Kieso_Intermediate_Accounting_16e_Chapter 20 Summary Notes (Pensions and Pension Expenses) PDF

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Summary

This document is a quick cover of the most important concepts to grasp about Chapter 20 for Pensions in Intermediate Accounting II. This summary covers the most important concepts to grasp in the chapter. Kieso, Intermediate Accounting 16th edition....

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CHAPTER 20 Accounting for Pensions and Postretirement Benefits

ASSIGNMENTS Item E20-1 E20-2 E20-3 E20-4 E20-5 E20-6 E20-7 E20-8 E20-9 E20-10 E20-11 E20-12 E20-13 E20-14 E20-15 E20-16 E20-17 E20-18 *E20-19 *E20-20 *E20-21 *E20-22 *E20-23 *E20-24

Time (minutes)

Description Pension expense, journal entries. Computation of pension expense. Preparation of pension worksheet. Basic pension worksheet. Application of years-of-service method. Computation of actual return. Basic pension worksheet. Application of the corridor approach. Disclosures: Pension expense and other comprehensive income. Pension worksheet. Pension expense, journal entries, statement presentation. Pension expense, journal entries, statement presentation. Computation of actual return, gains and losses, corridor test, and pension expense. Worksheet for E20-13. Pension expense, journal entries. Amortization of accumulated OCI (G/L), corridor approach, pension expense computation. Amortization of accumulated OCI balances. Pension worksheet—missing amounts. Postretirement benefit expense computation. Postretirement benefit worksheet. Postretirement benefit expense computation. Postretirement benefit expense computation. Postretirement benefit worksheet. Postretirement benefit worksheet—missing amounts.

Copyright © 2016 John Wiley & Sons, Inc.

Kieso, Intermediate Accounting, 16/e Instructor’s Manual

15–20 10–15 15–25 10–15 15–25 10–15 15–25 20–25 25–35 20–25 20–30 20–30 35–45 40–50 15–20 25–35 30–40 20–25 5–10 25–30 10–12 10–12 15–20 25–30

(For Instructor Use Only)

20-1

P20-1 P20-2 P20-3 P20-4 P20-5

2-year worksheet. 3-year worksheet, journal entries, and reporting. Pension expense, journal entries, amortization of loss. Pension expense, journal entries for 2 years. Computation of pension expense, amortization of net gain or loss-corridor approach, journal entries for 3 years. Computation of prior service cost amortization, pension expense, journal entries, and net gain or loss. Pension worksheet. Comprehensive 2-year worksheet. Comprehensive 2-year worksheet. Pension worksheet—missing amounts. Pension worksheet. Pension worksheet. Postretirement benefit worksheet. Postretirement benefit worksheet—2 years.

P20-6 P20-7 P20-8 P20-9 P20-10 P20-11 P20-12 *P20-13 *P20-14 CA20-1 CA20-2 CA20-3 CA20-4 CA20-5 CA20-6 CA20-7

20-2

Pension terminology and theory. Pension terminology. Basic terminology. Major pension concepts. Implications of GAAP rules on pensions. Gains and losses, corridor amortization. Nonvested employees—an ethical dilemma.

Copyright © 2016 John Wiley & Sons, Inc.

40–50 45–55 40–50 30–40 45–55 45–60 35–45 45–60 40–45 25–30 35–45 35–45 30–35 40–45 30–35 25–30 20–25 30–35 50–60 30–40 20–30

Kieso, Intermediate Accounting, 16/e Instructor’s Manual

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LEARNING OBJECTIVES 1. 2. 3. 4. 5. *6. *7. *8.

Understand the fundamentals of pension plan accounting. Use a worksheet for employer’s pension plan entries. Describe the accounting and amortization of prior service costs. Explain the accounting and amortization for unexpected gains and losses. Describe the requirements for reporting pension plans in financial statements. Identify the differences between pensions and postretirement healthcare benefits. Contrast accounting for pensions to accounting for other postretirement benefits. Contrast accounting for pensions under GAAP and IFRS.

*This material is covered in an Appendix to the chapter.

Copyright © 2016 John Wiley & Sons, Inc.

