1 pensions acctg 5120 david plumlee. page2 important fact… accounting we are talking about is for...
Post on 19-Dec-2015
213 views
TRANSCRIPT
1
Pensions
ACCTG 5120David Plumlee
page2
Important fact… Accounting we are talking about is for the
company!
The pension fund is actually managed and accounted for separately legal and accounting entity of its own…..
We focus on the impact of an asset/liability/expense for payment of the pension obligation from the company’s perspective
page3
Pensions: The Big Picture
EmployerPension Fund Trustee
Invests funds to earn a return and payout cash to retiree
Funding
Payments
RetireeBenefit Payments
page4
Basic questions
What is employer’s liability/asset (how should this be reported on the balance sheet)?
What is the current year’s expense associated with the plan?
page5
Defined Contribution Plan Employer contracts for an amount to
be contributed
Example Plan The company will make a contribution under the
plan equal to a stated percentage of the employee’s current annual salary. The percentages applied vary according to age (see attached table). All employees are required to make a 5% minimum contribution. Ownership of all contributions is fully vested in the participant.
page6
Defined Contribution Plan
Employee Employees Company%
Wages< age 45 7.0% $150,00045 to 49 8.5% $350,00050 to retirement 11.5% $200,000
page7
Company contribution
=$1,500,000* .07 + $3,500,000*.085 + $2,000,000*.115
=$335,000
page8
Defined Contribution Example
Total Employment Period Benefit period
page9
Defined Benefit Plan
Employer contracts for future payouts
Example Plan The company agrees to provide to all employees
at age 65, an annual pension benefit computed in accordance with the “benefit formula.” Ownership of all benefits becomes fully vested following three years of continuos employment with the company.
page10
Defined Benefit Example
Total Employment Period Benefit period
page11
Determining Employer Contribution
What does the employer need to do?
What is the amount of that liability?
page12
Actuarial Assumptions
Assume for an employee who works for this company: Benefits are $4,000 per year in retirement for every year
worked Expected # of years at company = 20 yrs Employee will live 15 years beyond retirement Settlement rate is 6%. (The interest rate implicit in the
annuity contract at retirement.) Expected rate of return 8%. ( The amount that funding
will earn.)
page13
Actuaries Determine Benefits
Current period Retirement
Total Employment Period
Actuarial Estimate of Retirement Benefits
= PV of Benefits @ Settlement Rate
page14
Actuaries Determine Benefits
Current period Retirement = 15 years
Remaining Employment Period = 20 years
Retirement Benefits =
page15
Actuaries Determine Funding
So, how much should the company fund this year?
What is that amount in this example?
page16
Actuaries Determine Funding
Current period Retirement = 15 years
Remaining Employment Period = 20 years
page17
Defined contribution vs. benefit plans
Benefit Employer’s
contribution is based on expected payout
Contract is for payments to retired employees employer bears risk associated with plan performance
Great uncertainty regarding annual pension expense
Contribution Employer’s
contribution to the plan is defined
No promises regarding ultimate pension benefit
Employees bear risk associated with plan performance
No uncertainty regarding annual pension expense
page18
Accounting for Defined Contribution Plans
Assume required contribution under terms of plan for 2003 is $335,000
Employer FundingContribution Status
Case A: $335,000 fully fundedCase B: $300,000 under fundedCase C: $600,000 over funded
page19
Accounting for Defined Contribution Plans
Case A:
Case B:
Case C:
page20
Defined BENEFIT Options
Cash basis accounting wait until employees retire expense actual payments to retired
employees
Modified cash basis accounting fund plan prior to retirement expense funding payments
Accrual basis accounting (FAS 87) expense pension related cost of services
provided in current year by employees
page21
What is the ‘obligation’?
