Understand the importance of pensions from a business perspective Identify and account for a defined contribution benefit plan Identify and explain what a defined benefit plan is and the related accounting issues ID: 459770
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After studying this chapter, you should be able to:Understand the importance of pensions from a business perspective.Identify and account for a defined contribution benefit plan.Identify and explain what a defined benefit plan is and the related accounting issues.Explain what the employer’s benefit obligation is, identify alternative measures for this obligation, and prepare a continuity schedule of transactions and events that change its balance.Identify transactions and events that change benefit plan assets, and calculate the balance of the assets.Explain what a benefit plan’s funded status is, calculate it, and identify what transactions and events change its amount.Identify the components of pension expense, and account for a defined benefit pension plan under the immediate recognition approach.Account for defined benefit plans with benefits that vest or accumulate other than pension plans.Identify the types of information required to be presented and disclosed for defined benefit plans, prepare basic schedules, and be able to read and understand such disclosures.Identify differences between the IFRS and ASPE accounting for employee future benefits and what changes are expected in the near future.
PENSIONS AND OTHER EMPLOYEE FUTURE BENEFITS
2Slide3
Pensions and Other Employee Future Benefits
3Introduction and Benefit Plan BasicsOverview of pensions and their importance from a business perspectiveDefined contribution plansDefined benefit plans
Presentation, Disclosure, and Analysis
Presentation
Disclosure
Analysis
Defined Benefit Pension Plans
The employer’s obligation
Plan assets
Funded status
Defined benefit cost components and the immediate recognition approach
Other defined benefit plans
IFRS/ASPE Comparison
Comparison of IFRS and ASPE
Looking aheadSlide4
Benefit Plans
Three examples of benefit plans:Pension and other post-retirement plans (e.g. health care and life insurance)Post-employment benefit plans (e.g. severance benefits and long-term disability benefits)Compensated absences (e.g. parental leaves, unrestricted sabbatical leaves)4Slide5
Nature of Pension Plans
A pension plan provides benefits (payments) to retirees for services provided during employmentThe employer sponsors and contributes to the fund and incurs the cost of the pension planRequires accounting for the employerThe pension plan receives the contributions, administers pension assets and makes pension payments to the beneficiariesRequires accounting for the pension plan5Slide6
Pension Fund Stream
6EMPLOYERPENSION FUNDCash paid to pension plan (contributions)$Fund
Assets
Pension recipients (benefits)Slide7
Pension Terminology
FundedEmployer sets aside money for future pension benefits in a separate legal entityContributoryEmployee and employer make contributions to the plan Non-contributoryEmployers bear the full cost of the pension planNo contributions made by employee7Slide8
Pension Plans
The two most common types of pension plans are:Defined contribution (DC) plansDefined benefit (DB) plans8Slide9
Defined Contribution Plans
Employer contributes a defined sum (either a fixed sum or related to salary) to a third partyOwnership of plan assets assumed by plan trusteeTrustee is responsible for investment and distribution of plan assetsEmployee assumes the economic riskNo guarantee made by employer as to benefits paidPlan does not specify the benefits the employees will receive or the method used to determine benefitsCost of the plan in the current year is known with certainty9Slide10
Defined Contribution Plans
Accounting is straightforward:Liability reported if contributions for the period have not been made in fullAsset reported if the amount contributed is more than required for the periodThe benefit cost (pension expense) is the amount the company is required to contribute to the plan10Slide11
Defined Contribution Plans
When plan is first established or when there is an amendment to the plan, the employer may be obligated to make contributions for previous employee services Called prior or past service costUnder IFRS, these costs are generally recognized immediately as an expenseSlide12
Defined Benefit Pension Plans
Pension benefits received by employee after retiring are specified (i.e. defined)Pension benefits are based on a formula with key variables such as years of service and expected salary level at retirementThe trust’s main goal is to ensure there will be enough pension assets to pay the employer’s obligation to employees when they retireThe employer assumes the economic riskAssets are legally owned by the trust but in substance belong to the employer (the beneficiary of the trust)The employer is responsible for making the defined benefit payments no matter what happens in the trustCost of plan not known with certainty, as it depends on uncertain future variables (e.g. employee turnover, mortality, inflation)12Slide13
Defined Benefit Pension Plans
Can be vesting or non-vestingVested amounts plan become the legal property of the employeeEmployees are entitled to receive vested benefits even after leaving the employ of the corporationAccounting for defined benefit plans is not easy to measure:The pension expense is not same as cash funding contribution Actuarial assumptions must be used extensively13Slide14
