Pensions

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					                                                             1



   Defined Contribution Plans
 The employer contributes a defined sum to a third party
  plan trust.
 Amounts to be funded are determined by the plan.
 The plan invests the contributed assets, which earn
  income, and makes distributions to retirees.
 There is no promise for specific future benefits.
 Market risk is borne by the employee.
 Accounting for the firm is relatively straightforward.
 For profit companies contribute to 401(k) plans and non-
  profit organizations contribute to 403(b) plans.
                                         2



Characteristics of a Pension Plan

                     A pension plan
                     requires that a
                   company provide
                 income to its retired
                 employees in return
                    for services they
                provided during their
                      employment.
                                                    3



      Defined Benefit Plans
 The retirement income,
 normally paid monthly,
 usually is determined on
     the basis of the
 employees earnings and
  length of service with
      the company.

$50,000 average salary X 2.5% per year X 30 years
           = $37,500 pension per year
                                                     4

           Internal Revenue
             Qualifications
Most companies design their pension plans to meet
the Internal Revenue Code qualifications, which
state that:
 1. Employer contributions are deductible for
    income tax purposes when paid.
2. Pension fund earnings are exempt from income
   taxes.
3. Employer contributions to the pension fund are
   not taxable to the employees until they receive
   their pension benefits.
                        5



Pension Relationships
                                                           6



       Defined Benefit Plans
 The employee is promised a certain amount of benefits
  at retirement.
 The amount received is based upon variables such as
  -Years of service
  -Ending salary or average of best (three) years
  -Multiplier, such as 2.5% per year of service
  -Age, if retiring early, a deduction will be made
 The employer remains liable for the benefits and bears
  the market risk.
 The employer is the trust-beneficiary.
 The accounting by the firm is complex.
                                            7



Projected Benefit Obligation
              The projected benefit
            obligation is the actuary’s
         estimate of the present value of
            benefits attributed to date
          based on future salary levels.
                                             8



Accumulated Benefit Obligation

              The accumulated benefit
             obligation is the actuary’s
          estimate of the present value of
             benefits attributed to date
          based on current salary levels.
                                                                9

                Components of
               Pension Expense
1.   +Service cost for the year. Increases pension expense.
2.   +Interest on projected benefit obligation (liability).
     Beginning PBO times the discount or settlement rate.
     Increases pension expense.
3.   -Expected return on plan assets during the year. Fair
     value of plan assets at beginning of year times expected
     long-term rate of return on plan assets. Generally
     decreases pension expense.
4.   +Amortization of prior service cost = Present value of
     additional benefits/modification of the plan amortized
     over the remaining service lives of active employees.
     Generally increases pension expense.
5.   +Gain or loss = Amortization of the cumulative net gain
     or loss from previous periods that has not yet been
     included in pension expense, in excess of the corridor.
                                10



Service Cost
       Service cost is the
    actuarial present value
   of the benefits attributed
    by the pension benefit
       formula to service
        rendered by the
     employees during the
         current period.
                          11



Interest Cost


   Interest cost is the
     increase in the
    projected benefit
  obligation due to the
    passage of time.
                                                        12



   Expected Return on Assets
 The expected return on
    plan assets is the      The expected return on
expected increase in plan   plan assets, if positive,
 assets due to investing     will decrease pension
        activities.                 expense.
                                                                   13



 Expected Return on Plan Assets
Projected Benefit Obligations        Projected Benefit Obligation
at Beginning of Period =             Grows to Equal Expected
Present Value of Benefits            Retirement Obligation
Earned to Date
                                                Retirement
      Interest = Projected Benefit x Discount
        Cost      Obligation          Rate


       Expected Return on Plan Assets
                                             Assets Used to Pay
       During Period
                                             Retirement Benefits
Plan assets at Beginning           Assets Grow to Equal
of Period at Fair Value            the Amounts Needed to
                                   Pay Retirement Benefits
                                              14



Prior Service Cost
   When a defined benefit plan is either
initiated or amended, credit is often given
     to employees for years of service
 provided before the date of initiation or
               amendment.
                                                           15



           Prior Service Cost
The retroactive benefit Prior service cost is reported
to a pension plan is theas a liability and as a negative
   prior service cost.          element of Other
                         Comprehensive Income for
                          the year at the date of the
                               plan amendment.
                                                16



Methods of Amortization
    Prior service cost may be amortized to
      pension expense over future service
   periods of employees active at the time of
     the plan amendment using either the
   straight-line or years-of-service method.
                                                              17



