Pension Plans & Accounting for income taxes Flashcards
Pension Plans
It is very important to note that a pension plan and the sponsoring company are two separate legal entities. The pension plan accounting covered below is not concerned with the pension plan’s accounting. Rather it is concern with how the sponsor company accounts for the plan
Accounting for pension plan is concerned primarily with determining the amount of
- Pension expenses that appears on the sponsor company’s I/S
- Any related pension accounts ( asset, liabilities and OCI ) that appear on the sponsor company’s B/S
Defined Benefit Plan
This type of plan defines the benefit to be paid to employees at retirement. Contribution are computed using actuarial assumptions of future benefit payments based on factors such as
- Employees’ compensation levels at or near retairment
- The number of years of employees service
- The number of years until the employee retires
- The number of years that the plan expects to pay benefit after an employee retires
Accumulated Benefit Obligation ( ABO)
The actuarial PV of benefits attributed by a formula based on current and past compensation levels. An ABO differs from a PBO ( projected benefit obligation) only in that the ABO includes no assumption about future compensation levels (Uses current salaries).
Projected Benefit Obligation ( PBO)
The actuarial PV of benefit attributed by the plan’s benefit formula to employees rendered prior to that date. PBO only uses an assumption as to future compnesation levels
Under IFRS, the defined benefit obligation ( DBO) is the defined benefit pension liability. The DBO and the PBO are calculated in a similar manner
Benefit Payments
Benefits are paid to pension plan participants after retirement. The payment of pension benefit reduces the projected benefit obligation and reduces plan assets
Beginning projected benefit obligation
+Service cost
+Interest cost
+Prior service cost from current period amendment
+Actuarial losses incurred in the current period
-Actuarial gains incurred in the current period
-Benefits paid to retirees
= Ending projected benefit obligation
Actual Return on Plan assets
Beginning FV of plan assets \+contribution \+Actual return on plan assets ( Squeeze) -Benefit paid to retirees =Ending fair value of plan assets
Most companies choose not to use the actual return on plan assets in the computation of pension expense because the actual return can vary drastically from period to period, causing earnings volatility
Interest cost
The increase in the projected benefit obligation during the current period that is due to the passage of time
Beginning of period PBO
X Discount rate
=Interest Cost
Return on Plan Assets
US GAAP allow companies to offset pension expense by either the actual return on plan assets or the expected return on plan assets
Expected return on plan assets ( Smooth earning)
Beginning FV of plan assets
X Expected rate of return on plan assets
= Expected return on plan assets
Under IFRS - Service cost
Service cost component of defined benefit cost includes both current service cost and past service cost.
Net interest on the defined benefit liability(asset)
=Net defined benefit liability X discount rate
The net defined benefit liability is the difference between the defined benefit obilgation and the FV of the plant asset
Amortization of Unrecognized prior service cost
Under US GAAP, in the period that a pension plan is initiated or amended, the resulting prior service cost increases the PBO and is recorded as unrecognized prior service cost in OCI. The unrecognized prior service cost in accumulated OCI is amortized to pension expense over plan participant’s remaining years of service.
Beg Unrecognized prior service cost
divide by average remanning service life
Amortization of prior service cost
GAAP VS IFRS
Under IFRS, prior service cost is referred to as past service cost. When a plan is amended, past service cost increases the DBO and is reported as defined benefit service cost on the income statement. Under IFRS, past service cost is not booked to OCI
Accounting for Gains and losses
GAAP, entities have two choices when accounting for gains or losses
- Recognize gains and losses on the I/S in the period incurred OR
- Recognize the gains and losses in OCI in the period incurred and then amortize the unrecognized gain and losses to pension expenses over time using corridor approach.
The Corridor Approach
An entity’s net unrecognized gain or loss is amortized over the employees average remanning service period, if as of the beginning of the year , this amount exceeds 10% of the greater of be beginning of the year balances of
- Market related value of plan asset = assets
- Projected benefit obligation (PBO) = Liabilities
Amortization of existing net obligation or net asset at implementation
Projected benefit obligation
(FV of plant asset)
Initial unfunded Obligation
divide by 15 years or avg. Employees job life ( greater)
= minimum amortization
Interest cost and funded status formula
Beg of period PBO
X Discount rate
=Interest Cost
FV of plan assets
(PBO)
=Funded status
Expected post-returement benefit obligation
The PV of all future benefits expected to be paid as of the measurement date. It is included
- The amount that has vested, plus
- The PV of expected future benefits that have not yet vested.
Post-retirement benefits
Transition to accural accounting was done in one of two ways
- Immediate expense recognition by recording the entire obilgation in one year as the effect of a change in accounting principle
- Delayed recognition by using S/L amortization over the avg. remaining service period of active plan participants.
