CPA Review-New rules for accounting for Pensions Part II

I am in a fantasic mood this week!  I got my final CPA grade and I passed.  I am done!  I have the State requirements to complete then I will be a CPA!  Just keep at it and study and you will pass too!

Last night I received an e-mail from a reader with questions on my post covering the new pension rules.  I thought I would use the questions for today’s post.

Q. This is probably a dumb question. By crediting Accu’d OCI, my understanding was this has the effect of increasing  the amount, since it is an equity account, rather than reducing it as you say.

It is an equity account, however, it is more of a holding spot for a variety of charges and income a company may have, pensions included.  It works similar to an offset account, in other words if you debit it, there is an increase in the OCI and a credit reduces the OCI.  It runs the opposite of what you expect an equity account to run.  Sorry, I am trying to stick to layman’s terms as much as I can for other readers.

Q. This is related to Q.(1). I’m struggling to make sense out of the journal entries. Also, am I right in understanding that for the current period, then, the Gain or Loss is recorded as Accu’d OCI (or just OCI ?) and in subsequent periods amortized to expense? And the amount amortized *this* period is based on prior period unrecognized Gains or Losses, not incuding this year’s?

To answer the second question I thought I would include examples and explinations of the calculations to hopefully draw out what was missed in my post.  This comes from the text where I got my information.

I.  Pension Expense

Debit Pension Expense (equal to the sum of the credits)

Credit Prior Service Cost (in Accumulated OCI) (for the portion amortized)

Credit Net Gains/Losses (in Accumulated OCI) (for the portion amortized)

Credit Pension Liability (for the sum of the service cost + interest cost +

expected return on plan assets)

Note:

The Prior Service Cost is included in Accumulated Other Comprehensive

Income.  A debit balance means the PSC resulted from an increase in the PBO

due to retroactive benefits.            The initial recording of the PSC was a debit

to Accumulated OCI and a credit to Pension Liability for the actuarially

determined increase in the PBO due to the retroactive provision of improved

benefits.  Therefore, PSC is credited when it is amortized.  The remaining

unamortized portion is in Accumulated OCI in Stockholders’ Equity.

The Net Gains/Losses amount is also included in Accumulated OCI, as either a

debit or credit, depending on whether it is net gains (credit) or net losses

(debit.)  Amortization of Net Gains/Losses reduces the balance in

Accumulated OCI.

The pension liability is a balance sheet liability on the books of the

company.  It is not the PBO, but instead represents amount owed to fund the

plan.

II.  Funding the Pension Plan

Debit Pension Liability (a balance sheet account.a liability on the

company’s books)

Credit Cash

This Journal Entry is for the amount of cash deposited into the plan’s

assets.  The determination of the cash contribution is separate from the

determination of the pension expense, and is based on legal requirements.

CPA Exam questions will usually provide the amount of cash as a “given.”

III.  Initial Recording of Gains and Losses

Debit Losses-Other Comprehensive Income

Credit Gains-Other Comprehensive Income

Debit or Credit the balancing amount to Pension Liability

Note:  these are the gains/losses that arise from changes in assumptions to

the PBO and/or from the differences between expected and actual returns on

plan assets.  They are subsequently amortized, as discussed earlier.  The

unamortized balances are reported in Accumulated Other Comprehensive Income

in stockholders’ equity.

IV.  New Prior Service Cost

Debit Prior Service Cost

Credit Pension Liability

This is the actuarially determined amount of prior service cost, as

discussed above.  The unamortized portion remains in Accumulated Other

Comprehensive Income until recognized in pension expense.

A SAMPLE PROBLEM

Here are some FACTS and then some calculations you need to know about the

new FAS.  (I hope this table of information comes through in a fairly

legible format.  In case it doesn’t, the first column is the item, the first

number is for 2008, and the second number is for 2009.)