Pensions and Other Employee Future Benefits
14Introduction and Benefit Plan BasicsOverview of pensions and their importance from a business perspectiveDefined contribution plansDefined benefit plans
Presentation, Disclosure, and Analysis
Presentation
Disclosure
Analysis
Defined Benefit Pension Plans
The employer’s obligation
Plan assets
Funded status
Defined benefit cost components and the immediate recognition approach
Other defined benefit plans
IFRS/ASPE Comparison
Comparison of IFRS and ASPE
Looking aheadSlide15
Defined Benefit Pension Plans
Three methods of measuring the pension obligation valuationVested benefit methodBased on current salary levelsIncludes only vested benefitsAccumulated benefit methodBased on current salary levelsIncludes both vested and non-vested serviceProjected benefit methodBased on future salary levelsIncludes both vested and non-vested service15Slide16
Defined Benefit Pension Plans
Projected benefit method is considered the best measure for accounting purposesPresent value of vested and non-vested benefits earned as at the reporting date (using future salary levels) is called defined benefit obligation (DBO) Under ASPE, the DBO is known as the accrued benefit obligation (ABO) ASPE also allows the accrued benefit obligation (ABO) for funding purposes which is based on different variables. 16Slide17
Defined Benefit Obligation (DBO)
Defined benefit obligation, beginning+ Current service cost+ Interest costBenefits paid to retirees+/- Past service costs of plan amendments during period+/- Actuarial gains (-) or losses (+) . = Defined benefit obligation, end of period17Slide18
Current Service Cost
The cost of benefits that will be provided in the future in exchange for current servicesThese costs are prorated on service:Annual expense is based on the total estimated benefit being allocated evenly over the years of service of the employee 18Slide19
Interest Cost
Interest accrues on the DBO as time passesSimilar to discounted debtCurrent market rateDetermined by reference to current yield on high-quality debt instrument (e.g. corporate bonds)Required by IFRS and ASPESettlement rateImplied rate on insurance contract that would effectively settle pension obligation Allowed under ASPE19Slide20
Benefits Paid to Retirees
Pension benefits are paid to retirees (former employees)Like all liabilities, the amount owing is decreased as these payments are madeSlide21
Past Service Costs
Similar to DC plans, when a plan is started or amended, credit is often given for past years of serviceThis amount is included in the pension benefit cost on the income statement in the year it is incurredNote that companies can also amend plans to reduce the benefits receivedResults in a decreased DBO and a past service benefitSlide22
Actuarial Gains and Losses
These gains and losses can occur because of:Changes in actuarial assumptionsA change in assumptions about future eventsExperience gains or lossesDifference between what actually happened and the actuarial assumption that was madeSlide23
Plan Assets
Plan assets, fair value at beginning + Contributions +/- Actual return - Benefits paid to retirees . = Plan assets, fair value at end of period* Actual return = Expected return + remeasurement gain on assets or – remeasurement actuarial loss on assets 23Slide24
Contributions
Contributions are made each year by:The employerThe employees (if applicable)Federal and provincial law dictate the funding requirementsThe Canadian Revenue Agency (CRA) also dictates regulations as well as what contributions are tax deductibleSlide25
Return on Plan Assets
The income generated on the assets less administration costsDue to year over year volatility, a long-term rate of return is estimatedThis is referred to as the expected returnUnder IFRS, rate used must be the same as the discount rate used to calculate interest costSlide26
Funded Status
Defined Benefit Obligation (DBO)- Fair Value of plan assets = Funded status DBO > Plan assets = underfunded = funded status liabilityDBO < Plan assets = overfunded = funded status asset26Slide27
Accounting for Pensions
Pension cost should be accrued and recognized in accounting periods that benefit from employees’ serviceTwo approaches to accounting for pension expenseImmediate recognition approachA form of this approach is required by IFRSAllowed under ASPEDeferral and amortization approachAllowed under ASPE27Slide28
Immediate Recognition Approach
Statement of Financial Position PresentationDBO and fund assets are off-balance sheet or memo accountsUnder IFRS, the net employee benefit or liability is reported Under ASPE, the net employee benefit or liability is reported based on the funded status of the planSlide29
Immediate Recognition Approach
Income Statement PresentationPension expense is made up of:Current service costInterest costActual return on plan assetsUnder IFRS, this amount is allocated between net income (interest amounts) and OCI (remeasurements)Past service costActuarial gains and lossesUnder IFRS, these are included in OCISlide30
The Pension Worksheet
Used to accumulate information needed for the formal journal entries and to keep track of the relevant pension plan items and components reported off-balance sheet30Slide31
Immediate Recognition Approach – Example (2013)
General Journal EntriesMemo RecordItems
Annual Pension Expense
Cash
Net Defined Benefit Liability/ Asset
Defined Benefit Obligation
Plan Assets
Bal. Jan 1 2013
0
100,000 Cr.
