Published on March 10, 2014
Pension Accounting Understand the nature/characteristics/ accounting of employer pension plans: Defined Benefit Plans. T P Adhikari & Associates, Chartered Accountants !1
PENSION ACCOUNTING Objectives: ● Pension Overview ● Fundamental differences between: – Defined contribution plans – Defined benefit plans* ● Accounting for Pension: – Key components: Pension expense ● Disclosure/presentation T P Adhikari & Associates, Chartered Accountants !2
Overview of Pension Plan A pension plan: An agreement between an employer/employee ! • Government plans: social security • Individual plans (IRA) • Employer Plans* à ! Emphasis: Pension Plan: for Corporation: Company set aside funds for employees’ service! T P Adhikari & Associates, Chartered Accountants !3
Pensions: SFAS 158 ● SFAS 158 Reporting pension items in the balance sheet and AOCI ● 132R: Disclosures ! ● IAS 19 T P Adhikari & Associates, Chartered Accountants !4
PENSION PLAN: Overview Employer Sponsors the plan Benefits Plan Administrator Contributions The plan administrator receives the contributions from the employer, invests the pension assets, and makes the benefit payments. T P Adhikari & Associates, Chartered Accountants Pension Recipients !5
TYPES OF PENSION PLANS TWO TYPES 1 DEFINED CONTRIBUTION PLAN Pension fund promise FIXED ANNUAL CONTRIBUTIONS $ DEFINED BENEFIT PLAN 2 promise FIXED RETIREMENT BENEFITS T P Adhikari & Associates, Chartered Accountants !6
Defined contribution plans ● ● • • Defined Contribution A plan that provides benefits based solely on what has been contributed and the earnings thereon Amounts to be funded are determined by the plan – No promise for specific future benefits. – Independent third party holds assets – Risk borne by employee – Accounting relatively straightforward Employer makes no guarantee to the amount of benefits Employees’ retirement benefits based on the amount of funds in the plan T P Adhikari & Associates, Chartered Accountants !7
Defined Benefit Pension Plans DEFINED BENEFIT PLAN Plan Characteristics Employer is committed to specified retirement benefits. Retirement benefits are based on a formula that considers years of service, compensation level, and age. T P Adhikari & Associates, Chartered Accountants Employer bears all risk of pension fund performance. !8
Accounting for Defined Benefit Plans ● Defined benefit plans – Employer’s contribution is based on the expected future benefits – Affected by many variables: ● Years of service ● Annual salary at retirement ● Retirement years – Etc. ! ● Future Obligation for retirement benefits is based on many estimates/assumptions T P Adhikari & Associates, Chartered Accountants !9
Actuaries and Pension Accounting Pension calculations involve actuarial assumptions. These are estimates. Assumptions involve: mortality rates, employee turnover, future salaries, rates of return, etc. T P Adhikari & Associates, Chartered Accountants !10
Measures of Pension Liability: Defined Benefit Plan Pension calculations involve actuarial assumptions. Benefits for vested and nonvested employees at future salaries Benefits for vested/ nonvested employees at current salaries Accumulated Benefit Obligation (GAAP) Projected Benefit Obligation (PBO) (AB0) T P Adhikari & Associates, Chartered Accountants !11
OVERVIEW: PENSION COMPONENTS Based On Actuarial Assumptions: How much to contribute annually for the service provided by employees 1. SERVICE PROVIDED Employee hired SERVICE COST Benefit Period Employee Retired PENSION EXPENSE T P Adhikari & Associates, Chartered Accountants !12
PENSION EXPENSE: INTEREST COST ● ● ● Interest cost : (PENSION EXPENSE) – the increase in the pension obligation (PBO) due to the accrual of an additional year of interest. PV of liability increases as you get closer to the due date – Interest cost = discount rate * beginning balance in PBO T P Adhikari & Associates, Chartered Accountants !13
INTEREST COST:PENSION EXPENSE ➢ PV of pension Obligation is increased by the interest cost on the beginning of PBO T P Adhikari & Associates, Chartered Accountants !14
OVERVIEW: TIMELINE COMPONENTS PRIOR (PAST) SERVICE COST Past Service Cost Employee Hired SERVICE COST Benefit Period Employee Retired Plan Initiation T P Adhikari & Associates, Chartered Accountants !15
PENSION EXPENSE: Prior Service Cost ● Establishing (or modifying/amended) a plan ! ● Cost of benefits granted for service rendered prior to the inception of the plan ! Increases PBO at date of amendment/ ● The entire amount of Past Service Cost is NOT recognized as expense in the current year ● Instead , Past Service Cost is recognized in the current period in Other Comprehensive Income (OCI) T P Adhikari & Associates, ● Chartered Accountants !16
Issues in Accounting: Defined Benefit Plans Periodic expense (Pension Expense) of having a pension plan 2. Plan Assets Resources set aside by the employer from which to pay the retirement in the future (invested by Trustee) 3. Employer’s Obligation to pay retirement benefits in the future 1. T P Adhikari & Associates, Chartered Accountants !17
Pension Plan Assets ● Resources with which the obligation will Satisfy: PLAN ASSETS ! ● Employee contribution in the Pension Fund (held by Trustee) ! ● Plan Assets are invested -in income producing assets. ! ● Accumulated balance: Contribution + return on T P Adhikari & Associates, investment Chartered Accountants !18