Description            2008            2009

Plan assets at beginning of year at fair value            $540,000 Unknown

PBO at beginning of year            $540,000 Unknown

Service cost for the year            32,400            33,600

Discount/settlement rate            9%            9%

Expected return on plan assets            7%            7%

Actual return on plan assets            37,800            45,000

Plan contributions for the year 38,400 45,800

Benefit payments made for the year            20,400            28,800

ABO at the end of the year            510,000 685,000

Accrued/prepaid pension cost at the end of the year            Unknown

Unknown

Prior service costs (granted on 1/10/09) due to plan amendments 0

40,000

Amortization of prior service costs    0            4,000

Actuarial loss due to changes in actuarial assumptions            0            50,000

Amortization of actuarial loss            0            0

Average remaining service life of employees            10 yrs            10 yrs

Funded status of plan at end of year            Unknown Unknown

Additional pension liability adjustment required at end of year 0

Unknown

Calculations, Journal Entries, Explanations and all those fun things:

=========2008=========

Calculation of Pension Expense for the year 2008:

$32,400 Service cost for the year (given above)

$48,600 Interest on beginning of the year PBO ($540,000 x 9%)

-$37,800 Expected return on plan assets ($540,000 x 7%)      (also equals

actual return)

$43,200 Total Pension Expense

Journal Entry at end of 2008:

Debit Pension Expense for $43,200 (calculated above)

Credit Cash for $38,400 (given above)

Credit Pension Liability for $4,800 (to balance journal entry)

Calculation of funded status at end of 2008:

PBO at end of year = $540,000Beginning Balance + $32,400Service Cost +

$48,600Interest Cost – $20,400Payments to Retirees = $600,600

Assets at end of year = $540,000Beginning Balance + $38,400Contributions -

$20,400Payments + $37,800Return = $595,800

Difference (liability exceeds assets, underfunded) = $4,800

This underfunded amount is shown in Pension Liability on the company books.

It resulted from the fact that the expense recorded was more than the cash

payments to the fund.  (See Journal Entry above.)  (Remember, no minimum

liability is required under FAS 158, because the Liability is being recorded

via the normal journal entries.)

=========2009=========

In 2009, two items arise that need our special attention:  Prior Service

Cost and Loss Due to Change in Assumptions Regarding PBO.  PSC is $40,000,

and will be amortized over 10 years.  (The Facts above show $4,000

amortization for 2009.)  The Loss is $50,000, but is not amortized; the facts

above show that the amortization of loss is $-0-.  (This means the

accumulated losses must not have passed the “corridor” test for

amortization.  Rarely on the Exam do you actually need to calculate the

amount of loss; it is most often just given to you.)

We do need to record these amounts on the books.  The journal entry is:

Debit Prior Service Cost-Accumulated Other Comprehensive Income for $40,000

Credit Pension Liability for $40,000

Debit Net Pension Gains/Losses-Accumulated Other Comprehensive Income for

$50,000

Credit Pension Liability for $50,000

(This is a new requirement with FAS 158.)

Calculation of Pension Expense for the year 2009:

$33,600 Service cost for the year (given above)

$57,654 Interest on beginning of the year PBO (($600,600 + $40,000Prior

Service Cost as of beginning of the year) x 9%)

-$41,706            Expected return on plan assets ($595,800 x 7%)

=$49,548            Sub-total – Expense

$4,000             Amortization of Prior Service Cost

=$53,548            Total Pension Expense

Journal Entry at end of 2009:

Part 1 of the Journal Entry:

Debit Pension Expense for $49,548

Credit Cash for $45,800

Credit Pension Liability for $3,748

Part 2 of the Journal Entry:

Debit Pension Expense for $4,000

Credit Prior Service Cost-Accumulated Other Comprehensive Income for $4,000

Note:  the Prior Service Cost amortization of $4,000 is credited to

Accumulated OCI.

Calculation of funded status at end of 2009:

PBO at end of year = $600,600 + $33,600Service Cost + $57,654Interest-

$28,800Payments + $50,000Loss + $40,000Prior Service Cost= $753,054

Assets at end of year = $595,800 + $45,000Actual Return + $45,800Plan Assets

- $28,800Payments =  $657,800

Difference (liability exceeds assets, underfunded) = $95,254

Liability balance on company’s balance sheet before considering the funded

status of the Plan:

2008

$4,800 (equal to underfunded balance in 2008, see 2008 journal entry)

2009

$90,000 (addition of Prior Service Cost plus Losses on PBO)

$3,748 (addition to liability in 2009 Pension Expense journal entry)

Sub-total            $98,548

Because the balance sheet liability ($98,548) exceeds the underfunded status

($95,254), no additional journal entry is required.

Well, I hope you made it through these calculations.  Hopefully this will clear up your understanding of the pension problem.