         Straight-line Method
 The average remaining service life of employees
   expected to receive benefits is calculated by
  dividing the total future service years by the
             number of employees.
Total future service years = average remaining service life
Number of employees expected
to receive benefits
                                         18



     Years-of-Service Method
The Board prefers a years-of-service
  amortization method where prior
service cost is divided by the number
 of future service years to be worked
    by participating employees, to
 obtain a cost per service-year. This
cost per service-year is multiplied by
      the number of service years
          consumed each year.
                                                         19



    Years-of-Service Method
At the beginning of 2007, Watts Company had nine
   employees who are expected to receive pension
benefits. One employee (A) is expected to retire after
 three years, one (B) after 4, two (C,D) after 5, two
    (E,F) after 6 and three (G,H,I) after 7 years.
                                                   20



   Years-of-Service Method
At that time, the company’s actuary computed the
           prior service cost at $400,000.
                                                        21



   Straight-Line Amortization
The seven employees will provide 50 years of service,
    so the average service provided will be 50 / 7 =
     5.56 years. The prior service cost of $400,000
       divided by 5.56 years equals $71,942 to be
        amortized to pension expense each year.
                                          22



       Gain or Loss
 A gain or loss from previous periods
arises because the actual amount of the
    PBO is different from what was
  assumed and because of changes in
         actuarial assumptions.
                                                          23



       Gain or Loss
   The gain or loss for the year is
recorded as a liability or asset and in
Other Comprehensive Income for the
                 year.



      Accrued/Prepaid Pension Cost        15,300
           Other Comprehensive Income (gain)     15,300
                                        24



       Gain or Loss
The excess of the accumulated gain or
   loss over a “corridor” amount is
amortized over the remaining service
 life of active employees expected to
    receive benefits under the plan.
                                                        25



 Amortization of Gain or Loss
The minimum amortization required is computed
 by dividing the total accumulated gain or loss
 subject to amortization at the beginning of the year
 by the average remaining service period of active
 employees expected to receive benefits.
The amount subject to amortization is the excess
 of 10% of the greater of the beginning balances of
 the projected benefit obligation and the fair value
 of the assets value. Use absolute values.
                                            26



Amortization of Gain or Loss

1. Amortization of any unrecognized net
   loss from previous periods is added to
   compute pension expense, or
2. Amortization of any unrecognized net
   gain from previous periods is deducted
   to compute pension expense.
                                                                              27



   Computation of Net Gain or Loss
  Use January 1 cumulative gain or loss for computation.
      Jan. 1      Projected      Fair
     Cumulative   Benefit       Value                Excess       Amortized
      Net Loss    Obligation    of Plan              Net Loss      Net Loss
Year   (Gain)      Actual       Assets    Corridor    (Gain)       (Gain)

2007    $13,000   $110,000     $100,000    $11,000    $2,000        $200
2008    (2,300)    135,000      130,000    13,500        ----         ----
2009     18,700    168,000      170,000    17,000      1,700         170
2010     27,500    230,000      215,000    23,000      4,500         450

    Assume the average
                                            Divide              Component
  remaining service period
                                          By 10 years           of pension
        is 10 years.
                                                                 expense
                                                         28



            Net Gain or Loss
December 31, 2007:

Amortized $200 of January 1 accumulated net loss to
pension expense.
December 31, 2007:
Accrued/Prepaid Pension Cost             200
   Other Comprehensive Income                      200
   (Amount amortized to pension expense during 2007)
                                                             29



            Net Gain or Loss
December 31, 2007:
Accrued/Prepaid Pension Cost           15,300
  Other Comprehensive Income                     15,300
  (Difference between $13,000 loss on January 1 and $2,300
                   gain on December 31)

December 31, 2008:
Other Comprehensive Income             21,000
  Accrued/Prepaid Pension Cost                   21,000
  (Difference between $2,300 accumulated gain on January 1
  and $18,700 accumulated loss on December 31)
                                                    30



 Projected Benefit Obligation
  Beginning projected benefit obligation
+ Prior service cost added this year
= Adjusted beginning projected benefit obligation
+ Service cost for the period
+ Interest cost on beginning PBO
+ Actuarial losses (or – Actuarial gains)
- Payments to retirees
= Ending projected benefit obligation
                                         31



               Plan Assets
  Beginning fair value of plan assets
+ Actual return on pension plan assets
+ Contributions by the company
- Payment to retirees
= Ending fair value of plan assets
                                                    32

