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As a result of such factors, it is not hard to believe offers and benefit packages in the not-too-distant fu- ture? To start, you should begin building re- tirement nest egg, rather than relying on your employer 5% Total  $361,000 7% $61,000 17% $33,000 9% $72,000 20% $151,000 42% Social Security Traditional pensions Households with an Adult Age 57�61, 2004 NATURE OF USING A PENSION REPORTING PENSION STATEMENTS Pension note disclosure ACCOUNTING FOR PENSIONS AND PREVIEW OF CHAPTER 20 �Chapter 20 NATURE OF PENSION PLANS is an arrangement whereby an employer provides benefits (pay- (company) $ InvestmentsEarnings Recipients (employees) $ ILLUSTRATION 20-1 Apension plan is agency. See the FASB Codification section (page 1092). Nature of Pension Plans As Illustration 20-2 indicates, pension expense is a substantial percentage of total their characteristics. Disclosures for Defined- Contribution Plans ILLUSTRATION 20-2 Size ofPension Expense ($ in millions)FundExpenseIncome $117,378$1,79928.77% �Chapter 20 Outside the U.S.,private Consequently,accounting for defined- NTERNATIONAL NSIGHT Defined-contribution plans have become much more popular with employers than defined-benefit plans. One reason is that they are cheaper. Defined-contribution plans often cost no more than 3 per- centof payroll, whereas defined-benefit plans can cost 5 to 6 percent of payroll. In the late 1970s approximately 15 million individuals had defined-contribution plans; today over 62 million do. The following chart reflects this significant change. It shows the percentage of companies using various types of plans, based on a survey of approximately 150 CFOs and man- aging corporate directors. WHICH PLAN IS RIGHT FOR YOU? 91% Although many companies are changing to defined-contribution plans, over 40 million indi- viduals still are covered under defined-benefit plans. The Role of Actuaries in Pension Accounting The problems associated with pension plans involve complicated mathematical con- siderations. Therefore, companies engage to ensure that a pension plan is ap- propriate for the employee group covered. Actuaries are individuals trained through a long and rigorous certification program to assign probabilities to future events and their financial effects. The insurance industry employs actuaries to assess risks and to ACCOUNTING FOR PENSIONS pension obligation that a company should report in the financial statements? (2)What is the pension expense for the period? Attempting to answer the first question has produced much controversy. Alternative Measures of the Liability Most agree that an employer�s is the deferred compensation obli- Measuring that obligation is not so simple, though, because there are alternative ways One measure of the pension obligation is to base it only on the benefits vested Vested benefits are those that the employee is entitled to receive even if he or she renders no additional services to the company. Most pension plans require a certain minimum number of years of service to the employer before an using only vested benefits, at current salary levels. Another way to measure the obligation uses both vested and nonvested years of service. On this basis, the company computes the deferred compensation amount �using current salary levels. This measurement of the pension obligation is called the An actuary�s primary purpose is to ensure that the company has established an appropriate Explain alternative measures for valuing the pension obligation. nation in the developed world.By the year 2015,24 percent of its popula- tion is expected to be over 65,com- 15 percent in the U.S.Aging popula- NTERNATIONAL NSIGHT �Chapter 20 vested employees Benefits for nonvested benefit obligation Benefits for vested and nonvested Accumulated benefit obligation benefit obligation ILLUSTRATION 20-3 Different Measures of the Which of these alternative measures of the pension liability does the profession of vested and nonvested benefits accrued to date, based on employees�future Those in favor of the projected benefit obligation contend that a prom- ise by an employer to pay benefits based on a percentage of the employees� future salaries is far greater than a promise to pay a percentage of their current salary, and such a difference should be reflected in the pension liability and pension Moreover, companies discount to present value the estimated future bene- fits to be paid. Minor changes in the interest rate used to discount pension ben- efits can dramatically affect the measurement of the employer�s obligation. For example, a 1 percent decrease in the discount rate can increase pension liabili- ties 