Accumulated benefit obligation (ABO)Estimate of total retirement benefits based on
current salary levels
Vested benefit obligationPortion of ABO that is vested
Projected benefit obligation (PBO)Estimate of total retirement benefits based on
future salary levels
page22
Major Components of a Pension Plan
PBOactuarial present value of future pension benefits
earned to date to be paid to employees in the future
Pension plan assetsvalue of assets set aside to satisfy obligation
**net pension obligation (asset) =PBO-pension assets**
Pension expenseamount charged to income for the period
page23
page24
Important Terms
Benefit payments pension payments to participants
Funding payments payments made to the trustee to fund
the plan
Transition adjustment “catch-up” adjustment that arose
when firms first adopted FAS 87
page25
Important Terms
Current service cost (CSC) present value of benefits earned
during the current period
Actual return on plan assets includes dividends, interest income
and capital gains and losses
Expected return on plan assets anticipated return on plan assets
based on the expected long-term rate of return on plan assets
page26
Important TermsExperience gain or loss
difference between actual and expected return on plan assets
Actuarial gain or loss a change in the value of the PBO
resulting from a change in actuarial assumptions
Prior service cost (PSC) cost of retroactive benefits granted in
a plan amendment
page27
Pension Assets
opening balance+ actual return on plan assets+ funding payments- benefit payments to retireesclosing balance
Pension Fund Trustee
Invests funds to earn a return and payout cash to retiree
page28
Projected Benefit Obligationopening balance+ current service cost+ prior service cost+ interest on obligation- benefit payments to
retirees+/- changes in assumptions (i.e. actuarial gains/losses)
closing balance
Employer
page29
Pension Expense
+ current service cost+ interest on pension obligation- actual return on plan assets+/- deferral of experience gain/loss+/- amortization of unrecognized gain/loss(including experience and actuarial gains/losses)
+ amortization of unrecognized prior service cost
+/- amortization of transition adjustmentpension expense
page30
Current Service Cost
Actuarial present value of new benefits earned by employees during current period
Current period Retirement
Total Employment Period
PV of additional retirement benefits
page31
Effect of Service Cost
PBO Service cost is
starting point Current service
cost will increase PBO on an annual basis
Expense Current service
cost increases in first year of plan,
same as for PBO
Beg Bal. $1,300,000Current SC 500,000 $ 500,000
Assume a $500,000 increase of PBO due to additional year of service
page32
Prior Service Cost Credit given to employees for past service
Initiate or amend a plan Retroactive benefits
really retroactive? Expectation of future service….
Increases PBO Amortize PSC for pension expense
Years of service method
prior service cost = $100,000, 5 year amortization
page33
Prior Service Cost
Current period Retirement
Total Employment Period
Plan Amendment
PV of benefits due to plan amendment or adoption for past periods
Prior service period
page34
Effect of PSC
PBO Increases by total
amount in year of change
Expense amortized into
over estimated life of employees effected, beginning with year of changeBeg Bal. $1,300,000
Current SC 500,000 $ 500,000PSC 100,000 20,000
page35
Interest on Pension Obligation
Employee is one year closer to retirement, which increase present value of benefits due to the time value of future benefits
Interest on the pension obligation (i.e. projected benefit obligation) outstanding during the period= beginning-of-year balance x settlement rate
Assume settlement rate = 10%
page36
Effect of Interest
Increases PBO Increases expense
Beg Bal $1,300,000Current SC 500,000 $ 500,000PSC 100,000 20,000Interest 130,000 130,000
page37
Payments and changes in assumptions
Benefit payments reduce PBO Payments have NO EFFECT on pension
expense Assume $30,000 funding payment Changes in actuarial assumptions
Increase or decrease PBO Amortized in pension expense (when too big!)
Assume actuarial assumptions change amount is increase in PBO of $40,000
page38
Effect of payments and changes in assumptions Payments decrease
PBO Changes in
actuarial assumptions change PBO
No effect Changes in actuarial
assumptions are amortized into expense using corridor approach
Beg Bal $1,300,000Current SC 500,000 $ 500,000PSC 100,000 20,000Interest 130,000 130,000Benefit pmt ( 30,000) 00Actuarial loss 40,000 00*
page39
Return on Plan Assets
Actual return = interest + dividends + cap. gains - cap.
