Chapter 20

Calculate Actual Return on PA

(Ending FV of PA - Beg FV of PA) - (Contributions - Benefits)

Calculate Unexpected Loss

(PA x expected return on plan assets) - actual return

Smoothing Techniques

*Netting* Only have 1 column where you are recording any G/L that happen. Net them afterwards. Gain= Credit Loss=Debit *Corridor Amortization* Amortize of net gain or loss. -Threshold. -10% of larger BB of PBO or PA. -BB of G/L account more then corridor- if not do nothing. -If yes, amortize the amount that exceeds the corridor. (BB Net G/L-Corridor)/ Number of Years -You will only accrue benefits when someone works. -FASB Invented the corridor approach for amortizing the accumulated net gain or loss balance when it gets too large. -10% of the larger of BB of PBO or the market-related value of PA -Any AOCI net fain or loss balance above the 10% must be amoritized.

Prior Service Cost Amortization of Prior Service Cost Cont.

- 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 Method: -Board prefers a years-of-service method -Employers may use straight-line amortization over the average remaining service life of employers.

Service Cost Components of Pension Expense

-Actuary predicts additional benefits that an employers must pay under plan's benefit formula as result of employee's current year's service, and then discounts the cost of the future benefits back to PV. *-Increases pension expense-will debit* -Actuarial PV of benefits attributed by the pension benefit formula to employee service during the year. -FASB adopted benefits/years-of-service actuarial method, which determines pension expense based on future salary levels. -Will always have this.

Smoothing Unexpected Gains and Losses on Pension Liability

-Companies report liability gains and liability losses in Other Comprehensive Income -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 SH Equity section.

What is the Pension Obligation a company should report to financial statements?

-Employer's pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan. *Ways to Measure* -Vested Benefits: Benefits for vested employees only at current salaries. -Vested Benefit Obligation: Benefits for vested employees at current salaries. -Accumulated Benefit Obligation: Benefits for vested and non vested employees at current salaries. -Projected Benefit Obligation: Deffered compensation amount on both on vested and vested service calculated at future salaries. •Future salaries are expected to be higher than current salaries, resulting in largest measurement of pension obligation. *FASB Choice*

IFRS 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. IFRS takes expected rate x BB Pension Asset. GAAP takes actual return and reduced pension expense. -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 AOCI and amortize these amount to income over remaining service lives, using the corridor approach. IFRS does not amortize G/L, they recognize them right away.

Actual Return on Plan Assets Components of Pension Expense

-Increase in pension funds from interest, dividends, and realized and unrealized changes in the FV of the plan asset. -decreases pension expense. -the more return, less cost the company incurs. -Unexpected G/L: Actual-Exp=G/L. Record Gain (credit), debit pension expense. Increase pension expense. Record Loss (debit), credit pension expense, decrease pension expense. -Positive Return: reduced pension expense-Debit -Negative Return: increases pension expense - Credit -Computer: (PA EB- PA BB) - (Contributions - Benefits Paid) -Investments in stocks, bonds, other securities, and real estate -Higher actual return on pension plan assets, less employer has to contribute eventually, less pension expense that needs to report.

Interest on Liability/Interest Expense Components of Pension Expense

-Interest for the period on the projected benefit obligation outstanding during the period. *-Increases pension expense- will debit.* -On PBO Liability:LT Liability. -Compute: Settlement Rate x BB of PBO -Interest component is interest for period on PBO outstanding during period. -discount rate should reflect the rates at which companies can effectively settle pension benefits. -Will always have this.

Defined Benefit Plan

-Outlines benefits that employees will receive when they retire. -Benefits are function of employee;s years of service and of compensation level in the years approaching retirement. -Employers are beneficiaries (determined by actuaries) -Trust's purpose is to safeguard and invest assets so there will be enough to pay employer's obligation to employees. -Trust is a separate entity, but it is the assets and liabilities belonging to the employer. As long as the plan continues, the employer is responsible for the payment of the defined benefits (without regard to what happens in the trust) -Employers are at risk because they must contribute enough to meet cost of benefits that the plan defines.

