Chapter 16:

1. Chapter 16: Pensions and Other Postretirement Benefits

2. Lecture • Pension plans • Defined contribution • Defined benefit • Postretirement benefits other than pensions • IFRS

3. What is a pension? an arrangement between an employer and employee for the payment of post-employment income, hereafter called pension benefits

4. Defined Contribution Plans • Benefit is defined as the future value of pension fund contributions made on an employee’s behalf • Exact value is unknown prior to retirement ; depends on future earnings of fund investments • Benefits are solely a function of accumulated contributions; therefore, the term defined contribution • Value of benefits is variable, dependent on contribution levels and earnings made on invested contributions

5. Defined Contribution Plans • Contribution rates normally stated as a percentage of wages or salaries • noncontributory, in which all contributions are made by the employer • contributory, where funding is shared by the employer and employee • assets are set aside for the sole purpose of paying pension benefits...pension fund

6. Defined Benefit Plans • Benefit is defined either as a specific dollar amount or by a general formula based on salary • Benefits may be expressed as a specific dollar amount, normally multiplied by years of membership in the plan (years of service) to determine the value of the benefit

7. Defined Benefit Plans • Value of pension benefits is directly related to the employee’s years of service • Benefits may be paid in one of two ways • as a single lump sum amount at retirement date • as a life annuity

8. Vesting • Refers to a qualifying period of pension plan membership that must be met before pension benefits legally exist • Pension benefits do not come into legal existence before vesting requirements are satisfied • Once benefits vest, there is a formal obligation between the plan and employees as set out in the terms of the plan

9. Single and Multiemployer Plans • Pension plans can be either single-employer or multiemployer plans • A multiemployer pension plan is one that is subject to collective bargaining agreements in which two or more employers are plan sponsors. • Under statutory requirements, one employer can contribute no more than 50 percent of initial contributions and • no more than 75 percent thereafter

10. Actuarial Funding of Defined Benefit Plans • Derive a time series of annual pension fund contributions that will accumulate to produce a projected pension fund balance sufficient to meet the cost of projected pension benefits • Builds up a pension fund to the same future balance needed to meet expected retirement benefits

11. Actuarial Funding Methods • Accumulated benefits • Projected benefit • For very young plans, the accumulated benefit method would recognize substantially less each year than projected benefit methods, and the reverse would be true for very old plans

12. Accumulated Benefits Method • A separate contribution may be calculated to supplement service cost • Service cost can be recalculated in such a way that the deficiency is implicitly funded as part of future service costs • A literal measurement of the value of current accumulated benefits based on the benefit formula in a plan

13. Projected Benefits Method • Individual methods develop contribution rates for individuals, which are then summed to derive the total contribution for the plan • Aggregate methods make funding calculations for the plan as a whole • A more even distribution of contribution levels with projected benefit methods.

14. ERISA, Social Legislation of 1974 • Membership eligibility and vesting requirements • Mandatory funding requirements • Investment diversification requirements • The guarantee of certain vested benefits in the event of plan terminations • Pension Benefit Guaranty Corporation (PBGC)

15. Are pension funds well protected? • 1980s overfunded pension plans and corporate raiders • Reduction of pension benefits • Convert existing plans into “cash balance plans”

16. Legal Relationships in Defined Benefit Plans • Sponsoring employer • A pension fund • Plan participants • The PBGC for plans subject to ERISA

17. ARB 36 ARB 47 APB Opinion No. 8 FASB Interpretation 3 SFAS No. 35 SFAS No. 36 SFAS No. 87 SFAS No. 88 SFAS No. 106 SFAS No. 112 SFAS No. 132 SFAS No. 158 Pension Accounting Standards

18. SFAS No. 87 and SFAS No. 88 • achieved greater uniformity in measuring accrued pension expense by mandating use of one actuarial method, the benefits/years-of-service approach • used service cost rather than the term normal cost

19. SFAS No. 106: 1990 • OPEB costs are a form of deferred compensation in which the employer receives current services in exchange for future benefits • Requires recognition and measurement of OPEB costs and obligations

20. SFAS No. 132 Amended SFAS Nos. 87, 88, and 106 • Relative to certain disclosures • Reconciliation of beginning and ending balances of projected benefit obligation and fair value of plan assets • the components of pension and OPEB expenses • the balances of unamoritized prior service costs and unrecognized gains or losses • discount rates, expected return on plan assets, and health care trend rates • Disclosures pertain to both pensions and OPRBs where applicable

21. SFAS No. 158 • Amends of FASB Statements No. 87, 88, 106, and 132(R) • Is applicable to single employer plans • Brings the overfunded (underfunded) status of a defined benefit pension plan from the footnotes to the body of the balance sheet

22. SFAS No. 158 • Certain costs or credits that arise during the period • but are not recognized as part of net periodic pension expense until subsequently amortized. • In the period when these items arise, they are charged or credited to other comprehensive income. • Disclosures have to be made relative to those elements of accrued net pension cost that are originally recognized as part of other comprehensive income.

23. SFAS No. 158 • The standard conveys more information to users, an improvement. • By showing the over (under) funded amount in the balance sheet itself, the standard brings an important number on to the balance sheet from the footnotes and also eliminates the conservatism of the old approach. • Another aspect of this standard is that the over (under) funded amounts for other post employment benefits (OPEB) must also be shown as an asset or liability.

24. Postretirement Benefits Other than Pensions • health care • life insurance outside of pension plans • additional welfare benefits such as • legal services • housing subsidies • tuition assistance • day care

25. Other Post-Employment Benefits (OPEB) • SFAS No. 106 • SFAS No. 112 • Theoretical Aspects of OPEB Accounting • Economic Consequences of OPEB Recognition • Financial statement preparers strongly opposed OPEB recognition due to to costs of preparation. • OPEB obligations on the balance sheet mean higher debt‑to‑equity ratios, which threaten debt covenants on bond issues. • In addition, management compensation is affected by SFAS No. 106.

26. IFRS • IAS 19, Accounting for Retirement Benefits in the Financial Statement of Employees which was revised in 2004, is under a four year review by the IASB (2006-2010) to study pensions and other post-retirement benefits related to • presentation and disclosures, • definitions of deferred benefit, defined contribution plans and cash balance plans, • smoothing and deferred mechanisms, and • the treatment of settlements and curtailments.

27. IFRS • Currently, IASB 19 requires that past service costs be expensed immediately rather than amortized over the service period or life expectancy of employees. • Under the Memorandum of Understanding, IASB and FASB are scheduled to complete their review of pension accounting by 2014.

28. Improving Accounting Standards • OPEB benefits should be spread over the working life of employees and not just to the full eligibility date. • Hence, the expense would be recognized in accordance with how benefits are received. • Any differences between the OPEB expense and liability can be easily handled as a noncurrent asset.

29. Improving Accounting Standards • There is a conflict between cash flow prediction and accountability in measuring pension service costs. • The use of projected benefits required by SFAS No. 87 entails questions of verifiability and the executory nature of future salaries makes it very questionable for accountability purposes. • We, therefore, return to the use of the accumulated benefit method (current salaries) for determining pension service costs because of its clearer applicability for the accountability objective.

30. Lecture Recap • Pension plans • Defined contribution • Defined benefit • Postretirement benefits other than pensions • IFRS