Acctg 303 Final Learning Objectives

Many companies are terminating long-standing defined benefit plans and substituting defined contribution plans. Why the shift? There are three main reasons:

1. Government regulations make defined benefit plans cumbersome and costly to administer. 2. Employers are increasingly unwilling to bear the risk of defined benefit plans; with defined contribution plans, the company's obligation ends when contributions are made. 3. There has been a shift among many employers from trying to "buy long-term loyalty" (with defined benefit plans) to trying to attract new talent (with more mobile defined contribution plans).

Difference between GAAP and IFRS for gains and losses

Accounting for Gains and Losses. Accounting for gains and losses in defined benefit plans (called "remeasurement" gains and losses under IFRS) under IAS No. 19 is similar to U.S. GAAP, but there are two important differences. The first difference relates to the make-up of the gain or loss on plan assets. As we know from the chapter, this amount under U.S. GAAP is the difference between the actual and expected returns, where the expected return is different from company to company and usually different from the interest rate used to determine the interest cost. Not so under IFRS, which requires that we use the same rate (the rate for "high grade corporate bonds") for both the interest cost on the defined benefit obligation (called projected benefit obligation or PBO under U.S. GAAP) and the interest revenue on the plan assets. In fact, under IFRS, we multiply that rate, say 6%, times the net difference between the defined benefit obligation (DBO) and plan assets and report the net interest cost/income: Net Interest cost(6%*(400-300) Plan assets (6%*300:interest income) DBO(6%*400:interest cost) As a result, the remeasurement gain (or loss) under IFRS usually is an amount different from the gain (or loss) on plan assets under GAAP: To Record Gains and Losses GAAP expected return=9% expected return=10% Plan Assets Gain-OCI (10%-9% of plan assets) IFRS Use same high grade corporate bond rate ex. 6% Plan assets( actual interest income in excess of 6%) Remeasurement Gain-OCI (10%-6%) A second difference relates to the treatment of gains and losses after they are initially recorded in OCI. We've seen that U.S. GAAP requires that gains and losses (either from the actual return exceeding an assumed amount [entries above] or from changing assumptions regarding the pension obligation [entries below]) are to be (a) included among OCI items in the statement of comprehensive income when they first arise and then (b) gradually amortized or recycled out of OCI and into expense (when the accumulated net gain or net loss exceeds the 10% threshold). Similar to U.S. GAAP, under IFRS these gains and losses are included in OCI when they first arise, but unlike U.S. GAAP those amounts are not subsequently amortized out of OCI and into expense. Instead, under IFRS those amounts remain in the balance sheet as accumulated other comprehensive income. The initial entries, then, are the same GAAP: Liability Loss-OCI PBO (Projected benefit obligation) LATER AMORTIZED OUT IFRS: Remeasurement Loss-OCI DBO(Defined benefit obligation) NOT AMORTIZED OUT EVER

Explain how the calculation of pension expense results in the smoothing of pension expense.

Because of politics, there is a delayed recognition of a gain or a loss. Delayed recognition was favored by a dominant segment of corporate America that was concerned with the effect of allowing gains and losses to immediately impact reported earnings. In 2008, the FASB decided to formally reconsider all aspects of accounting for postretirement benefit plans, including this treatment of gains and losses. This result might include immediately including gains and losses in pension expense, thereby eliminating income smoothing. The practical justification for delayed recognition is that, over time, gains and losses might cancel one another out. Given this possibility, why create unnecessary fluctuations in reported income by letting temporary gains and losses decrease and increase (respectively) pension expense? Of course, as years pass there may be more gains than losses, or vice versa, preventing their offsetting one another completely. So, if a net gain or a net loss gets "too large," pension expense must be adjusted. The FASB defines too large rather arbitrarily as being when a net gain or a net loss at the beginning of a year exceeds an amount equal to 10% of the PBO, or 10% of plan assets, whichever is higher. This threshold amount is referred to as the "corridor." When the corridor is exceeded, the excess is not charged to pension expense all at once. Instead, as a further concession to income smoothing, only a portion of the excess is included in pension expense. The minimum amount that should be included is the excess divided by the average remaining service period of active employees expected to receive benefits under the plan.

Identify and explain differences between GAAP and IFRS related to the statement of cash flows:

Classification of Cash Flows. Like U.S. GAAP, international standards also require a statement of cash flows. Consistent with U.S. GAAP, cash flows are classified as operating, investing, or financing. However, the U.S. standard designates cash outflows for interest payments and cash inflows from interest and dividends received as operating cash flows. Dividends paid to shareholders are classified as financing cash flows. IAS No. 7, on the other hand, allows more flexibility. Companies can report interest and dividends paid as either operating or financing cash flows and interest and dividends received as either operating or investing cash flows. Interest and dividend payments usually are reported as financing activities. Interest and dividends received normally are classified as investing activities. WHERE WERE HEADED They are working on making everyone use the direct method since they believe it is more useful to readers of financial statements. It would also require a management approach that combines the activities based on how they are used by management such as operating activities would consist of property, plant and equipment since those are used in the "core business". Also investing activities will be primarily investments in stocks and bonds.

Identify, explain and prepare the major disclosures required for pensions

Foremost among the useful disclosures are changes in the projected benefit obligation, changes in the fair value of plan assets, and a breakdown of the components of the annual pension expense.