Amortization of Prior Service Cost Components of Pension Expense

-Plan amendments often include provisions to increase benefits for employee service provided in prior years. -Company allocated the cost (prior service cost) of providing these retroactive benefits to pension expense in the future, especially to the remaining service-years of the affected employees. -Straight line method -Prior Service Cost is initially recorded in OCI and then recognized as a component of pension expense over there examining service lives of the employees who are expected to benefit from the change in plan. -Amortize to pension expense. -When amortize, charge to pension expense. increases pension exp. decreases PSC. -Increase Pension expense

If there is actual return on PA and expected return on PA

-Take Beginning balance of PA x expected rate of return on assets. Then subtract that number by the actual return on PA

Gain or Loss Components of Pension 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. -It depends if it is a gain or loss. 2 Types of Gains 2 Types of Losses *Asset G/L* Expected Return - Actual Return -Expected is more then actual= loss -Actual more than Expected= gain *Liability G/L* Actual PBO - Expected PBO - Actual is more than Expected= loss -Expected more than Actual= gain Unexpected swings in pension expense can result from 1. Sudden and large changes in the FV of plan assets 2. Changes in actuarial assumptions that affect the amount of PBO

Computing Amortization of Loss-Corridor

1. Greater of PBO or PA 2. Greater x 10% 3. Get Beginning Balance: Beginning Balance of Last Year (+ Loss or - Gain) - Amortization Amount 4. Corridor - Beginning Balance Net Gain or Loss / Average Remaining Life

Reporting Pension Plans Within Financial Statements

1. Recognition of net funded status of the plan. Do not record PBO and PA, instead funding status or difference between two. If overfunded, pension asset and is always noncurrent. if underfunded, pension liability and is LT liability but could have current components like paying benefits within year. 2. Classification of pension asset or pension liability 3. Aggregation of pension plans For individual employee type-FS needs to aggregate on BS 4. Actuarial gains and losses/ prior service cost Accounting OCI: GAAP perm. account Stakeholders equity on BS

Pension Worksheet

1. Record Beginning Balances of PBO and PA. PBO will be credit and PA will be debit. If there is a different between the two, record that in Pension Asset/Liability section. 2. Record the BB of the items and credit/debit (opposing) in PBO (credit) or PA (debit) -Service cost will be debit under Pension Expense -Interest Cost will be Debit under Pension Expense (If grant PSC add that to PBO before calculating) -Actual Return will be Credit under Pension Expense -Contributions will be a Credit under Cash -Benefits will be a Debit under PBO and Credit under PA 3. If PSC (plan amendment, grants PSC) -Make Item for PSC (date) and debit PV amount under PSC -Amortization for this amount will debit under pension expense and credit under PSC 4. Gain or Losses -If Actual and Expected return on plan assets- if actual more then dr. unexpected gain under pension expense and debit under gain/losses

Components of Pension Expense

1. Service Cost 2. Interest on Liability 3. Actual Return on Plan Assets 4. Gain or Loss 5. Amortization of Prior Service Cost

Pension Plan

Arrangement whereby an employer provides benefits (payments) to retired employees for services they provided in their working years. -Company/employer incurs the cost and makes contributions to the pension fund. -fund/plan is entity that receives the contributions from employers, administers the pension assets, and makes the benefit payments to retired employees. -It is funded when employer makes payments to a funding agency.

Smoothing Unexpected Gains and Losses on Plan Assets

Companies include the expected return on the plan assets as a components of pension expense, not the actual return in a given year. -Companyies record asset gains and asset losses in an account, Other Comprehensive Income (G/L), combining them with gains and losses accumulated in prior years.

Types of Pension Plans

Contributory: employees bear part of cost of the stated benefits or voluntarily make payments to increase their benefits. Ex. 401K Noncontributory: Employer bears the entire cost. Qualified Pension Plan: Plans that offer tax benefits. They permit deductibility of the employer's contributions to the pension fund and tax-free status of earnings from pension fund assets. Pension fund should be a separate legal and accounting entity. Maintain a set of books and prepares financial statements.

Entities Involved in Pension Plan

Employer (Company) -> Contributes Money to Pension Fund (where investments and earnings are held by Pension Plan Administrator- Assets & liabilities) -> Benefit Payments then go on to Pension Recipients (employees) The employers does not pay the employee. The funds pay them.

Defined Contribution Plan

Employer agrees to contribute to a pension trust a certain (fixed) sum each period, based on formula. -Defines only employer's contribution. Ex. 401K -Report liability on BS if does not make contribution in full, asset if makes more than required amount. -Addition to pension expense, must disclose a plan description, employee groups covered, the basis for determining contributions, the nature and effect of significant matters affecting comparability from period to period. -Risk borne by employees, benefits based on plan value.

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.

Overfunded or Underfunded

Measured as difference between FV of the Plan Asset and Project Benefit Obligation. -If PBO is higher then PA= underfunded= pension liability on BS -PA is higher then PBO= overfunded= pension asset

Calculate Pension Expense

Service Cost + Interest Cost (PBO x Settlement Rate) + Actual Return on Plan Asset - Unexpected Loss (if there was expected RPA) - Prior Service Cost Amort (OCI PSC / avg. remaining years) + = Pension Expense Ignore Contribution, Benefits Paid, Plan Assets, Accumulated OCI.