ILLUSTRATION 21-1 BASIC FEATURES AND TYPES OF PENSION PLANS. (defined). in the future is a computation.

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1 ILLUSTRATION 21-1 BASIC FEATURES AND TYPES OF PENSION PLANS Defined Contribution Plan The amounts of the contributions are known (defined). No promise regarding size of benefits. Defined Benefits Plan The amounts of benefits are known (defined). The amount of contribution needed now to pay benefits in the future is a computation. Employer (company) Contributions $ Pension Fund Investments Earnings $ $ Fund Assets Benefits $ Pension Recipients (employees) Must account for the costs of and contributions to the pension plan A separate legal and accounting entity. Maintains a set of books. 146

2 ILLUSTRATION 21-2 COMPONENTS OF PENSION EXPENSE COMPONENTS OF PENSION EXPENSE Service Cost + Interest Cost Actual Return On Plan Assets Pension Expense xx + Amort. Of Unrecognized PSC Cash xx {Company Funding ± Amort. Of Unrecognized Gain (Loss) Prepaid/Accrued Pension Cost xx {Difference Service Cost The actuarial present value of benefits earned by employees for the current year of service, measured by the actuary using the benefit formula and discounted to present value using the assumed discount (settlement) rate. Interest Cost The assumed discount rate multiplied by the beginning of year plan obligation measured as the projected benefit obligation. This indicates the increase in plan liabilities during a year due to the passage of time- in effect, interest expense for the year on an existing liability. Actual Return On Plan Assets The actual return on plan assets during the year determined based on the fair value of plan assets. This reduces pension expense it represents the investment return for the year on assets previously set aside to satisfy plan obligations. Amortization Of Unrecognized Prior Service Costs A plan initiation or amendment granting retroactive benefits to employees for services rendered previously results in an immediate increase in the projected benefit obligation and a deferred cost to be amortized. Prior service cost is amortized over the future serviceyears of employees. Amortization Of Unrecognized Net Gain Or Loss Amortization of the combination of (a) the current year's asset gains and losses and liability gains and losses and (b) the unrecognized net gain or loss from previous years. This may decrease or increase pension expense. 147

3 ILLUSTRATION 21-3 EXAMPLE: AMORTIZATION OF UNRECOGNIZED PRIOR SERVICE COST The pension plan covers 200 employees and prior service cost is $98,000. Number of Retirement Group Employees on Dec. 31 A B C D E F Computation of Service-Years Service-Years Year A B C D E F Total $98,000/700 = $140 per service-year. Annual Amortization of Prior Service Cost Service- Cost Per Annual Year Years Service-Year = Amortization $140 $28, , , , , , $98,

4 ILLUSTRATION 21-4 EXAMPLE: AMORTIZATION OF UNRECOGNIZED GAINS OR LOSSES The average remaining service life of all active employees is 5.5 years (beginning of the year) Projected benefit obligation 2,100,000 $2,600,000 $2,900,000 Market-related asset value 2,600,000 2,800,000 2,700,000 Unrecognized net loss 0 400, ,000 Corridor Test and Gain/Loss Amortization Schedule Minimum Projected Cumulative Amortization Benefit Plan Unrecognized of Loss Year Obligationa Assetsa Corridorb Net Lossa (For Current Year) 1997 $2,100,000 $2,600,000 $260,000 $ 0 $ ,600,000 2,800, , ,000 21,818c ,900,000 2,700, , ,182 70,579d aall as of the beginning of the period. b10% of the greater of projected benefit obligation or plan assets. c$400,000 $280,000 = $120,000; $120, = $21,818 d$400,000 $21,818 + $300,000 = $678,192 $678,182 $290,000 = $388,182 $388, = $70,579 (000s omitted) (100) The Corridor (200) (300)

5 ILLUSTRATION 21-5 THE PENSION WORK SHEET Both sets of records below are treated as one for entering transactions and events. Debits and credits must be equal for each transaction or event. Zarie Company Pension Work Sheet 1997 General Journal Entries Memo Record Annual Prepaid/ Projected Pension Accrued Benefit Plan Items Expense Cash Cost Obligation Assets Balance, Jan. 1, ,000 Cr. 100,000 Dr. (a) Service cost 9,000 Dr. 9,000 Cr. (b) Interest cost 10,000 Dr. 10,000 Cr. (c) Actual return 10,000 Cr. 10,000 Dr. (d) Contributions 8,000 Cr. 8,000 Dr. (e) Benefits 7,000 Dr. 7,000 Cr. Journal entry, 12/31 9,000 Dr. 8,000 Cr. 1,000 Cr.* Balance, Dec. 31, ,000 Cr.** 112,000 Cr. 111,000 Dr. *$9,000 $8,000 = $1,000 **$112,000 $111,000 = $1,000 Net balance = $1,000 Cr. (These two items must be in equal amount $1,000 in this example. These must be recorded in the regular general journal posted to the formal general ledger accounts. Maintains balances for the unrecorded (noncapitalized) pension items. Entry to record pension expense Pension Expense. 9,000 Cash. 8,000 Prepaid/Accrued Pension Cost 1,000 Source: C.G. Avery 150

6 ILLUSTRATION 21-6 PENSION RECONCILIATION SCHEDULE PENSION RECONCILIATION SCHEDULE Actuarial present value of benefit obligations: Vested benefit obligation $ xxx Accumulated benefit obligation $ xxx Projected benefit obligation (end of period) $ (xxxx) Plan assets at fair value (end of period) xxx Projected benefit obligation in excess of plan assets (xxx) Unrecognized prior service cost xx Unrecognized net gain or loss xx Prepaid/accrued pension cost (xxx) Adjustment required to recognize minimum liability (xx) Prepaid/accrued pension cost recognized in the balance sheet $ xxx Appears on Pension Work Sheet 151