Chapter 20: Accounting for Pensions Flashcards
Types of pension plans
- nature of pension plans
- defined contribution plan
- defined benefit plan
- provide income to employees during their retirement years
- the employer sponsors the plan, incurs the cost, and makes contributions
- the plan (a separate legal and accounting entity) receives contributions, administers plan assets, and makes benefit payments
nature of pension plans
- promises a fixed annual contribution to a pension fund
- employee chooses where to invest the fund
- employer’s only obligation is to remit an annual contribution
- employer records pension expense equal to the cash contribution
defined contribution plans
- promises a fixed level of retirement benefits derived using a pension formula
- employer is responsible for adequate funding to the plan
- a typical pension formula calculates annual retirement benefits based on years of service, age, and annual pay at retirement
defined benefit plan
What are 2 types of defined contribution plans?
- 401K
- Profit Sharing
He does the employer record pension expenses equal to cash?
Dr. Pension Plan
Cr. Cash
What is the formula to calculate the defined benefit plan?
1.5 x years of service x salary
What are the components of defined benefit pension plans?
- pension benefit obligation
- plan assets
- pension expense
Pension benefit obligations is future compensation obligation that is recorded…
only in the footnotes
What are the components of Pension Benefit Obligation (PBO)?
- service cost
- interest cost
- prior service cost
- loss (gain) on PBO
- retiree benefit paid
Increase attributable to another year of service
service cost
interest is accrued due to the passage of time
interest cost
plan amendment retroactive
prior service cost
due to change in actuarial assumptions
loss (gain) on PBO
What are the measurements of Pension Benefit Obligation?
- accumulated benefit obligation (ABO)
- vested benefit obligation (VBO)
- projected benefit obligation (PBO)
PV of retirement benefits using EXISTING compensation levels.
accumulated benefit obligation
vested portion of ABO
vested benefit obligation
PV of retirement benefits using PROJECTED compensation levels
projected benefit obligation
Pension plan assets are recorded….
only in the footnotes
- the resources used to fund the obligation
- a trustee manages the assets of the plan
- the plan assets can change
pension plan assets
A trustee manages the assets of the plan by performing the following…
- accepts employer contributions
- invests the contributions
- accumulates the earnings on the investments
- pays benefits from the plan assets to retire employees or their beneficiaries
The plan assets can change due to…
- actual return: interest, dividends, gains/losses
- employee contributions
- benefits paid
Pension expense is recorded…
on the income statement
The employers cost of having the plan.
pension expense
What are the components of pension expense?
- service cost
- interest cost
- return of plan assets
- amortization of prior service cost
- amortization of EXCESS net gain/losses
How is the service cost calculated?
1.5 x service years x salary
How is the interest cost calculated?
beginning PBO x Discount rate
- Positive return decreases expense
- negative return increases expense
- the expected return is used to calculate pension expense (income smoothing) (Beginning plan assets x expected return)
return on pension assets
- Cost of making plan amendments retroactive to prior years
- amortized over average remaining service life of active employees
amortization of prior service cost
- gains and losses occur when actuarial estimates change (liability) or when actual return on assets varies from expected return (asset)
- excess = cumulative gain/loss - 10% corridor
- excess gain/loss is amortized over average remaining service life
- amortize a gain: decreases expenses
- amortize a loss: increases expensed
amortization of EXCESS Net Gains/Losses
- funded status of the plan
- recording the periodic expense and funding of the plan
- recording gains and losses
reporting issues
The funding status of a plan must be recorded…
on the employer’s balance sheet
In the funding status of plan, when PBO is greater than assets it results in a net pension liability, this is called…
underfunded plan
In the funding status of a plan, when PBO is less than assets it results in a net pension asset, this is called…
overfunded plan