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20-3

CHAPTER SUMMARY NOTES: 1. Chapter 20 discusses the various aspects of accounting for pension plans. Accounting for pension costs is somewhat complicated because of the variety of social concepts, legal considerations, actuarial techniques, income tax regulations, and varying business philosophies that affect the development and maintenance of pension plans. This chapter relates these issues to the recommended accounting treatment for the costs associated with a pension plan. Fundamentals of Pension Plan Accounting 2. (L.O. 1) In accounting for a pension plan, consideration must be given to accounting for the employer and accounting for the pension plan itself. A pension plan is said to be funded when the employer sets funds aside for future pension benefits by making payments to a funding agency that is responsible for accumulating the assets of the pension fund and for making payment to the recipients as the benefits come due. In an insured plan, the funding agency is an insurance company; in a trust fund plan, the funding agency is a trustee. Types of Pension Plans 3. The most common types of pension arrangements are . The formula might consider such factors as age, length of service, employer’s profits, and compensation level. Accounting for a defined contribution plan is straightforward. The employer’s responsibility is simply to make a contribution each year based on the formula established in the plan. Thus, the employer’s annual cost is the amount it is obligated to contribute to the pension trust. If the contribution is made in full each year, no pension asset or liability is reported on the employer’s balance sheet. 4. The formula that is typically used provides for the benefits to be a function of the level of compensation near retirement and of the number of years of service. The accounting for a defined benefit plan is complex. Because the benefits are defined in terms of uncertain future variables, an appropriate funding pattern must be established to insure that enough monies will be available at retirement to meet the benefits promised.

Actuaries

20-4

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5. Because the problems associated with pension plans involve complicated actuarial considerations, actuaries are engaged to ensure that the plan is appropriate for all employee groups covered. Actuaries make predictions (actuarial assumptions) of mortality rates, employee turnover, interest and earnings rates, early retirement frequency, future salaries, and other factors necessary to operate a pension plan. Measures of the Liability 6. However, there are three ways to measure this liability. One approach is to base the obligation on the to which current employees are entitled. The vested benefits pension obligation is computed using current salary levels and includes only vested benefits. A second approach to the measurement of the pension obligation is to base the computation on all years of service performed by employees under the plan— both vested and nonvested¾using current salary levels. This measurement of the pension obligation is called the . A third measurement technique bases the computation on both vested and nonvested service using future salaries. Because future salaries are expected to be higher than current salaries, this approach, known as the results in the largest measurement of the pension obligation. 7. Regardless of the approach used, The profession has adopted the projected benefit obligation to measure the liability for the pension obligation. 8. Companies must recognize on their balance sheet the full overfunded or underfunded status of their defined benefit pension plan. The overfunded or underfunded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation.

Copyright © 2016 John Wiley & Sons, Inc.

Kieso, Intermediate Accounting, 16/e Instructor’s Manual

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Components of Pension Expense 9. Pension cost should be accounted for on the accrual basis. Accounting for pension plans requires measurement of the cost and its identification with the appropriate time periods. The determination of pension cost is very complicated because it is a function of a number of factors. These factors are identified and described below. The expense caused by the increase in pension benefits payable (the projected benefit obligation) to employees because of their services rendered during the current year. Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Because a pension is a deferred compensation arrangement, it is recorded on a discounted basis. Interest expense accrues each year on the projected benefit obligation based on a selected interest rate called the settlement rate. Actual Return on Plan Assets. Annual expense is adjusted for interest and dividends that accumulate within the fund as well as increases and decreases in the market value of the fund assets. Computation of the actual return on plan assets is illustrated by the following schedule: Fair value of plan assets at end of the period $2,500,000 Deduct: Fair value of plan assets at beginning of period... 1,800,000 Increase/decrease in fair value of plan assets ................... 700,000 Deduct: Contributions to plan during period ...................... $275,000 Less benefits paid during the period................................ 120,000 155,000 Actual return on plan assets ............................................... $ 545,000 If the actual return on the plan assets is positive (a gain) during the period, it is subtracted in the computation of pension expense. If the actual return is negative (a loss) during the period, it is added in the computation of pension expense. Amortization of Prior Service Cost. Because plan amendments are granted with the expectation that the employer will realize economic benefits in future periods, the cost (prior service cost) of providing these retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees. Gain or Loss. Two items comprise gain or loss: (1) the difference between the actual return and the expected return on plan assets, and (2) amortization of the unrecognized net gain or loss from previous periods.

