Pensions

Defined Contribution Plans:
Employer makes specified contribution
(Usually a % of salary, deposited in an account owned by the employee)

Benefits upon retirement are not specified or guaranteed

Employer has no future liability to the employee

Record expense for the period as the employee works:

The company reports no liability.

Defined Benefit Plans:
The Company promises to pay specific amount (annually/monthly) at retirement

The Company funds at a level that will grow to be able to pay the amount promised upon retirement according to the terms of the pension plan.

The amount paid is typically determined by a pre-set formula in the plan document.
For example: a % of the average of the last 3 years salary x # of years of service

Defined Benefit Plan Accounting (ASC 715):

ASC 715 specifies how to measure and record pension expense.
The cost must be expensed as employees work to earn the benefit.
Requires extensive footnote disclosures.

The Company must recognize a liability for the amount owed to employees that is not in currently in the pension trust fund (plan assets).

Cash payments by a company to the pension trust fund is regulated by ERISA.

Pension benefit obligation to employees is calculated by an actuary using various factors such as interest rates, employee length of life, years employees are expected to work, etc.

Projected Benefit Obligation (PBO) – Based on future salary levels at expected retirement

Accumulated Benefit Obligation (ABO) – Based on current salary levels at expected retirement

Vested Benefit Obligation (VBO) – Earned regardless of continued employment

Report a pension liability for under-funded amounts:  PBO > FMV Plan Assets
Report a prepaid pension asset when the plan is over-funded: PBO < FMV Plan Assets 

The Change in the Pension Benefit Obligation (PBO):

   Beginning PBO
+ Service Cost
+ Interest Cost
– Gain or + Loss on PBO (actuary changes, total CY amount)
– or + Prior Service cost (plan amendments, total CY amount)
– Payment of retirement benefits
= Ending PBO

The Change in Fair Market Value of Plan Assets:

   Beginning FMV of assets
+ Contributions
–  Payments to retirees
+ – Actual Return on assets
= Ending FMV of Assets

Calculate Pension Expense for the Current Year:

Components of Pension Expense:

Service Cost:

Annual Pension Benefit (salary x plan factor)
x    PV Annuity (period/rate)
= Amount Required to Pay out

Amount required to pay out
x     PV factor
= Amount invest now to have dollars available
for future payouts

Service cost is the amount that must be invested now to grow to the amount that will be necessary to fund required payments to retirees.

The current year cumulative amount is compared to the prior year cumulative amount to determine the current year service cost.

The current year service cost is the cost of employees working one more year.

Prior Service Cost:

Prior service cost occurs when:
1) the company begins a pension plan and gives credit for prior years worked
2) the company makes amendments to the plan that changes the amount that is owed employees for prior years worked.

Total prior service cost is recorded to “other comprehensive income” in the year the plan benefits are changed.

Amortization of Prior Service Cost:

Prior service cost is amortized (added to pension expense) over the average years employees are expected to work (service life.)

Interest Expense

The pension benefit obligation is stated at present value. Present value means future interest has been removed. Interest expense is added to get to the next year present value as each year passes. Interest expense increases pension expense and the amounts owed to employees (PBO).

Actuary Changes that Change the Pension Benefit Obligation:

The pension benefit obligation is determined using estimated factors such as how long employees will work, how long retirees will live, and the discount rate.

A change in factors also changes the pension benefit obligation.
The change to the obligation is recorded to “other comprehensive income” the year the changes occur.

Gains decrease and losses increase the pension benefit obligation.

Amortization of Gains and Losses from Changes to Actuary Assumptions:

The gain or loss from actuary changes is amortized (included in the pension expense) over the service life of the employees.

Amortization of Gains and Losses on Assets:

Companies may include the estimated return instead of the actual return as an offset to pension expense because the company does not have to contribute amounts earned.

When the estimated return is included in pension expense, the difference between the current year actual return and the estimated return is recorded to OCI as a deferred gain or loss.

The deferred gain or loss is the difference in the cumulative actual and cumulative estimated return on plan assets.

A portion of the difference in estimated and actual is included in pension expense when it
becomes large enough to make a difference: greater than 10% of the PBO or fair market value
of plan assets (whichever is greater) at the beginning of the year, amortized over the service life

Companies may also elect to include the actual return in pension expense resulting in no deferred gain or loss on assets.

Journal Entries for the Current Year:

Record pension expense:

Note: Entries to OCI are only included when the event occurs during the current year.

Record the company contribution:

Plan Assets
            Cash

Record the difference in actual and estimated return on assets:

Plan Assets
         OCI – Gain on Assets

            When actual return is greater than estimated return

OCI – Loss on Assets
          Plan Assets

     When actual return is less than estimated return

Record the current year actuary change or PSC:

Record Benefit Payments

PBO
             Plan Assets

The Pension Asset or Liability reported on the balance sheet is equal the funding status:

Compare the ending balance of the PBO to the FMV of plan assets to get the funding status.

   Pension Benefit Obligation (PBO) at the end of the year
–  FMV of Pension Plan Assets at the end of the year
= Funding Status

An under-funded amount is reported on the balance sheet as a Pension Liability.

An over-funded amount is reported on the balance sheet as a Pension Asset.

Pension Worksheet: