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