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

Pensions and Other Postretirement Benefits

Sid Glandon, DBA, CPAAssociate Professor of AccountingUniversity of Texas at El Paso

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.

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

Defined Contribution Plans

401(k) Plans Permit voluntary contributions by

employees (contributory plan) Money purchase plans Thrift plans Savings plans Profit-sharing plans

Components of Pension Expense

+ Service cost+ Interest on pension liability- Return on plan assetsAmortization of:+ Prior service cost+/- Losses/gains resulting from

a) revisions in estimates of pension liabilityb) investing plan assets

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

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

ExampleEmployee: SpencerYears of service: 15 yearsCurrent annual salary $40,000Pension formula: Estimated final annual salary $60,000 * Percentage 2%

* Years of service to date 15 Retirement benefit $18,000

Years of service remaining 10Estimated final annual salary $60,000

Estimated retirement period 20 yearsDiscount rate 6%

Fact Pattern

Estimated final annual salary $60,000 * Factor 2% * Years of service to date 15Earned retirement benefits $18,000

Earned Retirement Benefits

Estimated earned retirement annuity $18,000 * PVOA, n = 20, i = 6% 11.46992PV of retirement annuity at retirement date $206,459

Present Value of Retirement Annuity

PV of retirement annuity at retirement date $206,459 * PV$1, n = 10, i = 6% 0.55839Pension benefit obligation $115,284

Pension Benefit Obligation

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

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

Pension Expense

+ Service cost + Interest cost - Expected return on plan assets + Amortization of prior service cost + (-) Amortization of net loss or

(gain)

Recording Pension Expense and Pension Funding

Account Debit CreditPension expense $XXXPrepaid (accrued) pension cost $XXX Cash $XXXTo record pension expense and funding for the current year

Pension Spreadsheet

Informal Records PBO Plan assets Prior service cost Net loss (gain)

Formal Records Pension expense Cash Prepaid (accrued) pension cost

# Description PBOPlan

Assets

Prior Service

CostNet Loss (Gain)

Pension Expense Cash

Prepaid (Accrued)

CostAdditional Liability

Intangible Pension

Asset1 Beginning balance ($8,500) $7,800 $1,200 $600 $1,1002 Service cost (750) $7503 Interest cost (510) 5104 Actual return on plan assets 780 (780)5 Loss (gain) on plan assets (312) 3126 Loss (gain) on PBO (80) 807 Change in prior service cost

Amortization:8 Prior service cost (120) 1209 Net gain (loss)

10 Contributions to fund 145 ($145)11 Benefits paid 85 (85)12 Minimum liability adjustment13 Journal entry $912 ($145) (767)14 Ending balance ($9,755) $8,640 $1,080 $368 $333

Informal Records Formal Records

Pension Spreadsheet

#1 Reconciliation Between Beginning Informal and Formal Records

PBO ($8,500)Plan assets 7,800Prior service cost 1,200Net loss (gain) 600

$1,100

Prepaid (accrued) pension cost $1,100

Informal Records

Formal Records

#2 Service Cost

Given by actuary as $750

#3 Interest CostBeginning PBO $8,500Discount/interest rate 6% Interest cost $510


Assets

Prior Service

CostNet Loss (Gain)


Prepaid (Accrued)


Intangible Pension





Pension Spreadsheet

#4 Actual Return on Plan Assets

FV plan assets, end of year $8,640FV plan assets, beginning of year 7,800 Increase in FV of plan assets during year $840Contributions to fund 145Payments to retirees 85 Excess payments (contributions) during year (60)Actual return on plan assets $780

#5 Loss (Gain) on Plan Assets

Expected return on plan assets: FV of plan assets, beginning of year $7,800 Expected rate of return 6% Expected return $468Actual return on plan assets 780Loss (gain) on plan assets ($312)


Assets

Prior Service

CostNet Loss (Gain)


Prepaid (Accrued)


Intangible Pension





Pension Spreadsheet

#6 Loss (Gain) on PBOPBO, End of Year (actuarially determined) $9,755 PBO, Beginning of Year $8,500 Service cost 750 Interest cost 510 Benefits paid (85) Computed PBO, End of Year 9,675Loss (gain) on PBO $80


Assets

Prior Service

CostNet Loss (Gain)


Prepaid (Accrued)


Intangible Pension


Amortization:8 Prior service cost (120) 1209 Net gain (loss)10 Contributions to fund 145 ($145)11 Benefits paid 85 (85)12 Minimum liability adjustment13 Journal entry $912 ($145) (767)14 Ending balance ($9,755) $8,640 $1,080 $368 $333


Pension Spreadsheet

#7 Change in Prior Service Cost

In this case there is no change in prior service cost

#8 Amortization of Prior Service CostPrior service cost $1,200Average remaining service life per employee 10Amortization of prior service cost $120

#9 Amortization of Net Gain (Loss)

In this case there is no net gain (loss) on which amortization should be taken

#10 Contributions

The employer made contributions to the plan in the amount of $145

#11 Benefits Paid

The plan paid benefits to retirees in the amount of $85.

#12 Minimum Liability Adjustment

None in this case

Accumulated benefit obligation, End of Year ($8,500)FV of plan assets, End of Year 8,640 Minimum liability (ABO > FV of plan assets) 0

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

Account Debit CreditPension expense $912 Accrued pension cost 767 Cash $145To record pension expense and funding for the year

#14 Reconciliation Between Beginning Informal and Formal Records

PBO ($9,755)Plan assets 8,640Prior service cost 1,080Net loss (gain) 368

$333

Prepaid (accrued) pension cost $333

Informal Records

Formal Records

Postretirement Benefit Plans

Medical insurance Dental insurance Life insurance Other postretirement benefits

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

Net Cost of Benefits

Estimated annual medical costs Less: Retiree co-payments Less: Medicare paymentsEstimated net cost of annual benefits

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

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

Example: Measuring the Obligation

Fact Pattern:EPBO at 12/31/04 $48,000Years of service completed 5Expected total years of service 30Actuarially determined discount rate 5%

APBO at 1/1/05

Years completedTotal years

$48,000 * 5/30 = $8,000

EPBO * = APBO

APBO at 12/31/05

EPBO at 1/1/05 * [ 1 + discount rate ] = EPBO at 12/31/05

$48,000 * 1.05 = $50,400

Years completedTotal years

630

* = $10,080$50,400

* = APBO at 12/31/05EPBO at 12/31/05

Measuring APBO

APBO at 1/1/05 $8,000Interest cost: Beginning APBO $8,000 Discount rate 5% Interest cost 400Service cost: Ending EPBO 50,400 One year of service 1/30 Service cost 1,680APBO at 12/31/05 $10,080

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

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

Documents

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