An Overview of Pension Accounting

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History and Evolution of Pension Accounting Rules and Regulations

The fundamentals of pension accounting were mostly laid out by SFAS 87, Employers’ Accounting for Pensions, issued by the FASB in December 1985. This guidance evolved into ASC Topic 715 – Compensation—Retirement Benefits after the FASB published the new accounting standard update in April 2015. ASC Topic 715 came with some major changes to the original requirements such as the requirement to recognize the funded status of the plan on the sponsor’s balance sheet (SFAS 158) and a more recent change to the presentation requirements.

SFAS 132, Employers’ Disclosures about Pensions and Other Postretirements Benefits, was issued in February 1998 and substantially altered the required financial statement disclosures. In December 2003, a revision to SFAS 132 was issued. It retained the original disclosure requirements of SFAS 132 but required additional disclosures from employers about the assets, obligations, cash flows, and the net periodic benefit cost of defined benefit pension plans and their defined benefit postretirement plans.

SFAS158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, was issued in September 2006. It amended the recognition requirements by requiring an employer to recognize an asset or liability for the overfunded or underfund status of a defined benefit postretirement plan in the statement of financial position. This moved the information on the funded status of postretirement plans from the notes of the financial statements to the statements themselves.

The funded status of a benefit is measured as the difference between the fair value of the plan assets and the benefit obligation. The benefit obligation of a pension plan is the projected benefit obligation. For other postretirement benefit plans such as retiree health care plans, the benefit obligation is the accumulated postretirement benefit obligation. Bringing the funded status on the balance sheet also brought on to the balance sheet unamortized prior service costs and unamortized actuarial gains or losses. These amounts are, firstly, initially recognized in other comprehensive income (however, there are alternatives available for recognizing actuarial gains or losses). These amounts are then, secondly, accumulated into accumulated other comprehensive income in equity of the sponsor. These amounts are then thirdly and finally subsequently reclassified (recycled) to net periodic benefit cost in subsequent years.

ASC Topic 715 discusses the accounting and reporting standards affecting pensions. ASC Topic 715 requires the following:

  • A standardized method for measuring net periodic pension cost.
  • Recognition of the funded status of the plan as either a liability or an asset measured as the difference between the projected benefit obligation and the fair value of the plan assets.
  • Prescriptive disclosures.

SFAS 132 [Employers’ Disclosures about Pensions and other Postretirement Benefits] – December 2003 revision requires:

  • Retains the original disclosure requirements of SFAS 132.
  • Requires additional disclosure from employers about assets, obligations, cash flows, and the net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans.

SFAS 158 [Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans] requires:

  • Amends recognition requirements by requiring an employer to recognize as an asset or liability the overfunded or underfunded status of a defined benefit postretirement plan in the statement of financial position.
    1. Information on the funded status of the postretirement plans is moved from the notes of the financial statements to the statements themselves.
    2. The funded status of a benefit is measured as the difference between the fair value of the plan assets and the benefit obligation.
    3. he benefit obligation of a pension plan is the projected benefit obligation.
    4. For other postretirement benefit plans such as retiree health care plans, the benefit obligation is the accumulated postretirement benefit obligation.
  • Along with bringing the funded status on the balance sheet, the FASB also requires the balance sheet to hold the unamortized prior service costs and unamortized actuarial gains on losses.
    1. These amounts are also accumulated into the accumulated other comprehensive income in equity of the sponsor.
    2. These amounts are subsequently reclassified, also known as “recycling”, to net periodic benefit cost in subsequent years.

ASU 2015-04 issued on April 2015 allows the following:

For an entity with a fiscal year-end that does not coincide with a month end, ASU 2015-04 provides a practical expedient that permits the entity to measure defined benefit plan assets and obligations using the month-end that is closest to the entity’s fiscal year-end and apply that practical expedient consistently from year to year.

ASU 2017-07 issued in March 2017 changes the presentation of the net periodic benefit cost as follows:

  • The service cost element is different from the other components of net periodic benefit cost since ti is the one component that is a consequence of the employee’s work efforts during the period. As a result, an employer reports the service cost element in the same financial statement categories as other components of compensation cost.
  • The other components of net periodic benefit cost are reported separately from the service component and outside the subtotal of income from operations, if one is presented.
  • Furthermore, if an entity’s net periodic benefit cost qualifies for capitalization (such as a cost of internally manufactured inventory or a self constructed asset), only the service cost element is eligible for capitalization. You cannot include in the cost of building an asset the other costs of pensions for your employees.

