# Postretirement Benefit Accounting

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```					Postretirement Health Benefits.

Company promises to pay health care costs for retirees. Accounting issue: how to report
that liability and related costs in today’s financial statements. Answer: apply pension
accounting techniques studied in Chapter 17 with only minor modification. Main
difference: Service cost and interest cost arise from increase in accumulated
postretirement benefit obligation (APBO) rather than the increase in PBO as in the case
of pension accounting. New definition: Expected postretirement benefit obligation
(EPBO) is present value of future health benefits to be received by employees upon
number of years from date of hire until eligible to receive postretirement health benefits.
Thus, service cost is just EPBO/attribution period and interest cost is beginning APBO
times discount rate. Everything else is same as pension accounting.

Example problem

ABC began business on January 1, 2001 with one employee, Employee A. Employee
A, who turned age 41 on January 1, 2001, was hired at an annual salary of 75, 000. The
company provides full benefits for Employee A, including a defined contribution plan to
which it makes annual contributions equal to 15 % of A' s annual salary, health
insurance coverage during employment, and health insurance coverage after employment
if Employee A provides at least 15 years of service to the company.
Employee A is expected to retire on January 1, 2025 when s/ he turns 65 years of age,
and is expected to live for another 20 years following retirement. ABC estimates that it
will cost \$12, 000 per year to provide health care insurance coverage for Employee A
during his her retirement years. Use a 10% annual discount rate and assume that
insurance premiums are paid at the start of the year (i.e., the first payment of \$12,000
occurs on 1/1/2025).

Required

A. What is the amount of the expected postretirement benefit obligation (EPBO) at
1/1/2002? At 12/31/2002?

B. What is the amount of the accumulated postretirement benefit obligation (APBO) at
1/1/2002? At 12/31/2002?

C. What is the service cost component of postretirement benefit expense for 2002?

D. What is the interest cost component of postretirement benefit expense for 2002?

E. Reconcile the beginning and ending APBO for 2002.
F. What asset or liability will be reported on the company' s 12/ 31/2002 balance sheet
with respect to the postretirement benefit plan?

Solution

A. EPBO at 1/1/2002 is the present value (at 1/1/2002) of the obligation to purchase
health insurance for Employee A at an annual cost of \$12,000 beginning 1/1/2025 and
continuing thereafter for the remainder of Employee A’s life, which is expected to be 20
years (i.e., a total of 20 annual payments). The EPBO is calculated by first using PVAD
factor for n=20, i=.10 to determine the present value of the obligation as of 1/1/2025,
then using a present value of single sum factor to roll that value back from 1/1/2025 to
1/1/2002 . Per Table 5 on text page M40, PVAD(n=20, i=.10)=9.364920. Per Table on
text page M38, PVSS(n=23, i=.10)=0.111678

So, EPBO at 1/1/2002 = 12,000 x 9.364920 x 0.111678=12,550.

The EPBO at 12/31/2002 is calculated the same, except the PVSS factor is based on n=22
rather than n=23. PVSS(n=22, i=.10)=0.122846.

So, EPBO at 12/31/2002 = 12, 000 x 9.364920 x 0.122846=13,805

B. Per discussion above, the APBO=EPBO * (service to date/attribution period). The
service to date is the number of years of creditable service to date (i.e., number of years
that “counts” toward the required 15 years of service that must be provided before the
employee is eligible to receive the benefit). Since Employee A was hired on 1/1/2001, as
of 1/1/2002 there are 1 years of service to date. The attribution period is the number of
years between the hire date and the date the employee is first eligible to receive health
care benefits. In this case, Employee A is first eligible to receive health care benefits on
12/31/2020 (completion of the 20th year of service). So, the attribution period is 20 years.

Thus, the APBO at 1/1/2002 = EPBO at 1/1/2002 x 1/20, or \$628

The APBO at 12/31/2002 = EPBO at 12/31/2002 x 2/20, or 13,805 x 2/20=1381

C. Service cost is just EPBO at end of year / attribution period. So, service cost for 2002
is EPBO at 12/31/2002 divided by 20, or 13805/20 = 690.

D. Interest cost is just APBO at beginning of year times the discount rate. So, interest
cost for 2002 is APBO at 1/1/2002 times .10, or 628 x .10 = 63 (rounded).

E. APBO at end of year = APBO at beginning of year + service cost + interest cost +/-
actuarial gains and losses + prior service cost.

So, APBO at 12/31/2002 = APBO at 1/1/2002 + 2002 service cost + 2002 interest cost
(there are no actuarial gains/losses and no prior service cost).
Or, 1381=628 + 690 + 63

F. The difference between the APBO (at the balance sheet date) and the FMV of plan
assets (at the balance sheet date) will be reported on the balance sheet as either an asset
described as “Prepaid Postretirement Benefit Cost” (if FMV assets > APBO) or “Accrued
Postretirement Benefit Cost” (if APBO > FMV assets).

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