Pension Worksheet

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Copyright © 2016 John Wiley & Sons, Inc.

Kieso, Intermediate Accounting, 16/e Instructor’s Manual

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10. (L.O. 2) The text material makes use of a worksheet approach to illustrate accounting for pensions by the employer. The worksheet is unique to pension accounting and is utilized to record both the formal entries and memo entries that are necessary to keep track of all the employer’s relevant pension plan items and components. The basic format of the worksheet is as follows:

Pension Worksheet General Journal Entries

Items

Annual Pension Expense

Cash

Pension Asset/ Liability

Memo Record Projected Benefit Obligation

Plan Assets

a. The left side “General Journal Entries” columns of the worksheet determine the entries to be made in the formal general ledger accounts. The right side “Memo Record” columns maintain balances in the projected benefit obligation and the plan assets. The difference between the PBO and the plan assets is the Pension Asset/Liability, which is reported in the balance sheet.

b. On the first line of the worksheet, the beginning balances (if any) are entered. Subsequently, transactions and events related to the pension plan are recorded, using debits and credits using both records for recording the entries. For each transaction or event, the debits must equal the credits. The ending balance in the Pension Asset/Liability column should equal the net balance in the memo record. The worksheet approach to accumulating balances for pension accounting is a most effective means of keeping track of complicated computations. 2018 Entries and Worksheet 11. To illustrate the use of a worksheet, the following facts apply to Oehler Company for the year 2018: Plan assets, January 1, 2018 ....................................... Projected benefit obligation, January 1, 2018 .............. Annual service cost for 2018 ........................................ Settlement rate for 2018 ............................................... Actual return on plan assets for 2018........................... Contributions (funding) in 2018 .................................... Benefits paid to retirees in 2018 ................................... Copyright © 2016 John Wiley & Sons, Inc.

Kieso, Intermediate Accounting, 16/e Instructor’s Manual

$450,000 450,000 27,000 7% 30,000 32,000 17,000 (For Instructor Use Only)

20-7

The worksheet is completed as follows: Oehler Company

General Journal Entries Annual Pension Expense

Items

Cash

Pension Asset/ Liability

Balance, 1/1/18 (a) Service cost (b) Interest cost (c) Actual return

450,000 Cr. 27,000 Dr. *31,500 Dr. 30,000 Cr.

(d) Contributions

32,000 Cr. 17,000 Dr.

28,500 Dr.

Balance, 12/31/18

Plan Assets 450,000 Dr.

27,000 Cr. 31,500 Cr.

(e) Benefits Paid

Journal entry for 2018

Memo Record Projected Benefit Obligation

30,000 Dr. 32,000 Dr. 17,000 Cr.

32,000 Cr. 3,500 Dr. 3,500 Dr.

491,500 Cr.

495,000 Dr.

*$450,000 X .07

The journal entry for 2018 is: Pension Expense………………………….. 28,500 Cash………………………….. Pension Asset/Liability…………………………..

20-8

Copyright © 2016 John Wiley & Sons, Inc.

32,000 3,500

Kieso, Intermediate Accounting, 16/e Instructor’s Manual

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2019 Entries and Worksheet 12. To illustrate the use of a worksheet with prior service costs (PSC), the following facts apply to Oehler Company for the year 2019: Present value of prior service benefits granted January 1, 2019…. $42,000 Annual service cost for 2019 ........................................................... 28,000 Settlement rate for 2019 .................................................................. 7% Actual return on plan assets for 2019.............................................. 31,000 Contributions (funding) in 2019 ....................................................... 29,000 Benefits paid retirees in 2019 .......................................................... 24,000 Amortization of prior service costs................................................... 17,500 At the point that the plan is amended in 2019, the prior service cost increases the PBO and is charged to Other Comprehensive Income – PSC (and is reported in Accumulated Other Comprehensive Income – PSC in the equity section of the balance sheet). It is then amortized to Pension Expense over the remaining service lives of the affected employees. The journal entry to record pension expense, including the amortization of PSC, for 2019 is as follows: Pension Expense......................................................... Other Comprehensive Income (PSC).......................... Cash ..................................................................... Pension Asset/Liability ..........................................