      Pension Expense Equal to
              Funding
         Facts for the Carlisle Company
1. The company adopts a pension plan on
   January 1, 2007. No retroactive benefits were
   granted to employees.
2. The service cost each year is: 2007, $400,000;
   2008, $420,000; 2009, $432,000.
3. The projected benefit obligation at the
   beginning of each year is: 2008, $400,000;
   and 2009, $840,000.
                    Continued
                                                   33

      Pension Expense Equal to
              Funding
4. The discount rate is 10%.
5. The expected long-term rate of return on plan
   assets is 10%.
6. The company adopts a policy of funding an
   amount equal to the pension expense and
   makes a payment at the end of each year.
7. Plan assets are based on the amounts
   contributed each year, plus a return of 10%,
   less $20,000 to retired employees (beginning
   2008).
                                                       34

     Pension Expense Equal to
             Funding
  December 31, 2007:
  Pension Expense                400,000
    Cash                                     400,000
  December 31, 2008:
  Pension Expense                420,000
    Cash                                     420,000
Service cost (from actuary)       $420,000
Interest cost ($400,000 x 10%)      40,000
Expected return on plan assets
 ($400,000 x 10%)                  (40,000 )
Pension expense                   $420,000
                                            35



     Balance-Plan Assets
               Plan Assets
Cash from 2007       400,000   Paid to
Return in 2008        40,000   retirees
Cash from 2008       420,000   2008
                                   20,000
Bal. 1/1/09         840,000
                                                    36



            Balance-PBO
          Projected Benefit Obligation
                  400,000 Service cost 2007
                  420,000 Service cost 2008
                    40,000 Interest on 1/1/08 PBO
Benefits paid to
retirees in 2008
           20,000
                  840,000 Bal. 1/1/09
                                                        37

    Pension Expense Equal to
            Funding
 December 31, 2009:
 Pension Expense                 432,000
   Cash                                       432,000
Service cost (from actuary)      $432,000
Interest cost ($840,000 x 10%)     84,000
Expected return on plan assets
 ($840,000 x 10%)                 (84,000 )
Pension expense                  $432,000


  Note that the interest cost and the return on
   the plan assets offset each other each year.
                                                        38

          Funding Greater Than
            Pension Expense
       Carlisle Company funds $405,000 in 2007,
        $425,000 in 2008, and $435,000 in 2009.


December 31, 2007:
Pension Expense                     400,000
Accrued/Prepaid Pension Cost          5,000
  Cash                                        405,000

                                      Asset
                                                            39

          Funding Greater Than
            Pension Expense
December 31, 2008:
Pension Expense                         419,500
Accrued/Prepaid Pension Cost              5,500
  Cash                                            425,000
     Service cost (from actuary)    $420,000
     Interest cost ($400,000 x 10%)   40,000
     Expected return on plan assets
      ($405,000 x 10%)               (40,500 )
     Pension expense                $419,500

    Asset balance is now $5,000 + $5,500
                                          40



     Balance-Plan Assets
             Plan Assets
Cash from 2007     405,000   Paid to
Return 2008         40,500   retirees
Cash from 2008     425,000   2008
                                 20,000
Bal. 1/1/09        850,500
                                                             41

          Funding Greater Than
            Pension Expense
December 31, 2009:
Pension Expense                          430,950
Accrued/Prepaid Pension Cost               4,050
  Cash                                             435,000
    Service cost (from actuary)      $432,000
    Interest cost ($840,000 x 10%)     84,000
    Expected return on plan assets
     ($850,500 x 10%)                 (85,050 )
    Pension expense                  $430,950

      The balance in the asset account is $14,550
              ($5,000 + $5,500 + $4,050)
                                                       42

   Pension Expense Less Than
   Pension Funding & Expected
    Return Different from Both
  Actual Return & Discount Rate
 Carlisle Company funds $415,000 in 2007, $425,000
 in 2008, and $440,000 in 2009. The expected return
    is 11% and the actual return is 12% each year.
December 31, 2007:
Pension Expense                    400,000
Prepaid/Accrued Pension Cost        15,000
  Cash                                       415,000
                                                              43
   Pension Expense Less Than
   Pension Funding & Expected
    Return Different From Both
  Actual Return & Discount Rate
December 31, 2008:
Pension Expense                          414,350
Prepaid/Accrued Pension Cost              10,650
  Cash                                              425,000
        Service cost (assumed)           $420,000
        Interest cost ($400,000 x 10%)     40,000
        Expected return on plan assets
         ($415,000 x 11%)                 (45,650 )
        Pension expense                  $414,350

