PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACnthia J. !oone, Ph.D., CPACopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.Pensions and Other Postretirement BeneftsChapter 1717-2Nature of Pension Plans1. Pension plans provide income to individuals during their retirement years.2. This is accomplished by setting aside funds during an employees working years so that at retirement, the accumulated funds plus earnings from investing those funds are available to replace wages. 17-3Nature of Pension PlansFFor a pension plan to ualify for special ta! treatment it must meet the following reuirements"1.#over at least $%& of employees.2.#annot discriminate in favor of highly compensated employees.'.(ust be funded in advance of retirement through an irrevocable trustfund.).*enefits must vest after a specified period of service.+.#omplies with timing and amount of contributions.17-4Nature of Pension Plans17-5#ontributions are defined by agreement.#ontributions are defined by agreement.,mployer deposits an agreed-upon amount into an employee-directed investment fund.,mployer deposits an agreed-upon amount into an employee-directed investment fund.,mployee bears all risk of pension fund performance.,mployee bears all risk of pension fund performance.Plan #haracteristicsPlan #haracteristicsDefned Contribution Pension Plans17-6Defned Contribution Pension Plans"et#s assume that the annual $ontribution is to be %& o' an em(loee#s salar. I' an em(loee earned )**+,+++ durin, the ear, the $om(an would make the 'ollowin, entr:Pension e-(ense %,%++Cash%,%++.he em(loee#s retirement bene'its are totall de(endent u(on how well in/estments (er'orm.17-7,mployer is committed to specified retirement benefits.,mployer is committed to specified retirement benefits..etirement benefits are based on a formula that considers years of service, compensation level, and age..etirement benefits are based on a formula that considers years of service, compensation level, and age.,mployer bears all risk of pension fund performance.,mployer bears all risk of pension fund performance.Plan #haracteristicsPlan #haracteristicsDefned Beneft Pension Plans17-8Defned Beneft Pension PlanA (ension 'ormula mi,ht de'ine annual retirement bene'its as:* *01 &-2ears o' ser/i$e-3inal ear#s salarB this 'ormula, the annual bene'its to an em(loee who retires a'ter %+ ears o' ser/i$e, with a 'inal salar o' )*++,+++, would be:* *01 &- %+ ears - )*++,+++ 4 )56,+++17-9Defned Beneft Pension PlanThe key elements of a defined benefit pension plan are"1.The employers obligation to payretirement benefits in the future.2.The plan assets set aside by theemployer from which to pay theretirement benefits in the future.'.The periodic e!pense of having apension plan./n actuary assesses the various uncertainties 0employee turnover, salary levels, mortality, etc.1 and estimates the companys obligation to employees in connection with its pension plan. 17-10Pension ExpenseAn OverviewThe annual pension e!pense reflects changes in both the pension obligation and the plan assets.17-11The Pension Obligation1. /ccumulated benefit obligation 7AB89 .he a$tuar#s estimate o' the total retirement bene'its 7at their dis$ounted (resent /alue9 earned so 'ar b em(loees, a((lin, the (ension 'ormula usin, e-istin, $om(ensation le/els.2. 2ested benefit obligation 7:B89 .he (ortion o' the a$$umulated bene'it obli,ation that (lan (arti$i(ants are entitled to re$ei/e re,ardless o' their $ontinued em(loment.'. Pro3ected benefit obligation 7PB89 .he a$tuar#s estimate o' the total retirement bene'it 7at their dis$ounted (resent /alue9 earned so 'ar b em(loees, a((lin, the (ension 'ormula usin, estimated 'uture $om(ensation le/els. 7I' the (ension 'ormula does not in$lude 'uture $om(ensation le/els, the PB8 and the AB8 are the same.917-12The Pension Obligation17-13Projected Beneft ObligationJessica Farrow was hired by Global Communications in 2002.She is eligible to participate in the company's defined benefit pension plan.The benefit formula is!nnual salary in year of retirement"#umber of years of ser$ice"%.&'

!nnual retirement benefits

Farrow is e(pected to retire in 20)% after )0 years of ser$ice.*er retirement period is e(pected to be 20 years.!t the end of 20%%+ %0 years after being hired+ her salary is ,%00+000.The interest rate is -'.The company.s actuary pro/ects Farrow.s salary to be ,)00+000 at retirement.The P*4 is a more meaningful measurement because it includes a pro3ection of what the salary might be at retirement. 17-14Projected Beneft ObligationStep 1. Step 1.0se the pension formula to determine the retirement benefits earned to date. ,)00+000"%0" %.&' ,-0+000 per yearStep 2.Step 2. Find the present $alue of the retirement benefits as of the retirement date.The present $alue 1 The present $alue 1n n220+220+ i i2-'3 of the retirement annuity at2-'3 of the retirement annuity at the retirement date is ,-44+%5& 1,-0+000the retirement date is ,-44+%5& 1,-0+000 " %%.)