Intermediate accounting 2 exam -- ch 19-21

components of Pension Expense

service cost for the year

interest on the liability

actual return on plant assets

gain/loss

amortization of prior service cost

Service cost for the year

(increases pension expense) – [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. present value of new benefits earned by employees during the year]

interest on the liability

(increases pension expense) –  [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.]

actual return on plan assets

(generally decreases pension expense) – [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.] Actual return = (plan assets ending balance - plan assets beginning balance) - contributions + benefits paid

gain/loss

(decreases/increases pension expense) – [Volatility in pension expense can result from sudden and large changes in the fair value of plan assets (resulting in differences between the actual return and the expected return on plan assets) and by changes in the projected benefit obligation. We will discuss these complex computations later in the chapter.]

amortization of prior service cost

(generally increases pension expense) – [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.]

asset gain

actual return > expected return

(the value is the difference)

asset loss

actual return < expected return

(the value is the difference)

expected return =

fair value of plan assets at the beginning of the year * expected rate of return

items required in note disclosure for pensions

schedule, reconciliation, disclosure of the rates, table indicating the allocation of pension plan assets by category, expected benefit payments, nature and amount of changes, accumulated amount of changes

characteristics of post-retirement healthcare benefits

funding — generally not funded

benefit — generally uncapped and great variability

beneficiary — retiree, spouse, and other dependents

benefits payable — as needed and used

predictability — utilization difficult to predict. level of cost varies geographically and fluctuates over time

equity method to fair value method

previously recognized earnings/losses should remain as part of the carrying amount

no retrospective application

cost basis for accounting purposes is the carrying amount at the date of change. investor applies FV method completely when equity method is no longer appropriate. at next reporting date, investor should record unrealized holding gains/losses in income to recognize the difference between carrying amount and FV

fair value method to equity method

prospective approach

companies account for the effects of the change in (1) the period of change if the change effects that period only or (2) the period of change AND future periods if it affects both

investor company should add the cost of acquiring the additional interest in the investee company to the cost basis of their previously held interest (the present stock holding)

definition of a lease

a contractual agreement between a lessor and a lessee

vested benefit obligation

vested — current

Vested benefits are those that the employee is entitled to receive even if he or she is no longer employed by the company. Most pension plans require a minimum number of years of service to the employer before an employee achieves vested benefit status.

accumulated benefit obligation

vested & nonvested — current

projected benefit obligation

vested & nonvested — FUTURE

largest measurement of pension obligation

challenges of pension accounting

• recognize pension information in the financial statements -vs- disclose it only in the notes

• accrual basis — record expense when employees earn future benefits

• underfunded but viable plans

• lack of consistent terminology

• substantial amount of offsetting in measurement of pension expense and liability

another name for interest rate for the interest costs

settlement rate

how do we treat prior service costs

• prior service costs are initially recorded as an adjustment to OCI (debit OCI and credit Projected Benefit Obligation)

• the prior service cost is then recognized as a component of pension expense over the remaining service lives of the employees who are expected to benefit

• the prior service cost is amortized using either years-of-service or straight-line

lease classification tests

• transfer of ownership

• purchase option

• lease term

• present value

• alternative use

if all are no — finance lease

if any are yes — operating lease

change in accounting principle

retrospective

change in accounting estimate

prospective

correction of an error

prospective

change in entity

retrospective