Fall 2010 Class 9

Fall 2010 Class 9 - Chapter 19: Pension Source:...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Chapter 19: Pension Source: http://www.investored.ca Source: http://www.investored.ca Questions We Need to Answer Questions We Need to Answer 1. What is a pension? 1. 2. How do companies define pensions and How other employee future benefits? other 3. How to record and disclose pensions How and other future benefits? and 4. How do the off-balance-sheet pension How obligation and assets affect financial statements. Skills We Will Learn Skills We Will Learn • Identify types of pension plans and their Identify characteristics characteristics • Identify major components of pension expense Identify of defined benefit plans defined • Prepare the pension work sheet • Prepare journal entries to record pension Prepare expenses and contribution to pension plan. • Indicate how pensions and other future benefits Indicate are disclosed. How does pension work? TRUST COMPANY COMPANY Pension Expense Cash paid to pension Cash plan (funding) plan Accrued pension Accrued asset/liability asset/liability $ Plan Assets / Assets Projected Benefit Projected Obligation Obligation $ Employees (pension benefits) An Example of the Trust An Example of the Trust • The Ontario Teachers’ Pension Plan is an The independent corporation responsible for investing the fund’s assets and administering the pensions of Ontario’s 170,000 elementary and secondary school teachers and 108,000 retired teachers. The plan had net assets of $108.55 billion at December 31, 2007 and a long-term rate of return of 11.4% per year since 1990. Plan was originally created in 1917. 1917. Types of Pension & Employee Future Benefit Plans • Contributory – Both employee and employer make contributions to the Both plan • Non-contributory – Employers bear the full cost of the pension plan – No contributions made by employee • Vested – Amounts in the plan become the legal property of the Amounts employee, no longer contingent on employment. • Accumulative – Amount of benefits increases with the length of service. Amount • Defined Contribution plan v.s. Defined Benefit Plan Defined Contribution Plans (DCP) • Employer and employee Employer contributions are defined instead of the actual contributions pension benefit. • Employer contributes a defined sum to a third Employer party – plan trustee. – Ownership of plan assets assumed by trustee – Employeer is the trust-beneficiary Employeer trust-beneficiary • Employee assumes the economic risk risk – No guarantee on benefits paid to retirees • Cost of the plan in the current year is known Cost with certainty with Accounting and Disclosure Accounting and Disclosure Requirements for DCP • Liability reported if contribution (funding) is less than required required Dr. Pension Expense x Cr. Cash Accrued Pension Liability Accrued y (x-y) (x-y) • Asset reported if the amount contributed is more than required for the period required • Disclosure requirements: – Annual pension expense amount – Nature and effect of matters affecting comparability DCP: Journal Entries for employees’ DCP: Journal Entries for contribution Wages and Salaries expense XX Pension Contributions Payable Pension Contributions Payable Cash XX XX XX Defined Benefit Plan (DBP): Defined Benefit An Example • The Ontario Teachers’ Pension Plan is a defined benefit pension plan. This means your pension is defined by a formula that takes into account your average salary and credit. Providing you have at least two qualifying years, you are eligible for an unreduced pension when you reach age 65 or your 85 factor (age + qualifying years = 85 factor). • Your basic annual pension is: 2% X credit X best-five Your years’ average salary. years’ Source: http://www.otpp.com/ Source: Defined Benefit Plans (DBP) Defined Benefit • Benefits received by employees are predefined are – Contributions based on formula: • Employee’s years of service and expected salary Employee’s level at retirement level – Actuarial assumptions used extensively in accounting for defined benefit plans accounting – Cost of plan in current year not known with Cost not certainty • The employer remains liable to ensure benefit The liable payments payments • Employer is the trust-beneficiary Employer trust-beneficiary Pension obligation valuation Pension obligation valuation • Three Alternatives: 1. Vested benefit obligation – Includes only vested benefits – Based on current salary levels Based current 1. Accumulated benefit obligation – Includes both vested and nonvested benefits – Based on current salary levels Based current 1. Projected benefit obligation-Canadian GAAP – Includes both vested and nonvested benefits – Based on future salary levels Based future Projected Benefit Obligation (PBO) Projected Benefit Obligation (PBO) • Defined as the portion of the defined Defined obligation attributed to services provided to date date – Based on the present value of vested and Based present nonvested benefits nonvested • Also referred to as accrued benefit obligation Also accrued Pension Plan Assets Pension Plan Assets • Defined as assets retained in the pension Defined trust. • Resulted from pension contribution • Takes the form of long-term investments • The assets in the pension plan earn income The and this income including any capital appreciation reduces the eventual cost of the pension the Capitalization vs. Capitalization vs. Noncapitalization • Capitalization – – – Full obligation recognized as liability Pension plan assets reported as assets Liability and assets reduced by payment of Liability benefits benefits • Noncapitalization—Adopted by Canadian Noncapitalization—Adopted GAAP GAAP – Follows substance of the plan as separate legal Follows substance and accounting entity and – Obligation on B/S = amount of expense Obligation recognized less amount funded recognized The Pension Worksheet Journal Entries Journal Annual Annual Pension Cash Expense Expense Memo Record Accrued Accrued Pension A/L A/L Projected Projected Benefit Obligation Obligation Plan Plan Assets Assets Beginning Balances recorded here An ending credit An balance here is