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Table of Contents for

Financial Accounting Theory and Analysis:
Text and Cases, 11th Edition

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Prev Previous Chapter
CHAPTER 13: Leases

Next Next Chapter
CHAPTER 15: Equity
For many years, employers have been concerned with providing for the retirement needs of their workforce.
This concern resulted in the adoption of pension plans on a massive scale after World War II. Generally,
companies provide for pension benefits by making periodic payments to an outside funding agency. The
agency then assumes responsibility for investing the pension funds and making periodic benefit payments to
the recipients.
The two most commonly encountered types of pension plans are defined contribution plans and defined
benefit plans. A defined contribution plan sets forth a certain amount that the employer is to contribute to the
plan each period. For example, the plan may require the employer to contribute 8 percent of the employee's
salary each year. However, the plan makes no promises concerning the ultimate benefits to be paid. The
retirement benefits actually received by the recipients are determined by the return earned on the invested
pension funds during the investment period.
The details of a defined benefit plan agreement specify the amount of pension benefits to be paid out to plan
recipients in the future. For example, a company plan might promise that an employee retiring at age 65 will
receive 2 percent of the average of the highest five years' salary for every year of service. An employee
working for this company for 30 years will receive a pension for life equal to 60 percent of the average of his or
her highest five salary years. Companies that provide defined benefit pension plans (DBPPs) must make
sufficient contributions to the funding agency to meet benefit requirements when they come due. Although no
specific amount is required to be funded each period, the Employee Retirement Income Security Act (Discussed
later in the chapter) does impose minimum funding requirements on these plans.
The first employer-sponsored retirement plan was established in 1875 by the American Express Company.
Other pension plans by utilities, banks, and manufacturing companies followed shortly thereafter. Almost all
the early pension plans were defined benefit plans. However, in recent years, companies have begun moving
away from defined benefit plans as the plans have become more expensive to fund and as retirees have begun to
live longer. In their place has come a growth in defined contribution plans. As a result of this shift, there are
now about 30,000 defined benefit plans, compared to the all-time high of 112,000 in 1985.1
Accounting for defined contribution plans is relatively straightforward. Because the risk for future benefits is
borne by the employee, the employer's only cash outflow is the annual contribution to the pension plan fund.
Thus periodic pension expense is equal to the amount of promised annual contribution. When a company
adopts a defined contribution pension plan, the employer's financial statements should disclose the existence of
the plan, the employee groups covered, the basis for determining contributions, and any significant matters
affecting comparability from period to period (such as amendments increasing the annual contribution
percentage).
On the other hand, accounting for defined benefit plans is much more complex. In these plans, the pension
benefits to be received in the future are affected by uncertain variables such as turnover, mortality, length of
employee service, compensation levels, and earnings on the pension fund assets. In defined benefit plans, the
risks are borne by employers, because they must make large enough contributions to meet the pension benefits
promised. As a result, the amount of periodic pension expense incurred might not be equal to the cash
contributed to the plan.
This issue took on added prominence in the early 2000s. The combination of poor equity markets and low
interest rates severely reduced the investment returns of pension plans, causing deterioration in their funded
status as pension assets dropped in value while pension obligations remained the same or even increased. Up to
2004, companies were required to fund their plans by a formula that resulted in a cost of up to 120 percent of
the weighted average of the 30-year Treasury bond yield. The Treasury Department discontinued this bond in
2001, causing a sharp drop in the bond's interest rate and artificially inflating pension liabilities. Subsequently,
about 20 percent of companies with DBPPs either froze or canceled their plans from 2001 through 2003
because of the costs.2
In 2004, congressional legislation replaced the Treasury bond index with another index linked to the yield on
corporate bonds for a two-year period. During those two years, Congress was to decide whether the new
measure should be made permanent or be replaced by another. The subsequent enactment of the Pension
Protection Act of 2006 (discussed later in the chapter) allows long-term funding of underfunded plans by
providing a new interest rate assumption based on a modified yield curve formula.3 The 2008 credit crisis and
stock market crash further exacerbated the problem. The Wall Street Journal reported that pension plans at S&P
500 companies suffered large losses during the year, thereby requiring corporations to make large unplanned
cash contributions to fund their plans.4
In 2006, Congress passed and President Bush signed the Pension Protection Act of 2006. This legislation
requires companies who have underfunded their pension plans to pay higher premiums to the Pension Benefit
Guarantee Corporation (discussed later in the chapter) and extends the requirement of providing extra funding
to the pension systems of companies that terminate their pension plans. It also requires companies to analyze
their pension plans' obligations more accurately, closes loopholes that previously allowed some companies to
underfund their plans by skipping payments, and raises the cap on the amount employers are allowed to invest
in their own plans.
Because the future pension benefits are affected by uncertain variables and government actions such as the
Pension Protection Act of 2006, employers hire actuaries to help determine the amount of periodic
contributions necessary to satisfy future requirements. The actuary takes into consideration the future benefits
promised and the characteristics of the employee group (such as age and sex). The actuary then makes
assumptions about such factors as employee turnover, future salary levels, and the earnings rate on the funds
invested and then arrives at the present value of the expected benefits to be received in the future. The employer
then determines the funding pattern necessary to satisfy the future obligation.
The employer's actuarial funding method may be either a cost approach or a benefit approach. A cost
approach estimates the total retirement benefits to be paid in the future and then determines the equal annual
payment that will be necessary to fund those benefits. The annual payment necessary is adjusted for the amount
of interest assumed to be earned by funds contributed to the plan.
A benefit approach determines the amount of pension benefits earned by employee service to date and then
estimates the present value of those benefits. Two benefit approaches may be used: the accumulated benefits
approach or the benefits/years of service approach. The major difference between these two methods is that
under the accumulated benefits approach, the annual pension cost and liability are based on existing salary
levels, whereas under the benefits/years of service approach (also called the projected unit credit method), the
annual pension cost and liability are based on the estimated final pay at retirement. The liability for pension
benefits under the accumulated benefits approach is termed the accumulated benefits obligation. The liability
computed under the benefits/years of service approach is termed the projected benefit obligation.
Even though the actuarial funding approaches have been defined, accounting for the cost of pension plans
has caused a great deal of controversy over the years, and several authoritative pronouncements have been
issued. In the following sections, we trace the evolution of pension accounting standards.