Pension Accounting Public Disclosures

715-20-50-1 requires that:

An employer that sponsors postretirement benefit plans must provide the following information, separately for pension plans and other postretirement benefit plans. (1) Amounts related to the employer’s results of operations are disclosed for each period for which a statement of income is presented. (2) Amounts related to the employer’s statement of financial position are disclosed as of the date of each statement of financial position presented.

All of the following must also be disclosed:

  • How investment allocation decisions are made, including the factors influencing investment policies and strategies.
  • The classes of plan assets. Asset classes include cash, equity securities (e.g. U.S. companies and International Companies), mortgage-backed securities, etc., etc.
  • The inputs and valuation techniques used to measure the fair value of plan assets.
  • The effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period.
  • Significant concentrations of risk within plan assets. (1) Fair value measurements using quoted prices in active markets for identical assets or labilities (level 1). (2) Significant other observable inputs (level 2). (3) Significant unobservable inputs (level 3).

Pension Accounting Nonpublic Disclosures

A nonpublic entity is not required to disclose certain information. However, A nonpublic entity that sponsors one or more defined benefit pension plans or one or more other defined benefit postretirement plans must provide all of the following information, separately for pension plans and other postretirement benefit plans.

Amounts related to the employer’s results of operations must be disclosed for each period for which a statement of income is presented. Amounts related to the employer’s statement of financial position must be disclosed as of the date of each statement of financial position presented. The objectives of the disclosures about postretirement benefit plan assets are to provide users of financial statements with an understanding of:

  1. How investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies.
  2. The classes of plan assets.
  3. The inputs and valuation techniques used to measure the fair value of plan assets.
  4. The effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period.
  5. Significant concentrations of risk within plan assets.

Pension Accounting Subsequent Measurement

The measurements of plan assets and benefit obligations required by subtopic 715-30-35-61 shall be as of the date of the employer’s fiscal year-end statement of financial position except in both of the following cases: (1) The plan is sponsored by a subsidiary that is consolidated using a fiscal period that different from its parent’s, as permitted by paragraph 810-10-45-12. (2) The plan is sponsored by an investee that is accounted for using the equity method of accounting under paragraph 323-10-35-6, using financial statements of the investee for a fiscal period that is different from the investor’s, as permitted by that Subtopic.

If the aforementioned exceptions apply, the employer shall measure the subsidiary’s plan assets and benefit obligations as of the date used to consolidate the subsidiary’s statement of financial position and shall measure the investee’s plan assets and benefit obligations as of the date of the investee’s financial statement used to apply the equity method.

An asset for an overfunded plan should be classified as a noncurrent asset in a classified statement of financial position. In the case of underfunded plans, the amount reported as a current liability is the amount by which the actuarial present value of benefits payable in the next 12 months (or the operating cycle, if longer) exceeds the fair value of plan assets. The rest of the underfunding is reported as a noncurrent liability in a classified statement of financial position (FASB ASC 715-20-45-3).

Changes in the funded status are recognized as comprehensive income (or changes in unrestricted net assets of a not-for-profit organization) in the year in which the changes occur. Thus, all components of net periodic benefit cost are recognized either in current period net income (unless a portion of service cost qualifies for capitalization) or other comprehensive income.

Actuarial gains or losses and prior service costs or credits that arise during the period, but are not recognized as components of net periodic benefit cost for the period, are recognized as components of other comprehensive income.

Actuarial gains or losses may either be recognized :

  • Immediately in net income.
  • Immediately in net income Initially in other comprehensive income and subsequent reclassified to net income using a corridor approach.
BIG PICTURE INSIGHT

Topic 715, Compensation-Retirement Benefits, describes and defines the requirements of pension accounting and reporting. These requirements provide that:

  1. Periodic pension cost is measured by a standard method designed to improve comparability and
    understandability;
  2. A liability is recognized when the projected benefit obligation exceeds the fair value of plan assets; conversely, an asset is recognized when the fair value of the plan assets exceeds the projected benefit obligation; and
  3. The service cost component of net periodic benefit cost is included in the financial statement components where other employee compensation is recorded and the other components of net periodic benefit cost recognized in net income are reported below operating income.