15 percent. Accounting rules require that, at each measurement date, a com- The FASB and IASB are studying The actuary helps to select the interest rate, referred to as the iGAAP differs from U.S.GAAP in NTERNATIONAL NSIGHT accrual basis.This requires record- ing an expense when employees earn the future benefits,and recog- nizing an existing obligation to pay pensions later based on current services received. �Chapter 20 Expense liability (increases pension expense) for the year (increases pension expense) (decreases or increases pension expense) prior service cost (generally increases pension expense) ILLUSTRATION 20-4 Components of Annual Service Cost actuarial present valueof benefits attributed by the pension . That is, the actuary predicts a result of the employees� current year�s service, and then discounts the cost of those future benefits back to their present value. The Board concluded that . In other words, the present obligation resulting from a promise to pay a benefit of 1 percent of an employee�s differs from the promise to pay 1 percent of . To overlook this fact is to ignore an impor- tant aspect of pension expense. Thus, the FASB adopts the Intereston the Liability Because a company defers paying the liability until maturity, the company records it on a discounted basis. The liability then accrues interest over the life of the employee. The FASB did not address the question of how often to compound the interest cost. To simplify our illustrations and problem materials, we use a simple-interest computation, applying it to the beginning-of-the-year balance of the projected benefit liability. provide the necessary future cash flows to pay the pension benefits when due. �Chapter 20 ExpenseCash General Journal EntriesMemo Record ILLUSTRATION 20-7 Pension Expense 10,000 Dr. 8,000 Dr. 7,000 Cr. 111,000 Dr. 9,000 Dr. 10,000 Dr. 10,000 Cr. 9,000 Dr. 8,000 Cr. 8,000 Cr. 100,000 Cr. 9,000 Cr. 10,000 Cr. 7,000 Dr. 112,000 Cr. 1,000 Cr.* 1,000 Cr.** General Journal EntriesMemo Record ILLUSTRATION 20-8 Projected benefit obligation (Credit)$(112,000) �Chapter 20 Third, the company multiplies the number of service-years consumed each year by the cost per service-year, to obtain the annual amortization charge. To illustrate the amortization of the prior service cost under the years-of-service Describe the amortization of prior service costs. Service-Years YearABCDETotal 20114020405020170 201220405020130 2013405020110 2014502070 20152020 4040120200100 ILLUSTRATION 20-11 Computation of Annual TotalCost perAnnual YearService-Years Service-Year 2011170$160$27,200 201213016020,800 201311016017,600 20147016011,200 2015201603,200 YearExpense 2011$27,211 201227,211 201325,578* �Chapter 20 Pension Expense 192,000 Cr. 9,500 Cr. 19,200 Cr. 8,000 Dr. 212,700 Cr. 9,500 Dr. 19,200 Dr. 11,100 Cr. 44,800 Dr. 20,000 Cr. 20,000 Cr. 1,000 Cr. 77,600 Cr. 78,600 Cr. 0 52,800 Dr. 52,800 Dr. Pension 111,000 Dr. 111,000 Dr. 11,100 Dr. 8,000 Cr. 20,000 Dr. 134,100 Dr. ILLUSTRATION 20-12 Projected benefit obligation (Credit)$(212,700) unexpected gains and losses. �Chapter 20 Both iGAAP and U.S.GAAP use smoothing provisions.The Boards are NTERNATIONAL NSIGHT Whatdo the For some companies, pension plans generated real profits in the late 1990s. The plans not only paid Smoothing Unexpected Gains and Losses on the Pension Liability In estimating the projected benefit obligation (the liability), actuaries make assump- Explain the corridor approach to How the corridor works becomes apparent when we portray the data graphically, 200 150 100 50 0 20102011201220132014 Corridor If the balance in the Accumulated OCI account related to gains and losses stays within the upper and lower limits of the corridor, no amortization is required. In that case, Callaway carries forward unchanged the accumulated OCI related to gains and If amortization is required, the minimum amortization is the excess divided by the average remaining service period of active employees who are expected to receive ben- �Chapter 20 201020112012 Projected benefit obligation$2,100,000$2,600,000$2,900,000 Soft-White recorded in Other Comprehensive Income actuarial losses of $400,000 in 2010 and $300,000 in 2011. If the average remaining service life of all active employees is 5.5 years, the sched- Projected BenefitPlanAccumulated YearObligation As Illustration 20-16 indicates, the loss recognized in 2011 increased pension ex- It indicates that the corridor approach dampens the effects (reduces volatility) of these The rationale for the corridor is that gains and losses result from refinements in es- timates as well as real changes in economic value; over time, some of these gains and Unexpected