Historical Perspective
The rapidly increasing number of pension plans adopted by companies immediately after World War II caused
accountants to question the treatment of accounting for pension costs. A major concern was that many new
pension plans gave employees credit for their years of service before the plan was adopted. The point at issue
was the most appropriate treatment of costs associated with this past service. In  Accounting Research Bulletin
No. 47, “Accounting for Costs of Pension Plans” (superseded), the Committee on Accounting Procedure
expressed its preference that costs based on current and future service be systematically accrued during the
expected period of active service of the covered employees and that costs based on past services be charged off
over some reasonable period. The allocation of past service cost was to be made on a systematic and rational
basis and was not to cause distortion of the operating results in any one year.
Later, the Accounting Principles Board (APB) observed that despite the recommendations of ARB No. 47,
accounting for the cost of pension plans was inconsistent from year to year, both among companies and within
a single company. Sometimes the cost charged to operations was equal to the amount paid into the fund during
a given year; at other times, no actual funding occurred. Moreover, the amortization of past service cost ranged
up to 40 years.
Accounting inconsistencies and the growing importance of pension plan costs prompted the APB to
authorize Accounting Research Study No. 8, “Accounting for the Cost of Pension Plans.” This study was
published in 1965, and, after careful examination of its recommendations, the APB issued Opinion No. 8,
“Accounting for the Cost of Pension Plans” (superseded), in 1966. Because the conclusions of the APB were
generally similar to those of the research study, we review only the opinion here.

