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CHAPTER 20
Accounting for Pensions and Postretirement Benefits
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics Questions
Brief Exercises Exercises Problems
Concepts for Analysis
- Basic definitions and concepts related to pension plans.
- Worksheet preparation. 3 3, 4, 7, 10, 14, 15, 18
- Income statement recognition, computation of pension expense.
- Balance sheet recognition, computation of pension expense.
- Corridor calculation. 18 7 8, 13, 14, 16, 17, 18
- Prior service cost. 12, 13, 20 5, 6, 8 1, 2, 3, 5, 9, 11, 12, 13, 14
- Gains and losses. 14, 17, 21, 22
- Disclosure issues. 23 10 9, 11, 12 11, 12 3, 4
- Special Issues. 25
*10. Postretirement benefits. 26, 27, 28, 29
*This material is dealt with in an Appendix to the chapter.
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives Questions
Brief Exercises Exercises Problems
Concepts for Analysis
- Understand the fundamentals of pension accounting.
CA20-1,
CA20-2 CA20-
3, CA20-
- 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.
CA20-6 CA20-
- Describe the requirements for reporting pension plans in financial statements.
CA20-
*6. Identify the differences between pensions and postretirement healthcare benefits.
*7. Contrast accounting for pensions to accounting for other postretirement benefits.
ASSIGNMENT CHARACTERISTICS TABLE (Continued)
Item Description
Level of Difficulty
Time (minutes) CA20-1 Pension terminology and theory. Moderate 30– CA20-2 Pension terminology. Moderate 25– CA20-3 Basic terminology. Simple 20– CA20-4 Major pension concepts. Moderate 30– CA20-5 Implications of GAAP rules on pensions. Complex 50– CA20-6 Gains and losses, corridor amortization. Moderate 30– CA20-7 Nonvested employees—an ethical dilemma. Moderate 20–
ANSWERS TO QUESTIONS
** 1. A private pension plan is an arrangement whereby a company undertakes to provide its retired employees with benefits that can be determined or estimated in advance from the provisions of a document or from the company’s practices.
In a contributory pension plan the employees bear part of the cost of the stated benefits whereas in a noncontributory plan the employer bears the entire cost.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
** 2. A defined-contribution plan specifies the employer’s contribution to the plan usually based on a formula, which may consider such factors as age, length of service, employer’s profit, or compen- sation levels.
A defined-benefit plan specifies a determinable pension benefit that the employee will receive at a time in the future. The employer must determine the amount that should be contributed now to provide for the future promised benefits.
In a defined-contribution plan, the employer’s obligation is simply to make a contribution to the plan each year based on the plan formula. The benefit of gain or risk of loss from assets con- tributed to the plan is borne by the employee. In a defined-benefit plan, the employer’s obligation is to make sufficient contributions each year to provide for the promised future benefits. Therefore, the employer is at risk to the extent that contributions will not be adequate to meet the promised benefits.
LO: 1, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
** 3. The employer is the organization sponsoring the pension plan. The employer incurs the costs and makes contributions to the pension fund. Accounting for the employer involves: (1) allocating the cost of the pension plan to the proper accounting periods, (2) measuring the amount of pension obligation resulting from the plan, and (3) disclosing the status and effects of the plan in the financial statements.
The pension fund or plan is the entity which receives the contributions from the employer, administers the pension assets, and makes the benefit payments to the pension recipients. Accounting for the fund involves identifying receipts as contributions from the employer sponsor, income from fund investments, and computing the amounts due to individual pension recipients. Accounting for the pension costs and obligations of the employer is the topic of this chapter; accounting for the pension fund is not.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
** 4. When the term “fund” is used as a noun, it refers to assets accumulated in the hands of a funding agency for the purpose of meeting pension benefits when they become due. When the term “fund” is used as a verb, it means to pay over to a funding agency (as to fund future pension benefits or to fund pension cost).
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 20 (Continued)
(4) Amortization of prior service cost —the cost of retroactive benefits granted in a plan amend- ment (including initiation of a plan).
(5) Gains and losses —a change in the value of either the projected benefit obligation or the plan assets resulting from experience different from that assumed or expected or from a change in an actuarial assumption.
