CHAPTER 14

PENSIONS AND OTHERPOSTRETIREMENT

BENEFITS

Accounting for the Cost of Pension Plans

Types of plansDefined contributionDefined benefit

Actuarial funding methods for defined benefit plans

Cost approachBenefit approach1 Accumulated benefits approach2 Benefits/years of service approach

Historical Perspective

ARB No. 47

Accounting Research Study No. 8

APB Opinion No. 8

Measuring total costAllocating cost to proper accounting periodProviding cash to fund the pension planDisclosure

APB Opinion No. 8 Issues

Normal cost

Past service cost

Prior service cost

Actuarial gains and losses

Accounting Method Under APB No. 8

MinimumNormal costInterest on unfunded prior or post service costA provision for any vested benefit

MaximumNormal cost10% of past and prior service costInterest equivalent

Reasons for APB’S Inability to Reach A Conclusion

Two views of pensions1 A means of promoting efficiency

therefore, pension costs are associated with the plan and not specific individuals

2 A form of supplemental benefits therefore, they are related to specific employees

The Pension Liability Issue

Issues involved in preliminary viewsPeriod over which to recognize pension costs

How to spread pension cost over periods

Whether to include pension information on balance sheets

Balance Sheet

Pension Information

The Pension Liability Issue

Position taken was that liability should be recognized on the balance sheetPension benefit obligation

+ Actuarial present value of accumulated benefits with salary progression

– Less pension assets

+ Plus or minus valuation allowance

Opposition by AICPA

BalanceSheet

SFAS No. 87

Pension information should be prepared on the accrual basis while retaining three fundamental aspects of previous requirements

1. Delayed recognition of certain events2. Reporting net cost3. Offsetting assets and liabilities

Changes from APB Opinion No 8:1. Standardized method of measuring pension cost2. Immediate recognition of a pension liability when the accumulated

benefit obligation exceeds the fair value of plan assets3. Expanded disclosure requirements

Pension Cost

Components:Service cost

Interest cost

Return on plan assets

Amortization of unrecognized prior service cost

Amortization of gains and losses

Amortization of transition amount

Minimum liability recognitionWhen accumulated benefit obligation exceeds plan assets

Disclosures Required Under SFAS No. 87

A description of the plan including

groups covered

type of benefit formula

funding policy

types of assets held

significant nonbenefit liabilities

any matters affecting comparability of information presented

Net periodic pension cost by components

A schedule reconciling funding status with the amounts reported on the balance sheet by category.

SFAS No. 87 Theoretical Issues

Projected benefits approach

The settlement rate

Return on plan assets

Reporting the minimum liability

Accounting for the Pension Fund

Requires information on pension plan financial statements

Net assets available for benefits

Changes in net assets

Actuarial present value of accumulated plan benefits

Effects of certain factors

The Employee Retirement Income Security Act (ERISA)

Goals 1. create standards for the operation of

pension funds

2. correct abuses in the handling of pension funds

Concerned only with funding policies

Does not impact on the determination of periodic pension expense

Other Postretirement Benefits

SFAS No. 106 deals with several benefits offered to retired employees the most important are health insurance and life insurance

These benefits are offered in exchange for current service

similar to defined benefit pension plansshould be accounted for as such over the working life of employees

Prior treatment was pay-as-you-goEconomic consequences arguments of SFAS No. 106

Accounting Treatment Required By SFAS No. 106

Service cost

Interest

Amortization of prior service costs

Amortization of transition amount

Disclosure

SFAS No. 132

New requirements including:1 Standardization of the disclosure requirements

for pensions and other postretirement benefits

2 Requiring the disclosure of additional information on changes in the benefit obligation and fair value of plan assets

3 Eliminates some other disclosure requirements

The benefit to financial statement users includes disaggregated information on the six components of pension cost

Financial Analysis of Retirement Benefits

Individual components of pension cost have been found to convey different information to financial statement users

Economic consequences of SFAS No. 106

Best Buy no pension plan

no disclosure of any information on other postretirement benefits.

Circuit Cityhas a defined benefit pension plan

does not offer other postretirement benefits.

International Accounting Standards

The IASC has issued two standards affecting accounting for retirement benefits

1. A revised IAS No. 19, “Retirement Costs and Expenses”

2. IAS No. 26, “Accounting and Reporting by Retirement Benefit Plans”

IAS No. 19Retirement Costs and Expenses

Major provisions are:1. For defined contribution plans:

periodic contributions are recognized as expenses

2. For defined benefit plans:a) Current service cost should be recognized as an

expense

b) Past service costs, experience adjustments and changes in assumptions are to be recognized as expenses in a systematic manner over the working life of current employees.

c) Preferred method is the accrued benefit valuation method but projected benefit valuation method is acceptable

FASB Staff Review of IAS No 19

The original staff review noted that the social contract between employers and employees may be different in foreign countries

New standard is an improvement but allows similar plans to be accounted for differently under U. S. GAAP and IASC standards.

IAS No. 26: Accounting and Reporting by Retirement Benefit Plans

Separate reporting standards for defined benefit and defined contribution pension plans

No FASB staff review

Defined Contribution

Objectives

provide information about the plan and the performance of

investments

Defined Benefit

provide information that is useful in assessing the

relationship between plan resources and

future benefits

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Prepared by Richard Schroeder, DBAKathryn Yarbrough, MBA