Copyright © 2016 John Wiley & Sons, Inc.

Kieso, Intermediate Accounting, 16/e Instructor’s Manual

51,845 24,500 29,000 47,345

(For Instructor Use Only)

20-9

The worksheet would be completed as follows: Oehler Company Pension Worksheet—2019

General Journal Entries Annual Pension Expense

Items

Cash

OCIPrior Service Cost

Balance, Dec. 31, 2018 (a) Prior service cost Balance, Jan. 1, 2019 (b) Service cost (c) Interest cost (d) Actual return (e) Amortization of PSC (f) Contributions

Memo Record

Pension Asset/ Liability

Projected Benefit Obligation

3,500 Dr.

491,500 Cr.

42,000 Dr.

495,000 Dr.

42,000 Cr. 533,500 Cr. 28,000 Cr. 37,345 Cr.

28,000 Dr. *37,345 Dr. 31,000 Cr.

495,000 Dr

31,000 Dr.

17,500 Dr.

17,500 Cr. 29,000 Cr.

(g) Benefits

24,000 Dr.

Journal entry for 2019

Plan Assets

51,845 Dr. 29,000 Cr.

Accumulated OCI, Dec. 31, 2018 Balance, Dec. 31, 2019

29,000 Dr. 24,000 Cr.

24,500 Dr. 47,345 Cr. 0 24,500 Dr.

43,845 Cr.

574,845 Cr.

531,000 Dr.

*$533,500 X .07

The pension reconciliation schedule is as follows: Projected benefit obligation (Credit)......................... Plan assets at fair value (Debit) ............................... Pension asset/liability (Credit)..................................

$(574,845) 531,000 $ (43,845)

13. Prior Service Cost (PSC). When either initiating (adopting) or amending a defined benefit plan, a company often provides benefits to employees for years of service before the date of initiation or amendment. As a result of this prior service cost, the projected benefit obligation is increased to recognize this additional liability. The employer initially records the prior service cost as a component of Other Comprehensive Income. The employer then charges the prior service cost to pension expense over the remaining service lives of the employees who are expected to benefit from the change in the plan. The cost of the 20-10

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Kieso, Intermediate Accounting, 16/e Instructor’s Manual

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retroactive benefits (including any benefits provided to existing retirees) is the increase in the projected benefit obligation at the date of the amendment.

Gains and Losses 14. (L.O. 4) Because of the concern to companies that pension plans would have uncontrollable and unexpected swings in pension expense, the profession decided to reduce the volatility by using smoothing techniques. Asset gains (occurring when actual return is greater than expected return) and asset losses (occurring when actual return is less than expected return) are recorded in an Other Comprehensive Income (G/L) account and combined with unrecognized gains and losses accumulated in prior years (Accumulated OCI). Liability gains (resulting from unexpected decreases in the liability balance) and liability losses (resulting from unexpected increases) are deferred and combined in the same Other Comprehensive Income (G/L) account used for asset gain or losses. Corridor Amortization 15. The Accumulated Other Comprehensive Income (G/L) account can continue to grow if asset gains and losses are not offset by liability gains and losses. To limit this potential growth, the FASB requires the corridor approach for amortizing the balance in Accumulated OCI when it gets too large. The Accumulated OCI account balance is considered too large and must be amortized when it exceeds 10% of the larger of the beginning balance of the projected benefit obligation or the market-related value of plan assets. Any systematic method of amortizing the excess may be used, but it cannot be less than the amount computed using straight-line amortization over the average remaining service-life of all active employees. Amortization of the excess unrecognized net gain or loss should be included as a component of pension expense, only if, as of the beginning of the year, the unrecognized net gain or loss exceeds the corridor.

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Kieso, Intermediate Accounting, 16/e Instructor’s Manual

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