Chapter 19 Pensions - Summary Intermediate Accounting PDF

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Chapter 19: Pensions and Other Post Employment Benefits Nature of Pension Plans - The chapter focuses on the pension plan accounting in the employer’s perspective. - If the pension is funded, the flow of cash is as follows:

^ This means that the employers sets aside money for future pension benefits in a separate legal entity that is responsible for accumulating the pension plan assets and for making payments to the recipients as the benefits come due. (Once transferred, the assets are not the company’s anymore). - In contributory plans, the employee and employer make contributions to the plan. - In non-contributory plans, the employer bears the entire cost. - The pension benefits are taxable when received by the pensioner. - The two most common types of pension plans are: 1) Defined Contribution Plans 2) Defined Benefit Plans

Defined Contribution Plans - Specifies how the employer’s contribution or payments into the plan are determined, rather than identifying what benefits will be received by the employee. (i.e.: the employer’s contributions are defined; the employee’s benefits are not). - The contributions may be a fixed sum or a percentage of salary. - The amounts that are contributed are usually turned over to a trustee who is responsible for the investment and distribution of plan assets. - Employee assumes the economic risk as there is no guarantee made by the employer as to the benefits paid. Remember, this plan does not specify the benefits the employer will receive or even the method used to determine benefits. - The accounting for ‘Defined Contribution Plans’  A liability is reported if contributions for the period have not been made in full. An asset is reported if more than the required amount has been contributed.

Defined Benefit Pension Plans - Specifies the benefits to be received by the employee (or the method of determining those benefits). - In this case, the employer assumes the economic risk, not the employee. The employer is responsible for making the defined benefit payments no matter what happens in the trust. The employer is also at risk because the cost is uncertain as it depends on many factors (employee turnover, length of service, etc.) - Defined benefit plans can be vesting or non-vesting. - The objective in accounting for these plans is for the expense and liability related to these plans to be recognized over the accounting periods in which the related services are provided by the employees. - Under ASPE, re-measurements are charged to net income. - Under IFRS, re-measurements are charged to other comprehensive income. - The trust’s main purpose under a defined benefit plan is to safeguard assets and to invest them so that there will be enough to pay the employer’s obligation to the employees. - Note that the pension expense is not the same as the employer’s cash funding contribution. The Employer’s Obligation - There are three different ways of measuring the employer’s pension obligation. (1) Vested Benefit Method  Actuaries calculate the vested benefit obligation using vested benefits only, at current salary levels. (2) Accumulated Benefit Method  The deferred compensation amount is calculated on all years of employees’ service (both vested and non-vested) using current salary levels. (3) Projected Benefit Method  Deferred compensation amount is calculated using both vested and non-vested service and is based on future salary levels. - Regardless of which method is used, the estimated future benefits to be paid are discounted to their present value. - The projected benefit method is the adopted method for calculating the defined benefit obligation (DBO) for accounting purposes – the present value of vested and non-vested benefits earned to the date of the balance sheet, with the benefits measured using employees’ future salary levels. - The defined benefit obligation (DBO) for funding purposes is used as an option under ASPE which tends to focus more on current salary levels and often uses a different discount rate.

Changes in the Defined Benefit Obligation - The DBO increases as employees provide further services (continue working) and earn additional benefits, and as interest is added to this outstanding discontinued liability. The obligation decreases as benefit payments are made to retirees. Annual Pension Benefit on Retirement = 2% of final salary * years of service * Refer to Appendix 19A Example

Defined benefit obligation, beginning + Current service cost + Interest cost – Benefits paid to retirees (former employees) +/- Past service costs of plan amendments during period +/- Actuarial gains (-) or losses (+) . = Defined benefit obligation, end of period

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The current service cost is the cost of the benefits that are to be provided in the future in exchange for the services that the employees provided in the current period. Included in pension expense in the same period under both IFRS and ASPE. The interest cost is based on the DBO that is outstanding at the beginning of the period.

Plan Assets - Plan assets are assets that have been set aside in a trust or other legal entity that is separate from the employer company. These assets are restricted and can be used only to settle the related DBO. Plan assets, fair value at beginning of period + Contributions +/- Return on plan assets - Benefits paid to retirees . = Plan assets, fair value at end of period  

The amount of the employer company’s contributions to the plan has a direct effect on the plan’s ability to pay the DBO. The return on plan assets can be thought of as the income generated on the assets being held by the trustee.

Surplus or Deficit - The difference between the DBO and the pension assets’ fair value at a point in time is known as the plan’s surplus or deficit.

Defined Benefit Obligation (DBO) – Fair Value of plan assets (end of period) = Plan’s surplus or deficit, (end of period) • •

DBO > Plan assets = underfunded = deficit (benefit liability) DBO < Plan assets = overfunded =surplus (benefit asset)

Defined Benefit Cost Components - Under ASPE, actuarial gains and losses (fluctuations in the PV of the DBO) are recognized through net income. Under IFRS, they are recognized through OCI. Illustration of Pension Accounting Using a Pension Work Sheet - Key note:  Neither the DBO nor the fund assets are recognized directly in the sponsoring company’s accounts; they are both off-balance sheet accounts. The fund assets belong to the benefit trust, and the DBO is a liability of the sponsoring company ONLY to the extent that there are not enough assets in the fund to cover the total obligation. - The balance in the Net Defined Benefit Liability/Asset column must equal the net balance in the Memo Record column. * Refer to example

Presentation: - Defined benefit assets/liabilities are generally classified as long-term. - Components of benefit costs may be reported together or separately on the income statement....