Deferred Compensation

Question 1

What is a defined contribution pension plan?

Answer 1

The amount of the employer contribution is defined by contract.

The benefits paid during retirement are dependent on the return on the pension fund assets and therefore are not defined. The employee bears the risk of fund performance in this type of plan. The sponsoring firm has no obligation to the employee beyond the total annual contribution

Question 2

How do you account for a defined pension plan?

Answer 2

simple: The amount of annual pension expense recognized is the required contribution. Any shortfall represents a liability until the employer covers it. If the payment is not expected to be within one year of the balance sheet date, the liability is discounted to present value.

Question 3

What is a defined benefit pension plan?

Answer 3

The benefits paid during retirement are based on a formula and therefore are defined.

The contribution to the pension fund is not defined. The employer bears the risk in this type of plan because the benefit is defined

Question 4

What is the difference between a contributory and noncontributory benefit plan?

Answer 4

In a contributory plan, contributions to the pension plan are made by the employer and the employees. In noncontributory plans, contributions to the pension plan are made by the employer only.

Question 5

How do you account for a Defined Benefit Pension Plan?

Answer 5

Is based on accrual accounting: pension expense is recognized as benefits are earned and the pension obligation is recognized for unpaid benefits.

One of the costs of generating current period revenue is the provision, by the employer, of employee pension benefits. That cost is matched as pension expense against the revenues it helped generate. Also, the definition of a liability is met because pension benefits are promised as credits are earned during the employee service period.

Question 6

How much is the annual benefit for a defined benefit plan?

Answer 6

(years of service/40)(final or highest annual salary)(age at retirement/65)

Question 7

What is pension expense?

Answer 7

The cost to the firm of providing the pension benefits earned during the year. This amount is reported in the income statement and has five independently computed components (Service Cost, Interest Cost, expected return on plan assets, amortization of prior service cost, amortization of net gain or loss)

Question 8

What is the PBO (Projected benefit obligation)

Answer 8

The present value of unpaid pension benefits promised for work done through the balance sheet date, as measured by the benefit formula. PBO reflects future salaries if they are used in the formula, but PBO reflects service credits earned only through the balance sheet date.

Question 9

What is the pension liability?

Answer 9

The difference between ending PBO and plan assets at the balance sheet date, reported in the balance sheet. Pension liability (PBO - assets) is the amount underfunded. If the plan is overfunded (assets exceed PBO), then pension asset is reported (assets - PBO).

Question 10

What is ABO - accumulated benefit obligation

Answer 10

the present value of unpaid pension benefits through the balance sheet using current salaries. This calculation is the same as for PBO except that the latter uses future salaries.

Question 11

What is VBO - vester benefit obligation

Answer 11

the present value of vested benefits;

In most situations, the following relationship holds: PBO > ABO > VBO.

Question 12

What is the discount rate in reference to pension plan accounting?

Answer 12

the rate used for all actuarial present value pension calculations. It is the rate at which the pension obligation could be settled and is pegged at the market rate of interest

Question 13

What is the expected rate of return in reference to pension plan accounting?

Answer 13

the rate used to compute expected return on plan assets, one of the components of pension expense

Question 14

What 5 compenents make up Pension Expense?

Answer 14

Service Cost, Interest Cost, expected return on plan assets, amortization of prior service cost, amortization of net gain or loss

Question 15

What is the Service Cost (Pensions)?

Answer 15

The actuarial present value of pension benefits earned during the current period. This amount is the increase in pension expense due to service provided during the year. Service cost is an immediate increase in PBO

Question 16

What is the interest cost in pensions?

Answer 16

growth in PBO for the period due to the passage of time = (discount rate)x(PBO at Jan. 1).

Question 17

What is the expected return on plan assets for pensions?

Answer 17

(expected rate of return)x(plan assets at Jan. 1 at market value). This component reduces pension expense.

Question 18

What is the amortization of prior service cost for pensions?

Answer 18

This is an immediate increase in PBO from the retroactive application of an increase in benefits for service already rendered (from plan amendments or from retroactive application to employee service before the plan’s adoption). It is called “prior” service cost because the service cost of previous years has been increased.

Amortization is computed using one of two methods (a free choice but the firm must be consistent):

1. Straight-line method (amortize PSC over the average remaining service period of employees covered by the amendment);
2. Service method (amortize an equal amount of PSC per service-year, more amortization is recognized when more employees are working).

Question 19

What is the amortization of net gain or loss for pensions?