100,000 Dr.
a) Service cost
9,000 Dr.
9,000 Cr.
b) Interest cost
10,000 Dr
10,000 Cr.
c) Actual return
10,000 Cr.
10,000 Dr.
d) Contributions
8,000 Cr.
8,000 Dr.
e) Benefits paid
7,000 Dr.
7,000 Cr.
Expense entry, 2013
9,000 Dr.
9,000 Cr.
Contribution entry, 2013
8,000 Cr.
8,000 Cr.
Balance Dec. 31, 2013
1,000 Cr.
112,000 Cr.
111,000 Dr.
31Slide32
Immediate Recognition Approach – Example (2013)
To record expense:Pension Expense 9,000 Net Defined Benefit Liability/Asset 9,000To record contribution:Net Defined Benefit Liability/Asset 8,000 Cash 8,00032Slide33
Immediate Recognition Approach – Example (2014)
General Journal EntriesMemo RecordItems
Annual Pension Expense
Cash
Net Defined Benefit Liability/ Asset
Defined Benefit Obligation
Plan Assets
Bal. Dec. 31 2013
1,000 Cr.
112,000 Cr.
111,000 Dr.
f) Past service cost
80,000 Dr.
80,000 Cr.
g) Service cost
9,500 Dr.
9,500 Cr.
h) Interest cost
19,200 Dr
19,200 Cr.
i) Actual return
11,100 Cr.
11,100 Dr.
j) Contributions
20,000 Cr.
20,000 Dr.
k) Benefits paid
8,000 Dr.
8,000 Cr.
Expense entry, 2014
97,600 Dr.
97,600 Cr.
Contribution entry, 2014
20,000 Cr.
20,000 Cr.
Balance Dec. 31, 2014
78,600 Cr.
212,700 Cr.
134,100 Dr.
33Slide34
Immediate Recognition Approach – Example (2014)
To record expense:Pension Expense 97,600 Net Defined Benefit Liability/Asset 97,600To record contribution:Net Defined Benefit Liability/Asset 20,000 Cash 20,00034Slide35
Immediate Recognition Approach – Example (2015: ASPE)
General Journal EntriesMemo RecordItems
Annual Pension Expense
Cash
Net Defined Benefit Liability/ Asset
Defined Benefit Obligation
Plan Assets
Bal. Dec. 31 2014
78,600 Cr.
212,700 Cr.
134,100 Dr.
l) Service cost
13,000 Dr.
13,000 Cr.
m) Interest cost
21,270 Dr
21,270 Cr.
n) Actual return
12,000 Cr.
12,000 Dr.
o) Contributions
24,000 Cr.
24,000 Dr.
p) Benefits paid
10,500 Dr.
10,500 Cr.
q)
Actuarial loss
28,530 Dr.
28,530 Cr.
Expense entry, 2015
50,800 Dr.
50,800 Cr.
Contribution entry, 2015
24,000 Cr.
24,000 Cr.
Balance Dec. 31, 2015
105,400 Cr.
265,000 Cr.
159,600 Dr.Slide36
Immediate Recognition Approach – Example
(2015: ASPE)To record expense:Pension Expense 50,800 Net Defined Benefit Liability/Asset 50,800To record contribution:Net Defined Benefit Liability/Asset 24,000 Cash 24,00036Slide37
Immediate Recognition Approach – Example (2015: IFRS)
General Journal EntriesMemo Record
Items
Remeasure-ment (Gain) Loss OCI
Annual Pension Expense
Cash
Net Defined Benefit Liability/ Asset
Defined Benefit Obligation
Plan Assets
Bal. Dec. 31 2014
78,600 Cr.
212,700 Cr.
134,100 Dr.
l) Service cost
13,000 Dr.
13,000 Cr.
m) Interest cost
21,270 Dr
21,270 Cr.
n)
Expected return
14,610 Cr.