Note to instructor: Regarding return on plan assets, the final component is expected rate of return. We are assuming above that an adjustment is made to the actual return to determine expected return.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
10. The service cost component of net periodic pension expense is determined as the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period. The plan’s benefit formula provides a measure of how much benefit is earned and, therefore, how much cost is incurred in each individual period. The FASB concluded that future compensation levels had to be considered in measuring the present obligation and periodic pension expense if the plan benefit formula incorporated them.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
11. The interest component is the interest for the period on the projected benefit obligation outstanding during the period. The assumed discount rate should reflect the rates at which pension benefits could be effectively settled (settlement rates). Companies should look to rates of return on high- quality fixed-income investments currently available whose cash flows match the timing and amount of the expected benefit payments.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- 12. Service cost is the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period. Actuaries compute service cost at the present value of the new benefits earned by employees during the year. Prior service cost is the cost of retroactive benefits granted in a plan amendment or initiation of a pension plan. The cost of the retroactive benefits is the increase in the projected benefit obligation at the date of the amendment.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- 13. When a defined-benefit plan is either initiated or amended, credit is often given to employees for years of service provided before the date of initiation or amendment. The cost of these retroactive benefits are referred to as prior service cost. Employers grant retroactive benefits because they expect to receive benefits in the future. As a result, prior service cost should not be recognized as pension expense entirely in the year of amendment or initiation. It is recognized as an adjustment to other comprehensive income. It should be recognized during the service periods of those employees who are expected to receive benefits under the plan. Consequently, prior service cost is amortized over the service life of employees who will receive benefits and is a component of net periodic pension expense each period.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- 14. Liability gains and losses are unexpected gains or losses from changes in the projected benefit obligation. Liability gains (resulting from unexpected decreases) and liability losses (resulting from unexpected increases) are recognized in other comprehensive income. The accumulated gains and losses are then amortized to expense over the remaining service lives of active employees expected to receive benefits.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 20 (Continued)
- 15. If pension expense recognized in a period exceeds the current amount funded, a liability account referred to as Pension Asset /Liability arises; the account would be reported either as a current or long-term liability, depending on the ultimate date of payment.
If the current amount funded exceeds the amount recognized as pension expense, an asset account referred to as Pension Asset /Liability arises; the account would be reported as a non-current asset. Because these assets are used to fund the pension obligation, noncurrent classification is appropriate.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- 16. Computation of actual return on plan assets
Fair value of plan assets at end of period ................................. $10,150, Deduct: Fair value of plan assets at beginning of period .......... 9,500, Increase in fair value of assets.................................................. 650, Deduct: Contributions to plan during the period ....................... $1,000, Add: Benefits paid during the period ................................... 1,400,000 400, Actual return on plan assets ..................................................... $ 1,050,
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- 17. An asset gain occurs when the actual return on the plan assets is greater than the expected return on plan assets while an asset loss occurs when the actual return is less than the expected return on the plan assets. A liability gain results from unexpected decreases in the pension obligation and a liability loss results from unexpected increases in the pension obligation.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- 18. Corridor amortization occurs when the accumulated OCI (G/L) balance gets too large. The gain or loss is too large when it exceeds the arbitrarily selected FASB criterion of 10% of the larger of the beginning balances of the projected benefit obligation or the market-related value of the plan assets. The excess gain or loss balance may be amortized using any systematic method but the amortization cannot be less than the amount computed using the straight-line method over the average remaining service-life of active employees expected to receive benefits.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- 19. The amount of the pension asset/liability to be reported on the company’s balance sheet is as follows: Projected benefit obligation.......................................................... $(400,000) Pension plan assets..................................................................... 350, Pension liability ............................................................................ $ (50,000)
In the financial statements, the company will report a pension liability of $50,000. This amount is also referred to as the funded status of the plan.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- 20. The prior service cost arising in the year of the amendment (which increases the projected benefit obligation) is recognized by an offsetting debit to Other Comprehensive Income (PSC). In subsequent periods, the $9,150,000 will be amortized into periodic pension expense over the remaining service lives of the employees. This approach is consistent with the treatment for actuarial gains and losses.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 20 (Continued)
- 25. The accounting issue that arises from these terminations is whether a gain should be recognized by the corporation when these assets revert (often called asset reversion transactions) to the company. The profession requires that these gains or losses be reported immediately in most situations.
LO: 5, Bloom: K, Difficulty: Simple, Time: 5-7, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*26. Postretirement benefits other than pensions include healthcare and other welfare benefits provided to retirees, their spouses, dependents, and beneficiaries. The other welfare benefits include life insurance offered outside a pension plan, dental care as well as medical care, eye care, legal and tax services, tuition assistance, day care, and housing activities.
