pension accounting

Pension Accounting

Understand the nature/characteristics/accounting of employer pension plans:

Defined Benefit Plans.

T P Adhikari & Associates, Chartered Accountants

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Objectives: ● Pension Overview ● Fundamental differences between:

– Defined contribution plans – Defined benefit plans*

● Accounting for Pension: – Key components: Pension expense

● Disclosure/presentation


PENSION ACCOUNTING

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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!


Overview of Pension Plan

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● SFAS 158 Reporting pension items in the balance sheet and AOCI

● 132R: Disclosures !

● IAS 19


Pensions: SFAS 158

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PENSION PLAN: Overview

Employer Sponsors the plan

Plan Administrator

Pension Recipients

Contributions

Benefits

The plan administrator receives the contributions from the employer, invests the pension assets, and makes the benefit payments.

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TYPES OF PENSION PLANS TWO TYPES

$DEFINED CONTRIBUTION PLAN

1

2DEFINED BENEFIT PLAN

promise FIXED ANNUAL CONTRIBUTIONS

promise FIXED RETIREMENT BENEFITS

Pension fund

T P Adhikari & Associates, Chartered Accountants !6

● 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


Defined contribution plans

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Defined Benefit Pension Plans

Employer is committed to specified retirement

benefits.

Retirement benefits are based on a formula that

considers years of service, compensation

level, and age.

Employer bears all risk of pension fund

performance.

Plan Characteristics

DEFINED BENEFIT PLAN

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● 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


Accounting for Defined Benefit Plans

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Pension calculations involve actuarial assumptions.

Assumptions involve:

mortality rates, employee turnover, future salaries, rates of return, etc.

These are estimates.

Actuaries and Pension Accounting

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Measures of Pension Liability: Defined Benefit Plan

Accumulated Benefit

Obligation

(AB0)

Projected Benefit

Obligation

(PBO)

Benefits for vested/ nonvested employees at current salaries

Benefits for vested and nonvested employees at future salaries (GAAP)

Pension calculations involve actuarial assumptions.

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OVERVIEW: PENSION COMPONENTS

Employee hired

Employee Retired

1. SERVICE PROVIDED Benefit Period

Based On Actuarial Assumptions: How much to contribute annually for the service provided by employees

SERVICE COST

PENSION EXPENSE

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● 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


PENSION EXPENSE: INTEREST COST

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INTEREST COST:PENSION EXPENSE

➢PV of pension Obligation is increased by the interest cost on the beginning of PBO



OVERVIEW: TIMELINE COMPONENTS

PRIOR (PAST) SERVICE COST

Plan Initiation

Employee Hired

Employee Retired

Past Service Cost SERVICE COSTBenefit Period

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● 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

PENSION EXPENSE: Prior Service Cost

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1. 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


Issues in Accounting: Defined Benefit Plans

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● 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

investment T P Adhikari & Associates, Chartered Accountants

Pension Plan Assets

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– 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


Return on Plan Asset

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● 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


Actuarial Gains and Losses

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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*

NET GAINS/LOSSES



Corridor Amount

The corridor amount is 10% of the greater of . . .

PBO at the beginning of the period.

Fair value of plan assets at the beginning of the period.

Or

STEPS 1: GREATER OF PBO & PLAN ASSETS 2: 10% OF STEP 1 3…. Next slide…

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Gains and Losses

2009 Net Loss Amortization ($ in millions)

PBO 400$

Fair value of plan assets 300

Net loss for 2009 55

Average service life 15

EXAMPLE

Apply steps: 1.Greater of PBO & Plan Assets = PBO $400 2.10% of PBO i.e. 400 x 10% = $40

2013

2013

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Gains and Losses

Net loss 55$

Corridor amount ($400 x 10%) 40

Excess at the beginning of the year 15$

$15,000,000 ÷ 15 years = $1,000,000

STEP 3: FIND THE EXCESS TO BE AMORTIZED

AMORTIZATION:

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So far….. PENSION EXPENSE= Service Cost

+ Interest Cost - expected return on plan Asset +Amortization (if any) of Prior service cost +/- Amortization (net) Gains/Losses


Defined Benefit Plan: Net Periodic Pension Cost

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● 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.


REPORTING: Employer’s Obligation & Plan Asset

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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.

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● 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


Pension Disclosures

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– 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


Pension Disclosures

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● 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


Pension Disclosures

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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

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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


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can we help?

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We can be contacted at the following office; TP Adhikari & Associates,

Chartered Accountants 2

nd Floor, 723/60, Tanka Prasad Ghumti Sadak,

Anamnagar, Kathmandu- 32, Nepal GPO Box No. 10915

Contact No: 01-4247816 / 4247917 Email : [email protected]

Fax: +977-1-4247917 !CONTACT PERSON: CA Thakur Prasad Adhikari Cell +977 9851094055

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