Lecture Intermediate accounting (IFRS/e) - Chapter 17: Pensions and other postemployment benefits

This chapter include objectives: Explain the fundamental differences between a defined contribution pension plan and a defined benefit pension plan; distinguish among the vested benefit obligation, the accumulated benefit obligation, and the projected benefit obligation; describe the five events that might change the balance of the PBO;...

© 2013 The McGraw-Hill Companies, Inc.

Chapter 17

PENSIONS AND OTHER

POSTEMPLOYMENT

BENEFIT PLANS

17 - 2

Nature of Pension Plans

1 Pension plans provide income to

individuals during their retirement years

2 This is accomplished by setting aside

funds during an employee’s working years so that at retirement, the

accumulated funds plus earnings from investing those funds are available to replace wages

17 - 3

Nature of Pension Plans

F

For a pension plan to qualify for special tax

treatment it may need to meet the following

requirements:

1.Cover a substantial proportion of employees.

2.Cannot discriminate in favor of highly

compensated employees.

3.Must be funded in advance of retirement through

an irrevocable trust fund.

4.Benefits must vest after a specified period of

service.

5.Complies with timing and amount of

contributions.

17 - 4

Nature of Pension Plans

17 - 5

Contributions

are defined

by agreement.

Contributions

are defined

by agreement.

Employer deposits an agreed-upon amount into

an directed investment

employee-fund.

Employer deposits an agreed-upon amount into

an directed investment

employee-fund.

Employee bears all risk

of pension

fund performance.

Employee bears all risk

of pension

fund performance.

Plan Characteristics

Defined Contribution Plans

17 - 6

Defined Contribution Plans

Let’s assume that the annual contribution is to

be 3% of an employee’s salary If an employee earned $110,000 during the year, the company

would make the following entry:

Defined benefit expense 3,300

The employee’s retirement benefits are totally dependent upon how well investments perform.

17 - 7

Employer is committed to

specified retirement benefits

Employer is committed to

specified retirement benefits

Retirement benefits are based on a formula that considers years of service, compensation level, and age.

Retirement benefits are based on a formula that considers years of service, compensation level, and age.

Employer bears all risk

of pension

fund performance.

Employer bears all risk

of pension

fund performance.

Plan Characteristics

Defined Benefit Plans

17 - 8

Defined Benefit Plan

A pension formula might define annual retirement

benefits as:

1 1/2 % x Years of service x Final year’s salary

By this formula, the annual benefits to an employee who retires after 30 years of service,

with a final salary of $100,000 , would be:

1 1/2 % x 30 years x $100,000 = $45,000

17 - 9

Defined Benefit Plan

The key elements of a defined benefit

plan are:

1.The employer’s obligation to pay

retirement benefits in the future.

2.The plan assets set aside by the

employer from which to pay the

retirement benefits in the future.

3.The periodic expense of having a

17 - 10

Defined Benefit Cost—An Overview

The annual defined benefit cost reflects changes in both the defined benefit obligation and the plan assets.

Components of Defined Benefit Cost

+ Service cost ascribed to employee service during the period

+ Interest accrued on the defined benefit liability

- Return on the plan assets*

- Past service cost attributed to employee service before an amendment to

the defined benefit plan + or (-) Losses or (gains) from revisions in the defined benefit liability or from

investing plan assets

= Defined Benefit Cost

*The actual return is adjusted for any difference between actual and expected

return, resulting in the expected return being reflected in defined benefit expense This loss of gain from investing plan assets is combined with losses and gains

from revisions in the defined benefit liability.

17 - 11

The Defined Benefit Obligation

1 Accumulated benefit obligation The actuary’s estimate of

the total retirement benefits (at their discounted present

value) earned so far by employees, applying the pension

formula using existing compensation levels.

2 Vested benefit obligation The portion of the accumulated

benefit obligation that plan participants are entitled to

receive regardless of their continued employment.

3 Projected benefit obligation The actuary’s estimate of the

total retirement benefit (at their discounted present value) earned so far by employees, applying the pension formula using estimated future compensation levels Under the

projected credit unit approach, units of benefits increase

with each year of service.

17 - 12

The Defined Benefit Obligation

17 - 13

Defined Benefit Obligation

Jessica Farrow was hired by Global Communications in 2000.  She is 

eligible to participate in the company's defined benefit pension plan.  The  benefit formula is:

actuary projects Farrow’s salary to be $400,000 at retirement.

