Intermediate Financial Accounting Postretirement Benefits Other than Pensions

Intermediate Financial Accounting

Postretirement Benefits Other than Pensions

The Financial Statements 2

Accounting for Postretirement Benefits Identify the differences between

pensions and postretirement benefits other than pensions (i.e., health-care benefits).

To learn the accounting for postretirement benefits other than pensions.


About SFAS No. 106

Postretirement benefits other than pensions include health care benefits and other welfare benefits (i.e., tuition, eye care, legal & tax services, day care, housing assistance) for retirees, their dependents and spouses.


Accounting Practice of OPEB (Other Post Employment Benefits) Prior to SFAS 106 Only recognizes them when pay - on a

cash basis. Reasons of NOT pre-funding these

benefit plans:

1. The payments to pre-fund health care costs are NOT tax deductible.


Accounting Practice of OPEB (Other Post Employment Benefits) Prior to SFAS 106

2. These OPEB were once perceived to be low cost employee benefits and could be changed or eliminated at will, and, therefore, Not a legal liability.


Accounting Practice of OPEB under SFAS 106 The liability of OPEB should be

recognized during the employment of employee, rather than delay to their retirement. OPEB is a form of deferred compensation.

Thus, the accounting treatment of OPEB is on an accrual basis, rather than on a cash basis.


Accounting Practice of OPEB under SFAS 106 (contd.) When IBM adopted SFAS No. 106 in 3/91,

it resulted in $2.3 billion charge and the first ever quarterly loss in IBM history.

GE disclosed a $2.7 billion liability on 4th quarter of 1993 when adopting SFAS 106.

AT&T charged $2.1 billion when adopting SFAS 106.


Differences between Pension Benefits & Health Care Benefits Reasons why FASB does not issue one statement for

both pension benefits and OPEB:Item Pension Health Care BenefitsFunding Generally funded NotBenefit Well-defined & level

dollar amountGenerally uncapped & great

variabilityBeneficiary Retiree (may be some

benefits to survivingspouse)

Retiree, spouse, anddependents

Benefit Payable Monthly As needed & usedPredictability Variables are predictable Utilization difficult to predict

Level of Cost variesGeographically & fluctuates

over time Because of the substantial differences, FASB issues

different statements for these two benefits.


Obligations under Postretirement Benefits Expected postretirement benefits

obligation (EPBO): The actuarial present value as of a

particular date of all benefits expected to be paid to employees and their dependents after retirement.

The EPBO is NOT recorded in the F/S, but it is used in measuring periodic expense.


Obligations under Postretirement Benefits (contd.) Accumulated postretirement benefits

obligation (APBO): The actuarial present value of future

benefits attributed to employees’ services rendered to a particular date.


Obligations under Postretirement Benefits (contd.) APBO = EPBO for retirees. APBO = EPBO for active employees

with full date eligibility for benefits (fully eligible for benefits).

APBO < EPBO for active employees NOT fully eligible for benefits.


Postretirement Expense (recognized on I/S) Postretirement expense (net periodic

postretirement benefit cost): The annual expense that employer

recognized on the income statement. It consists of many similar components used to compute annual pension expense.


Postretirement Expense (contd.)

The components are:+ 1. Service cost . The portion of

EPBO attributed to employee service during the period.

+ 2. Interest cost. The interest on APBO attributable to

the passage of time.- 3. Actual return on plan assets.


Postretirement Expense (contd.)

The components are (contd.):+ 4. Amortization of prior service

cost.+ or - 5. Gains and losses.

+ 6. Amortization of transition obligation.


The Transition Amount

At the adoption of SFAS No. 106, a transition amount is computed as the difference between:

(1). The APBO and (2). The fair value of the plan assets plus any accrued obligation or less and prepaid cost(mostly zero at adoption)

Due to most plans are unfunded, larger transition obligations occur at the adoption of SFAS No. 106.


The Transition Amount - the Accounting Treatments A. Immediate Recognition (IR Method)

Cumu. Eff. of Acct.Change1 xxxDeferred Tax Assets xxx

Prepaid/Accrued Postret. Benefit Cost

xxx (reported on B/S as

a long-term liability)

1. The tax effect if deferred because only the actual payment for retiree benefits are tax deductible.


The Transition Amount - the Accounting Treatments (Contd.) The Prepaid/Accrued account can only

be reduced by funding, not by payments of benefits.

Payments of benefits reduce the APBO which is only disclosed in the footnote, not recognized.


The Transition Amount - the Accounting Treatments (contd.)

B. Deferred recognition:Amortize the transition amount on

a straight-line basis over the average remaining service period to expected retirement of the employees or 20 years if it is longer. Similar entry as for the IR method will be recorded. Once chosen, the method cannot be changed.


Off Balance Sheet Items Related to Postretirement Benefits1. EPBO

2. APBO

3. Postretirement plan assets

4. Unrecognized transition amount

5. Unrecognized prior service cost

6. Unrecognized net gains or losses


Example 1

1997 Entries & work sheetAssuming on 1/1/97, Quest adapts

SFAS No. 106 to account for its health care benefit plan. The following facts apply to the post retirement benefits plan for the year of 1997:

1. Plan assets at fair value on 1/1/97: $0


Example 1 (contd.)

