Connect

Close
Skip to eBook contentSkip to Chapter linksSkip to Content links for this ChapterSkip to eBook links

Chapter17: Pensions and Other Postretirement Benefits

Accounting for Postretirement Benefit Plans Other Than Pensions

As we just discussed, it's necessary to attribute a portion of the accumulated postretirement benefit obligation to each year as the service cost for that year as opposed to measuring the actual benefits employees earn during the year as we did for pension plans. That's due to the fundamental nature of these other postretirement plans under which employees are ineligible for benefits until specific eligibility criteria are met, at which time they become 100% eligible. This contrasts with pension plans under which employees earn additional benefits each year until they retire.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/818573/wh_b.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (0.0K)</a> LO11

We account for pensions and for other postretirement benefits essentially the same way.

p. 971

GRAPHIC 17-16
Measuring Service Cost

Measuring the service cost differs, though, due to a fundamental difference in the way employees acquire benefits under the two types of plans.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/971_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   The way we measure service cost is the primary difference between accounting for pensions and for other postretirement benefits. Otherwise, though, accounting for the two is virtually identical. For example, a company with an underfunded postretirement benefit plan with existing prior service cost and net loss–AOCI would record the following journal entries annually:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/971_2.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

We record the annual expense and funding for other postretirement benefit plans the same way we do for pensions.

We record losses and gains (as well as any new prior service cost should it occur) the same way we do for pensions.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/818573/236.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (13.0K)</a>
ETHICAL DILEMMA
 

Earlier this year, you were elected to the board of directors of Champion International, Inc. Champion has offered its employees postretirement health care benefits for 35 years. The practice of extending health care benefits to retirees began modestly. Most employees retired after age 65, when most benefits were covered by Medicare. Costs also were lower because life expectancies were shorter and medical care was less expensive. Because costs were so low, little attention was paid to accounting for these benefits. The company simply recorded an expense when benefits were provided to retirees. The FASB changed all that. Now, the obligation for these benefits must be anticipated and reported in the annual report. Worse yet, the magnitude of the obligation has grown enormously, almost unnoticed. Health care costs have soared in recent years. Medical technology and other factors have extended life expectancies. Of course, the value to employees of this benefit has grown parallel to the growth of the burden to the company.

p. 972

   Without being required to anticipate future costs, many within Champion's management were caught by surprise at the enormity of the company's obligation. Equally disconcerting was the fact that such a huge liability now must be exposed to public view. Now you find that several board members are urging the dismantling of the postretirement plan altogether.

A Comprehensive Illustration

We assumed earlier that the EPBO at the end of 2009 was determined by the actuary to be $10,842. This was the present value on that date of all anticipated future benefits. Then we noted that the EPBO at the end of the next year would have grown by 6% to $11,493. This amount, too, would represent the present value of the same anticipated future benefits, but as of a year later. The APBO, remember, is the portion of the EPBO attributed to service performed to a particular date. So, we determined the APBO at the end of 2010 to be <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_im1705.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a> or $3,612. We determined the $328 service cost noted earlier for 2010 as the portion of the EPBO attributed to that year: <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_im1706.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   Now, let's review our previous discussion of how the EPBO, the APBO, and the postretirement benefit expense are determined by calculating those amounts a year later, at the end of 2011. Before doing so, however, we can anticipate (a) the EPBO to be $11,493 × 1.06, or $12,182, (b) the APBO to be <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_im1707.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a> of that amount, or $4,177, and (c) the 2009 service cost to be <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_im1708.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a> of that amount, or $348. In Illustration 17-9 we see if our expectations are borne out by direct calculation.

ILLUSTRATION 17-9
Determining the Postretirement Benefit Obligation

The EPBO is the discounted present value of the total benefits expected to be earned.

The fraction of the EPBO considered to be earned this year is the service cost.

The fraction of the EPBO considered to be earned so far is the APBO.

Assume the actuary has estimated the net cost of retiree benefits in each year of Jessica Farrow's 20-year expected retirement period to be the amounts shown in the calculation below. She is fully eligible for benefits at the end of 2034 and is expected to retire at the end of 2039.

