PensionProf. Alex Ampadu

340 Jacobs Management CenterPhone: 645-3265

Pension Fund Characteristics

• Noncontributory• Contributory• Defined Contribution• Defined Benefit• Vested Benefits

Types of Pension Plans

Features of Pension Plans

Potential Measures ofPension Liability

VestedBenefit

Obligation

AccumulatedBenefit

Obligation

ProjectedBenefit

Obligation

PV of ExpectedCash Flows

Benefits forvestedemployeesat currentsalaries

Benefits for vested andnonvested employeesat current salaries

Benefits for vested and nonvestedemployees at future salaries

(GAAP)

Components of Pension PlansService Cost+ Interest Cost– Actual Return On Plan Assets + Amort. Of Unrecognized PSC± Amort. Of Unrecognized Gain (Loss)

Pension Expense xxCash xx Prepaid/Accrued Pension Cost xx

(Company Funding Difference)

Components of “NET PERIODIC PENSION COST”

• Current Service Cost – The present value of all benefits earned in the current period. In other words, the increase in the PBO (Projected Benefit Obligation) resulting from employee services in the current period. The pension benefit formula is applied to compute a present value. The actuary provides service cost.

• Interest Cost – The increase in the projected benefit obligation during the current period that is due to the passage of time. (Similar to the recognition of interest expense)

• FORMULA:Beg. of period PBO

x Settlement rate = Interest Cost

• Expected Return on Plan Assets – Standard setters decided that having actual return be a part of pension expense could result in large fluctuations in pension expense from year-to-year (performance of plan investments can vary widely over time – think of the recent performance of the stock market). Consequently, this component is defined as actual return adjusted for the difference

between actual and expected return – in other words, expected return.• FORMULA:

Beg. FV of plan assets x Expected rate of return on plan assets = Expected return on plan assets

• We will see shortly that this difference between actual and expected return is reflected in <GAINS> and losses (UNRECOGNIZED)

Example:• The average remaining service life of all active

employee is 5.5 years.

2008 2009 2010 (beginning of the year)

Projected benefit obligation 2,100,000 2,600,000 2,900,000Market related asset value 2,600,000 2,800,000 2,700,000Unrecognized net loss -0- 400,000 300,000

Example (cont)• Corridor Test and Gain/Loss Amortization Schedule

cumulative Minimum

Year PBO Plan Assets (a) Corridor (b) Unrecognized Amortization Loss (a) of Loss

(current yr)x8 $2,100,000 $2,600,000 $260,000 $ -0- $-0-X9 2,600,000 2,800,000 280,000 400,000 21,818 (c) X10 2,900,00 2,700,000 290,000 678,812 70,579 (d)

(a) All as of the beginning of the period(b) 10% of the greater of projected benefit obligation or plan assets(c) $400,000 - $280,000 = $120,000; $120,00 / 5.5 = $21,818(d) $400,000 - $290,000 + $300,000 = $678,192

$678,192 - $290,000 = $388,182$388,182 / 5.5 = $70,579

RELEVANT FACTS

IFRS and GAAP separate pension plans into defined contribution plans and defined benefit plans. The accounting for defined contribution plans is similar.

Both IFRS and GAAP compute unrecognized past service costs (PSC) (referred to as prior service cost in GAAP) in the same manner. However, IFRS recognizes any vested amounts immediately and spreads unvested amounts over the average remaining period to vesting. GAAP amortizes PSC over the remaining service lives of employees.

RELEVANT FACTS

Under IFRS, companies have the choice of recognizing actuarial gains and losses in income immediately (either net income or other comprehensive income) or amortizing them over the expected remaining working lives of employees. GAAP does not permit choice; actuarial gains and losses are reported in “Accumulated other comprehensive income” and amortized to income over remaining service lives.

For defined benefit plans, GAAP recognizes a pension asset or liability as the funded status of the plan (i.e., defined benefit obligation minus the fair value of plan assets). IFRS recognizes the funded status, net of unrecognized past service cost and unrecognized net gain or loss.

At the end of the current period, Oxford Ltd. has a defined benefit

obligation of $195,000 and pension plan assets with a fair value of

$110,000. The amount of the vested benefits for the plan is $105,000.

What amount related to its pension plan will be reported on the

company’s statement of financial position?

a. $5,000.

b. $90,000.

c. $85,000.

d. $20,000.

IFRS SELF-TEST QUESTION

At the end of the current year, Kennedy Co. has a defined benefit

obligation of $335,000 and pension plan assets with a fair value of

$245,000. The amount of the vested benefits for the plan is $225,000.

Kennedy has unrecognized past service costs of $24,000 and an

unrecognized actuarial gain of $8,300. What account and amount(s)

related to its pension plan will be reported on the company’s statement of

financial position?

a. Pension Liability and $74,300.

b. Pension Liability and $90,000.

c. Pension Asset and $233,300.

d. Pension Asset and $110,000.

IFRS SELF-TEST QUESTION

At January 1, 2012, Wembley Company had plan assets of $250,000

and a defined benefit obligation of the same amount. During 2012,

service cost was $27,500, the discount rate was 10%, actual and

expected return on plan assets were $25,000, contributions were

$20,000, and benefits paid were $17,500. Based on this information,

what would be the defined benefit obligation for Wembley Company at

December 31, 2012?

a. $277,500. c. $27,500.

b. $285,000. d. $302,500.

IFRS SELF-TEST QUESTION