14,610 Dr.
o) Remeasurement loss
2,610 Dr.
2,610 Cr.
p) Contributions
24,000 Cr.
24,000 Dr.
q) Benefits paid
10,500 Dr.
10,500 Cr.
r) Liability loss
28,530 Dr.
.
28,530 Cr.
Expense entry, 2015
31,140 Dr.
19,660 Dr.
50,800 Cr.
Contribution entry, 2015
24,000 Cr.
24,000 Cr.
Balance Dec. 31, 2015
105,400 Cr.
265,000 Cr.
159,600 Dr.Slide38
Immediate Recognition Approach – Example
(2015: IFRS)To record expense:Pension Expense 19,660Remeasurement Loss (OCI) 31,140 Net Defined Benefit Liability/Asset 50,800To record contribution:Net Defined Benefit Liability/Asset 24,000 Cash 24,00038Slide39
Valuation of Accrued Benefit Asset
Accrued benefit asset cannot exceed expected future benefits (valuation allowance may be necessary to reduce the value on statement of financial position)Referred to as the asset ceiling testChange in valuation allowance is generally recognized through pension expense in net income39Slide40
Other Defined Benefit Plans with
Benefits that Vest or AccumulateAccrual accounting is appropriate for post-retirement benefits, post-employment benefits and long-term compensated absencesExample: post-retirement health care benefits Since the right to the benefit is earned by rendering service, the cost and related liability are accrued as employee provides serviceIFRS generally follows the same approach as for pension plans, except that actuarial gains/losses and past service costs are reflected in OCIUnder ASPE, defined benefit plans where benefits vest or accumulate based on service are accounted for in same way as defined benefit pension plans40Slide41
Defined Benefit Plans with Benefits that Do Not Vest or Accumulate
E.g. parental leave plans (in excess of what government provides), long-term disability plansUse “event accrual” method to accrue full costWhen event occurs that obligates entity:Benefit Expense xx Benefit Liability xxWhen the compensated absence is taken:Benefit Liability xx Cash xx41Slide42
Pensions and Other Employee Future Benefits
42Introduction and Benefit Plan BasicsOverview of pensions and their importance from a business perspectiveDefined contribution plansDefined benefit plans
Presentation, Disclosure, and Analysis
Presentation
Disclosure
Analysis
Defined Benefit Pension Plans
The employer’s obligation
Plan assets
Funded status
Defined benefit cost components and the immediate recognition approach
Other defined benefit plans
IFRS/ASPE Comparison
Comparison of IFRS and ASPE
Looking aheadSlide43
Presentation
Defined benefit assets/liabilitiesGenerally reported separately for each benefit plan (unless all plans result in asset or liability)Generally classified as long-termBenefit costsComponents of benefit costs may be reported together or separately on the income statement43Slide44
Disclosure Requirements
Disclosures under ASPE include:Description of each plan and any major changes in terms during the yearInformation on most recent actuarial valuation for funding purposesFunded status at year end (including FV of plan assets and ABO)Explanation of differences between funded status and amounts recorded on balance sheet44Slide45
Disclosure Requirements
Additional disclosure requirements under IFRS include:Characteristics of defined benefit plans and related risksAmounts included in statements from the plansHow the plans help with cash flow managementReconciliations of beginning to ending balances of PV of the net defined benefit liability/asset, plan assets and DBOAmounts included in periodic net income and OCIUnderlying assumptions and sensitivity informationMany others such as the estimate of following year’s expected funding contributions 45Slide46
Analysis
Analysis generally focuses on predicting future cash flow obligationsIt is very important to validate the major assumptions underlying the fund status and future cash requirements, especiallyDiscount rate used to measure DBOCurrent service costInterest costSmall changes in key variables can have a very significant impact46Slide47
Pensions and Other Employee Future Benefits
47Introduction and Benefit Plan BasicsOverview of pensions and their importance from a business perspectiveDefined contribution plansDefined benefit plans
Presentation, Disclosure, and Analysis
Presentation
Disclosure
Analysis
Defined Benefit Pension Plans
The employer’s obligation
Plan assets
Funded status
Defined benefit cost components and the immediate recognition approach
Other defined benefit plans
IFRS/ASPE Comparison
Comparison of IFRS and ASPE
Looking aheadSlide48
Looking Ahead
Recent changes to IFRS has created additional differences between IFRS and ASPEExpected replacement of the ASPE pension section is expected to take these differences into account48Slide49
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