk of fund performance
Defined Contribution Plans
401(k) Plans Permit voluntary contributions by
employees (contributory plan) Money purchase plans Thrift plans Savings plans Profit-sharing plans
Components of Pension Expense
+ Service cost+ Interest on pension liability- Return on plan assetsAmortization of:+ Prior service cost+/- Losses/gains resulting from
a) revisions in estimates of pension liabilityb) investing plan assets
Pension Obligations
Vested benefits obligation Present value of vested benefits at present pay
levels Accumulated benefit obligation (ABO)
Present value of vested and nonvested benefits at present pay levels
Projected benefit obligation (PBO) Present value of vested, nonvested and
additional benefits related to projected pay increases
Projected Benefit Obligation
Earned retirement benefits retirement annuity based on current data
Present value of retirement annuity PV of retirement annuity at retirement date
Projected benefit obligation PV of retirement annuity at current date
ExampleEmployee: SpencerYears of service: 15 yearsCurrent annual salary $40,000Pension formula: Estimated final annual salary $60,000 * Percentage 2%
* Years of service to date 15 Retirement benefit $18,000
Years of service remaining 10Estimated final annual salary $60,000
Estimated retirement period 20 yearsDiscount rate 6%
Fact Pattern
Estimated final annual salary $60,000 * Factor 2% * Years of service to date 15Earned retirement benefits $18,000
Earned Retirement Benefits
Estimated earned retirement annuity $18,000 * PVOA, n = 20, i = 6% 11.46992PV of retirement annuity at retirement date $206,459
Present Value of Retirement Annuity
PV of retirement annuity at retirement date $206,459 * PV$1, n = 10, i = 6% 0.55839Pension benefit obligation $115,284
Pension Benefit Obligation
Components that Cause Changes to Projected Benefit Obligation
Service cost Current year of service
Interest cost Beginning PBO * discount rate
Prior service cost Result of plan amendments
Gain or loss on the PBO Revision of estimates
Payment of retirement benefits
Pension Plan Assets
Pension plan assets are managed by a trustee
Expected return on assets is included in periodic pension expense
PBO > Plan Assets Underfunded pension plan
Plan Assets > PBO Overfunded pension plan
Pension Expense
+ Service cost + Interest cost - Expected return on plan assets + Amortization of prior service cost + (-) Amortization of net loss or
(gain)
Recording Pension Expense and Pension Funding
Account Debit CreditPension expense $XXXPrepaid (accrued) pension cost $XXX Cash $XXXTo record pension expense and funding for the current year
Pension Spreadsheet
Informal Records PBO Plan assets Prior service cost Net loss (gain)
Formal Records Pension expense Cash Prepaid (accrued) pension cost
# Description PBOPlan
Assets
Prior Service
CostNet Loss (Gain)
Pension Expense Cash
Prepaid (Accrued)
CostAdditional Liability
Intangible Pension
Asset1 Beginning balance ($8,500) $7,800 $1,200 $600 $1,1002 Service cost (750) $7503 Interest cost (510) 5104 Actual return on plan assets 780 (780)5 Loss (gain) on plan assets (312) 3126 Loss (gain) on PBO (80) 807 Change in prior service cost
Amortization:8 Prior service cost (120) 1209 Net gain (loss)
10 Contributions to fund 145 ($145)11 Benefits paid 85 (85)12 Minimum liability adjustment13 Journal entry $912 ($145) (767)14 Ending balance ($9,755) $8,640 $1,080 $368 $333
Informal Records Formal Records
Pension Spreadsheet
#1 Reconciliation Between Beginning Informal and Formal Records
PBO ($8,500)Plan assets 7,800Prior service cost 1,200Net loss (gain) 600
$1,100
Prepaid (accrued) pension cost $1,100
Informal Records
Formal Records
#2 Service Cost
Given by actuary as $750
#3 Interest CostBeginning PBO $8,500Discount/interest rate 6% Interest cost $510
# Description PBOPlan
Assets
Prior Service
CostNet Loss (Gain)
Pension Expense Cash
Prepaid (Accrued)
CostAdditional Liability
Intangible Pension
Asset1 Beginning balance ($8,500) $7,800 $1,200 $600 $1,1002 Service cost (750) $7503 Interest cost (510) 5104 Actual return on plan assets 780 (780)5 Loss (gain) on plan assets (312) 3126 Loss (gain) on PBO (80) 807 Change in prior service cost
Amortization:8 Prior service cost (120) 1209 Net gain (loss)
10 Contributions to fund 145 ($145)11 Benefits paid 85 (85)12 Minimum liability adjustment13 Journal entry $912 ($145) (767)14 Ending balance ($9,755) $8,640 $1,080 $368 $333
Informal Records Formal Records
Pension Spreadsheet
#4 Actual Return on Plan Assets
FV plan assets, end of year $8,640FV plan assets, beginning of year 7,800 Increase in FV of plan assets during year $840Contributions to fund 145Payments to retirees 85 Excess payments (contributions) during year (60)Actual return on plan assets $780
#5 Loss (Gain) on Plan Assets
Expected return on plan assets: FV of plan assets, beginning of year $7,800 Expected rate of return 6% Expected return $468Actual return on plan assets 780Loss (gain) on plan assets ($312)