      The balance in the asset account is $25,650
                                          44



     Balance-Plan Assets
             Plan Assets
Cash from 2007     415,000   Paid to
Return 2008         49,800   retirees
Cash from 2008     425,000   2008
                                 20,000
Bal. 1/1/09        869,800
                                                    45



            Balance-PBO
          Projected Benefit Obligation
                  400,000 Service cost 2007
                  420,000 Service cost 2008
                    40,000 Interest on 1/1/08 PBO
Benefits paid to
retirees in 2008
           20,000
                  840,000 Bal. 1/1/09
                                                             46
    Pension Expense Less Than
  Pension Funding and Expected
     Return Different From Both
   Actual Return &Discount Rate
December 31, 2009:
Pension Expense                          420,322
Prepaid/Accrued Pension Cost              19,678
  Cash                                             440,000
        Service cost                       $432,000
        Interest cost ($840,000 x 10%)       84,000
        Expected return on plan assets
         ($869,800 x 11%)                   (95,678 )
        Pension expense                    $420,332

     The balance in the asset account is $49,478
                                                47

  Difference Between Expected
        and Actual Return
  Because the 12% actual return is $49,800,
    which is $4,150 higher than the $45,650
   expected return, a journal entry must be
  made to Accrued/ Prepaid Pension Cost and
  Other Comprehensive Income for the year.
           A gain increases income.

Accrued/ Prepaid Pension Cost   4,150
   Other Comprehensive Income           4,150
                                                    48

 Pension Expense Including
Amortization of Prior Service
           Cost
Carlisle Company awarded retroactive benefits
to employees when it adopted the pension plan.
The prior service costs were estimated to be $2
million, which is to be amortized over 20 years.
Carlisle decided to increase its contributions to
    $705,000 in 2007, $715,000 in 2008, and
               $730,000 in 2009.
                                                      49

     Pension Expense Including
    Amortization of Prior Service
               Cost
    As required by FAS 158, the prior service costs
     of $2 million must be recorded as a liability
        and also as a negative element of Other
         Comprehensive Income for the year.


Other Comprehensive Income     2,000,000
    Accrued/Prepaid Pension Cost         2,000,000
     Pension Expense Including                                 50



    Amortization of Prior Service
               Cost
December 31, 2007:
Pension Expense                            700,000
  Accrued/Prepaid Pension Cost               5,000
   Cash                                              705,000
  Service cost                         $400,000
  Interest cost ($2,000,000 x 10%)      200,000
  Amortization of prior service cost
  ($2,000,000/ 20 years)                100,000
  Pension expense                      $700,000
                                                       51

    Pension Expense Including
   Amortization of Unrecognized
        Prior Service Cost
    The 2007 pension expense includes $100,000
   amortization of prior service cost ($2,000,000/
   20 years). Therefore, the company must record
     an adjusting entry to increase 2007 Other
               Comprehensive Income.

Accrued/Prepaid Pension Cost   100,000
    Other Comprehensive Income               100,000
                                          52



  Balance-PBO
Projected Benefit Obligation
         400,000 Service cost 2007
       2,000,000 Prior service cost
         200,000 Interest on 1/1/07 PBO

        2,600,000 Bal. 1/1/08
     Pension Expense Including                                  53



    Amortization of Prior Service
               Cost
December 31, 2008:
Pension Expense                             702,450
  Prepaid/Accrued Pension Cost               12,550
  Cash                                                715,000
 Service cost (assumed)               $420,000
 Interest cost ($2,600,000 x 10%)      260,000
 Expected return on plan assets
  ($705,000 x 11%)                     (77,550 )
 Amortization of prior service cost    100,000
 Pension expense                      $702,450
                                                       54

     Pension Expense Including
    Amortization of Prior Service
               Cost
       The 2008 pension expense also includes
    $100,000 amortization of prior service cost so
   the company must record an adjusting entry to
    increase 2008 Other Comprehensive Income.