Return on Plan Asset – Expected return on plan assets (FASB) – *Expected rate of return: ● Based on long-term rate of return anticipated given investment of plan assets – Expected return on plan asset decreases the pension cost and increases plan asset T P Adhikari & Associates, Chartered Accountants !19
Actuarial Gains and Losses Actuarial assumptions are subject to inaccuracies as time goes by and circumstances change ● The estimate of the PBO also require revision ● Inc/Dec in PBO is referred to gain/loss ● T P Adhikari & Associates, Chartered Accountants !20
NET GAINS/LOSSES NET GAINS/LOSSES: 1. Gains/Losses from the return on Assets 2. Gains/Losses from changing assumptions (PBO) = NET GAINS/LOSSES • Deferred and reported as OCI • Amortized using Corridor rule* T P Adhikari & Associates, Chartered Accountants !21
Corridor Amount STEPS 1: GREATER OF PBO & PLAN ASSETS 2: 10% OF STEP 1 3…. Next slide… The corridor amount is 10% of the greater of . . . PBO at the beginning of the period. Or Fair value of plan assets at the beginning of the period. T P Adhikari & Associates, Chartered Accountants !22
Gains and Losses EXAMPLE 2013 2009 Net Loss Amortization ($ in millions) PBO $ 400 Fair value of plan assets 300 2013 Net loss for 2009 55 Average service life 15 Apply steps: 1.Greater of PBO & Plan Assets = PBO $400 2.10% of PBO i.e. 400 x 10% = $40 T P Adhikari & Associates, Chartered Accountants !23
Gains and Losses STEP 3: FIND THE EXCESS TO BE AMORTIZED Net loss Corridor amount ($400 x 10%) Excess at the beginning of the year $ $ 55 40 15 AMORTIZATION: $15,000,000 ÷ 15 years = $1,000,000 T P Adhikari & Associates, Chartered Accountants !24
Defined Benefit Plan: Net Periodic Pension Cost So far….. PENSION EXPENSE= Service Cost + Interest Cost - expected return on plan Asset +Amortization (if any) of Prior service cost +/- Amortization (net) Gains/Losses T P Adhikari & Associates, Chartered Accountants !25
REPORTING: Employer’s Obligation & Plan Asset ● The employer’s obligation and plan assets are not individually reported in a company’s primary financial statements: ! ● the difference between the two, the funded status, is reported as: ! ● ● a pension liability if underfunded or a pension asset if overfunded. T P Adhikari & Associates, Chartered Accountants !26
Funded Status of Pension Plan Projected Benefit Obligation (PBO) - Plan Assets at Fair Value Underfunded / Overfunded Status This amount is reported in the balance sheet as a Pension Liability or Pension Asset. T P Adhikari & Associates, Chartered Accountants !27
Pension Disclosures ● The details for net periodic pension cost – the service cost component. – the interest cost component. – the expected return on plan assets the amortization of PSC, transition amount and unrecognized gain/loss (separately) – Gain or loss from settlement or curtailment of plan T P Adhikari & Associates, Chartered Accountants !28
Pension Disclosures – Amount and types of assets held – Assumptions related to discount rate, rate of increase in compensation, expected return on plan assets – Alternative amortization policies – Past practice or history of regular benefit increases T P Adhikari & Associates, Chartered Accountants !29
Pension Disclosures ● Employers with multiple plans – Information can be combined but the computations are made for each individual plan ● Net position for over-funded plans would be reported in noncurrent assets ● Net position for under-funded plans would be reported in liabilities – Part may be reported as a current liability – See next slide T P Adhikari & Associates, Chartered Accountants !30
Disclosure of Pension Plans FASB 132 1. A reconciliation between the beginning and ending balances for the projected benefit obligation 2. A reconciliation between the beginning and ending balances in the fair value of the pension fund The fair value of plan assets (changes between BOY and EOY) ● PBO Obligation (changes between BOY and EOY) ● ! ● EoY = end of year BoY = beginning of year ! T P Adhikari & Associates, Chartered Accountants !31
IAS 19: INFORMATION ● ● The standard covers all employee benefits - not just pensions. This note focuses on pensions but a later section considers other employee benefits. The key pension points are: Assets are taken at market value ● Liabilities are calculated using an interest rate based on the yield on high quality corporate bonds at the valuation date (usually taken as AA-rated) ● There is a limit to the amount that can be recognized as a prepayment (surplus) in the company balance sheet ! ● Actuarial gains and losses may be: recognized in the P&L immediately – recognized in the P&L on a smoothed basis – recognized immediately in the statement of recognized income and expense – ● The cost of past service benefit increases is recognized immediately to the extent that the increases are vested immediately T P Adhikari & Associates, Chartered Accountants !32
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business contacts We can be contacted at the following office; TP Adhikari & Associates, Chartered Accountants nd 2 Floor, 723/60, Tanka Prasad Ghumti Sadak, Anamnagar, Kathmandu- 32, Nepal GPO Box No. 10915 Contact No: 01-4247816 / 4247917 Email : firstname.lastname@example.org Fax: +977-1-4247917 ! CONTACT PERSON: CA Thakur Prasad Adhikari Cell +977 9851094055 !34
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