reported with Long-term Liabilities Liabilities An ending debit An balance is reported with other Deferred Charges Charges Pension transactions are recorded through the worksheet, using debits Pension and credits (all entries must therefore balance) and Funded Status Funded Status • Funded status = PBO − Fair Value of plan Funded assets assets • PBO > Plan assets = underfunded – The company will have a accrued pension The liability on B/S liability • PBO < Plan assets = overfunded – The company will have a accrued pension The asset on B/S asset Note Disclosure on Pension • Both IFRS and PE GAAP recommend the Both noncapitalization approach noncapitalization – Pension amounts recorded by the company (most most are disclosed in notes) are • PBO • Plan Assets • Unrecognized Past Service Costs (PSC) • Unrecognized Net Actuarial Gains/Losses • Unrecognized Net Transitional Asset/Liability Immediate Recognition Approach Immediate Recognition Approach versus Deferral and Amortization Approach • Immediate Recognition: – ABO is based on valuation used for funding purposes, not based on projected benefits obligation – Because all changes are recognized immediately (i.e. actuarial gains/losses and post service costs), pension expense is highly variable from year to year • Deferral and Amortization: – ABO is based on valuation used for accounting purposes, based on projected benefits obligation – Actuarial gains/losses and post service costs not fully recognized 19 Other Off­Balance­Sheet Items Other Off­Balance­Sheet Items Memo Record Projected Plan Projected Plan Benefit Assets Assets Obligation Obligation Unrecognized Past nized Service Cost Cost Unrecognized Net nized Actuarial Gain or Loss Loss Unrecognized nized Transition Amount Amount Amort. over Amort. exp. Remaining yrs of service until full eligibility full Corridor Corridor amort. over average remaining service yrs Amort. over the expected average remaining service yrs service Pension Expense­Deferral and Amortization Approach Service Cost for Current Year + Interest on the Liability + Expected return on Plan Assets − Pension Expense + Amortized Past Service Costs + or − or Amortized Net Actuarial Gain or Loss + or − or Amortized Transitional Asset or Obligation Pension Expense­Immediate Recognition Approach Current service cost + Current interest cost + Actual return on return Plan Assets − Pension Expense + or − or Past Service Costs recognized immediately + or − or Actuarial gains/losses recognized Immediately 22 22 An Example: P19­11 on page 1292 An Example: P19­11 on page 1292 Options within Deferral and Amortize Approach • Both PE GAAP and IFRS allow for option to Both immediately recognize actuarial gains and losses into income into • IFRS also allows for immediate recognition in other IFRS comprehensive income (OCI) rather than net income income 24 24 Valuation of Accrued Benefit Asset • Accrued benefit asset cannot exceed expected Accrued future benefits (valuation allowance may be necessary to reduce the value on statement of financial position) financial • Change in valuation allowance is generally Change recognized through benefit expense 25 25 Disclosure Requirements • Disclosures under PE GAAP include: – Description of each plan and any major Description changes in terms during the year changes – Information on most recent actuarial Information valuation for funding purposes valuation – Funded status at year end, (including FV of Funded plan assets and ABO) plan – Explanation of differences between funded Explanation status and amounts recorded on balance sheet sheet 26 26 Disclosure Requirements • Additional disclosure requirements under IFRS Additional include: include: – Reconciliations: Reconciliations: • Beginning to ending balances of PV of ABO and FV Beginning of fund assets of • Funded status to balance sheet benefit liability or Funded asset asset – Amount included in periodic net income (and OCI) – Underlying assumptions and sensitivity information – Estimate of following year’s expected funding Estimate contributions 27 27 Defined Benefit Plans: Benefits Do Not Defined Benefit Plans: Benefits Do Not Vest or Accumulate (1) • E.g. parental leave plans (in excess of what E.g. government provides), some long-term disability plans disability • No basis on which to accrue expense – No benefits not related to service provided. Entitlement comes with being an employees Entitlement Defined Benefit Plans: : Benefits Do Defined Benefit Plans: : Benefits Do Not Vest or Accumulate (2) • Therefore use “event accrual method” to Therefore “event accrue full cost accrue • When event occurs that obligates entity: Benefit Expense xx Benefit Liability xx Benefit • When the benefit is taken Benefit Liability xx Cash xx Cash Summary of Pension Expense Summary of Pension Expense Components and Methods Pension expense component Method used to determine cost Effect on pension expense expense 1 Service Cost Present Value + 2 Interest Expense Current Rate + 3 Expected Return on Plan Assets Long-Term Expected Rate of Return - 4 Prior Service Cost Amortize + 5 Actuarial Gains and Losses and Corridor method (amortize excess) +/+/- 6 Transition Gains and Losses and Amortize over EARSL +/- Summary of PBO Transactions Summary of PBO Transactions PBO, beginning of period + Current Service Cost + Interest Cost + PSC during period − Benefits paid to retirees Benefits − Actuarial Gains Actuarial + Actuarial Losses = PBO, end of period • The PV of pension The benefits earned to date by employees • Most information Most relating to PBO provided by actuaries provided Summary of Plan Assets Transactions Summary of Plan Assets Transactions Plan assets (FV) beginning Plan of period of + Employer/employee Employer/employee funding funding ± Actual return Actual − Benefits paid out Benefits = Plan assets (FV) end of Plan period period Actual return Actual = expected return expected + experience gain or − Experience loss on assets Experience ...
View Full Document

This note was uploaded on 03/15/2012 for the course BUS 303 taught by Professor Brown during the Spring '11 term at Simon Fraser.

Ask a homework question - tutors are online