Accrued/Prepaid Pension Cost   100,000
    Other Comprehensive Income               100,000
                                                    55



           Balance-PBO
          Projected Benefit Obligation
                   400,000 Service cost 2007
 Benefits paid 2,000,000 Prior service cost
 to retirees       200,000 Interest on 1/1/07 PBO
in 2008            420,000 Service cost 2008
         20,000 260,000 Interest on 1/1/07 PBO
                 3,260,000 Bal. 1/1/09
                                            56



     Balance-Plan Assets
               Plan Assets
Cash from 2007       705,000   Paid to
Return in 2008        84,600   retirees
Cash from 2008       715,000   2008
                                   20,000
Bal. 1/1/09        1,484,600
     Pension Expense Including                                   57



    Amortization of Prior Service
               Cost
December 31, 2009:
Pension Expense                              694.694
Accrued/Prepaid Pension Cost                  35,306
  Cash                                                 730,000
 Service cost                         $432,000
 Interest cost ($3,260,000 x 10%)      326,000
 Expected return on plan assets
  ($1,484,600 x 11%)                  (163,306 )
 Amortization of prior service cost    100,000
 Pension expense                      $694,694
                                      58



 Disclosures
According to FASB Statement No.
  132R and 158, a company must
disclose specific information about
  a defined benefit pension plan,
      including the following:
                                                      59



                Disclosures
1. A reconciliation of      2. A reconciliation of
   the beginning and           the beginning and
   ending balances of          ending balances of
   the projected benefit       the fair value of
   obligation.                 the plan assets.

                           4. The discount rate,
 3. The components            the rate and the
    and amount of             expected long-term
    pension expense.          rate of return on the
                              plan assets.
                              60



           Required Funding
A company must fund its
  pension plan each year
    at an amount that at
  least equals the service
   cost for the year plus
   the amount needed to
        amortize any
    underfunding over a
     maximum of seven
           years.
                                                       61



 Summary of Journal Entries
1. Pension expense.
Entries to Accrued/Prepaid Pension Cost and Other
     Comprehensive Income
2. Record prior service cost.
3. Record difference between expected return and
     actual return.
4. Record amortization of prior service cost.
5. Record amortization of cumulative gain or loss.
6. Record changes in PBO (not illustrated in text).
----------------------------------------------------
7. Close Other Comprehensive Income to
     Accumulated Other Comprehensive Income
                                              62

  Termination Benefits Paid to
          Employees
FASB Statement No. 88 requires that a
company record a loss and a liability for
termination benefits when the following two
conditions are met:
 1. The employee accepts the offer, and
2. The amount can be reasonably
   estimated.
                                  63



Other Postemployment Benefits
     Many companies offer
  additional benefits to former
      employees after their
 retirement--widely referred to
            as OPEB.
      What are the major
      differences between
  postretirement healthcare
    benefits and pensions?
                                                           64



 Other Postemployment Benefits
 Item              Pensions             Healthcare
Beneficiary Retired employee (some  Retired employee,
            residual benefit to     spouse, and
            surviving spouse)       dependents
Benefits    Defined, fixed dollar   Not limited, paid as
            amount, paid monthly    used, varies
                                    geographically
Funding    Funding legally required Usually not funded
           and tax deductible       because not legally
                                    required and not tax
                                    deductible
                                                      65



             OPEB Benefits
The net postretirement benefit expense includes the
following components:
1.   Service cost
2.   Interest cost
3.   Expected return on plan assets
4.   Amortization of prior service cost
5.   Amortization of net gain or loss
                                                      66

         Illustration of
      Accounting for OPEB
Livingston Company adopts a healthcare plan for
  retired employees on January 1, 2007. At that
  time the company has two employees and one
 retired employee. The discount rate is 10%, all
 employees were hired at age 25 and will become
  eligible for full benefits at age 55. The retired
     employee was paid $1,500 postretirement
    healthcare benefits in 2007. The company
determines its accumulated postretirement benefit
             obligations to be $100,000.
                      Continued
                                                  67


         Illustration of
      Accounting for OPEB
Service cost (actuarially determined)   $ 1,100
Interest cost ($100,000 x 0.10)          10,000
Expected return on plan assets                0
Amortization of prior service cost
    ($100,000 ÷ 5)                       20,000
Gain or loss                                  0
Postretirement Benefit Expense          $31,100


                    Continued
                                                       68


          Illustration of
       Accounting for OPEB
January 1, 2007
Other Comprehensive Income        100,000
   Accrued Postretirement Benefit
    Cost                                  100,000
 December 31, 2007
 Postretirement Benefit Expense      31,100
    Accrued Postretirement Benefit
      Cost                                    31,100
                                                               69


           Illustration of
        Accounting for OPEB
To record the payment of retirement benefits
Accrued Postretirement Benefit Cost            1,500
   Cash                                                1,500
To record amortization of prior service cost
Accrued Postretirement Benefit Cost 20,000
   Other Comprehensive Income              20,000

				
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