Gain or Loss Remaining Service Life Year Accumulated OCI (G/L) Current-year Gain or Loss In essence, these gains and losses are subject to �Chapter 20 CostGains/Losses ILLUSTRATION 20-18 December 31, 2011, PBO balance$212,700 Service cost [entry (m)]13,000 Interest cost [entry (n)]21,270 Benefits paid(10,500) December 31, 2012, PBO balance (before liability increases)$236,470 Projected benefit obligation (Credit)$(265,000) Whatdo the few years. It is a real roller coaster. �93�94�95�96�97�98�99�00�01�02�03�04�05�06�07 statements. REPORTING PENSION PLANS IN FINANCIAL STATEMENTS involves extensive reporting and disclosure requirements. We will cover these requirements in two categories: (1) those within the financial statements, and �Chapter 20 actuarial gains and losses and prior service cost as part of other comprehensive income, the Board believes that the usefulness of financial statements is enhanced. To illustrate the presentation of other comprehensive income and related accumu- lated OCI, assume that Obey Company provides the following information for the year 2010. None of the Accumulated OCI on January 1, 2010, should be amortized in 2010. Actuarial liability loss$60,000 Prior service cost benefit adjustment15,000 Other comprehensive loss$75,000 Both the actuarial liability loss and the prior service adjustment decrease the funded OBEY COMPANY TATEMENT ORTHE �Chapter 20 Accumulated other comprehensive income, January 1, 2010$40,000 Other comprehensive loss75,000 Accumulated other comprehensive loss, December 31, 2010$35,000 ILLUSTRATION 20-26 OBEY COMPANY Common stock$100,000 By providing information on the components of comprehensive income as well as to- tal accumulated other comprehensive income, the company communicates all changes The IASB and FASB are NTERNATIONAL NSIGHT Adisclosure of the rates used in measuring the benefit amounts (discount rate, ex- �Chapter 20 ZARLE COMPANY 201020112012 Service cost$ 9,000$9,500$13,000 Interest cost10,00019,20021,270 ILLUSTRATION 20-28 Pension Disclosure for 2011, 2012 ZARLE COMPANY 201020112012 Benefit obligation at beginning of year$100,000$112,000$212,700 Service cost9,0009,50013,000 Interest cost10,00019,20021,270 Amendments (Prior service cost)�0�80,000�0� Actuarial loss�0��0�28,530 Benefits paid(7,000)(8,000)(10,500) Benefit obligation at end of year112,000212,700265,000 The 2010 column reveals that Zarle underfunds the projected benefit obligation by $1,000. The 2011 column reveals that Zarle reports the underfunded liability of $78,600 plan disclosures. CostGains/Losses ILLUSTRATION 20-29 Comprehensive Pension �Chapter 20 2013 Corridor Test Zarle formally records pension expense for 2013 as follows. Pension Expense44,312 Many plans are underfunded but still quite viable.For example,at one time Loews Corp. shortfall,but also had earnings of In 2006,Congress passed the Pension Protection Act.This new law has many provisions. One important aspect of the Act is that it will force many companies to expedite their contributions to their pension plans.One group estimates that companies in the S&P 500 would have had to contribute $47 billion to their pension plans if the new rules were fully phased in for 2006.That amount is about 57 percent more than the $30 billion that companies were expecting to contribute to their plans that year.( Source Credit Suisse,�Pension Protection Act,�August 14,2006,p.1.) The law requires plan administrators to publish a comprehensive description and ZARLE COMPANY OTESTOTHE TATEMENTS noncontributory and provides pension benefits that are based on the employee�s compensation during Amounts recognized in other comprehensive income Rates used to estimate Funded status of plan Amounts recognized in the Reconciliations of pension �Chapter 20 that there has been no change in substance, but merely a change in form. However, the FASB disagrees. It requires recognition in earnings of a gain or loss when the employer (PBGC) recently announced that it would take over responsibility for the pilots� pension plan at federal agency, which acts as an insurer for corporate pension plans, has spent much of the past lines are next. For example, the PBGC also became the trustee of it may soon announce a takeover of that struggling carrier�s other three pension plans. The grand $3.6 $1.4 $0.84 $0.73 $0.69 $0.57 $0.55 $0.67 $1.2 Concluding Observations Hardly a day goes by without the financial press analyzing in depth some issue related You will wantto read the CONVERGENCE CORNER For discussion of how international convergence efforts relate to pension accounting. The accounting for various forms of compensation plans under iGAAPis found in (�Share-Based