Understanding Pension Accounting for Defined Benefit Plans

Pension Accounting
Understand the nature/characteristics/
accounting of employer pension plans:
Defined Benefit Plans.

T P Adhikari & Associates,
Chartered Accountants
!1

PENSION ACCOUNTING
Objectives:
● Pension Overview
● Fundamental differences between:
– Defined contribution plans
– Defined benefit plans*

●

Accounting for Pension:
– Key components: Pension expense

●

Disclosure/presentation

!2

Overview of Pension Plan
A pension plan:
An agreement between an employer/employee
!

• Government plans: social security
• Individual plans (IRA)
• Employer Plans* à
!

Emphasis: Pension Plan: for Corporation:
Company set aside funds for employees’ service!


!3

Pensions: SFAS 158
●

SFAS 158 Reporting pension items in the
balance sheet and AOCI

●

132R: Disclosures
!

●

IAS 19


!4

PENSION PLAN: Overview
Employer
Sponsors the plan

Benefits
Plan
Administrator

Contributions

The plan administrator receives the
contributions from the employer,
invests the pension assets, and
makes the benefit payments.


Pension Recipients

!5

TYPES OF PENSION PLANS 
TWO TYPES

1

DEFINED
CONTRIBUTION
PLAN

Pension fund

promise
FIXED
ANNUAL
CONTRIBUTIONS

$

DEFINED
BENEFIT
PLAN

2

promise
FIXED
RETIREMENT

BENEFITS

!6

Defined contribution plans
●

●

•
•

Defined Contribution
A plan that provides benefits based solely on what has been
contributed and the earnings thereon
Amounts to be funded are determined by the plan
– No promise for specific future benefits.
– Independent third party holds assets
– Risk borne by employee
– Accounting relatively straightforward
Employer makes no guarantee to the amount of benefits
Employees’ retirement benefits based on the amount of funds in
the plan

!7

Defined Benefit Pension Plans
DEFINED BENEFIT PLAN

Plan Characteristics

Employer is committed
to specified retirement
benefits.

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


Employer bears all
risk of pension fund
performance.

!8

Accounting for Defined Benefit Plans
●

Defined benefit plans
– Employer’s contribution is based on the expected future

benefits
– Affected by many variables:
● Years of service
● Annual salary at retirement
● Retirement years
– Etc.
!

●

Future Obligation for retirement benefits is
based on many estimates/assumptions

!9

Actuaries and Pension Accounting
Pension calculations involve
actuarial assumptions.
These are
estimates.
Assumptions involve:
mortality rates, employee turnover, future salaries,
rates of return, etc.


!10

Measures of Pension Liability: 
Defined Benefit Plan

Pension calculations involve
actuarial assumptions.
Benefits for vested and nonvested
employees at future salaries

Benefits for vested/ nonvested employees at current
salaries

Accumulated
Benefit
Obligation

(GAAP)
Projected
Benefit
Obligation

(PBO)

(AB0)


!11

OVERVIEW: PENSION COMPONENTS
Based On Actuarial Assumptions:
How much to contribute annually for the service provided by employees

1. SERVICE PROVIDED

Employee
hired

SERVICE COST

Benefit Period

Employee
Retired

PENSION EXPENSE


!12

PENSION EXPENSE: INTEREST COST
●
●

●

Interest cost : (PENSION EXPENSE)
– the increase in the pension obligation
(PBO) due to the accrual of an additional
year of interest.
PV of liability increases as you get closer
to the due date
– Interest cost = discount rate * beginning

balance in PBO


!13

INTEREST COST:PENSION EXPENSE

➢ PV

of pension Obligation is increased by
the interest cost on the beginning of PBO


!14

OVERVIEW: TIMELINE 
COMPONENTS 
PRIOR (PAST) SERVICE COST
Past Service Cost

Employee
Hired

SERVICE COST

Benefit Period

Employee
Retired

Plan
Initiation


!15

PENSION EXPENSE: Prior Service Cost
●

Establishing (or modifying/amended) a plan
!

●

Cost of benefits granted for service rendered prior
to the inception of the plan
!

Increases PBO at date of amendment/
● The entire amount of Past Service Cost is NOT
recognized as expense in the current year
● Instead , Past Service Cost is recognized in the
current period in Other Comprehensive Income
(OCI)
●


!16

Issues in Accounting: 
Defined Benefit Plans
Periodic expense (Pension Expense) of having a
pension plan
2. Plan Assets Resources set aside by the employer
from which to pay the retirement in the future
(invested by Trustee)
3. Employer’s Obligation to pay retirement benefits
in the future
1.


!17

Pension Plan Assets
●

Resources with which the obligation will  
Satisfy: PLAN ASSETS
!

●

Employee contribution in the Pension Fund
(held by Trustee)
!

●

Plan Assets are invested -in income producing
assets.

