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BU397 (49)
Chapter 19

Chapter 19 Notes.docx

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Allan Foerster

Chapter 19- Pensions Benefit Plans - 3 types of benefit plans o Pension and other post retirement benefits  Provide health care or life insurance benefits after an employee’s retirement o Post-employment plans  Benefits being provided after employment but before retirement o Compensated absences  Includes payments made while an employee is absent from work - Employee future benefit plans can be o Defined Contribution Plans (DC)  Specifies how the entity’s contributions or payments into the plan are determined  Rather than identifying what benefits will be received by the employee or the method of determining those benefits  Once the entity pays the contributions into the fund, it has no further obligation  Even if the fund does not have enough assets to pay for the employee benefits  Amounts paid are usually to specific individuals  Amounts are defined and can be a fixed sum or based on salary  The amounts contributed are usually turned over to a third party (trustee) who acts on behalf of the beneficiaries  The third party assumes ownership of the plan assets and is responsible for their investment and distribution  The employer assumes no risk  The amount of the pension benefit that the employee finally collects under the plan depends on  The amounts that have been contributed  Income that has accumulated  Treatment of forfeitures of funds created by the termination of employees before retirement  Investment alternatives available upon retirement  Employers obligation in the current is dictated by the amounts to be contributed and is known with certainty  A liability is reported on the employer’s balance sheet only if the required contributions have not been made in full at the reporting date  DR Pension Expense  CR Cash  CR Accrued Pension Liability  Asset is recorded if more than required has been contributed  DR Pension Expense  DR Accrued Pension Asset  CR Cash  The annual benefit cost is the amount that the company is obligated to contribute to the plan  Under ASPE prior or past service cost  When a plan is first established or amended, employer may be required to make contributions for employee services that were provided prior to the start of the plan  These costs are amortized in a rational and systematic way and are added to the current service cost as part of the annual benefit expense over the period that the organization is expected to realize the economic benefits from the plan change  Cost of the plan for the period might contain interest charges on any related discounted amounts and a reduction for interest earned on any unallocated plan surplus  Under IFRS these costs are generally recognized immediately in expense  Disclosure  Annual pension expense amount  Nature and effect of matters affecting comparability  Amount of cash paid/payable in year o Defined Benefit Plans  A plan that specifies either the benefits to be received by an employee or the method of determining those benefits  Vesting means an employee keeps the rights to the benefits even if the employee no longer works for the entity  For plans where the entitlement to benefits increases with the length of the employee’s service  The objective of accounting is for the expense and liability related to the plans to be recognized over the accounting periods in which the related services are provided by the employees Pension Plans - An arrangement in which an employer provides benefits (payments) to employees after they retire for services that the employees provided while they worked - Employers sponsor and contribute to the fund and incurs the cost of the pension plan o Accounting for the employer - The pension plan receives the contributions, administers the pension assets, and makes pension payments to the beneficiaries o Accounting for pension plans - A funded pension plan o Means the employer sets money aside for future pension benefits by making payments to a funding agency that is responsible for  Accumulating the pension plan assets  For making payments to the recipients - The assets that are transferred become the assets of the pension plan o Which is a separate legal entity - Stream o Company puts assets in the trust, the trust pays assets to the retirees - Contributory plans o When the employees also voluntarily make payments to increase their benefits - Non-contributory o Employer bears the entire cost and no contributions are made by the employees - Vested o The amounts in the plan become the legal property of the employee  Meaning the employee is entitled to receive benefits even after leaving the company Defined Benefit Pension Plans - Identifies the pension benefits that an employee will receive after retiring - The benefits are typically a function of an employee’s years of service and compensation level in the years approaching retirement - The trusts main goal is to ensure there will be enough pension assets to pay employer’s obligation to employees when they retire o To ensure this, there is usually a requirement that funds be set aside during the service life of the employees - The employer is the beneficiary of a defined benefit trust - As long as the plan continues, the employer is liable for paying the defined benefits - The employer must make up any shortfall in the accumulated assets held by the trust - If excess assets have accumulated in the trust the employer may be able to recapture them through reduced future funding or through a reversion of the funds - The employer assumes the economic risks o Employee is secure because the benefits to be paid on retirement are predefined o The employer is at risk because the cost of the plan is uncertain as it depends on future variables - It is difficult to measure the pension cost and liability to be recognized each period as employees provide services to earn their pension entitlement - An appropriate funding pattern must be established to assure that enough funds will be available at retirement to provide the promised benefits - The expense to be recognized each period is not the same as the employer’s cash funding contribution - Actuaries are used to extensively Defined Benefit Obligation - An employers pension obligation is the deferred compensation obligation that it has to its employees for their service under the terms of the pension plan - The benefits vested to employees is one measure of the pension obligation o Benefits that an employee is entitled to receive even if he or she provides no additional services to the company o Actuaries calculated the vested benefit obligation using vested benefits only, at current salary levels - Another way to measure the obligation is by using both non-vested and vested benefits o The deferred compensation is calculated on all years of an employee’s service, vested and non-vested, using current salary levels o Known as the accumulated benefit obligation - A third method uses vested and non-vested service, and incorporates future salaries projected to be earned over the period to retirement o Projected benefit obligation - Regardless of the method used, the estimated future benefits to be paid are discounted to their PV - The Third method is the best measure specifically for accounting purposes - The Accrued Benefit Obligation (ABO) for accounting purposes is the PV of vested and non-vested benefits earned to the balance sheet date, with benefits measured using employees future salary levels - ABO for funding purposes is measured differently o Tends to focus more on current salary levels Changes in ABO - ABO beginning of period + Current service cost + Interest Cost – Benefits paid to retirees +/- past service costs of plan amendments during period +/- actuarial gains (-) or losses (+) during period (Not on assets though, that’s in plan assets) o = ABO end of period - Current Period Service Costs o The cost of the benefits that are to be provided in the future in exchange for the services that the employees provided in the current period o It is the amount of pension benefit earned in the current period o The method for allocating the estimated cost to the individual years during which the entitlement to the benefits builds  Accrues a relatively equal charge for each period  Prorated on service approach o Actuaries predict the additional benefits that must be paid under the plan’s benefit formula as a result of the employee’s current year of service and then discounts the cost of these benefits to their present value o For defined benefit plans where future benefits depend on the length of service  Actuaries base the accounting calculations on future salary levels and then attributes the cost of the future benefits to the accounting period  Usually between the date of hire and the date when the employee becomes eligible for full benefits o Known as the attribution period  The obligation to provide benefits is attributed to the periods in which the employee provides the service that gives rise to the benefits - Interest cost o Benefits are essentially elements of wages that are deferred  Therefore, time value of money must be considered o Because the obligation is not paid until maturity, it is measured on a discounted basis o As time to maturity passes, interest accrues on the accrued benefit obligation just as it does on any discounted debt  Interest is based on the accrued benefit obligation that is outstanding during the period o Interest rate used is the current yield on high-quality
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