Answer 19

This component causes pension expense to be gradually increased or decreased by (a) changes in PBO caused by estimate changes or experience changes, and (b) differences between expected and actual return on plan assets.

If actual return exceeds expected return, the difference is a gain, and vice versa. The gains and losses from both sources are netted into one amount at the beginning of each year.

Question 20

How do the 5 compents effect Pension Expense?

Answer 20

Service cost and interest costs always increase pension expense
Expected Return on Plant Assets reduces pension expense
Amortization of PSC usually always increases the pension expense
The Amortization of net gain decreases pension expense and a loss increases it

Question 21

What are the 2 methods to amortize prior service cost?

Answer 21

Straight line (take the total PSC amount and divide it by the average remaining service period)

Service Method - divide the PSC by the total years remaining. Multiply this number by the number of employees working each year.

Question 22

What are the 2 computations for amortizing the net gain or loss?

Answer 22

1. Determining the amortization of the net gain or loss at the beginning of the current year to include in pension expense for the year. There are two methods of amortization allowed: (1) minimum (corridor) amortization (most popular) and (2) SL amortization. Both use average remaining service period of employees as the denominator. The firm must be consistent in its application. If corridor amortization is not chosen, any consistently applied method resulting in an amortization amount is acceptable. SL is the most popular choice for the second alternative.
2. Determining the net gain or loss at the end of the current year for amortization the following year. The ending net gain or loss = beginning net gain or loss - amortization of beginning net gain or loss + or - PBO gain or loss for the current year + or - asset gain or loss for the current year.

Question 23

What is the complete formula for PBO at balance sheet date?

Answer 23

PBO = SC to date + interest cost to date - benefits paid to date + PSC + net PBO gain or loss to date.

Question 24

What is the corridor method?

Answer 24

The corridor is plus or minus 10% of the larger of PBO and assets, both at the beginning of the year. Subtract this value from the gain/loss before amortizing. This method results in lower amortization relative to the SL method allowing for more cancellation of gains and losses over time.

Question 25

How are gains/losses treated for pensions under IFRS?

Answer 25

gains and losses are not subsequently amortized into pension expense. Net income is never affected. Rather, pension gains and losses are treated as permanent owners’ equity items

Question 26

What items are included in nonretirement postemployment benefits?

Answer 26

These benefits include salary continuation, severance pay, supplemental unemployment benefits, job training, counseling and disability benefits for inactive or former employees, continuation of health care and insurance coverage, and wages for disability or terminated employees

Question 27

When are nonretirment postemployment benefits recorded?

Answer 27

The expense and associated liability is recorded when employees earn the benefits, not when the benefits are paid

Question 28

When is it necessary to accrue Nonretirement Postemployment Benefits?

Answer 28

in 2 situations:
1-When the benefits meet the following four criteria
a. The employer’s obligation relating to employees’ rights to receive compensation for future absences is attributable to employees services already rendered;
b. The obligation relates to rights that vest or accumulate;
c. Payment of the compensation is considered probable;
d. The amount of the compensation can be reasonably estimated;

2-When the benefits do not meet the four conditions above, the accounting standard for contingencies applies

Question 29

What items are included in retirement benefits?

Answer 29

In addition to pensions, many firms provide other postretirement benefits to retirees based on the service they provided during their years as employees. Such benefits are often referred to as “OPEB” or other postemployment benefits. These benefits may include one or more of the following:

1. Health care or Medical Care Benefits;
2. Dental Care Benefits;
3. Eye Care Benefits;
4. Life Insurance Benefits;
5. Benefits related to Legal Services;
6. Benefits related to Tax Services;
7. Benefits related to Tuition Assistance;
8. Benefits related to Day Care;
9. Benefits related to Housing Assistance.

Question 30

How do you account for postretirement benefit plans?

Answer 30

As with pensions, the primary measure of the postretirement benefit obligation is netted against plan assets. The difference, postretirement benefit liability, is reported in the balance sheet.

First – Expected Postretirement Benefit Obligation (EPBO) is computed
Second – APBO is computed as the fraction of EPBO earned by the employee as of the balance sheet date

Question 31

What are the 6 components that make up postretirement benefit expense?

Answer 31

Service cost
Interest Cost
Expected REturn on Assets
Amortization of PSC
Amortization of gain/loss
Amortization of transition obligation

Question 32

With postretirement benefits, can an employee reach full eligibility before retirement?

Answer 32

employees often reach full eligibility before retirement. In these cases, no additional benefits are earned beyond the full eligibility date.