APB Opinion No. 8

APB Opinion No. 8 identified basic problems associated with accounting for the cost of DBPPs as (1)
measuring the total amount of costs associated with a pension plan, (2) allocating the total pension costs to the
proper accounting periods, (3) providing the cash to fund the pension plan, and (4) disclosing the significant
aspects of the pension plan on the financial statements.
The APB's conclusions concerning these questions were based to a large extent on two basic beliefs or
assumptions. First, the Board believed that most companies will continue the benefits called for in a pension
plan even if the plan is not fully funded year to year. Therefore the cost should be recognized annually whether
or not the plan is funded. Second, the Board adopted the view that the cost of all past service should be charged
against income after the adoption or amendment of a plan and that no portion of such cost should be charged
directly to retainedearnings. In APB Opinion No. 8, several issues were addressed, and various terms were
introduced. In the following paragraphs we examine these issues and terms as originally defined by the APB.
However, it should be noted that subsequent pronouncements have modified these definitions and/or changed
the terminology.

Normal Cost
The current expense provision of pension cost was termed normal cost in APB Opinion No. 8. This was the
amount required to be expensed each year, based on the current number of employees and the actuarial cost
method being used. As noted earlier, the actuarial cost method must take into consideration such factors as
employee turnover, mortality, and the treatment of actuarial gains and losses. However, the APB did not
specify which actuarial cost method to use.

Past Service Cost

When a pension plan is adopted, the employees are usually given credit for previous years of service. These
benefits were referred to as past service cost and were to be charged to expense in current and future periods.
Past service cost was calculated by determining the present value of the amount of future benefits accruing to
the current employee group. Before APB Opinion No. 8 was issued, many companies charged past service
costs against retained earnings as prior period adjustments. This policy was based on the theory that the
benefits of employee service had been obtained in prior periods; therefore, the cost associated with those
benefits should be charged to previous periods. APB Opinion No. 8 eliminated this treatment of past service
costs, and later pronouncements concurred.

Prior Service Cost

Prior service costs were pension costs assigned to years preceding the date of a particular actuarial valuation.
Prior service cost arose as a result of an amendment to the original pension agreement or changes in the
actuarial assumptions of the pension plan. When the pension agreement is amended or the underlying
assumptions change, it becomes necessary to recalculate the expected future benefits accruing to the current
employee group. This calculation is similar to the determination of past service cost.

Actuarial Gains and Losses

The pension cost for any period is based on several assumptions. These assumptions often do not coincide with
actual results. It is therefore necessary to make periodic adjustments so that actual experience is recognized in
the recorded amount of pension expense. Under APB Opinion No. 8, periodic pension expense included normal
cost and amortization of past and prior service costs. These costs were estimated based on actuarial
assumptions. If in a subsequent period, the actuary revised his or her assumptions based on new information, a
periodic adjustment would be required. APB Opinion No. 8 termed the deviations between the actuarial
assumptions and subsequent changes in assumptions due to actual experience actuarial gains and losses.
The amount of any actuarial gain or loss was to be recognized over current and future periods by one of two
acceptable methods:
 1. Spreading. The net actuarial gains and losses were applied to current and
future costs through an adjustment to either normal cost or past service cost
each year.
2. Averaging. An average of the sum of previously expensed annual actuarial
gains and losses and expected future actuarial gains and losses was applied
to normal cost.

Basic Accounting Method

Before APB Opinion No. 8 was issued, the Board could not completely agree on the most appropriate measure
of cost to be included in each period. Consequently, it was decided that annual cost (expense) should be
measured by an acceptable actuarial cost method, consistently applied, that produces an amount between a
specified minimum and maximum. (In this context, an acceptable actuarial cost method should be rational and
systematic and should be consistently applied so that the cost is reasonably stable from year to year.)
The minimum annual provision for pension cost could not be less than the total of

1. Normal cost (cost associated with the years after the date of adoption or
amendment of the plan)
2. An amount equivalent to interest on any unfunded past or prior service cost
3. If indicated, a provision for vested benefits (benefits that are not contingent
on the employee continuing in the service of the company)
The maximum annual provision for pension cost could not be more than the total of