Payment�). addresses the accounting for a wide range of compensation elements� ABOUT THE NUMBERS The following schedule is taken from the annual report of , which uses iGAAP. CONVERGENCE CORNER RELEVANT FACTS iGAAP and U.S.GAAP separate pension plans into similar. For defined-benefit plans,both iGAAP and U.S.GAAP SUMMARY OF LEARNING OBJECTIVES Third, the company multiplies the number of service-years consumed each year times the cost per service-year, to obtain the annual amortization charge. Explain the accounting for unexpected gains and losses. In estimating the projected KEY TERMS �Chapter 20 ACCOUNTING GUIDANCE After a decade of study, the FASB in December 1990 issued GAAPrules on �Employ- APPENDIX ItemPensionsHealthcare Benefits Generally funded.Generally Well-defined and level dollarGenerally uncapped and great amount.variability. �Chapter 20 12/31/2007 $ in millions)ObligationUnderfundedEquity $64,01374.53%172.57% Ford Motor Company 28,09686.21%499.22% 40,38557.91%35.01% Verizon Communications Inc. 27,30684.83%53.98% 12,98386.10%11.23% 7,66297.06%85.10% 8,732100%64.82% So, how big are OPEB obligations? REALLYbig. Source : Company reports. OPEBs�HOW BIG ARE THEY? of Hire (age 29) Plan Amendment Date (age 34) Beginning of Eligibility Period (age 45) Eligibility (Vesting) Date (age 55) Estimated Prior Service Cost APBO future benefits �Chapter 20 ILLUSTRATIVE ACCOUNTING ENTRIES �Chapter 20 (d) Service cost (e) Interest cost General Journal EntriesMemo Record ILLUSTRATION 20A-6 2012 Corridor Test Accumulated OCI at beginning of year$60,200 �Chapter 20 DISCLOSURES IN NOTES TO THE FINANCIAL STATEMENTS Tootsie Roll Industries, Inc. Note 7Employee Benefit Plans (partial) 20072006 Benefit obligation, beginning of year$12,582$9,924 Service cost667524 Interest cost694539 Actuarial (gain)/loss(550)2,101 Benefits paid(179)(506) Benefit obligation, end of year$13,214$12,582 1% Increase1% Decrease Amounts recognized in other comprehensive income Reconciliation of OPEB Components of OPEB Rates used to estimate ACTUARIAL ASSUMPTIONS AND CONCEPTUAL ISSUES The Governmental Accounting Standards Board (GASB) was organized in 1984 as an operating en- tity of the Financial Accounting Foundation (FAF) to establish standards of financial accounting and reporting for state and local governmental entities. Similar to the FASB, FAF Trustees are responsi- ble for selecting the members of the GASB and its Advisory Council, funding their activities, and exercising general oversight (with the exception of the GASB�s resolution of technical issues). The GASB�s function is important because high-quality external financial reporting can demonstrate fi- credit, and many legislative and regulatory decisions. �Chapter 20 SUMMARY OF LEARNING OBJECTIVES FOR APPENDIX 20A KEY TERMS FASB CODIFICATION Exercises Access the FASB Codification at http://asc.fasb.org/home to prepare responses to the following exercises. Provide Codification references for your responses. Be sure to check the companion website for a Review and Analysis Exercise,with solution. All asterisked Questions, Exercises, and Problems relate to material in the appen- dix to the chapter. QUESTIONS pension plan differ from a noncontributory plan? �Chapter 20 Accounting for Income Taxes (parent company of ) reported the following for 2007 (in Service cost$370 Interest on P.B.O.672 BRIEF EXERCISES Exercises prior service costs to its employees. The employees are expected to provide 2,000 service years in the fu- ture, with 350 service years in 2010. Compute prior service cost amortization for 2010. At December 31, 2010, Besler Corporation had a projected benefit obligation of $560,000, plan E20-1(Pension Expense, Journal Entries) EXERCISES �Chapter 20 Accounting for Income Taxes E20-2(Computation of Pension Expense) Bickner Company provides the following information about Service cost$90,000 Contribution to the plan105,000 Prior service cost amortization10,000 EmployeeYears of Service Jim3 Paul4 Nancy5 Dave6 Kathy6 On January 1, 2010, the company amended its pension plan increasing its projected benefit obligation by Instructions Compute the amount of prior service cost amortization for the years 2010 through 2015 using the years- Exercises ObligationValue 2009$2,000,000$1,900,000 20102,400,0002,500,000 20112,950,0002,600,000 20123,600,0003,000,000 The average remaining service life per employee in 2009 and 2010 is 10 years and in 2011 and 2012 is Balances or Values at December 31, 2010 Projected benefit obligation$2,737,000 Accumulated benefit obligation1,980,000 �Chapter 20 Accounting for Income Taxes Exercises Indicate the pension-related amounts that would be reported on the income statement and the