Chapter 20 Flashcards
Why are pensions so important?
effects everyone, not just an accounting problem
What is the old standard that applies to pension plans and follows accrual accounting?
SFAS 87: Accounting for Pension Plans
What is the new standard that relates to pension plans?
SFAS 158
What is a pension plan?
Provides benefits to retirees for services provided during employment
What are the two types of pension plans?
Defined contribution and Defined benefit
How does the accounting for pension plans work?
the work is done today but have to estimate for the future.
What is a defined contribution plan?
employer contributes a defined sum to a (third party) plan trust
How does a defined contribution plan work?
plan accumulates assets and makes distributions to retirees
What is an employer’s pension expense under a defined contribution plan?
equal to annual contribution needed (employees are beneficiaries)
When does an employer accrue a liability under a defined contribution plan?
when the contribution made is less then pension expense
When does an employer accrue an asset under a defined contribution plan?
when the contribution made is greater than pension expense
What is an example of a defined contribution plan?
401K that does not tie you to a company
How does a 401K operate?
If employee puts it in, company will match it and contribution is tax deductible
What entry is made when an employer makes a contribution?
Debit pension expense, credit cash
Whay is a defined benefit plan?
employee is promised certain amount of benefits at retirement (usually periodic), nothing is done as work is done
How does a defined benefit plan work?
trust accumulates assets, employer remains liable to ensure benefit payments, and the employer is the trust beneficiary
Who uses defined benefit plans?
most manufacturing companies and governments
What are the differences between defined contribution plans and defined benefit plans?
1) contribution: employer contributions defined, benefit: retiree benefits are fixed amount, 2) contribution: retiree benefits depend on fund performance, benefit: employer contributions to plan depend on promised benefits to retirees, 3) contribution: retirees bear investment risk, benefit: employers bear investment risk
What do pension calculations involve?
actuarial assumptions which are estimates
What do actuarial assumptions involve?
Mortality rates, employee turnover, future salaries, and rates of return
Where are actuarial assumptions found?
Deep in the footnotes of financial statements
What are the components of pension cost?
1) Service cost, 2) Interest cost, 3) Return on plan assets, 4) Gains and losses, 5) Amortization of unrecognized prior service cost
What is service cost?
expense caused by the increase in PBO payable to employees because of service rendered during the current year, new work performed
What is interest cost?
company pays interest on beginning balance of PBO based on company’s projected interest rate
Who’s liable for the promised employee benefits?
the company
What determines the interest expense?
the settlement rate
What is the result of a company not fully paying their PBO?
have unfunded liability that accrues interest
What is a PBO?
Pension Benefit Obligation, pension liability, more realistic assumption
What is an ABO?
Accumulated Benefit Obligation, old approach, no assumption of future changes
Is a PBO or ABO larger?
PB because assumes inflation and other factors
Is a PBO or ABO more conservative?
PBO
What are unrecognized gains and losses?
deviations of actual amounts from estimated amounts
When do you amortize the unrecognized gains and losses?
only if they exceed 10% of the greater of the PBO or market-related value (both as of beginning of year) and only recognize excess
How are unrecognized gains and losses amortized?
over the remaining service life of active employees
How are gains or losses created?
by differences in expected vs. actual return
What is market-related value or fair value of plan assets?
Assets accounted for at fair value
What is the effect of losses and gains on pension expense?
Losses - increase pension expense, Gains - decrease pension expense
When does unrecognized prior service cost result?
only when a plan has been changed
How is unrecognized prior service cost allocated to pension expense?
Based on remaining service years of concerned employees
How is unrecognized prior service cost amortized?
straight-line
Where is unamortized unrecognized prior service cost recognized?
in other comprehensive income
What is unrecognized prior service cost’s effect on pension expense?
always increases pension expense because cannot cut benefits
What changes were brought about by SFAS 158?
1) Use of OCI account, 2) Recognition of Pension Funding Asset or Liability, 3) No longer minimum liability computation based on ABO (now have adjustments to OCI)
What accounts effect OCI?
Prior service cost and gains and losses (second biggest), also affected by gains and losses from AFS (biggest component)
What is the journal entry for the recognition of a pension funding asset or liability?
debit Pension Expense and Pension Asset/Liability (if overpaying) and credit Cash (company contribution) and Pension Asset/Liability (if underpaying)
If a company is underpaying their pension expense, what happens to the pension asset/liability account?
credit pension asset/liability
What are the three OCI accounts?
OCI - AFS, OCI - G/L, OCI - PSC
What is a vested benefit obligation?
smallest, only benefits that have been entirely vested
What does the pension expense journal entry tell you?
Pension expense for individual year, still need to determine the end of the year balance
How do the various aspects of pension expense effect pension expense?
1) Service: increase, 2) Interest: increase, 3) Return on assets: decrease (could have negative return in loss year and would increase), 4) Prior service cost: increase, 4) Amortization of gain/loss: increase if loss and decrease is gain
How is interest calculated?
beginning PBO x rate
How do prior service cost and amortization of gains and losses effect OCI?
amortization of losses and prior service cost are credits to OCI and amortization of gains is a debit to OCI
Calculation of prior service cost
Total amount/useful life or service life
Return on assets calculation
fair value of plan assets x ERR (different from interest rate)
What is the materiality test used for gains and losses?
corridor approach (lag measure), always start one year later and evaluates PY performance, determines if G/L is too big
Process of determining gains and losses
1) Does a gain/loss exist?, 2) If yes, is it material?, 3) Determine through corridor approach: a) Compare assets to liabilities, b) Take the bigger, c) Multiply by 10%, 4) Take excess and divide by service years