   Calculating the APBO and the postretirement benefit expense at the end of 2011, 12 years after being hired, begins with estimating the EPBO.

   Steps to calculate (a) the EPBO, (b) the APBO, and (c) the annual service cost at the end of 2011, 12 years after being hired, are:

(a).

  

1.

 

Estimate the cost of retiree benefits in each year of the expected retirement period and deduct anticipated Medicare reimbursements and retiree cost-sharing to derive the net cost to the employer in each year of the expected retirement period.

2.

 

Find the present value of each year's net benefit cost as of the retirement date.

3.

 

Find the present value of the total net benefit cost as of the current date. This is the EPBO.

(b).

  

Multiply the EPBO by the attribution factor, (service to date/total attribution period). This is the APBO. The service cost in any year is simply one year's worth of the EPBO.

(c).

  

Multiply the EPBO by <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_im1709.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>


   The steps are demonstrated in Illustration 17-9A.

p. 973

ILLUSTRATION 17-9A
EPBO, APBO, and Service Cost in 2011

The actuary estimates the net cost to the employer in each year the retiree is expected to receive benefits.

As of the retirement date, the lump-sum equivalent of the expected yearly costs is $62,269.

The EPBO in 2011 is the present value of those benefits.

The APBO is the portion of the EPBO attributed to service to date.

The service cost is the portion of the EPBO attributed to a particular year's service.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/973_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

DECISION MAKERS' PERSPECTIVE

When they analyze financial statements, investors and creditors should be wary of the nonstandard way companies report pension and other postretirement information. Recall that in the balance sheet, firms do not separately report the benefit obligation and the plan assets. Also, companies have considerable latitude in making the several assumptions needed to estimate the components of postretirement benefit plans. Fortunately, information provided in the disclosure notes makes up for some of the deficiency in balance sheet information and makes it possible for interested analysts to modify their analysis. As for pensions, the choices companies make for the discount rate, expected return on plan assets, and the compensation growth rate can greatly impact postretirement benefit expense and earnings quality. The disclosures required are very similar to pension disclosures. In fact, disclosures for the two types of retiree benefits typically are combined.38 Disclosures include:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/Spiceland_cover.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

Postretirement benefit amounts reported in the disclosure notes fill a reporting gap left by the minimal disclosures in the primary financial statements.

  

Descriptions of the plans.

  

Estimates of the obligations (PBO, ABO, vested benefit obligation, EPBO, and APBO).

p. 974

  

The percentage of total plan assets for each major category of assets (equity securities, debt securities, real estate, other) as well as a description of investment strategies, including any target asset allocations and risk management practices.

  

A breakdown of the components of the annual pension and postretirement benefit expenses for the years reported.

  

The discount rates, the assumed rate of compensation increases used to measure the PBO, the expected long-term rate of return on plan assets, and the expected rate of increase in future medical and dental benefit costs.

  

Estimated benefit payments presented separately for the next five years and in the aggregate for years 6–10.

  

Estimate of expected contributions to fund the plan for the next year.

  

Disclosures also include (a) any changes to the net gain or net loss and prior service cost arising during the period, (b) the accumulated amounts of these components of accumulated other comprehensive income, and (c) the amounts of those balances expected to be amortized in the next year.

  

Other information to make it possible for interested analysts to reconstruct the financial statements with plan assets and liabilities included. <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/818573/ora.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (0.0K)</a>

CONCEPT REVIEW EXERCISE

OTHER POSTRETIREMENT BENEFITS

Technology Group, Inc., has an unfunded retiree health care plan. The actuary estimates the net cost of providing health care benefits to a particular employee during his retirement years to have a present value of $24,000 as of the end of 2011 (the EPBO). The benefits and therefore the expected postretirement benefit obligation relate to an estimated 36 years of service and 12 of those years have been completed. The interest rate is 6%.

Required:

Pertaining to the one employee only:

1.

  

What is the accumulated postretirement benefit obligation at the end of 2011?

