F6: Pension Plans Flashcards
Pension accounting is based on what type of accounting?
Accrual
What causes accounting problems with defined benefit plans?
The use of estimates and assumptions
Contributory vs Noncontributory
Contributory- employees required to contribute to the plan
Noncontributory- only the employer contributes
The term “funding” refers to:
The sponsor company making contributions to the plan
The 2 non-GAAP methods of pension plans
1- “Pay-as-you-go” Method
2- “Terminal Funding” Method
“Pay-as-you-go” definition
- Cash basis method
- Expenses pension payments after someone has retired
“Terminal Funding” definition
- Cash basis method
- Pays entire pension plan liability upon retirement by purchasing an annuity-type insurance policy
The 2 GAAP methods of pension plans
1- Defined Contribution Plan
2- Defined Benefit Plan
1 example of a Defined Contribution Plan
401K
Defined Benefit Plan definition
- Defines the benefits to be paid to employees at retirement
- Calculated by using actuarial assumptions of future benefits
4 factors that get looked at for defined benefit plan actuarial assumptions
1- EE’s compensation levels near retirement
2- # of years of service
3- # of years until retirement
4- # of years the plan expects to pay benefits after retirement
ABO
- Accumulated Benefit Obligation
- use current salary
PBO
- Projected Benefit Obligation
- use guess future salary
Service cost definition
- Present value of all pension benefits earned by employees in the current year
- Provided by the actuary
Interest cost happens because of:
the passage of time
Prior service cost definition
- Service prior to initiation of plan that employees retroactively receive credit for
- Subsequent plan amendments
Components that INCREASE PBO:
1- Service Costs
2- Interest Costs
3- Prior Service Costs
4- Actuarial loses
Components that DECREASE PBO:
1- Actuarial gains
2- Benefit payments
How to calculate the PBO
Beginning PBO \+ service cost \+ interest cost \+ prior service cost \+ actuarial losses - actuarial gains - benefits paid to retirees = Ending PBO
Plan assets should be reported at:
Fair value
To calculate ending value of plan assets
Beginning fair value of plan assets \+ contributions \+ actual return on plan assets (squeeze) - benefits paid to retirees = Ending fair value of plan assets
Pension expense on I/S AKA (and definition)
“Net periodic pension cost”
-The increase in PBO during the period
I/S Expense Formula (SIR AGE)
current Service cost \+ Interest cost - Return on plan assets \+ Amortization of prior service cost - Gains and + losses \+ amortization of Existing net obligation or net asset = Net Periodic Pension Cost
Current service cost definition
PV of all benefits earned in current period
Interest cost definition and calculation
Increase in PBO due to the passage of time
Beginning of period PBO
X Discount Rate
= Interest Cost
US GAAP allows companies to offset pension expense by one of two ways:
Either by:
1- actual return on plan assets
2- expected return on plan assets
How to calculate expected return on plan assets
Beginning FV of plan assets
X expected rate of return on plan assets
= Expected return on plan assets
How is unrecognized prior service costs recorded? (and calculation)
As unrecognized prior service cost in OCI
Beginning unrecognized prior service cost
/ by the average remaining service life
= amortization of prior service cost
Gains/Losses arise from two sources:
1- difference between expected and actual return on plan assets
2- changes in actuarial assumptions
If good for the plan = gain
If bad for the plan = loss
Entities have two choices when accounting for gains/losses:
1- recognize on I/S in period incurred
2- recognize in OCI when incurred and then amortize (most often used to smooth earnings)
The “corridor approach” definition
Gains/losses can be amortized IF exceeds 10% of the GREATER of beginning year balances of:
1- market related value of plan assets
2- PBO
The “corridor approach” calculation
Unrecognized gain/loss - 10% of PBO OR Market related value (greater of) = Excess / by average remaining service life = Amortization of unrecognized gain/loss
“Funded Status” calculation for B/S
FV of plan assets
- PBO
= Funded status
If Overfunded,
Pension plan asset (always noncurrent)
this is a positive funded status
If Underfunded,
Pension Plan liability (can be current, noncurrent, or both)
this is a negative funded status
Settlements definition
Sale of assets to buy annuity contracts
Curtailments definition
Events that reduce expected remaining years of service or eliminate accrual of defined benefit for a significant # of employees
Termination Benefits definition & calculation
When employees are paid to terminate their rights to future pension payments
Lump sum payment
+ PV termination benefits
= Special term benefit
2 rules of thumb when it comes to disclosures
1- More disclosure is better than less
2- Disclose as much as reasonably possible
Relationship between pension plan and sponsoring company
They are two separate legal entities
GAAP requires f/s be presented by the pension plan itself