Amortization or expense of the transition obligation
formula
Accumulated post -retirement benefit obligation
(PV of plant asset)
= Initial unfunded
Divide by 20 year or avg. remaining service period ( greater of)
= Minimum amor
or
Expense full amount
Post-employment benefit
Post-employment benefit are paid by companies to former or inactive employees during the period after their employment and before their retirement. This is not the same as post-retirment benefits such as
- Salary continuation
- Severance benefits
- Fringe benefits
- Job training, disability related
Post-employment ( Liability recognition)
Liabilities for post-empolyement benefit are accrued if all of the following condition are met
- The employer obligation is attributable to service already rendered ( liability)
- The obligation relates to right that vest or accumulate
- Payment of the compensation is probable
- The amount can be reasonably estimated
*Footnote disclosure is required when all four criteria are not met.
Accumulated Post-retirement Benefit Obligation (APBO)
The APBO is the PV of future benefits that have vested as of the measurement date. The APBO is discounted using as assumed discount rate
- This rate should reflect return on high quality, fixed income investment
- The discount rate is used to determine the APBO, EPBO, and the service and interest cost components of net periodic post-reretirment benefit cost
Pension Gain and losses under IFRS
under IFRS, Gain and losses referred to as re-measurements and actuarial gains and losses and difference between actual return on plant asset and interest income. All re-measurements of the net defined benefit liability (asset) are reported OCI and are NOT re-classified ti the I/S in subsequent periods
Intra-period Tax allocation
Intra-period tax allocation involves apportioning the total tax provision for financial accounting purposes in a period between the income and loss from
IDEA & OCI (PUFER)
Inter-period Tax allocation
The objective of inter-period tax alloaction is to recognize through the matching principle the amount of current and future tax related to events than have been recognized in financial accounting income.
There are two types of differences between pretax GAAP and financial income and taxable income. All differences are either permanent differences and temporary differences
Permanent differences
it’s affect current tax computation and do not affect the deferred tax computation. Revenue and expense that either
Enter into pretax GAAP financial income but never into taxable income ( IE, Interest income on state or municipal obligation)
Enter ion taxable income but never into pretax GAAP Financial income ( IE Dividend received deduction)
Temporary Differences
Affect current and deferred required
Items that are first recognized for tax purposes will eventually be recognized for GAAP purposes ( or vice versa) therefore, the differences are temproary and will eventually turn around
Deferred Tax Liabilities
Deferred tax liabilities are anticipated future tax liabilities derived from situation where future taxable income will be greater than future financial accounting income due to temporary differences. All deferred tax liabilities are recognized on the B/S
Deferred Tax assets
Deferred tax assets arise when the amount of taxes paid in the current period exceeds the amount of income tax expenses in the current period. They are anticipated future benefits derived from situations where future taxable income will be less than future financial accounting income due to temporary differences.
Valuation Allowance
If it more likely than not ( a likelihood of more than 50% ) that part or all of the deferred tax asset will not be realized, a valuation allowance is recognized.
Valuation allowances are not permitted under IFRS, Instead, a deferred tax asset is recongized when it is probable ( more likely than not) that sufficient taxable profit will be able available against which the temporary difference can be utilized.
Uncertain Tax Positions
An uncertain tax position is defined as some level of uncertainty of the sustainability of a particular tax position taken by a company. US GAAP require
a more likely than not level of confidence before reflecting a tax benefit in an entity’s F/S
Two -step approach Step 1- Recognition of tax benefit a) Test More likely than not b) Threshold consideration c) Test Failed
Step 2- Measurement of the tax benefit
Enacted Tax Rate
Measurement of deferred taxed based on the applicable tax rate. This require using the enacted tax rate expected to apply items (temporary differences) in the periods the taxable item to be paid or realized
Changes in Tax Laws or Rates
The liability method requires that the deferred tax account (asset or liability) be adjusted when the tax rates changes. It should be adjusted when the tax rates enacted not just proposed or estimated.
he adjustment enters into income tax expense for that period as a component of income from continuing operations
Changes in Tax laws or Rates (IFRS)
Under IFRS, adjustment for changes in deferred tax balances due to changes in tax laws or rates are recognized on the I/S except when the deferred tax balances arises from a transactions or event that is recognized in OCI, and the adjustment should be recorded in OCI.
Changes in the Tax status of an Enterprise
At the date a nontaxable entity becomes a taxable entity, a deferred tax liability or asset should be recognized for any temporary differences.
If taxable entity becomes a nontaxable entity, any exiting deferred tax liability or asset should be eliminated.
The effect should included in income from continuing operations in the period of the changes
Defined benefit pension plan F/S
A pension plan and the sponsoring company are two separate legal entities. I pension plan acconting outlined above in only concerned with how sponsor company accounts for the plan. US GAAP requires that F/S be presented by the pension plan itself - Required F/S follows
- Statement of Net Assets of Available for benefits
- Statement of changes in Net assets available
- Statement of Accumulated plan benefits
- Statements of changes in Accumulated plan benefits
A statement of cash flows is not required.