during the Year(Gain) or Loss 2010$300,000 2011480,000 2012(210,000) 2013(290,000) 2010$4,000,000$2,400,000 20114,520,0002,200,000 20125,000,0002,600,000 20134,240,0003,040,000 Gustafson Inc. has a stable labor force of 400 employees who are expected to receive benefits under theplan. The total service-years for all participating employees is 5,600. The beginning balance of �Chapter 20 Accounting for Income Taxes Annual Pension (7)(8)(9)(10)(11) 1,100 Cr. Service Pension General Journal Entries Exercises Instructions �Chapter 20 Accounting for Income Taxes Instructions Annual 183,000 Dr. (6)(7) (8)(9) 30,000 Dr. 27,000 Dr. General Journal Entries See the book�s companion website,www.wiley.com/college/kieso,for a PROBLEMS Problems 200920102011 Annual service cost$16,000$19,000$ 26,000 �Chapter 20 Accounting for Income Taxes For Year Ended December 31, 201020112012 Problems As a result of the operation of the plan during 2010, the actuary provided the following additional data Service cost for 2010$108,000 �Chapter 20 Accounting for Income Taxes Annual Pension 249,000 Dr. (7)(8)(9) 205,000 Dr. 18,000 Dr. 41,000 Dr. 15,000 Cr. Service Cost (10)(11) 46,000150,500 Cr. Pension General Journal Entries Instructions Problems As a result of the operation of the plan during 2011, the actuary provided the following additional data at December 31, 2011. Service cost for 2011$ 45,000 �Chapter 20 Accounting for Income Taxes CA20-1(Pension Terminology and Theory) Many business organizations have been concerned with CONCEPTS FOR ANALYSIS CA20-4(Major Pension Concepts) Davis Corporation is a medium-sized manufacturer of paperboard containers and boxes. The corporation sponsors a noncontributory, defined-benefit pension plan that covers its 250 employees. Sid Cole has recently been hired as president of Davis Corporation. While re- viewing last year�s financial statements with Carol Dilbeck, controller, Cole expressed confusion about several of the items in the footnote to the financial statements relating to the pension plan. In part, the footnote reads as follows. The benefits are based on years of service and the employee�s compensation during the last four years allowed under the federal tax code. Contributions are intended to provide for benefits expected to be earned in the future as well as those earned to date. (including vested benefits of $636)$ (870) Projected benefit obligation$(1,200) �Chapter 20 Accounting for Income Taxes ObligationValue 2009$2,200,000$1,900,000 20102,400,0002,500,000 20112,900,0002,600,000 20123,900,0003,000,000 The average remaining service life per employee in 2009 and 2010 is 10 years and in 2011 and 2012 is Using Your Judgment FINANCIAL REPORTING Financial Reporting Problem The Procter & Gamble Company (P&G) are presented in Appendix 5B or can be accessed at the book�s companion www.wiley.com/college/kieso Instructions What kind of pension plan does P&G provide its employees in the United States? USING YOUR JUDGMENT �Chapter 20 Accounting for Income Taxes Instructions Use the information on Kyowa to respond to the following requirements. What are the key differences in accounting for pensions under U.S. and Japanese standards? Briefly explain how differences in U.S. and Japanese standards for pensions would affect the amounts reported in the financial statements. In light of the differences identified above, would Kyowa�s income and equity be higher or lower under U.S. GAAPcompared to Japanese standards? Explain. Note 1. Basis of Presenting Consolidated Financial Statements (partial) 20072007 Projected benefit obligations�(62,221)$(526,895) 20072007 Service cost�(2,445)$(20,705) Interest cost1,51812,855 Using Your Judgment BRIDGE TO THE PROFESSION Professional Research: FASB Codification Monat Company has grown rapidly since its founding in 2002. To instill loyalty in its employees, Monat particularly any gains or losses that develop in the plan. Monat has asked you to conduct some research Instructions Access the FASB Codification at http://asc.fasb.org/home to conduct research using the Codification Research System to prepare responses to the following items. Provide Codification references for your responses. Briefly describe how pension gains and losses are accounted for. Accounting for Pensions Time Remaining 2 hours 20 minutes Remember to check the book�s companion website to find additional resources for this chapter. CHAPTER LEARNING OBJECTIVES After studying this chapter, you should be able to: promise income and other benefits to re- tired employees in exchange for services during their working years. However, a shift is on from traditional defined-benefit plans, in Where Have All the Pensions Gone?