1. Normal cost
2. Ten percent of the past service cost (until fully amortized)
3. Ten percent of the amounts of any increase or decrease in prior service cost
arising from amendments of the plan (until fully amortized)
4. Interest equivalents on the difference between pension costs and amounts
funded
The Board's disagreement over the measurement of annual cost revolved around two differing viewpoints
regarding the nature of pension cost. One view held that pensions are a means of promoting efficiency by (1)
providing for the systematic retirement of older people and (2) fulfilling a social obligation expected of a
business enterprise. Accordingly, pension costs are associated with the plan itself rather than specific
employees and the amount of pension expense is the amount that must be contributed annually to keep the plan
in existence indefinitely. The alternative view was that pensions are a form of supplement benefit to the current
employee group, so that the amount of pension expense in any period is related to specific employees. This
view is rooted in labor economics and is based on the theory that employees contract for wages based on their
marginal revenue product. Thus a pension represents payments during retirement of deferred wages that were
earned during each year of employment, and the amount of pension expense is established by determining the
benefits expected to become payable to specific employees in the future. Under either view, annual pension
expense would include normal costs. However, only the second view would include past and prior service costs
in the determination of annual pension cost.
By requiring the specified minimum and maximum provisions, APB Opinion No. 8 did narrow the range of
practices previously employed in determining the annual provision of pension cost. However, it should be noted
that these minimum and maximum provisions were arbitrarily determined. Thus the only theoretical
justification for their use was a higher degree of uniformity. In addition, the Board decided that only the
difference between the amount charged against income and the amount funded should be shown in the balance
sheet as accrued or prepaid pension cost. The unamortized and unfunded past and prior service cost was
not considered to be a liability by the Board and was not required to be disclosed on the balance sheet. This
decision caused a great deal of controversy and resulted in many debates among accountants over the proper
amount of future pension costs to be disclosed on financial statements.
The Pension Liability Issue
In 1981, the FASB proposed a significant change in the method to account for pension cost. The Board
enumerated several reasons for this proposed change. First, the number of pension plans had grown
enormously since the issuance of APB Opinion No. 8 in 1966. A research study performed by the then–Big
Eight accounting firm Coopers & Lybrand indicated that there were 500,000 private pension plans in the
United States in 1979, and that total plan assets exceeded $320 billion. Also affecting pension plans were
significant changes in laws, regulations, and economic factors, not the least of which was double-digit
inflation.
Second, the Board contended that pension information was inadequate, despite the increased disclosures
mandated by SFAS No. 36 (discussed later in the chapter). Finally, the flexibility of permitted actuarial methods
resulted in a lack of comparability among reporting companies, according to some financial statement users.
The basic issues involved in the FASB's proposal, titled “Preliminary Views,” were as follows:

1. Over what period should the cost of pensions be recognized? In 1981,

pension costs could be recognized over a period of 30 to 40 years, which is
generally longer than the current workforce is expected to continue working.
2. How should pension costs be spread among or allocated to the individual
periods? The basic question here was whether the practice of choosing
among a variety of acceptable costs and funding methods met the needs of
users of financial statements.
3. Should information about the status of pensions be included in the statement
of changes in financial position? This was undoubtedly the most
controversial of the issues considered.
The positions taken in the FASB's “Preliminary Views” would have required an employer sponsoring a
defined benefit pension plan to recognize a net pension liability (or asset) on its balance sheet. This disclosure
would have comprised the following three components: the pension benefit obligation less the plan's net assets
available for benefits plus or minus a measurement valuation allowance. This calculation of pension cost
coincides with the view that pension expense should be recognized in the period in which the employees render
their services. This view is consistent with the matching principle.
One organization that opposed the position of the “Preliminary View” was the AICPA task force on pension
plans and pension costs. This group's opposition was expressed in several general areas:

