IM_CH_16 - Chapter 16 Pensions and Other Postretirement...

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Chapter 16: Pensions and Other Postretirement Benefits Instructor’s Manual 7 th edition Page 1 of 10 CHAPTER HIGHLIGHTS Chapter 16 is intended to give the student a comprehensive overview of legal, funding, and accounting aspects of corporate-sponsored pension plans. The lengthy background material at the beginning of the chapter is necessary in order to understand the accounting implications of defined contribution and defined benefit plans. A weakness of most accounting discussion on pensions is the avoidance of technical issues. As a result, the accounting theory and policy issues are not clearly delineated. For example, it is not possible to discuss accounting issues independent of legal and funding aspects. Because of this, it is highly recommended that students read Appendix 15-A on actuarial funding. The chapter also introduces post-retirement benefits other than pensions arising from SFAS No. 106. The fundamental theory and policy issue is whether a pension plan gives rise to an accounting liability for the sponsoring corporation. Past and present accounting standards have said no, and the emphasis has been defining annual pension expense. An arbitrary and flexible policy existed in which accrued pension expense had to be based on one of five actuarial methods prior to SFAS No. 87. The situation was analogous to arbitrary depreciation methods. SFAS No. 87 allows only one actuarial method for calculating pension expense, a rigid uniformity approach. SFAS No. 87 also came down in favor of liability recognition. This position is little more than a belated acknowledgment that ERISA created a legally unavoidable obligation for pension plan sponsors. At this point, the policy issue turns to measuring the liability. Two theories from the labor economics literature, implicit and explicit contract views, are useful in relating what the FASB attempted in Preliminary Views (the implicit contract view, i.e., using projected future salaries to value the pension benefit in real terms) versus the compromise position in SFAS No. 87 (the explicit contract view, i.e., using current salary levels to value projected benefits). FAS No. 87 is definitely a compromise made in the interest of getting pensions onto the balance sheet, where they do belong. While accrued pension expense is linked to the increase in actuarial valuation of benefits over the period using future salary projections, the standard only requires a liability to be recognized if the value of benefits measured using current salary projections exceeds the pension fund. Naturally, actuarial values are lower when current salaries are used. The other dubious character of the standard, and an issue not fully brought out in the text, concerns the creation of an intangible pension asset on the balance sheet if a pension liability is recognized. Surely this is either a charge to income, or a prior period adjustment. By debiting this “odd” intangible pension asset, a smoothing effect occurs viz. the income statement recognition of unfunded pension liabilities.
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