Pensions & Other Post Employment Benefits – after SFAS No. 158

1. Pensions & Other Post Employment Benefits – after SFAS No. 158 Includes certain slides provided by authors of Skousen, Stice & Stice and Kieso, Weygandt & Warfield Intermediate Accounting textbooks, as modified and adapted by Teresa Gordon

2. Types of plans • Contributory Plan • Non-Contributory Plan • Defined Contribution Plan • Defined Benefit Plan

3. Defined contribution plans • A plan that provides benefits based solely on what has been contributed and the earnings thereon < 401(k) > • Amounts to be funded are determined by the plan • No promise for specific future benefits. • Independent third party holds assets • Risk borne by employee • Accounting relatively straightforward

4. Defined benefit plans • A pension plan that determines the amount of benefit to be provided • Contributions based on estimated amounts needed to meet expected payments • Form versus substance of trust • Risk borne by employer • Accounting by employer is complicated

5. Services Wages and Salaries Contributions Pension Fund Retired Employees Defined Benefits Defined Benefit Pension Plan Employer Current Employees

6. Pension Approaches • Before FASB 87 & 88: • “pay as you go” or “noncapitalization” • FASB 87 & 88 • Capitalization approach • Full obligation reported only in notes • FASB 158 • Pension & post-retirement benefit cost is same as FASB 87 • Full obligation is now reported on balance sheet • Additional items now on statement of comprehensive income

7. Capitalization approach to pensions: • Employer has full liability for benefits related to service already rendered by employee • Expense is recognized as employees work (service cost) and this increases the liability • Liability balance increases every year since present value of future benefits is larger (less time remains to cash outflow) • Liability is reduced through payments to retirees • Assets of the plan are considered pledged, collateral against a liability • Liability less designated assets reported on balance sheet (net presentation)

8. PV of Expected Cash Flows Measures of Pension Liability Benefits for vested and nonvested employees at future salaries Benefits for vested and non- vested employees at current salaries Accumulated Benefit Obligation Projected Benefit Obligation Benefits for vested employees at current salaries Vested Benefit Obligation (GAAP)

9. Interest/return rates • Discount rate • Rates on high-quality fixed-income investments with maturities consistent with expected payments to retirees • Generally equivalent to a portfolio of zero-coupon bonds with appropriate maturities • Expected rate of return • Based on long-term rate of return anticipated given investment of plan assets

10. What happens when • Interest rates increase? • Interest rates decrease?

11. A working paper for pensions

12. Accounts on Employer’s Books • Net Periodic Pension Cost (Expense) • Amount recognized by the employer on the income statement • Pension expense includes six basic elements (more later) • Other comprehensive income • Up to three amounts reported for changes in balance of AOCI amounts (see next slide)

13. Working Paper – Pension Expense

14. A working paper for pensions

15. Accounts on Employer’s Books • On balance sheet – Net funded position • When PBO > Plan Assets, reported as noncurrent liability (with current liability if there are inadequate plan assets to cover current payments to retirees) • When Plan Assets > PBO, reported as noncurrent asset

16. A working paper for pensions

17. Accounts on Employer’s Books • Accumulated other comprehensive income (AOCI) • Account appears as part of owners’ equity section of balance sheet • Three pension related balances • Transition gain or loss • Prior service cost • Actuarial gains or losses

18. A working paper for pensions

19. Plug to balance JE Self-checking features Funded status must equal PBO + Plan Assets Each blue row must add across to ZERO Balance forwards

20. Net Periodic Pension Cost • Net periodic pension cost (the expense) consists of six basic elements: • Service cost • Interest cost • Expected return on plan assets • Amortization (if any) of • Transition gain or loss • Prior service cost • Unrecognized gain or loss

21. Pension Definitions • Prior Service Cost (PSC) • Cost of benefits granted for service rendered prior to the inception of the plan • Increases PBO at date of amendment but cost is amortized to expense over future years • Reduces funded status since PBO is higher • Recognized as charge to OCI at date of plan amendment • Amortization method recommended: • Years of service method • Straight-line or other methods that amortize PSC faster are also acceptable

22. Actuarial Gains and Losses • Actuarial assumptions are subject to inaccuracies as time goes by and circumstances change • There is a materiality provision for determining when gains and losses are sufficiently large to require amortization (charge to expense) • 10% Corridor Rule

23. Kieso, Weygandt & Warfield 11th ed. Illustration 20-14, page 1034

24. 10% Corridor Amortization • Amortization is required only on the portion of unrecognized net gain or loss that exceeds 10% of the greater of: • PBO at beginning ofyear, or • market-related value of plan assets at the beginning of the year.

25. Settlements & Curtailments • Additional FASB standards govern major changes in pension plans: • Settlements • No further obligations to some or all employees • Curtailments • Results in significant reduction in expected years, or • No further accrual of benefits • Handling will require further research (primarily FASB 88)

26. Pension Disclosures [FAS 132(R)] • Amount and types of assets held • Assumptions related to discount rate, rate of increase in compensation, expected return on plan assets • Alternative amortization policies • Past practice or history of regular benefit increases

27. Pension Disclosures [FAS 132(R)] • The details for net periodic pension cost • the service cost component. • the interest cost component. • the expected return on plan assets [FAS 132] • the amortization of PSC, transition amount and unrecognized gain/loss (separately) • Gain or loss from settlement or curtailment of plan

28. Pension Disclosures:Reconciliations • The fair value of plan assets (changes between BOY and EOY) • PBO Obligation (changes between BOY and EOY) Easily obtained from our work paper! EoY = end of yearBoY = beginning of year

29. Pension Disclosures • Employers with multiple plans • Information can be combined but the computations are made for each individual plan • Net position for over-funded plans would be reported in noncurrent assets • Net position for under-funded plans would be reported in liabilities • Part may be reported as a current liability • See next slide

30. Current portion of liability • The current portion (determined on a plan-by-plan basis) is the amount by which the actuarial present value of benefits in PBO that are payable in the next 12 months* exceeds the fair value of plan assets * As always, the operating cycle might be longer than 12 months in which case we’d use the operating cycle

31. Other Postretirement Benefits FASB 106 Appendix Material in KWW text Also changed by FASB No. 158

32. Other Post-retirement Benefits • The accounting is similar to pension accounting EXCEPT that • the terminology is slightly different • EPBO • APBO

33. Kieso, Weygandt & Warfield 11th ed. Illustration 20A-3, page 1056

34. APBO vs EPBO • Prior to the date on which an employee attains full eligibility for the benefits that employee is expected to earn • APBO < EPBO • On and after the full eligibility date, • APBO = EPBO • In other words • EPBO > APBO until the employee has earned the right to full benefits • EPBO = APBO after the employee has worked long enough to earn full eligibility

35. Kieso, Weygandt & Warfield 11th ed. Illustration 20A-2, page 1056 • Cost attributed to period from hire to eligibility (vesting)

36. Postretirement Benefit Worksheet • Would be the same as a pension worksheet with modified labels at the top • Pension Expense becomes Postretirement Benefit Expense. • PBO becomes APBO.

37. Working paper for FAS106

38. Net periodic postretirement benefit cost. • The expense basically includes the same elements as pension cost: • Service cost -- the actuarial present value of benefits attributed to services rendered by employees during the period. • Interest cost -- the interest on the beginning balance of the accumulated postretirement benefit obligation • Less expected return on plan assets. • Amortizations (transition, prior service cost and unrecognized gain or loss)

39. Comparing FASB 87 & 106