1. The amounts involved did not meet the definition of assets or liabilities
under SFAC No. 3 (now SFAC No. 6).
2. A pension arrangement is essentially an executory contract that under
existing GAAP is accounted for only as the covered services are performed.
3. Too much subjectivity is involved in determining the amount of the net
pension liability—that is, the number is too soft to be reported in basic
financial statements.
4. The FASB had not demonstrated the need to amend APB Opinion No.
8 extensively.
Despite this opposition, the FASB remained steadfast in its determination to change previous pension
accounting methods. Under the method originally advocated in “Preliminary Views,” the pension benefit
obligation would have comprised an accrual for benefits earned by the employees but not yet paid, including
prior service credits granted when a plan is initiated or amended. The obligation would include both vested and
nonvested benefits and would be measured based on estimates of future compensation levels.
The proposed measure of the pension benefit obligation was called the actuarial present value of
accumulated benefits with salary progression. As a result, the proposed method would have required a forecast
of salary growth for pension plans that defines benefits in terms of an employee's future salary. Because most
sponsors use financial pay plans, the salary growth assumption would result in pension benefit obligations
larger than those previously being reported.
On the other hand, if plan assets exceeded the benefit obligation, a company would report a net pension asset
on its balance sheet. The plan's investment assets available for benefits would be measured at fair value,
consistent with SFAS No. 35, “Accounting and Reporting for Defined Benefit Pension Plans.”5
The third component of the net pension liability was to be the measurement valuation allowance. This
component was intended to reduce the volatility of the net pension liability inherent in the prediction of events,
such as future changes in the pension benefit obligation and the plan assets, due to experience gains and losses
or changes in actuarial assumptions.
Under “Preliminary Views,” the amount of annual pension expense that an employer would recognize would
have been the sum of four factors:

1. The increase in the pension benefit obligation attributable to employee

service during the period (conceptually similar to “normal cost”).
2. The increase in the pension benefit obligation attributable to the accrual of
interest on the obligation (because the obligation is the discounted present
value of estimated future payments).
3. The increase in plan assets resulting from earnings on the assets at the
assumed rate (reducing the periodic pension expense).
4. The amortization of the measurement valuation allowance, which can either
increase or decrease the pension expense. Actuarial gains or losses would be
included in the measurement of the valuation allowance.

SFAS No. 87
After deliberating the issues addressed in “Preliminary Views” for several years, the FASB reached a
consensus in 1985 and issued SFAS No. 87, “Employers' Accounting for Pensions” (see FASB ASC 715). This
release was the product of compromises and resulted in several differences from the FASB's original position
expressed in “Preliminary Views.” SFAS No. 87 maintained that pension information should be prepared on the
accrual basis and retained three fundamental aspects of past pension accounting: delaying recognition of
certain events, reporting net cost, and offsetting assets and liabilities.
The delayed-recognition feature results in systematic recognition of changes in the pension obligation (such
as plan amendments). It also results in changes in the values of assets set aside to meet those obligations.
The net cost feature results in reporting, as a single amount, the recognized consequences of the events that
affected the pension plan. Three items are aggregated to arrive at this amount: (1) the annual cost of the benefits
promised, (2) the interest cost resulting from the deferred payment of those benefits, and (3) the result of
investing the pension assets.
Offsetting means that the value of the assets contributed to a pension plan and the liabilities recognized as
pension cost in previous periods are disclosed as a single net amount in the employer's financial statements.
The FASB members expressed the view that the understandability, comparability, and usefulness of pension
information would be improved by narrowing the range of methods available for allocating the cost of an
employee's pension to individual periods of service. The Board also stated that the pension plan's benefit
formula provides the most relevant and reliable indicator of how pension costs and pension benefits are
incurred. Therefore SFAS No. 87 required three changes in previous pension accounting:

1. A standardized method of measuring net pension cost. The Board indicated

that requiring all companies with defined benefit plans to measure net period
pension cost, taking into consideration the plan formula and the service
period, would improve comparability and understandability.
2. Immediate recognition of a pension liability when the accumulated benefit
obligation exceeds the fair value of the pension assets. The accumulated
benefit obligation is calculated using present salary levels. Because salary
levels generally rise, the amount of the unfunded accumulated benefit
 obligation represents a conservative floor for the present obligation for
future benefits already earned by the employees.
3. Expanded disclosures intended to provide more complete and current
information than can be practically incorporated into the financial
statements at this time.

