Employers are at risk with defined-contribution plans because they must contribute enough to meet

the cost of benefits that the plan defines. FALSE

Which of the following does the FASB argue indicates a more realistic measure of the employers
obligation under the pension plan on a going-concern basis and should be used as the basis for
determining service cost? PBO
The interest on the projected benefit obligation component of pension expense reflects the rates at
which pension benefits could be effectively settled.
Which one of the following is not a component of pension expense? Amortization of projected
benefit obligation.
If the actual return on plan assets is positive, then it is subtracted from the annual pension expense.
TRUE
Prior service cost is amortized on a years-of-service method or on a straight-line basis over the
average remaining service life of active employees.
The unrecognized net gain or loss balance must be amortized when it exceeds 10% of the larger of
the: beginning projected benefit obligation or beginning market-related asset value.
The pension asset/liability is the difference between the: projected benefit obligation and the fair
value of plan assets.
Service cost is the expense caused by the increase in pension benefits payable to employees because
of their services rendered during years prior to the current year. FALSE
In a defined benefit plan, pension expense is equal to the firms cash contribution. FALSE
Prior service costs due to a pension plan amendment are expensed in the year the amendment
occurred. FALSE
The market-related asset value is used to determine the corridor and to calculate the expected return
on plan assets. CORRIDOR YES, EXP RET ON PLAN ASSETS NO

Pension plan
Pension plan - is an arrangement where by the employer
provides benefits (payments) to retired employees for the
services they provide in their working years.
- A pension plan is funded when the employer makes payments
to a funding agency. That agency accumulates the assets and
makes payments to the recipients

Qualified pension plans

plans that offer tax benefits. Permit deductibility of the
employer's contributions to the pension fund and tax-free status
of earnings from pension fund assets.

Defined Contribution Plans

provide the employee an opportunity to invest pre-tax money
deducted on a regular basis in a group of mutual funds and other
investments

Defined Benefit Plan

Defined Benefit Plan - retirement plan that provides the
participant with a fixed benefit upon retirement.
- These benefits typically are a function of an employee's years of
service and of the compensation level in the years approaching
retirement.
- Employers are at risk with defined benefit plans because they
must contribute enough to meet the cost of benefits that the plan
defines
- The expenses recognized every period is not necessarily equal
to the cash contribution

Accounting for pensions

In accounting for a company's pension plan, two questions arise:
(1) What is the 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.

Vested benefits
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 employee achieves vested
benefits status. Companies compute the vested benefit obligation
using only vested benefits, at current salary levels.

accumulated benefit obligation.

Accumulated benefit obligation - Another way to measure the
obligation uses both vested and nonvested years of service. On
this basis, the company computes the deferred compensation
amount on all years of employees' serviceboth vested and
nonvestedusing current salary levels.

Projected benefit obligation (FASB choice)

Projected benefit obligation - the present value of vested and
nonvested benefits accrued to date, based on employees' future
salary levels.
- Those in favor of the projected benefit obligation contend that a
promise 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 expense.

Alternative Measures of Pension Liability

The choice between these measures is critical. The choice affects
the amount of a company's pension liability and the annual
pension expense reported.

Actuarial present value

Actuarial present value - is the amount payable adjusted to
reflect the time value of money and the probability of payment
(by means of decrements for events such as death, disability,
withdrawals, or retirement) between the present date and the
expected date of payment.

Recognition of the Net Funded Status of the Pension Plan

Companies must recognize on their balance sheet the full
overfunded or underfunded status of their defined benefit
pension plan.
- Recognize that GAAP applies to pensions as well as other
postretirement benefit plans (OPEBs).
- The overfunded or underfunded status is measured as the
difference between the fair value of the plan assets and the
projected benefit obligation.

Recognition of the Net Funded Status of the Pension Plan

(Example)
To illustrate, assume that Coker Company has a projected benefit
obligation of $300,000, and the fair value of its plan assets is
$210,000. In this case, Coker Company's pension plan is
underfunded, and therefore it reports a pension liability of
$90,000 on its balance sheet. If, instead, the fair value of Coker's
plan assets were $430,000, it would report a pension asset of
$130,000 .

Pension Expense (recognition)

The expense recognition principle and the definition of a liability
justify accounting for pension cost on the accrual basis. This
requires recording an expense when employees earn the future
benefits, and recognizing an existing obligation to pay pensions
later based on current services received.

