More Present Value - Pensions

SFAS 87, SFAS 112, SFAS 88, SFAS 106, SFAS 132(R) and SFAS 158 all cover pensions and postretirement benefits.

To get started here are a few terms, these may not make sense now, but will show up on a few CPA problems:

• Defined Contribution Plan - A plan that specifies a company's contribution. The accounting for this is apparently simple. The sponsor company only needs to make one journal entry. Out of 41 practice problems in the Pensions module in my Wiley book, not a single one involved defined contribution plans. That's probably because it's not as complex as...
• Defined Benefit Plan - It's a plan that specifies the benefits paid to employees at retirement. Contributions are calculated based on actuarial estimates. The accounting for this is very complex. A sponsor company needs to make multiple journal entries. Out of 41 practice problems, about half involved this type of plan. The other half involved other postretirement plans which share a lot of common characteristics.
• Accumulated Benefit Obligation (ABO) - PV of benefits based on current and past compensation levels. Not future.
• Projected Benefit Obligation (PBO) - PV of benefits based on future compensation levels.
• Fair Value of Plan Assets - market value of the securities and other investments in the pension fund
• Vested Benefits - benefits already earned by employees by reason of retiring or meeting some other requirement. The employee has a right to these benefits whether she continues working or not.
• Prior Service Cost - costs of benefits based on past service. When a new plan is implemented or an existing plan is amended, the company has to go back and add past costs to current balances as if they had those costs on the books all along.
• Service Costs - PV of all pension benefits earned by a company's employees in the current year. This increases PBO. Usually given in a problem.
• Interest Cost - Increases PBO by passage of time. Usually the problem will give you a discount rate and a beginning PBO. Multiply these to get interest cost.
• Actual or Expected Return on Plan Assets - They'll usually give you a rate of return and the FV of plan assets. Multiply these to get return.

Net Periodic Pension Expense - this is a fancy name for pension expense. A lot goes into NPPE, so I looked at an old Becker book, and I found the mnemonic "SIR-AGE" helpful.

• S - Service cost (current), usually given
• I - Interest cost. discount rate * beginning PBO
• (R) - Return on plan assets. This will decrease NPPE (it's a return on the market).
• A - Amortization of Prior Service Costs.
• (G) - Gain or loss amortization. A gain will decrease NPPE (just like a return).
• E - Existing net obligation (liability) or net asset amortization

These are the six components that go into Net Periodic Pension Expense. Here's a little more detail about each:

• Service Cost - Usually given, but is simply the difference between beginning and ending Unrecognized Prior Service Cost
• Interest Cost - Discount rate * FV of plan assets
• Return on Plan Assets - Expected rate of return * beginning PBO. Remember to subtract the return on plan assets from NPPE. A return decreases expense, just like a gain.
• Amortization of Prior Service Cost - Usually given, but if the problem gives 12/31/yr. 2 unrecognized PSC and 12/31/yr. 1 unrecognized PSC, simply subtract these to get the amortization of the PSC
• Gain/Loss Amortization - A gain will decrease expense and a loss will increase it. For example, one of the problems in my Wiley book gives unrecognized net loss, market-related asset value (M-RAV), and PBO. Take the larger of PBO and M-RAV. Whichever is larger, multiply it by 10%. Got it? Then subtract the unrecognized net loss from that number. Take the difference and divide it by the average remaining service period (usually given). This is a summary of the "Corridor Approach" confusingly described in SFAS 87, para. 187-189. Do a problem to get a better idea. Agree?
• Existing Net Obligation/Net Asset Amortization - If PBO > FV of plan assets, you have an obligation; if FV > PBO, you have an asset. If PBO > FV, then take the difference and divide it by EITHER 15 years OR the average employee job life, whichever is greater.

That's a summary that may not make sense until after studying the Pensions module.

Disclosures

Under SFAS 87 and SFAS 106, the funded status of pension plans was only required to be reported in the footnotes. SFAS 158 came out in Sept. 2006 (finally, I know) to require funded status to be reported right on the Balance Sheet. SFAS 158 also eliminated delayed recognition of certain components allowed under 87 and 106. Lastly, 158 requires a company to consider tax effects.

I was surprised to learn that a company must disclose the effects of a one-percentage-point (not two or ten, some questions seriously try to throw you off this way...) increase or decrease in the trend rates for health care costs for the aggregate of the service and interest coasts components and the accumulated postretirement benefit obligation for the following year and years after. I haven't seen a practice problem that actually requires that to be computed, but there are a few that simply ask if you know that. This is required under SFAS 132(R) starts on pg. 24. SFAS 132(R) requires a list of disclosures including: amount of unrecognized prior service cost and fair value of plan assets.

I should add that this post is meant for people who have already studied this module and would like a summary or regular person's interpretation. It's also meant for me to see if I have retained the information well enough. If there are any mistakes, please point them out.

Thanks to the four people who may have read this far.