Pension Cost
Under the guidelines of FASB ASC 715, the components of net pension cost reflect different aspects of the
benefits earned by employees and the method of financing those benefits by the employer. The following
components are required to be included in the net pension cost recognized by an employer sponsoring a
defined benefit pension plan:

1. Service cost
2. Interest cost
3. Return on plan assets
4. Amortization of unrecognized prior service cost
5. Amortization of gains and losses
6. Amortization of the unrecognized net obligation or unrecognized net asset at
the date of the initial application of SFAS No. 87 (the transition amount)
The service cost component is the actuarial present value of the benefits attributed by the pension formula to
employee service for that period. This requirement means that one of the benefit approaches discussed earlier
must be used as the basis for assigning pension cost to an accounting period. It also means that the
benefits/years of service approach should be used to calculate pension cost for all plans that use this benefit
approach in calculating earned pension benefits. The FASB position is that the terms of the agreement should
form the basis for recording the expense and obligation, and the plan's benefit formula is the best measure of
the amount of cost incurred each period. The discount rate to be used in calculating service cost is the rate at
which the pension benefits could be settled, such as by purchasing annuity contracts from an insurance
company. This rate is termed the settlement-basis discount rate.
The interest cost component is the increase in the projected benefit obligation owing to the passage of time.
Recall that the pension liability is calculated on a discounted basis and accrues interest each year. The interest
cost component is determined by accruing interest on the previous year's pension liability at the settlement-
basis discount rate.
The return on plan assets component is the difference between the fair value of these assets from the
beginning to the end of the period, adjusted for contributions, benefits, and payments. That is, the interest and
dividends earned on the funds actually contributed to the pension fund, combined with changes in the market
value of invested assets, will reduce the amount of net pension cost for the period. SFAS No. 87 allows the use
of either the actual return or the expected return on plan assets when calculating this component of pension
expense.
Prior service cost is the total cost of retroactive benefits at the date the pension plan is initiated or amended.
Prior service cost is assigned to the expected remaining service period of each employee who is expected to
receive benefits. (As a practical matter, the FASB allows for a simplified method of assigning this cost to future
periods; the company may assign this cost on a straight-line basis over the average remaining service life of its
active employees.)
Gains and losses include actuarial gains and losses or experience gains and losses. Actuarial gains and
losses occur when the actuary changes assumptions, resulting in a change in the projected benefit obligation.
For example, if the actuary increases the discount rate, the beginning projected benefit obligation is reduced.
This means that prior expense recognition for interest, service cost, and prior service cost was overstated. Thus
the amount of the change in the beginning projected benefit obligation is an actuarial gain. Experience gains
and losses occur when net pension cost includes the expected, rather than the actual, return on plan assets. The
expected return presumes that plan assets will grow to a particular amount by the end of the period. If, for
example, the actual return is greater than expected, future pension costs will be defrayed further and an
experience gain takes place.
 The FASB ASC 715 guidelines contain a minimum requirement for the recognition of these gains and
losses. At a minimum, the amount of gain or loss to be amortized in a given period is the amount by which the
cumulative unamortized gains and losses exceed what the pronouncement termed the corridor. The corridor is
defined as 10 percent of the greater of the projected benefit obligation or market value of the plan assets. The
excess, if any, is divided by the average remaining service period of employees who are expected to receive
benefits. The rationale using the corridor approach is that typically these gains and losses are random errors and
should have an expected value of zero. That is, over time, actuarial gains and losses should offset each other.
Only extreme values are required to be recognized. The corridor procedure is similar to statistical procedures
that are designed to identify outliers.
SFAS No. 87 required significant changes in pension accounting from what was previously required in APB
Opinion No. 8. As a result, the Board decided to allow a relatively long transition period. Most companies were
not required to follow the provisions of SFAS No. 87 until the 1987 calendar year. In addition, the minimum
liability provision (discussed in the next section) was not required to be reported until calendar year 1989.
Because these changes were so significant, an unrecognized net obligation or unrecognized net asset often
resulted when changing to the new reporting requirements. Therefore, the provisions of SFAS No. 87 required
companies to determine, on the date the provisions of this statement were first applied, the amount of the
projected benefit obligation and the fair value of the plan assets. This resulted in either an unrecognized net
obligation or an unrecognized net asset. This amount, termed the transition amount, was to be amortized on a
straight-line basis over the average remaining service period of employees expecting to receive benefits.