Components of Pension Expense

Components of pension expense:
1. Service Costs
2. Interest of the liability
3. Actual Return on Plan Assets

4. Amortization of Prior Service Costs

5. Gain or loss

Components of Pension Expense (Service Costs)

Service Cost. Service cost is the expense caused by the increase in
pension benefits payable (the projected benefit obligation) to
employees because of their services rendered during the current
year. Actuaries compute service cost as the present value of the
new benefits earned by employees during the year.

Components of Pension Expense (Interest of the liability)

Interest On the Liability. Because a pension is a deferred
compensation arrangement, there is a time value of money
factor. As a result, companies record the pension liability on a
discounted basis. Interest expense accrues each year on the
projected benefit obligation just as it does on any discounted
debt. The actuary helps to select the interest rate, referred to as
the settlement rate.

Settlement Rate
The assumed discount rate at which the pension benefits could
be "settled." Derived from rates in current annuity contracts.

Components of Pension Expense (Actual Return on Plan

Assets)
Actual Return On Plan Assets. The return earned by the
accumulated pension fund assets in a particular year is relevant
in measuring the net cost to the employer of sponsoring an
employee pension plan. Therefore, a company should adjust
annual pension expense for interest and dividends that
accumulate within the fund, as well as increases and decreases in
the fair value of the fund assets.

Components of Pension Expense (Amortization of Prior Service

Costs)
Amortization of Prior Service Cost. Pension plan amendments
(including initiation of a pension plan) often include provisions
to increase benefits (or in rare situations, to decrease benefits)
for employee service provided in prior years. A company grants
plan amendments with the expectation that it will realize
economic benefits in future periods. Thus, it allocates the cost
(prior service cost) of providing these retroactive benefits to
pension expense in the future, specifically to the remaining
service-years of the affected employees.

Components of Pension Expense (Gain or loss)

Gain or Loss. Volatility in pension expense can result from
sudden and large changes in the fair value of plan assets and by
changes in the projected benefit obligation (which changes when
actuaries modify assumptions or when actual experience differs
from expected experience). Two items comprise this gain or loss:
(1) the difference between the actual return and the expected
return on plan assets, and (2) amortization of the net gain or loss
from previous periods. We will discuss this complex computation
later in the chapter.

Actual Return On Plan Assets

The actual return on the plan assets is the increase in pension
funds from interest, dividends, and realized and unrealized
changes in the fair value of the plan assets. Companies compute
the actual return by adjusting the change in the plan assets for
the effects of contributions during the year and benefits paid out
during the year.
Asset Return =
(Plan assets ending balance - Plan assets beginning balance) (Contribution - Benefits Paid)

Actual Return On Plan Assets

If the actual return on the plan assets is positive (a gain) during
the period, a company subtracts it when computing pension
expense. If the actual return is negative (a loss) during the
period, the company adds it when computing pension expense.

Amortization of Prior Service Cost (psc)

When either initiating (adopting) or amending a defined benefit
plan, a company often provides benefits to employees for years of
service before the date of initiation or amendment. As a result of
this prior service cost, the projected benefit obligation is
increased to recognize this additional liability. In many cases, the
increase in the projected benefit obligation is substantial.
- FASB says not to recognize an expense for these prior service
costs (PSC) at the time it initiates or amends a plan?
- Instead, the employer initially records the prior service cost as
an adjustment to other comprehensive income. The employer
then recognizes the prior service cost as a component of pension
expense over the remaining service lives of the employees who
are expected to benefit from the change in the plan.

Amortization of Prior Service Cost (psc)

The cost of the retroactive benefits (including any benefits

provided to existing retirees) is the increase in the projected
benefit obligation at the date of the amendment.

Amortization of Prior Service Cost (psc)

The Board prefers a years-of-service method that is similar to a
units-of-production computation. First, the company computes
the total number of service-years to be worked by all of the
participating employees. Second, it divides the prior service cost
by the total number of service-years, to obtain a cost per serviceyear (the unit cost). Third, the company multiplies the number of
service-years consumed each year by the cost per service-year, to
obtain the annual amortization charge.

Corridor approach
-to limit the growth of the accumulated OCI account, the FASB
-for amortizing the account's accumulated balance when its get
too large. The FASB set a limit of 10% of the larger of the
beginning balances of the projected benefit obligation or the
market-related value of the plan assets
-Above that size, the accumulated OCI account related to gains
and losses is consider too large and must be amortized

Recognition of the Net Funded Status of the Pension Plan

Companies must recognize on their balance sheet the overfunded
(pension asset) or underfunded (pension liability) status of their
defined benefit pension plan. The overfunded or underfunded
status is measured as the difference between the fair value of the
plan assets and the projected benefit obligation.

