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.