Minimum Liability Recognition

Unlike other expenses that are recognized in the income statement, periodic pension cost is not tied to changes
in balance sheet accounts. The FASB ASC 715 guidelines require amortization of prior service cost, gains and
losses, and the transition amount, but the unamortized amounts for these items are not recorded. Hence,
the funded status of the plan (the difference between the projected benefit obligation and the fair value of plan
assets) is not recognized in the accounting records. Recall that the FASB's original position on this issue,
expressed in “Preliminary Views,” was that a liability exists when the projected benefit obligation exceeds the
plan assets (i.e., the plan is underfunded) or that an asset exists when the reverse is true. Because agreement on
this issue could not be reached, the Board developed a compromise position that requires recognition of a
liability, termed the minimum liability, when the accumulated benefit obligation exceeds the fair value of the
plan assets. Thus, even though future salary levels are used to calculate pension expense, the liability reported
on the balance sheet need take into consideration only present salary levels. The result is that the balance sheet
and income statements are not articulated, a condition that is contrary to the conceptual framework.
The portion of the underfunded pension obligation that is not already recognized in the accounting records
occurs because the company has unamortized prior service cost or unamortized gains and losses. Because the
minimum liability is based on current salary levels and is therefore likely to be less than the underfunded
projected benefit obligation, total unamortized prior service cost and unamortized gains and losses are likely to
exceed the amount needed to increase the pension liability to the minimum required. The FASB ASC 715
guidelines require that when an additional liability is recognized to meet the minimum liability requirement, the
offsetting debit is to be allocated first to an intangible asset for the unamortized prior service cost. The
remainder, if any, is due to unamortized net losses and is reported as an element of other comprehensive
income. The minimum liability is reassessed at the end of each accounting period, and necessary adjustments
are made directly to the intangible asset or stockholders' equity.

Disclosures
The FASB ASC 715 guidelines require employers to disclose information beyond that previously required.
Perhaps the most significant of these added disclosures are the components of net pension cost and the funding
status of the plan. Specifically, employers sponsoring defined benefit plans must disclose the following
information:

1. A description of the plan, including employee groups covered, type of

benefit formula, funding policy, types of assets held, significant nonbenefit
liabilities (if any), and the nature and effect of significant matters affecting
comparability of information for all periods presented
 2. The amount of net periodic pension cost for the period, showing separately
the service cost component, the interest cost component, the actual return on
assets for the period, and the net total of other components
3. A schedule reconciling the funded status of the plan with amounts reported
in the employer's statement of financial position, showing separately
a. The fair value of plan assets
b. The projected benefit obligation identifying the accumulated benefit
obligation and the vested benefit obligation
c. The amount of unrecognized prior service cost
d. The amount of unrecognized prior net gain or loss
e. The amount of any remaining unrecognized transition amount
f. The amount of any additional liability recognized
g. The amount of net pension asset or liability recognized in the
statement of financial positions (the net result of combining the
preceding six items)
h. The weighted average assumed discount rate and the weighted
average expected long-term rate of return on plan assets
The annual pension cost reported by corporations under the FASB ASC 715 guidelines will usually be
different from the cost previously disclosed under the provisions of APB Opinion No. 8. The magnitude of these
differences depends on such factors as the pension plan's benefit formula, employees' remaining service
periods, investment returns, and prior accounting and funding policies. Companies that have underfunded
pension plans with a relatively short future employee service period may be required to report significantly
higher pension expense.
When SFAS No. 87 was released, the Board stated that the pronouncement was a continuation of its
evolutionary search for more meaningful and more useful pension accounting information. The Board also
stated that while it believes that the conclusions it reached are a worthwhile and significant step in that
direction, these conclusions are not likely to be the final step in the evolution.

SFAS No. 87: Theoretical Issues

The issuance of SFAS No. 87 (see FASB ASC 715) might have created as many issues as it resolved. Criticism
of the pronouncement has been directed at the projected benefits approach, use of the settlement rate to
discount projected benefits, allowing alternative measures of return, and the minimum liability requirement.