Explain what the OCI- Pension accounts represent and their effect on current and future financial statements

Other comprehensive income (OCI) items are reported both (a) as they occur and then (b) as an accumulated balance within shareholder's equity in the balance sheet.

Identify and explain the purpose of the statement of cash flows:

The GAAP requirement for the statement of cash flows was issued in direct response to FASB Concept Statement 1, which stated that the primary objective of financial reporting is to "provide information to help investors and creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise.

Explain the purpose of ERISA and PBGC

The Pension Protection Act of 2006 and the Employee Retirement Income Security Act of 1974 (ERISA) establish the pension funding requirements. Subject to these considerations, cash contributions are actuarially determined with the objective of accumulating (along with investment returns) sufficient funds to provide promised retirement benefits. Pension plans typically require some minimum period of employment before benefits vest. Before the Employee Retirement Income Security Act (ERISA) was passed in 1974, horror stories relating to lost benefits were commonplace. It was possible, for example, for an employee to be dismissed a week before retirement and be left with no pension benefits. Vesting requirements were tightened drastically to protect employees. These requirements have been changed periodically since then. Today, benefits must vest (a) fully within five years or (b) 20% within three years with another 20% vesting each subsequent year until fully vested after seven years. Five-year vesting is most common. ERISA also established the Pension Benefit Guaranty Corporation (PBGC) to impose liens on corporate assets for unfunded pension liabilities in certain instances and to administer terminated pension plans. The PBGC provides a form of insurance for employees similar to the role of the FDIC for bank accounts and is financed by premiums from employers equal to specified amounts for each covered employee. It makes retirement payments for terminated plans and guarantees basic vested benefits when pension liabilities exceed assets. The vested benefit obligation is actually a subset of the ABO, the portion attributable to benefits that have vested. It is not unusual for pension plans today to be underfunded. Historically the funded status of pension plans has varied considerably. Prior to the Employee Retirement Income Security Act (ERISA) in 1974, many plans were grossly underfunded. The law established minimum funding standards among other matters designed to protect plan participants. The new standards brought most plans closer to full funding. Then the stock market boom of the 1980s caused the value of plan assets for many pension funds to swell to well over their projected benefit obligations. More than 80% of pension plans were overfunded. As a result, managers explored ways to divert funds to other areas of operations. Today a majority of plans again are underfunded. The economic crisis has taken its toll. Stock market declines reduced the funded status of pension plans from 108% at the end of 2007 to 79% at the end of 2008. In 2009, pension plans of the country's 500 largest companies were underfunded by $200 billion. Partly in response to the severe underfunding and partly spurred by attractive stock prices, unusually high cash contributions to plan assets reduced the underfunded status during 2009. Then, despite positive stock market returns in 2010, the funded status for plans at the 1,500 largest U.S. companies tracked by Standard & Poor's dropped to 81% at the end of 2010, down from 84% in 2009. One culprit was low interest rates. Low interest rates hurt plans' funded status because the pension obligation is a present value calculation that increases with a lower discount rate. Even small interest rate changes have big effects on funded status. Many of the underfunded plans are with troubled companies, placing employees at risk. The PBGC guarantees are limited to about $3,400 per month, often less than promised pension benefits.

Explain the accounting for terminated plans:

To cut down on cumbersome paperwork and lessen their exposure to the risk posed by defined benefit plans, many companies are providing defined contribution plans instead. When a plan is terminated, GAAP requires a gain or loss to be reported at that time. For instance, Melville Corporation described the termination of its pension plan in the following disclosure note: "As a result of the terminate of the defined benefit pension plan, the company recorded a nonrecurring gain of approximately $4,000,000 which was the amount of plan assets that reverted to the company."

Which plan is most common defined benefit or defined contribution?

Today, approximately three-fourths of workers covered by pension plans are covered by defined contribution plans, roughly one-fourth by defined benefit plans. This represents a radical shift from previous years when the traditional defined benefit plan was far more common. However, very few new pension plans are of the defined benefit variety

Difference between GAAP and IFRS for pension expense

Under IFRS we don't report pension expense as a single net amount. Instead, we separately report (a) the service cost component (including past service cost) and (b) the net interest cost/income component in the income statement and (c) remeasurement gains and losses as other comprehensive income.

Indicate how pension-related accounts are shown on the employer's financial statements (classification, presentation, and amount)

You know from the pension question! If not message me!! :)

Difference between GAAP and IFRS for prior service cost:

called past service cost under IFRS is combined with the current service cost and reported within the income statement rather than as a component of other comprehensive income as it is under U.S. GAAP. Service cost DBO service cost 2012 DBO Prior Service Cost

Defined Contribution Pension Plans

promise fixed annual contributions to a pension fund (say, 5% of the employees' pay). Employees choose (from designated options) where funds are invested—usually stocks or fixed-income securities. Retirement pay depends on the size of the fund at retirement.

Defined Benefit Pension Plans

promise fixed retirement benefits defined by a designated formula. Typically the pension formula bases retirement pay on the employees' (a) years of service, (b) annual compensation (often final pay or an average for the last few years), and sometimes (c) age. Employers are responsible for ensuring that sufficient funds are available to provide promised benefits.