AC 311 Notes 4/15

Overview of Postretirement Benefit Plans

• Major focus on two types of postretirement benefit plans:

  • Defined Contribution Plans

  • Employer's contribution is specified but no guaranteed benefits.

  • Example: Employer matches employee contributions up to a limit.

  • Employee is responsible for managing their investments for retirement.

  • Defined Benefit Plans

  • Employer guarantees specific retirement benefits based on a formula.

  • The employer assumes the investment risk and is liable for ensuring there are sufficient funds to cover promised benefits.

Impact on Financial Statements

• Both defined contribution and defined benefit plans have different impacts on financial statements:

  • Defined Contribution Plans:

  • Recognize pension expense based on contribution amount (ll decrease pretax income).

  • No liabilities recorded on the balance sheet.

  • Defined Benefit Plans:

  • Recognize pension expense for current benefits earned (service costs, interest costs, expected return on assets).

  • Must report a liability (Projected Benefit Obligation - PBO) on the balance sheet as well as plan assets.

  • A funded status is presented as either a net pension asset (overfunded) or a net pension liability (underfunded).

Defined Benefit Plan Measurement

• Important to measure amounts owed to employees, consider:

  • Projected Benefit Obligation (PBO):

  • Captures both earned and unearned benefits, adjusted for salary projections at retirement.

  • Accumulated Benefit Obligation (ABO):

  • Focuses on earned benefits using current salary.

Plan Assets Account

• Used to distribute benefit payments.

• Employer (plan sponsor) makes contributions to this account.

• Plan assets are invested to achieve returns that help cover benefit costs.

• The balance sheet reports the net of PBO and plan assets as a single line item:

  • Net credit balance indicates underfunding (net pension liability).

  • Net debit balance indicates overfunding (net pension asset).

Financial Transactions and Accounting for Defined Benefit Plans

• Payment of benefits reduces both the PBO and the plan assets indicator of obligations owed to retirees.

• Recognize pension expenses:

  • Service Cost: Current year's benefits earned by employees.

  • Interest Cost: Increase in liability over time due to the time value of money.

  • Expected Return on Plan Assets: Estimated income from invested assets used to offset pension expense.

• Gains or losses based on the actual vs. expected return are reported in Other Comprehensive Income (OCI) to avoid volatility in income statements.

Detailed Components of Pension Expense in Defined Benefit Plans

• Service Cost: Increases pension expense for benefits earned in the current year.

• Interest Cost: Represents growth in the liability due to time; increases pension expense as well.

• Expected Return on Plan Assets: Decreases current period pension expenses due to anticipated income from asset investments.

• Prior Service Cost Amortization:

  • Reflects retroactively applied benefits due to plan changes; amortized over time through OCI before affecting net income.

• Gains and Losses Amortization:

  • Adjustments due to estimates changing over time for both plan assets and liabilities, reported in OCI rather than the income statement.