2.

  

What is the expected postretirement benefit obligation at the end of 2012?

3.

  

What is the service cost to be included in 2012 postretirement benefit expense?

4.

  

What is the interest cost to be included in 2012 postretirement benefit expense?

5.

  

What is the accumulated postretirement benefit obligation at the end of 2012?

6.

  

Show how the APBO changed during 2012 by reconciling the beginning and ending balances.

7.

  

What is the 2012 postretirement benefit expense, assuming no net gains or losses and no prior service cost?

SOLUTION

1.

  

What is the accumulated postretirement benefit obligation at the end of 2011?

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_eq1710.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

2.

  

What is the expected postretirement benefit obligation at the end of 2012?

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_eq1711.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

3.

  

What is the service cost to be included in 2012 postretirement benefit expense?

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_eq1712.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

p. 975

4.

  

What is the interest cost to be included in 2012 postretirement benefit expense?

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_eq1713.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

5.

  

What is the accumulated postretirement benefit obligation at the end of 2012?

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_eq1714.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

6.

  

Show how the APBO changed during 2012 by reconciling the beginning and ending balances.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/975_3.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

7.

  

What is the 2012 postretirement benefit expense, assuming no net gains or losses and no prior service cost?

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/975_4.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>


FINANCIAL REPORTING CASE SOLUTION

1.

  

Why is pension plan underfunding not a concern in your present employment?(p. 939) In a defined contribution plan, the employer is not obliged to provide benefits beyond the annual contribution to the employees' plan. No liability is created. Unlike retirement benefits paid in a defined benefit plan, the employee's retirement benefits in a defined contribution plan are totally dependent on how well invested assets perform in the marketplace.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_p1701a.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

2.

  

Were you correct that the pension liability is not reported in the balance sheet? What is the liability?(p. 941) Yes and no. The pension liability is not reported separately in the balance sheet. It is, however, combined with pension assets with the net difference reported in the balance sheet. The separate balance is disclosed, though, in the notes. For United Dynamics, the PBO at the end of 2011 is $2,628 million.

3.

  

What is the amount of the plan assets available to pay benefits? What are the factors that can cause that amount to change?(p. 948) The plan assets at the end of 2011 total $2,807 million. A trustee accepts employer contributions, invests the contributions, accumulates the earnings on the investments, and pays benefits from the plan assets. So the amount is increased each year by employer cash contributions and (hopefully) a return on assets invested. It is decreased by amounts paid out to retired employees.

4.

  

What does the “pension asset” represent? Are you interviewing with a company whose pension plan is severely underfunded?(p. 949) The pension asset is not the plan assets available to pay pension benefits. Instead, it's the net difference between those assets and the pension obligation. United Dynamics' plan assets exceed the pension obligation in each year presented and therefore is one of the few companies whose pension plan is overfunded.

p. 976

5.

  

How is the pension expense influenced by changes in the pension liability and plan assets?(p. 950) The pension expense reported on the income statement is a composite of periodic changes that occur in both the pension obligation and the plan assets. For United Dynamics in 2011, the pension expense included the service cost and interest cost, which are changes in the PBO, and the return on plan assets. It also included an amortized portion of prior service costs (a previous change in the PBO) and of net gains (gains and losses result from changes in both the PBO and plan assets). <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/818573/ora.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (0.0K)</a>




37The prior service cost for other postretirement benefits is amortized over the average remaining time until “full eligibility” for employees rather than until retirement as is the case for pension plans. This is consistent with recording “regular” service cost over the time to full eligibility.

38FASB ASC 715–60–50: Compensation–Retirement Benefits–Defined Benefit Plans–Other Postretirement–Disclosure (previously “Employers' Disclosures about Pensions and Other Postretirement Benefits,” Statement of Financial Accounting Standards No. 132 (Stamford, Conn.: FASB, 1998)).

2011 McGraw-Hill Higher Education
Any use is subject to the Terms of Use and Privacy Notice.
McGraw-Hill Higher Education is one of the many fine businesses of The McGraw-Hill Companies.