-5523.Step 3.Step 3. Find the present $alue of the retirement benefits as of the current date.The present $alue 1 The present $alue 1n n260+260+ i i2-'3 of the retirement benefits at2-'3 of the retirement benefits at 20%% is ,%%5+422 1,-44+%5&20%% is ,%%5+422 1,-44+%5& " .%7)%%3.This is the 89:. 17-15Projected Beneft ObligationStep 1. Step 1.0se the pension formula to determine the retirement benefits earned to date. ,)00+000"%%" %.&' , --+000 per yearStep 2.Step 2. Find the present $alue of the retirement benefits as of the retirement date.The present $alue 1 The present $alue 1n n220+220+ i i2-'3 of the retirement annuity at2-'3 of the retirement annuity at the retirement date is ,7&7+0%& 1,--+000the retirement date is ,7&7+0%& 1,--+000 " %%.)-5523.Step 3.Step 3. Find the present $alue of the retirement benefits as of the current date.The present $alue 1 The present $alue 1n n2 225 25++ i i2-'3 of the retirement benefits at2-'3 of the retirement benefits at 20%2 is ,%65+7%& 1,7&7+0%&20%2 is ,%65+7%& 1,7&7+0%& " .%4)&-3.This is the 89:. If the actuary If the actuarys estimate of the final salary hasnt changed,s estimate of the final salary hasnt changed, the PBO a year later at the end of 2012 ould !e "13#,$1%. the PBO a year later at the end of 2012 ould !e "13#,$1%.17-16Projected Beneft Obligation17-175ervice cost is the increase in the P*4 attributable to employee service performed during the period.Projected Beneft Obligation17-186nterest cost is the interest on the P*4 during the period.Projected Beneft Obligation17-19Prior service cost is the increase in the P*4 due to a plan change that provides credit for employee service rendered in prior years.Projected Beneft Obligation17-207oss or gain on P*4 results from revising estimates used to determine the P*4.Projected Beneft Obligation17-21.etiree benefits paid reduce the P*4.Projected Beneft Obligation17-22Projected Beneft Obligation;8' $ourse, these e-(anded amounts are not sim(l the amounts 'or Jessi$a 3arrow multi(lied b 1,+++ em(loees be$ause her ears o' ser/i$e, e-(e$ted retirement date, and salar are not ne$essaril re(resentati/e o' other em(loees. Also, the e-(anded amounts take into a$$ount e-(e$ted em(loee turno/er and $urrent retirees.& and the a$tual return is *+&. a$tual return is *+&. 17-31Amortization of Prior Service CostIn 2012, Global Communications amended the pension plan, increasing the PBO at that time.For all plan participants, the prior service cost as !"0 million at 1#1#12.$he average remaining service li%e o% the active emplo&ee group is 1' &ears.=?% million P5# A 1+ @ =) million per year17-32Gains and Losses4nly if a net gain or net loss e!ceeds the BcorridorC is a charge to pension e!pense allowed. 17-33Corridor Amount.he $orridor .he $orridor amount is *+& o' amount is *+& o' the the ,reater,reater o'o'PB8 at the PB8 at the be,innin, o' the be,innin, o' the (eriod.(eriod.3air /alue o' (lan 3air /alue o' (lan assets at the assets at the be,innin, o' the be,innin, o' the (eriod.(eriod.8r8r17-34Gains and Losses6f the beginning net unrecogniDed gain or loss e!ceeds the corridor amount, amortiDation is recogniDed using the following formula . . . 9et unrecogniDed gain or loss at beginning of year/verage remaining service period of activeemployees e!pected to receive benefits under the plan #orridor amountE17-35Gains and Losses 201( )et *oss +morti,ation -! in millions.PBO /00 ! Fair value o% plan assets (00 )et loss %or 201( ''+verage service li%e 1')*6 million )*6 million A *6 ears 4 )* millionA *6 ears 4 )* million17-36Determining Pension Expense17-37Recording Gains and LossesFor 2%1', the actual return on plan assets e!ceeded the e!pected return by =' million. 6n addition, there was a =2' million loss from changes made by the actuary when it revised its estimate of future salary levels causing its P*4 estimate to increase.%- **0%64)%,@*1 IPB8'ra$tion APB8 attributedAssume the obli,ation in$reases b the @&.17-50How the APBO Changed.he two elements o' the in$rease in 1+*1 $an be se(arated as 'ollows:17-51Attribution.he (ro$ess o' .he (ro$ess o' assi,nin,assi,nin, the $ost o' the $ost o' bene'its to the ears durin, whi$h bene'its to the ears durin, whi$h those bene'its are those bene'its are assumed to be assumed to be earned earned b em(loees.b em(loees.17-52Accounting for Postretirement Beneft Plans Other Than Pensions(easuring 5ervice #ost/ttribute a portion of the accumulated postretirement benefit obligation to each yearas the service cost for that year.17-53Appendix 17: Service Method of Allocating Prior Service Cost.he allo$ation a((roa$h that re'le$ts the de$linin, ser/i$e (attern o' em(loees is $alled the ser/i$e method. .he method reKuires that the total number o' ser/i$e ears 'or all em(loees be $al$ulated. .his $al$ulation is usuall done b the a$tuar./ssume