May 5 2025 113 Notes
Exercise 40: PBO and Unknown Variables
- Beginning balance of Projected Benefit Obligation (PBO): 146,000.
- Actuary states PBO pending balance: 140,000.
- PBO is a balance sheet liability; its balances are normally on the credit side.
- Interest cost exists because the PBO is a present value number.
Interest Cost
- Interest cost increases the PBO.
- If not given, calculate it by multiplying the discount rate by the beginning balance of PBO.
Journal Entries and Pension Expense Components
- Understanding journal entries helps identify all affected accounts, crucial for exams.
- Pension expense has five components:
- Service cost
- Interest cost
- Actuarial gain/loss on PBO
- Prior service cost (PSC) amendment
- Amortization of net gain or loss
Actuarial Gain on PBO
- Actuarial gains/losses arise from actuarial assumptions (mortality, retirement rates, etc.) affecting the present value calculation.
- A gain on a liability allows for decreasing the liability (debit).
- Gains are not immediately recognized in regular income; they're temporarily placed in Other Comprehensive Income (OCI).
- OCI eventually goes to Accumulated Other Comprehensive Income (AOCI).
Prior Service Cost (PSC) Amendment
- PSC amendments involve retroactive benefits granted through negotiations (often with unions).
- These new benefits increase the liability (credit).
- Companies don't immediately recognize the full liability in regular income; instead, it goes to OCI (debit to OCI, credit to PBO).
Benefits Paid
- Benefits paid reduce the PBO liability (debit).
- Dollars are disbursed from the plan assets (credit), not directly from cash.
- Cash contributions are made to a trustee account (plan assets), which are then invested.
Service Cost
- Service cost represents the new benefits earned in the current period by employees and is determined by the actuary.
- It increases the PBO, as it's an additional obligation (credit).
Plan Assets
- Plan assets have a normal debit balance.
- Actual return on plan assets is calculated as a percentage of the beginning balance.
- Benefits paid come out of plan assets.
Smoothing and Expected Return on Plan Assets
- FASB allows smoothing the effects of pension accounting due to market volatility.
- Companies estimate an expected return on plan assets.
- Expected return reduces pension expense (credit).
- If actual return differs from expected return, the difference goes to OCI as a gain or loss.
Actual vs. Expected Return
- If Expected return > Actual return = Loss (Debit to OCI)
- If Actual return > Expected return = Gain (Credit to OCI)
OCI and AOCI
- OCI items eventually go to AOCI.
- PSC goes into its own AOCI account.
- Gains and losses (actuarial and return on plan assets) are netted together in one AOCI account.
Contributions
- Contributions are when the employer puts money into the plan assets with the trustee, so debit plan assets and credit cash.
Exercise 44
- Service cost: 60,000
- Expected return: 92,80
- Amortization of PSC: 2,000
- Amortization of net pension loss: 2,222
- Benefits: 40,0000
- One One PPO: 194,000
- Discount rate: 10%
Discount Rate
- The discount rate reflects the present value nature of the PBO liability.
- Beginning-of-period carrying value * effective rate = interest. In pensions, the effective rate is the discount rate.
- In bonds, it is the market or yield rate, and in leases, it is the implicit rate.
Service Cost (Detailed)
- Service cost increases pension expense (debit) and increases the PBO (credit).
Interest Cost (Detailed)
- Beginning of the period carrying value (PBO) times the discount rate equals the interest cost for the period.
- Interest cost increases pension expense (debit) and increases the PBO (credit).
Expected Return (Detailed)
- Expected return decreases pension expense (credit).
- If actual return equals expected return, no further action is needed.
Unequal actual and expected returns
- If Actual return > Expected return: credit pension expense; a gain. Results in a credit to OCI
- If Actual return < Expected return: A loss that results in a debit to OCI
Amortization of PSC (Detailed)
- Amortization of PSC recognizes a portion of the previously deferred cost into pension expense (debit).
- The credit is to OCI amortization of prior service cost, which flows to AOCI.
Amortization of Net Pension Loss (Detailed)
- If the AOCI account has a large debit balance (net loss), a portion is amortized into pension expense.
- Amortization of net loss increases pension expense (debit).
- The credit is to OCI amortization of net loss.
- If the balance had been a Gain = credit in the AOCI then it will be a benefit to the expense
Nuts and Bolts Accounting
- OCI and AOCI always have the same directional effect (debit or credit).
- Same directional impact as retained earnings
Benefits Paid (Revisited)
- Benefits are paid out of plan assets (credit), reducing the PBO liability (debit).
Financial Reporting: Components of Pension Expense
- Important to know how entries affect financial statements.
Reporting
- Plan assets beginning balance: 78,0750
- PBO starting balance: 75,000
- AOCI PSC beginning balance: debit side
Financial Statement Presentation
- Service cost debits the pension expense and credit to the ABO.
- Prior service cost goes to amortization.
- Plan assets earn something.
Balance Sheet Reporting
- Asset is bigger than the liability = overfunded.
- Liability is bigger than the asset, the pension is underfunded.
AOCI
- AOCI prior service cost: Bracketed because a debit balance
- If there is an AOCI instead of this = plus
- If there is an AOCI net loss it would be placed in brackets.
Amortization
- Non operating. Should be an expected return.
- The returns reduce the pension expense.
Income Statement Items
- Operating item: Curtis cost
- Nonoperating: Everything else
Comprehensive income statement
- Pension, service cost: 49000. Under operating expense
- Beneath income an OCR may be needed.
- Gain or loss on asset plant
- Gain or loss on
- A new plan amendment.