2. Actual & expected returns on plan assets in 1997: $0.

3. APBO, 1/1/97 is $400,000 (Transition obligation at the adoption of 106).

4. Service costs for 1997 is $22,000.5. Prior service cost: $0.6. Discount rate: 8%.


Example 1 (contd.)

7. Contributions (funding) to plan in 1997 are $38,000.

8. Benefit payments to employees from plan in 97 are $28,000.

9. An average remaining service to full eligibility: 21 years.

10. An average remaining service to retirement: 25 years.

11. Transition amount to be amortized.


J.E. of Quest memo record

Items

Annual Post-retirement Expense

CashPrepaid/ Accrued

CostAPBO Plan Assets

Unrecognized Transition Amount

Balance 1/1/97 400,000(Cr) 400,000(Dr)

(a) service cost 22,000(Dr) 22,000(Cr)

(b) Interest cost 32,0001(Dr) 32,000(Cr)

(c) Contributions 38,000(Cr) 38,000(Dr)

(d) Benefit payments 28,000(Dr) 28,000(Cr)

(e) Amortization of Transition 16,0002(Dr) 16,000(Cr)

J.E. fr 1997 70,000(Dr) 38,000(Cr) 32,000(Cr) 426,000(Cr) 10,000(Dr) 384,000(Dr)

Balance 12/31/97 32,000(Cr)

1. 400,000 x 8% = 32,000

2. 400,000 / 25 = 16,000


Example 1 (contd.)

Journal entry recorded on

12/31/97

Postretirement benefit expense 70,000

Cash 38,000

Prepaid/accrued Postreti. Benefit cost 32,000


Example 1 -Reconciliation Schedule

APBO ($426,000) cr.

Plan Assets 10,000 dr.

Funded Status (416,000) cr.

Unrecognized

Transition Amo. 384,000 dr.

($32,000) cr.


Recognition of Gains & Losses (G/L)

Gains & losses represent change in APBO or the change in value of plan assets resulting for actual experience difference from expected or from change in actuarial assumptions.


Amortization of G/L

The corridor approach applies. The corridor is the greater of 10% * APBO

or 10% * market value of plan assets. If the unrecognized G/L is greater than the

corridor, the excess amount needs to be amortized and included in as a component of the postretirement expense.


Amortization of G/L (contd.)

If the unrecognized G/L is less than the corridor, NO amortization of G/L is needed.

If amortization is required, the minimum amortization amount is the excess gain or loss (beyond the corridor) divided by the average remaining life to expected retirement of all active employees.


Amortization for G/L (contd.)

Any systematic amortization method can be used as long as:

(a) The amount amortized in any period is greater than the minimum amount calculated above;

(b) the method applied consistently, and

(c ) the method is applied similarly for both gains and losses.


Example 2

1998 Entries and work sheetContinuing the Quest illustration to

1998, the following facts apply to the plan for the year of 98:

1. Actual return on plan assets: $6002. Expected return on plan assets:

$8003. Discount rate: 8%


Example 2 (contd.)

4. Increase in APBO due to changes in actuarial assumptions is $60,000.

5. Service cost for 1998 is $26,000.6. Contributions (funding) to plan are

$50,000.7. Benefit payments to employees in

1998 are $35,000.


Example 2 (contd.)

8. Average remaining service to full eligibility: 21 years.

9. Average remaining service to retirement: 25years.


J.E. of Quest memo record

Items

Annual Post-retirement Expense

CashPrepaid/ Accrued

CostAPBO

Plan Assets

Unrecognized Transition Amount

Unrecognized Net G/L

Balance 1/1/98 32000(Cr) 426000(Cr) 10000(Dr) 384000(Dr)

(a) service cost 26000(Dr) 26000(Cr)

(b) Interest cost1 34080(Dr) 34080(Cr)

(c) Actual Return 600(Cr) 600(Dr)

(d) Unexpected Loss 200(Cr) 200(Dr)

(e) Contributions 50000(Cr) 50000(Dr)

(f) Benefits 35000(Dr) 35000(Cr)

(g) Amortization: Transaction 16000(Dr) 16000(Cr)(h) Increase in APBO-loss 25280(Cr) 60000(Cr) 60000(Dr)

J.E. fr 1997 75280(Dr) 50000(Cr) 57280(Cr) 511080(Cr) 25600(Dr) 368000(Dr) 60200(Dr)

(d) & (h) are components of gains & losses

1. 426,000 x 8% = 34,080

The following worksheet presents all the postretirement benefit entries and information Recorded by Quest in 98


Example 2 (contd.)

Journal entry on 12/1998:

Postretirement benefit expense 75,280

Cash 50,000

Prepaid/accrued cost 25,280


Example 2 -Reconciliation Schedule

APBO ($511,080) cr.

Plan Assets 25,600 dr.

Funded Status (485,480) cr.

Unrecognized

Transition Amo. 368,000 dr.

Unrecog. Gain/loss 602,000 dr.

Accrued cost ($57,280) cr.


Footnote Disclosures of Postretirement Benefits other than Pensions The disclosures for postretirement benefits other than pensions parallel with those for the pensions. Thus, refer to the disclosure notes for pensions in Chapter 17 for these disclosures.

Documents

Intermediate Financial Accounting Postretirement Benefits Other than Pensions