LO: 7, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*27. The FASB did not cover both pensions and healthcare benefits in the earlier pension accounting rules because of the significant differences between the two types of postretirement benefits. These differences are listed in the following schedule:
Differences between Postretirement Healthcare Benefits and Pensions
Item Pensions Healthcare Benefits Funding Generally funded. Generally NOT funded. Benefit Well-defined and level dollar amount. Generally uncapped and great variability. Beneficiary Retiree (maybe some benefit to surviving spouse).
Retiree, spouse, and other dependents. Benefit Payable Monthly. As needed and used. Predictability Variables are reasonably predictable. Utilization difficult to predict. Level of cost varies geographically and fluctuates over time.
LO: 6, Bloom: AN, Difficulty: Simple, Time: 5-7, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*28. The major differences between pension benefits and postretirement benefits are listed below:
Differences between Postretirement Healthcare Benefits and Pensions
Item Pensions Healthcare Benefits
Funding Generally funded. Generally NOT funded. Benefit Well-defined and level dollar amount. Generally uncapped and great variability. Beneficiary Retiree (maybe some benefit to surviving spouse).
Retiree, spouse, and other dependents. Benefit Payable Monthly. As needed and used. Predictability Variables are reasonably predictable. Utilization difficult to predict. Level of cost varies geographically and fluctuates over time.
Additionally, although healthcare benefits are generally covered by the fiduciary and reporting standards for employee benefit funds under ERISA, the stringent minimum vesting, participation, and funding standards that apply to pensions do not apply to healthcare benefits.
LO: 6, Bloom: AN, Difficulty: Simple, Time: 5-7, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 20 (Continued)
*29. EPBO (expected postretirement benefit obligation) is the actuary’s present value of all benefits expected to be paid after retirement, while APBO (accumulated postretirement benefit obligation) is the actuarial present value of future benefits attributed to employees’ services rendered to a particular date.
The components of postretirement expense are service cost, interest cost, expected return on plan assets, amortization of prior service cost, and gains and losses.
LO: 7, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
BRIEF EXERCISE 20-1 (continued)
*Note: We show actual return on the worksheet to ensure that plan assets
are properly reported. If expected and actual returns differ, then an addi-
tional adjustment is made to compute the proper amount of pension expense.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 20-
Pension Expense.................................................... 73,000,
Pension Asset/Liability................................... 2,000,
Cash................................................................. 71,000,
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 20-
Cost per service year:
2017 amortization:
350 X $80 = $28,
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 20-
Project benefit obligation ....................................................... $(560,000)
Plan assets at fair value .......................................................... 322,
Pension liability ....................................................................... $(238,000)
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 20-
Net loss in accumulated OCI .................................................. $465,
Corridor (10% X $3,300,000) ................................................... (330,000)
Excess...................................................................................... 135,
Average remaining service life ............................................... ÷ 7.
Minimum amortization ............................................................ $ 18,
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 20-
Projected benefit obligation ................................................... $2,600,
Fair value of plan assets ......................................................... (2,000,000)
Pension liability (classified short-term or
long-term depending on when due) ................................... $ 600,
Prior service cost is reported as a component of accumulated other compre-
hensive income in stockholders’ equity.
LO: 5, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 20-
(a) Other Comprehensive Loss for 2017 is as follows:
Actuarial liability loss .............................................. ($ 28,000)
Unexpected asset gain ............................................ 18,
Other comprehensive loss ...................................... ($ 10,000)
(b) The computation of comprehensive income for 2017 is as follows:
Net income ............................................................... $ 26,
Other comprehensive loss ...................................... (10,000)
Comprehensive income........................................... $ 16,
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 20-
Pension Assets
(at fair value)
Projected Benefit
Obligation
Pension Asset /
Liability
Plan X $600,000 $500,000 $100,000 asset
Plan Y $900,000 $720,000 $180,000 asset
Plan Z $550,000 $700,000 $150,000 liability
Lahey reports a pension asset of $280,000 ($100,000 + $180,000) and a pension
liability of $150,000.
LO: 5, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
SOLUTIONS TO EXERCISES
EXERCISE 20-1 (15–20 minutes)
(a) Computation of pension expense:
Service cost ..................................................... $ 60,
Interest cost ($500,000 X .10) ......................... 50,
Expected return on plan assets ..................... (15,000)
Prior service cost amortization ...................... 8,
Pension expense for 2017 .............................. $103,
(b) Pension Expense .................................................... 103,
Cash ................................................................. 90,
Pension Asset /Liability ................................... 5,
Other Comprehensive Income (PSC) ............. 8,
LO: 1, 2, Bloom: AN, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 20-2 (10–15 minutes)
Computation of pension expense:
Service cost............................................................. $ 90,
Interest cost ($700,000 X 10%) ............................... 70,
Expected return on plan assets ............................. (64,000)
Prior service cost amortization .............................. 10,
Pension expense for 2017 ...................................... $106,
LO: 1, 2, 3, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Copyright © 201 EXERCISE 20-3 (15–25 minutes)