Classification of Pension Asset or Pension Liability

No portion of a pension asset is reported as a current asset. The
excess of the fair value of the plan assets over the benefit
obligation is classified as a noncurrent asset.
- The rationale for noncurrent classification is that the pension
plan assets are restricted. That is, these assets are used to fund
the projected benefit obligation, and therefore noncurrent
classification is appropriate.

Classification of Pension Asset or Pension Liability

The current portion of a net pension liability represents the
amount of benefit payments to be paid in the next 12 months (or
operating cycle, if longer), if that amount cannot be funded from
existing plan assets. Otherwise, the pension liability is classified
as a noncurrent liability.

Classification of Pension Asset or Pension Liability

Recently, the FASB required more extensive disclosures related
to pension plan assets. At a minimum, companies must disclose
the amount of assets allocated to equities, government and
corporate bonds, mortgage-backed securities, derivatives, and
real estate. Also, information on concentrations of risk must be
explained. Finally, fair value disclosures would be required,
including classification of amounts into levels of the fair value
hierarchy.

Fair Value Hierarchy

The fair value hierarchy provides insight into the priority of
valuation techniques that are used to determine fair value. The
fair value hierarchy is divided into three broad levels.
Fair Value Hierarchy
Level 1: Observable inputs that reflect quoted prices for Least
Subjective
identical assets or liabilities in active markets.
Level 2: Inputs other than quoted prices included in Level 1 that
are observable for the asset or liability either directly or through
corroboration with observable data.
Level 3: Unobservable inputs (for example, a company's own
data or assumptions). Most Subjective As indicated, Level 1 is the
most reliable because it is based on quoted prices, like a closing
stock price in the Wall Street Journal. Level 2 is the next most
reliable and would rely on evaluating similar assets or liabilities
in active markets. At the least-reliable level, Level 3, much
judgment
is needed based on the best information available to arrive at a
relevant and reliable fair value measurement.

Aggregation of Pension Plans

The Board takes the position that all overfunded plans should be
combined and shown as a pension asset on the balance sheet.
Similarly, if the company has two or more underfunded plans,
the underfunded plans are combined and shown as one amount
on the balance sheet.
- The FASB rejected the alternative of combining all plans and
representing the net amount as a single net asset or net liability.
The rationale: A company does not have the ability to offset
excess assets of one plan against underfunded obligations of

another plan. Furthermore, netting all plans is inappropriate

because offsetting assets and liabilities is not permitted under
GAAP unless a right of offset exists.

Actuarial Gains and Losses/prior Service Cost

Actuarial gains and losses not recognized as part of pension
expense are recognized as increases and decreases in other
comprehensive income. The same type of accounting is also used
for prior service cost. The Board requires that the prior service
cost arising in the year of the amendment (which increases the
projected benefit obligation) be recognized by an offsetting debit
to other comprehensive income.

Postretirement Benefits Accounting Provisions

Healthcare and other postretirement benefits for current and
future retirees and their dependents are forms of deferred
compensation. They are earned through employee service and
are subject to accrual during the years an employee is working.

attribution period
The period of time over which the postretirement benefit cost
accrues is called the attribution period. It is the period of service
during which the employee earns the benefits under the terms of
the plan.

Obligations Under Postretirement Benefits

In defining the obligation for postretirement benefits, the FASB
maintained many concepts similar to pension accounting. It also
designed some new and modified terms specifically for
postretirement benefits. Two of the most important of these
specialized terms are (a) expected postretirement benefit
obligation and (b) accumulated postretirement benefit
obligation.

Expected postretirement benefit obligation (EPBO)

The expected postretirement benefit obligation (EPBO) is the
actuarial present value as of a particular date of all benefits a
company expects to pay after retirement to employees and their
dependents. Companies do not record the EPBO in the financial
statements, but they do use it in measuring periodic expense.

Accumulated postretirement benefit obligation (APBO)

The accumulated postretirement benefit obligation (APBO) is the
actuarial present value of future benefits attributed to employees'
services rendered to a particular date. The APBO is equal to the

EPBO for retirees and active employees fully eligible for benefits.
Before the date an employee achieves full eligibility, the APBO is
only a portion of the EPBO. Or stated another way, the difference
between the APBO and the EPBO is the future service costs of
active employees who are not yet fully eli

Postretirement expense
Postretirement expense is the employer's annual expense for
postretirement benefits. Also called net periodic postretirement
benefit cost, this expense consists of many of the familiar
components used to compute annual pension expense. The
components of net periodic postretirement benefit cost are as
follows.