The DBO as a measure of projected benefits is a more meaningful measure because it includes a projection of what the salary might be at retirement

17 - 16

Defined Benefit Obligation

The Defined Benefits Obligation Changes as a Result of:

Cause Effect Frequency

Interest Cost + Each period (except the first period

of the plan, when no obligation exists to accrue interest)

Past Service Cost + Only if the plan is amended (or

initiated) that period

Remeasurement + or - Whenever revisions are made in the defined loss or gain benefit liability estimate or actual returns on

plan assets differ from expected returnsRetiree benefits paid - Each period (unless no employees have yet

retired under the plan)

17 - 17

Service cost is the increase in the DBO attributable

to employee service performed during the period.

Defined Benefit Obligation

The Defined Benefits Obligation Changes as a Result of:

Cause Effect Frequency

Interest Cost + Each period (except the first period

of the plan, when no obligation exists to accrue interest)

Past Service Cost + Only if the plan is amended (or

initiated) that period

Remeasurement + or - Whenever revisions are made in the defined loss or gain benefit liability estimate or actual returns on

plan assets differ from expected returnsRetiree benefits paid - Each period (unless no employees have yet

retired under the plan)

17 - 18

Interest cost is the interest on the DBO during the

period.

Defined Benefit Obligation

The Defined Benefits Obligation Changes as a Result of:

Cause Effect Frequency

Interest Cost + Each period (except the first period

of the plan, when no obligation exists to accrue interest)

Past Service Cost + Only if the plan is amended (or

initiated) that period

Remeasurement + or - Whenever revisions are made in the defined loss or gain benefit liability estimate or actual returns on

plan assets differ from expected returnsRetiree benefits paid - Each period (unless no employees have yet

retired under the plan)

17 - 19

Past service cost is the increase in the DBO due to a plan change that provides credit for employee service rendered in

prior years.

Defined Benefit Obligation

The Defined Benefits Obligation Changes as a Result of:

Cause Effect Frequency

Interest Cost + Each period (except the first period

of the plan, when no obligation exists to accrue interest)

Past Service Cost + Only if the plan is amended (or

initiated) that period

Remeasurement + or - Whenever revisions are made in the defined loss or gain benefit liability estimate or actual returns on

plan assets differ from expected returnsRetiree benefits paid - Each period (unless no employees have yet

retired under the plan)

17 - 20

Remeasurement loss or gain results from revising estimates used to determine the DBO and from changes in

returns on plan assets.

Defined Benefit Obligation

The Defined Benefits Obligation Changes as a Result of:

Cause Effect Frequency

Interest Cost + Each period (except the first period

of the plan, when no obligation exists to accrue interest)

Past Service Cost + Only if the plan is amended (or

initiated) that period

Remeasurement + or - Whenever revisions are made in the defined loss or gain benefit liability estimate or actual returns on

plan assets differ from expected returnsRetiree benefits paid - Each period (unless no employees have yet

retired under the plan)

17 - 21

Retiree benefits paid reduce the DBO.

Defined Benefit Obligation

The Defined Benefits Obligation Changes as a Result of:

Cause Effect Frequency

Interest Cost + Each period (except the first period

of the plan, when no obligation exists to accrue interest)

Past Service Cost + Only if the plan is amended (or

initiated) that period

Remeasurement + or - Whenever revisions are made in the defined loss or gain benefit liability estimate or actual returns on

plan assets differ from expected returnsRetiree benefits paid - Each period (unless no employees have yet

retired under the plan)

17 - 22

Defined Benefit Obligation

The changes in the DBO for Global Communications during 2011 were as follows:

($ in millions)*

DBO at the beginning of 2011† (amount assumed) $400

Service cost, 2011 (amount assumed) 41

Interest cost: $400 x 6% 24

Actuarial loss (gain) on DBO (amount assumed) 23

Less: Retiree benefits paid (amount assumed) (38)

DBO at the end of 2011 $450

*Of course, these expanded amounts are not simply the amounts for Jessica Farrow

multiplied by 2,000 employees because her years of service, expected retirement date, and salary are not necessarily representative of other employees Also, the expanded amounts take into account expected employee turnover and current retirees

† Includes the past service cost that increased the DBO when the plan was amended in 2010

17 - 23

Plan Assets

The plan assets are not reported separately in the statement of financial position but are netted together with the DBO to report either a net defined benefit asset

(debit balance) or a net defined benefit liability (credit

balance).

The higher the expected

return on plan assets , the less

the employer must actually

contribute On the other hand,

a relatively low expected

return means the difference

must be made up by higher

contributions.

