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FINANCIAL

ACCOUNTING
THEORY AND
ANALYSIS:
TEXT AND CASES
11TH EDITION

RICHARD G.
SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY

CHAPTER 14
PENSIONS AND
OTHER
POSTRETIREMENT
BENEFITS

Accounting for the Cost of


Pension Plans
Types of plans

Defined contribution
Defined benefit

Actuarial funding methods


for defined benefit plans

Cost approach
Benefit approach
1
2

Accumulated benefits approach


Benefits/years of service approach

Historical
Perspective
47
ARB No.

APB Opinion No. 8

Acco
u
Res nting
Stud earch
y No
.8

Measuring total cost


Allocating cost to proper
accounting
period
Providing cash to fund
the pension plan
Disclosure

APB Opinion No. 8


Issues

Normal cost
Past service cost
Prior service cost
Actuarial gains and losses

Accounting Method Under


APB No. 8

Minimum

Normal cost
Interest on unfunded prior or post
service cost
A provision for any vested benefit

Maximum

Normal cost
10% of past and prior service cost
Interest equivalent

APBS Inability to Reach A


Conclusion

Two views of pensions


2

A means of promoting efficiency

Therefore, pension costs are associated with the plan


and not specific individuals

A form of supplemental benefits

Therefore, they are related to specific employees

The Pension Liability


Issue

Issues involved in preliminary views

Period over which to recognize pension costs


How to spread pension cost over periods
Whether to include pension
information on balance sheets
Balan
ce

Sheet

Pensio
Inform n
atio

The Pension Liability


Issue

Position taken was that liability should be recognized on


the balance sheet
Pension benefit obligation
Actuarial present value of accumulated benefits with salary
progression
2 Less pension assets
Balance
Plus or minus valuation allowance

Opposition by AICPA

Sheet

SFAS No. 87 (See FASB


ASC 715)
Pension information

Should be prepared on the accrual basis


While retaining three fundamental aspects of previous
requirements

1.
2.
3.

Delayed recognition of certain events


Reporting net cost
Offsetting assets and liabilities

Changes from APB Opinion No 8:


1.
2.

3.

Standardized method of measuring pension cost


Immediate recognition of a pension liability when the
accumulated benefit obligation exceeds the fair value of
plan assets
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 recognition

When accumulated benefit obligation exceeds plan


assets

Disclosures Required Under FASB


ASC 715

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.

FASB ASC 715: 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.

2.

Create standards for the operation of pension


funds
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 (See FASB ASC 715)

These benefits are offered in exchange for current


service

Deals with several benefits offered to retired employees


The most important are health insurance and life insurance

Similar to defined benefit pension plans


Should be accounted for as such over the working life of
employees

Prior treatment was pay-as-you-go


Economic consequences arguments of SFAS No.
106

Accounting Treatment Required


By SFAS No. 106 (See FASB

ASC 715)

Service cost
Interest
Amortization of prior service costs
Amortization of transition amount
Disclosure
Postemployment Benefits

SFAS No. 132 (See FASB ASC 715


-20-50)

New requirements including:


2

Standardization of the disclosure requirements for


pensions and other postretirement benefits
Requiring the disclosure of additional information on
changes in the benefit obligation and fair value of plan
assets
Eliminates some other disclosure requirements

The benefit to financial statement users includes


disaggregated information on the six
components of pension cost

SFAS No. 158

2005: FASB, in conjunction with IASB,


added 2-phase review of accounting
for pension plans to agenda
1.

2.

Address info about DBPP & OPBP in


Notes, but not in financial statements
Other financial accounting and reporting
issues

SFAS No. 158

Requires recognition of:


1.

2.

3.

4.

Overfunding or underfunded DBPP or


OPBP on statement of financial position
Gains and losses, net of tax, and prior
service costs and components
DBPP and OPBP assets and obligations
on fiscal year-end
Disclose certain items in notes

SFAS No. 158

Completed phase one


No income statement affect
Phase two will reconsider

All aspects of accounting for DBPPS or


OPBPs
Possibly requiring companies to disclose
gross pension assets and liabilities on
balance sheets

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
Hershey

Has a defined benefit pension plan


Offers other postretirement benefits

Tootsie Roll

Has a defined benefit pension plan


Offers postretirement health care and
life insurance benefit plans

International Accounting
Standards
The IASC has issued two standards
affecting accounting for retirement
benefits

1.

2.

A revised IAS No. 19, Retirement Costs and


Expenses
IAS No. 26, Accounting and Reporting by
Retirement Benefit Plans

IAS No. 19:


Retirement Costs and
Expenses
Major provisions are:

For defined contribution plans:

1.

Periodic contributions are recognized as expenses

For defined benefit plans:

2.
a)

b)

c)

Current service cost should be recognized as an


expense
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.
Preferred method is the accrued benefit valuation
method but projected benefit valuation method is
acceptable

IAS No. 19:


Retirement Costs and
Expenses
IASB currently engaged in project to amend
March 2008: discussion paper issued
IASB to issue 3 disclosure drafts

1.

2.

3.

Appropriate discount rate for measuring employee


benefits
Recognition and presentation of changes in defined
benefit obligations and plan assets, disclosures, and
other issues
Accounting for contribution-based promises

IAS No. 19: Retirement Costs and


Expenses
(Amendment)

June 2011, amendment published


Deferred initial plans for full review of pension
accounting
Final amendment requires other
comprehensive income presentation changes
for pensions only.

IAS No. 19: Retirement Costs and


Expenses
(Amendment)
Amendment:

Requires recognition of changes in net defined benefit liability


(asset)
Introduces enhanced disclosures about defined benefit plans
Modifies accounting for termination benefits
Clarifies miscellaneous issues

Classification of employee benefits


Current estimates of mortality rates
Tax and administrative costs
Risk-sharing and conditional indexation features

Incorporates other matters submitted to IFRS Interpretations


Committee

IAS No. 26: Accounting and


Reporting by Retirement
Benefit Plans

Separate reporting standards for defined benefit and


defined contribution pension plans
Objectives
Defined
Contribution

Defined Benefit

provide information
about the plan and
the performance of
investments
provide information
that is useful in
assessing the
relationship between
plan resources and
future benefits

Prepared by Kathryn Yarbrough, MBA


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