Pension Accounting Before and After Dec. 2006

Summaries

The GAAP allows delayed recognition of certain events that affect the value of the plan assets and obligations.

Old standard: unrecognized not need to report in balance sheet

New standard: reported immediately in balance sheet

Old standard:

Funded Status (= new standard Net Pension asset)

+ unrecognized loss

+ unrecognized cost

+ unrecognized transition obligaton

= Net Pension asset

In both the new and old standards, pension is reported in netted amount. As a result, a small change in assumption can have big impact on Pension (net liability/asset). Companies can report different pension funds separately. So it is possible to have both asset and liability in the balance sheet.

*** Company makes funding decision based on the net pension obligation. Plan assets can only be used for pension benefits.

Pension plan expense is a measure of the PV of the cost to provide the future benefits.

The pension cost is a smoothed one based on an expected return on assets. Then deferment and amortization are used. (Both old and new standards)

First 10% (of the greater of the PBO or market related value) is deferred and the excess will be amortized.

Market Related Value: average asset value when we amortize the difference between the actual and expected return over the next 5 years.

Therefore,

Ending market related value = Beginning market related value + expected return/contributions – benefits paid +/- 20% of deferred asset gains/ losses over past 5 years

Expected return on asset  = expected rate x market-related value

Actual return on asset = actual rate x FMV

Funded Status (True Economic Status of the Fund)= Asset FV  - PBO (underfunded <0, overfunded >0)

Old standards: unrecognized events are off balance sheet:

Net Pension Asset (liability) (This is reporting/ accounting value) = Funded status + unrecognized losses, service cost, transition obligation – unrecognized gains/ prior transition asset

Then reconciliation of the funded status to the net pension asset/liability in the footnote.

Minimum Liability Allowance: ABO – FV of asset has to be shown in the balance sheet. If the liability (calculated from PBO) is less than that, then must add an item called minimum liability allowance to the liability and intangible asset to the asset side.

Non-pension postretirement benefits (e.g. health care)

1. Accumulated postretirement benefit obligation (APBO) ~ PBO but use different discount rate, needs to estimate and disclose the health care cost trend rate.
2. Funded status = FV of asset  - APBO
3. No Minimum liability adjustment

New Standards:

Unrecognized events have to appear in the balance sheet. So it is the real funded status.

Calculation of pension expense is still the same.

Income statement is still the same as in the old standard (still include unrecognized items).

After changing the net pension liability (e.g. decrease 1000), the deferred tax (increase by tax rate =1000×0.4) and equity (decrease by 1000×0.6) have to adjusted accordingly!