17 - 24

Plan Assets

Global Communications funds its defined benefit plan by contributing the year’s service cost plus a portion of the

contributed to the pension fund in 2011

Plan assets at the beginning of 2011 were valued at $300 million The expected rate of return on the investment of

end of 2011 to retired employees The plan assets at the

Plan assets at the beginning of 2011 $ 300,000,000 Return on plan assets (10% x $300 million) 30,000,000 Cash contributions 48,000,000 Less: Retiree benefits paid (38,000,000)Plan assets at the end of 2011 $ 340,000,000

17 - 25

Funded Status of the Pension Plan

OVERFUNDED

assets exceeds the actuarial present value

of all benefits earned by

participants.

UNDERFUNDED

assets is below the actuarial present value

of all benefits earned by

participants.

17 - 26

Reporting the Funded Status of

Defined Benefit Plan

Defined Benefit Obligation (DBO)

- Plan Assets at Fair Value Underfunded / Overfunded Status

Defined Benefit Obligation (DBO)

- Plan Assets at Fair Value Underfunded / Overfunded Status

17 - 27

The Relationship Between Defined Benefit Cost and Changes in the DBO and Plan

Assets

Expected return on the plan assets

Global's 2011 Defined Benefit Expense ($ in millions)

Interest cost is calculated as:

DBOBeg × Discount rate

Global had DBO of $400,000,000 on 1/1/11 The

actuary uses a discount rate of 6%.

actuary uses a discount rate of 6%

2011 Interest Cost DBO 1/1/11 $400,000,000 × 6% = $24,000,000

17 - 30

Return on Plan Assets

$300,000,000 on 1/1/11 The trustee uses an expected

return of 6% and the actual return is 10%.

return of 6% and the actual return is 10%

Beginning value of plan assets $ 300,000,000

Global's 2011 Defined Benefit Expense ($ in millions)

17 - 31

Past Service Cost

In 2011, Global Communications amended the pension plan, increasing the DBO at that time For all plan participants, the past service cost was $4

million

Service cost $ 41 Interest cost 24 Expected return on the plan assets (18) Past service cost 4 Defined Benefit Expense $ 51 Global's 2011 Defined Benefit Expense ($ in millions)

17 - 32

Remeasurement gains and Losses

Defined Benefit Obligation

Return on Plan

Assets Higher than

Low er than

17 - 33

Determining Defined Benefit Expense

Service cost $ 41 Interest cost 24 Expected return on the plan assets (18) Past service cost 4 Defined Benefit expense $ 51 Global's 2011 Defined Benefit Expense ($ in millions)

17 - 34

Remeasurement Gains and Losses

For 2011, the actual return on plan assets exceeded the expected return by $12 million In addition, there was a $23 million loss from changes made by the actuary when it revised its estimate of future salary levels causing its DBO estimate to increase Global would make the following

journal entry to record the gain and loss:

OCI = Other comprehensive income

17 - 35

RECORD DEFINED BENEFIT EXPENSE IN 2011

($ in millions)

Defined benefit expense (calculated above) 51

Plan assets ( $18 expected return on assets) 18

DBO ( $41 service cost + $24 interest cost 69

+ $4 past service cost)

 Service cost and interest cost add to Global’s PBO

 The return on plan assets adds to the plan assets

Expected return on plan assets ($30 actual, less $12gain) (18)

Past service cost 4

69 PBO

18 Less: plan assets

51 Net defined benefit

liability

17 - 38

IFRS vs U S GAAP

• Require that remeasurement gains

and losses be included

immediately among OCI items in

the statement of comprehensive

• Gains and losses are amortized

over future periods using the

“corridor” approach.

Differences in accounting for actuarial gains and

losses using IFRS and U.S GAAP.

amortized over the average remaining service period

17 - 40

Comprehensive Income

Comprehensive income is a more expansive view of

income than traditional net income.

($ in millions)

Other comprehensive income:

Unrealized holding gains (losses) on investments $x

Pension plan:

Loss-due to revising a DBO estimate (23) Gain-return on plan assets exceed expected 12 Deferred gains (losses) from derivatives x

Gains (losses) from foreign currency translation x xx

17 - 41

Comprehensive Income

17 - 42

As part of a joint project with the FASB, the IASB

issued a revised version of IAS No.1, “Presentation

of Financial Statements,” that revised the standard

to bring international reporting of comprehensive

income largely in line with U.S standards IFRS

does not permit reporting other comprehensive income in the statement of shareholders’ equity.

IFRS vs U S GAAP

17 - 43

PENSION SPREADSHEET

(  )s indicate credits; debits otherwise   

($ in millions)  

        DBO 

      Plan  Assets  

        OCI 

      Pension  Expense 

        Cash 

Net  Pension  (Liability)  / Asset  

17 - 44

IFRS vs U S GAAP

Under IFRS there is no requirement to present the various components of defined benefit expense as a single net amount U.S GAAP requires employers to present the expense as a

net amount and prohibits the reporting of separate components on the income statement.