!
●

Accumulated balance: Contribution + return on
investment
!18

Return on Plan Asset
– Expected return on plan assets (FASB)
– *Expected rate of return:
●

Based on long-term rate of return anticipated given investment
of plan assets

– Expected return on plan asset decreases the pension cost

and increases plan asset


!19

Actuarial Gains and Losses
Actuarial assumptions are subject to
inaccuracies as time goes by and
circumstances change
● The estimate of the PBO also require
revision
● Inc/Dec in PBO is referred to gain/loss
●


!20

NET GAINS/LOSSES
NET GAINS/LOSSES:
1. Gains/Losses from the return on Assets
2. Gains/Losses from changing assumptions
(PBO)
= NET GAINS/LOSSES
• Deferred and reported as OCI
• Amortized using Corridor rule*

!21

Corridor Amount 

STEPS
1: GREATER OF PBO & PLAN ASSETS
2: 10% OF STEP 1
3…. Next slide…

The corridor
amount is 10% of
the greater of . . .

PBO at the
beginning of the
period.
Or
Fair value of plan
assets at the
beginning of the
period.


!22

Gains and Losses
EXAMPLE
2013
2009 Net Loss Amortization ($ in millions)
PBO
$
400
Fair value of plan assets
300
2013
Net loss for 2009
55
Average service life
15
Apply steps:
1.Greater of PBO & Plan Assets = PBO $400
2.10% of PBO i.e. 400 x 10% = $40


!23

Gains and Losses
STEP 3: FIND THE EXCESS TO BE AMORTIZED

Net loss
Corridor amount ($400 x 10%)
Excess at the beginning of the year

$
$

55
40
15

AMORTIZATION:

$15,000,000 ÷ 15 years = $1,000,000

!24

Defined Benefit Plan: 
Net Periodic Pension Cost
So far…..
PENSION EXPENSE=
Service Cost
+ Interest Cost
- expected return on plan Asset
+Amortization (if any) of Prior service cost
+/- Amortization (net) Gains/Losses

!25

REPORTING:  
Employer’s Obligation & Plan Asset
●

The employer’s obligation and plan assets are not
individually reported in a company’s primary financial
statements:

!
●

the difference between the two, the funded status, is
reported as:

!
●
●

a pension liability if underfunded or
a pension asset if overfunded.

!26

Funded Status of Pension Plan
Projected Benefit Obligation (PBO)
- Plan Assets at Fair Value
Underfunded / Overfunded Status

This amount is reported in the
balance sheet as a Pension Liability
or Pension Asset.

!27

Pension Disclosures
●

The details for net periodic pension cost
– the service cost component.
– the interest cost component.
– the expected return on plan assets the

amortization of PSC, transition amount and
unrecognized gain/loss (separately)
– Gain or loss from settlement or curtailment of
plan

!28

Pension Disclosures
– Amount and types of assets held
– Assumptions related to discount rate,

rate of increase in compensation,
expected return on plan assets
– Alternative amortization policies
– Past practice or history of regular
benefit increases

!29

Pension Disclosures
●

Employers with multiple plans
– Information can be combined but the computations

are made for each individual plan
● Net position for over-funded plans would be
reported in noncurrent assets
● Net position for under-funded plans would be
reported in liabilities
– Part may be reported as a current liability
– See next slide


!30

Disclosure of Pension Plans 
FASB 132
1. A reconciliation between the beginning and ending

balances for the projected benefit obligation
2. A reconciliation between the beginning and ending
balances in the fair value of the pension fund
The fair value of plan assets  
(changes between BOY and EOY)
● PBO Obligation  
(changes between BOY and EOY)
●

!
●

EoY = end of year 
BoY = beginning of year

!


!31

IAS 19: INFORMATION 
●
●

The standard covers all employee benefits - not just pensions. This note focuses on pensions but
a later section considers other employee benefits. The key pension points are:
Assets are taken at market value  

●

Liabilities are calculated using an interest rate based on the yield on high quality corporate
bonds at the valuation date (usually taken as AA-rated)  

●

There is a limit to the amount that can be recognized as a prepayment (surplus) in the
company balance sheet

!
●

Actuarial gains and losses may be:  
recognized in the P&L immediately
– recognized in the P&L on a smoothed basis
– recognized immediately in the statement of recognized income and expense 
–

●

The cost of past service benefit increases is recognized immediately to the extent that the
increases are vested immediately

!32

business contacts
We can be contacted at the following office;
TP Adhikari & Associates,
nd
2 Floor, 723/60, Tanka Prasad Ghumti Sadak,
Anamnagar, Kathmandu- 32, Nepal
GPO Box No. 10915
Contact No: 01-4247816 / 4247917
Email : tpadhikari2012@gmail.com
Fax: +977-1-4247917

!
CONTACT PERSON: CA Thakur Prasad Adhikari
Cell +977 9851094055

!34

Understanding Pension Accounting for Defined Benefit Plans

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