Pensions and Other Postretirement Benefits

1. Pensions and Other Postretirement Benefits Sid Glandon, DBA, CPA Associate Professor of Accounting University of Texas at El Paso

2. 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.

3. 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

4. Defined Contribution Plans • 401(k) Plans • Permit voluntary contributions by employees (contributory plan) • Money purchase plans • Thrift plans • Savings plans • Profit-sharing plans

5. Components of Pension Expense + Service cost + Interest on pension liability - Return on plan assets Amortization of: + Prior service cost +/- Losses/gains resulting from a) revisions in estimates of pension liability b) investing plan assets

6. 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

7. 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

8. Example

12. 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

13. 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

14. Pension Expense + Service cost + Interest cost - Expected return on plan assets + Amortization of prior service cost + (-) Amortization of net loss or (gain)

15. Recording Pension Expense and Pension Funding

16. Pension Spreadsheet • Informal Records • PBO • Plan assets • Prior service cost • Net loss (gain) • Formal Records • Pension expense • Cash • Prepaid (accrued) pension cost

18. #1 Reconciliation Between Beginning Informal and Formal Records

19. #2 Service Cost • Given by actuary as $750

20. #3 Interest Cost

22. #4 Actual Return on Plan Assets

23. #5 Loss (Gain) on Plan Assets

25. #6 Loss (Gain) on PBO

27. #7 Change in Prior Service Cost • In this case there is no change in prior service cost

28. #8 Amortization of Prior Service Cost

29. #9 Amortization of Net Gain (Loss) • In this case there is no net gain (loss) on which amortization should be taken

30. #10 Contributions • The employer made contributions to the plan in the amount of $145

31. #11 Benefits Paid • The plan paid benefits to retirees in the amount of $85.

32. #12 Minimum Liability Adjustment • None in this case

33. #13 Year-End Journal Entry to Record Pension Expense and Funding

34. #14 Reconciliation Between Beginning Informal and Formal Records

35. Postretirement Benefit Plans • Medical insurance • Dental insurance • Life insurance • Other postretirement benefits

36. 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

37. Net Cost of Benefits

38. 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

39. 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

40. Example: Measuring the Obligation

41. APBO at 1/1/05

42. APBO at 12/31/05

43. Measuring APBO

44. 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

45. 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