# Description PBOPlan
Assets
Prior Service
CostNet Loss (Gain)
Pension Expense Cash
Prepaid (Accrued)
CostAdditional Liability
Intangible Pension
Asset1 Beginning balance ($8,500) $7,800 $1,200 $600 $1,1002 Service cost (750) $7503 Interest cost (510) 5104 Actual return on plan assets 780 (780)5 Loss (gain) on plan assets (312) 3126 Loss (gain) on PBO (80) 807 Change in prior service cost
Amortization:8 Prior service cost (120) 1209 Net gain (loss)
10 Contributions to fund 145 ($145)11 Benefits paid 85 (85)12 Minimum liability adjustment13 Journal entry $912 ($145) (767)14 Ending balance ($9,755) $8,640 $1,080 $368 $333
Informal Records Formal Records
Pension Spreadsheet
#6 Loss (Gain) on PBOPBO, End of Year (actuarially determined) $9,755 PBO, Beginning of Year $8,500 Service cost 750 Interest cost 510 Benefits paid (85) Computed PBO, End of Year 9,675Loss (gain) on PBO $80
# Description PBOPlan
Assets
Prior Service
CostNet Loss (Gain)
Pension Expense Cash
Prepaid (Accrued)
CostAdditional Liability
Intangible Pension
Asset1 Beginning balance ($8,500) $7,800 $1,200 $600 $1,1002 Service cost (750) $7503 Interest cost (510) 5104 Actual return on plan assets 780 (780)5 Loss (gain) on plan assets (312) 3126 Loss (gain) on PBO (80) 807 Change in prior service cost
Amortization:8 Prior service cost (120) 1209 Net gain (loss)10 Contributions to fund 145 ($145)11 Benefits paid 85 (85)12 Minimum liability adjustment13 Journal entry $912 ($145) (767)14 Ending balance ($9,755) $8,640 $1,080 $368 $333
Informal Records Formal Records
Pension Spreadsheet
#7 Change in Prior Service Cost
In this case there is no change in prior service cost
#8 Amortization of Prior Service CostPrior service cost $1,200Average remaining service life per employee 10Amortization of prior service cost $120
#9 Amortization of Net Gain (Loss)
In this case there is no net gain (loss) on which amortization should be taken
#10 Contributions
The employer made contributions to the plan in the amount of $145
#11 Benefits Paid
The plan paid benefits to retirees in the amount of $85.
#12 Minimum Liability Adjustment
None in this case
Accumulated benefit obligation, End of Year ($8,500)FV of plan assets, End of Year 8,640 Minimum liability (ABO > FV of plan assets) 0
#13 Year-End Journal Entry to Record Pension Expense and Funding
Account Debit CreditPension expense $912 Accrued pension cost 767 Cash $145To record pension expense and funding for the year
#14 Reconciliation Between Beginning Informal and Formal Records
PBO ($9,755)Plan assets 8,640Prior service cost 1,080Net loss (gain) 368
$333
Prepaid (accrued) pension cost $333
Informal Records
Formal Records
Postretirement Benefit Plans
Medical insurance Dental insurance Life insurance Other postretirement benefits
Post Retirement Health Benefits
Subject to the same assumptions as pension plans
Additional assumptions Benefits are unrelated to service Benefits are based on medical need Costs are shared between employer and
retiree Coverage is extended to spouses and qualified
dependents
Net Cost of Benefits
Estimated annual medical costs Less: Retiree co-payments Less: Medicare paymentsEstimated net cost of annual benefits
Assumptions in addition to those applied to pension plans
Estimated current cost of providing health benefits to retirees
Demographic characteristics of potential retirees
Benefits provided by Medicare Expected health care cost trends
Postretirement Benefit Obligation
Expected postretirement benefit obligation (EPBO) Actuarial estimate of PV of future
postretirement benefits Accumulated postretirement benefit
obligation (APBO) Portion of EPBO attributed to employee
service to date
Example: Measuring the Obligation
Fact Pattern:EPBO at 12/31/04 $48,000Years of service completed 5Expected total years of service 30Actuarially determined discount rate 5%
APBO at 1/1/05
Years completedTotal years
$48,000 * 5/30 = $8,000
EPBO * = APBO
APBO at 12/31/05
EPBO at 1/1/05 * [ 1 + discount rate ] = EPBO at 12/31/05
$48,000 * 1.05 = $50,400
Years completedTotal years
630
* = $10,080$50,400
* = APBO at 12/31/05EPBO at 12/31/05
Measuring APBO
APBO at 1/1/05 $8,000Interest cost: Beginning APBO $8,000 Discount rate 5% Interest cost 400Service cost: Ending EPBO 50,400 One year of service 1/30 Service cost 1,680APBO at 12/31/05 $10,080
Postretirement Benefit Expense
Service cost Ending EPBO * one year of service
Interest cost Beginning APBO * discount rate
Amortization Prior service cost
Liability resulting from plan amendment Net loss (Gain)
Liability resulting in changes in assumptions Transition amount
Liability at adoption of plan
Required Disclosures
Changes in APBO Components of net periodic
postretirement benefit expense Weighted-average discount rate,
rate of compensation used to compute postretirement benefit obligation
Assumed health care cost trends