6 John Wiley & Sons, Inc.
Kieso,
(^) Intermediate Accounting,
(^) 16/e, Solutions Manual
(For Instructor Use Only)
VELDRE COMPANY
Pension Worksheet— 2017 General Journal Entries Memo Record
Items
Annual Pension Expense Cash
OCI
Prior Service Cost
Pension Asset/Liability
Projected Benefit Obligation Plan Assets Balance, January 1, 2017 60,000 Cr. 700,000 Cr. 640,000 Dr. Service cost 90,000 Dr. 90,000 Cr. Interest cost 70,000 Dr. 70,000 Cr. Actual return* 64,000 Cr. 64,000 Dr. Amortization of PSC 10,000 Dr. 10,000 Cr. Contributions 105,000 Cr. 105,000 Dr. Benefits 40,000 Dr. 40,000 Cr. Journal entry for 2017*** 106,000 Dr. 105,000 Cr. 10,000 Cr. 9,000 Dr. Accumulated OCI, Dec. 31, 2016 150,000 Dr. Balance, Dec. 31, 2017 140,000 Dr. 51,000 Cr. 820,000 Cr. 769,000 Dr.**
*$70,000 = $700,000 X 10%.
****Note: We show actual return on the worksheet to ensure that plan assets are properly reported. If expected and actual return differ, then an additional adjustment is made to compute the proper amount of pension expense.**
*****Pension Expense ................................................. 106, *Pension Asset/Liability ........................................ 9, Other Comprehensive Income (PSC) ......... 10, Cash ............................................................. 105,
LO: 1, 2, 3, Bloom: AN, Difficulty: Moderate, Time: 15-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Copyright © 2016 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only) 20-
EXERCISE 20-5 (15–25 minutes)
Computation of Service-Years
Year Jim Paul Nancy Dave Kathy Total
Cost per service-year: $72,000 ÷ 24 = $3,
Computation of Annual Prior Service Cost Amortization
Year
Total
Service-Years
Cost Per
Service-Year
Annual
Amortization
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 20-6 (10–15 minutes)
Computation of Actual Return on Plan Assets
Fair value of plan assets at 12/31/17 ....................... $2,725,
Fair value of plan assets at 1/1/17 ........................... (2,400,000)
Increase in fair value of plan assets ....................... 325,
Deduct: Contributions to plan during 2017 ........... $280,
Less benefits paid during 2017 ................ 350,000 (70,000)
Actual return on plan assets for 2017 ..................... $ 395,
LO: 1, Bloom: AP, Difficulty: Simple, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 20-7 (15–25 minutes)
RYDELL CORP.
Pension Worksheet— General Journal Entries Memo Record
Items
Annual Pension Expense Cash
OCI–Prior Service Cost
Pension Asset/ Liability
Projected Benefit Obligation
Plan Assets Balance, Dec. 31, 2016 0 13,800 Cr. 560,000 Cr. 546,200 Dr. Prior service cost 120,000 Dr. 120,000 Cr. Balance, Jan. 1, 2017 680,000 Cr. 546,200 Dr. Service cost 58,000 Dr. 58,000 Cr. Interest cost 61,200 Dr. 61,200 Cr. Actual return* 52,280 Cr. 52,280 Dr. Amortization of PSC 17,000 Dr. 17,000 Cr. Contributions 65,000 Cr. 65,000 Dr. Benefits 40,000 Dr. 40,000 Cr. Journal entry for 2017 83,920 Dr. 65,000 Cr. 103,000 Dr. 121,920 Cr. Accumulated OCI, Dec. 31, 2016 0 Balance, Dec. 31, 2017 103,000 Dr. 135,720 Cr. 759,200 Cr. 623,480 Dr.**
*$61,200 = $680,000 X .09.
****Note: We show actual return on the worksheet to ensure that plan assets are properly reported. If expected and actual returns differ, then an additional adjustment is made to compute the proper amount of pension expense.**
LO: 1, 2, 3, Bloom: AP, Difficulty: Moderate, Time: 15-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
20
Copyright © 201
(^6) John Wiley & Sons, Inc.
Kieso,
(^) Intermediate Accounting,
(^) 1 (^6) /e, (^) Solutions Manual
(For Instructor Use Only)