losses
Expected return = actuary’s expected rate of return x plan assets
Difference is the ‘experience gain or loss’
Pension Fund Trustee
page40
Details of expected return Actual return reduces pension
expense with ‘experience’ gains/losses deferred
Net result is EXPECTED return reduces pension expense
Amortize experience gains/losses when they gets too large
page41
Return on plan assets
Plan assets = $1,000,000 Actual return at 25%= $250,000 Expected return at 11% = $110,000
unexpected gain (i.e. experience gain) = 250,000-110,000=140,000
Reduce pension expense by $250,000 Defer experience gain of $140,00
(incr. Pension exp.)
page42
Effect of return on plan assets No effect Reduces expense by
expected return Actual return less the
deferred ‘experience gain/loss’
Beg Bal $1,300,000Current SC 500,000 $ 500,000PSC 100,000 20,000Interest 130,000 130,000Benefit pmt ( 30,000) 00Actuarial loss 40,000 00*Actual return 000 (250,000)Deferred exp gain 000 140,000
page43
Delayed Recognition Under FAS 87
Impact of following items not fully recognized when they occur
experience gains and losses actuarial gains and losses (i.e. impact
of changes in assumptions) prior service cost transition adjustment (IGNORE!!)
page44
With Full Recognition:expense PBO plan assets
balance balance+ csc + csc+ psc + psc+ interest exp. + interest exp.- actual return + actual return
- benefits - benefits+ contributions
+/- actuarialgains and losses
+/- actuarialgains and losses
total expense balance balance
page45
Effect of Delayed RecognitionPrepaid (accrued) pension reported
on balance sheet may not equal net pension asset (obligation) i.e. frequently companies have
significant off-balance sheet pension liabilities or pension assets
Total pension expense does not equal the change in the PBO
page46
The Corridor ApproachMinimum amortization
allow gains less losses to accumulate until net amount deferred exceeds a defined threshold
amortization required when beginning-of-year net gain or loss exceeds 10% of maximum opening (PBO or fair value of plan assets)
amortization period is Estimated Average Remaining Service Life of the active employees expected to receive benefits
amount amortized is the EXCESS over the corridor amount.
(beginning net deferred gain/loss - threshold)/EARSL
page47
Corridor Example Beginning fair value of plan assets =
$1,000,000
Beginning of year PBO = $ 1,300,000
Beginning of year deferred gain/loss = $180,000
End of year deferred gain = $320,000
EARSL = 10 years
page48
Corridor Solution Determine 10% threshold
10% of beginning PBO = $130,000 10% of beginning FV plan assets = $100,000
Amortization amount Beginning deferred gain/loss = $180,000Corridor (10% of PBO) 130,000
Total amort. Amount $50,000(This year’s portion $50,000/10=$5,000)
page49
Effect of amortization No effect Increases expense
Beg Bal $1,300,000Current SC 500,000 $ 500,000PSC 100,000 20,000Interest 130,000 130,000Benefit pmt ( 30,000) 00Actuarial loss 40,000 00*Actual return 000 (250,000)Deferred exp gain 000 140,000Amortization 000 5,000
page50
What do we record? Journal entry to record pension
expense as calculated above
Entry to record funding payment
Balance to pension asset/liability
page51
What is not on the balance sheet?
Unrecognized experience gains/losses Plan assets include actual return not
expected return Unrecognized prior service cost
PBO includes entire prior service cost not amortized
Unrecognized actuarial gains/losses PBO includes all actuarial gains/loss
page52
Minimum liability Concerns over underfunded plans
with no balance sheet recognition Requires reporting of ‘minimum
liability’ Difference between fair value of plan
assets and ABO Can only report in a liability, not
additional asset…. (when ABO is less than FV of plan assets)
page53
Recording Compare minimum liability to balance
sheet and adjust for difference Debit contra equity account for amount
related to PSC Debit balance to Intangible Asset-Deferred
Pension Cost Credit additional pension liability for amount
minimum liability exceeds reported liability/asset
page54
Minimum Liability ExampleAssume no minimum liability attributable to PSC.
Intangible Asset - Deferred Pension Cost $XXXX
Minimum Liability $XXXX
Assume $ 100,000 attributable to PSC.
Intangible Asset - Deferred Pension Cost $(XXXX-$100k)
Contra Equity Account $100K
Minimum Liability $XXXX