Projected Benefits Approach

When the benefit formula uses future salary levels, the FASB ASC 715 guidelines require that service cost and
the employer's present obligation for future benefits earned to date be measured using projected future salary
levels. This measurement can be defended on the basis that employees contract for retirement benefits. These
benefits are earned while the employee works; thus, matching would dictate that they be an accrued expense.
Also, the projected benefit obligation represents a present obligation to pay the future benefits that employees
have already earned. Thus the projected benefit obligation qualifies as a liability under SFAC No. 6.
Critics contend that the projected obligation implies that the benefits earned to date will be paid. This is true
only for employees who have vested benefits or who will remain employees until the benefits do vest. Some
feel that only vested benefits should be considered a present liability, because vested benefits are the only
portion that the company has a present legal obligation to pay if the plan were terminated. Others feel that the
accumulated benefits approach provides the more appropriate measure, because it is a conservative estimate of
the present obligation for future benefits and would be the amount that the employer would set aside if the plan
were terminated and the employer wanted to provide for all employees who were vested and might vest in the
future. Moreover, the accumulated benefits approach does not require subjective projections of future salary
levels. At the other extreme, some feel that the projected benefits approach understates the present liability,
because it does not take into consideration projected years of service.
The Settlement Rate
The FASB ASC 715 guidelines require that the actuarially determined projected benefit obligation be
calculated using a discount rate at which the plan could be effectively settled. For example, the rate at which
the company could currently obtain an annuity contract to provide the projected future benefits would be an
appropriate settlement rate. The FASB felt that the actuary's rate should not be affected by the return expected
on funded assets. The projected benefit obligation is a liability. The discount rate selected is chosen to measure
the liability and has nothing to do with how the assets that are set aside to satisfy that liability are invested.
Opponents argue that the settlement rate is a short-term current rate and that the pension obligation is not
going to be settled currently; rather, it is a long-term phenomenon. The settlement rates fluctuate from period to
period, resulting in volatile measures of the projected benefit obligation, service cost, and interest. Some agree
with the FASB that the discount rate used need not be the expected return on plan assets but argue that it should
be based on a more long-run measure of typical pension fund asset returns over time. Others contend that the
fund provides the means by which the company will settle the pension obligation, and thus the return on the
plan assets is the relevant rate at which to discount projected benefits.

Return on Plan Assets

The FASB ASC 715 guidelines require that net pension cost include the actual return, or that the actual return
be adjusted to the expected return. Allowing these two alternatives represents a compromise. The FASB favors
including the actual return. For the most part, the actual return is a realized return. Furthermore, recognition of
the actual return is consistent with the comprehensive income concept. Nevertheless, the Board's preference for
measuring the return component was criticized, because it would produce volatile measures of pension expense
from period to period. The FASB conceded by allowing the expected return to be included, instead using the
expected rate of return on plan assets applied to the market-related asset value of the plan assets. The market-
related asset value is a long-term measure of asset value. Hence, the expected return should allow the
smoothing of net periodic pension cost. At the same time, allowing the minimum amortization of actuarial and
experience gains and losses should provide further assurance of a smoother, less volatile periodic pension
expense.

Reporting the Minimum Liability

One aim of the FASB ASC 715 guidelines is to report the net pension obligation on the balance sheet.
However, for many companies, reporting the net obligation measured using projected benefits would
dramatically affect total liabilities and debt-to-equity ratios. Moreover, some contended that the projected
benefit obligation overstates the pension liability because it does not represent the legal liability or the most
likely settlement amount. The Board acquiesced to the concerns and opted for a minimum liability
measurement based on the more conservative accumulated benefit obligation. This requirement has been
superseded by SFAS No. 158 (see FASB ASC 715), discussed later in the chapter.
If the projected benefit obligation provides the more appropriate measure, then reporting the minimum
liability understates liabilities. Furthermore, it is inconsistent with the measurement of periodic pension
expense, which is measured using projected benefits. Such an inconsistency perpetuates the criticism regarding
pension reporting under APB Opinion No. 8, that pension accounting is contrary to the fundamental notion that
the financial statements should be articulated. Empirical research has demonstrated that pension obligations are
considered liabilities, but to date there is no conclusive evidence that the market perceives one method of
measuring the obligation or pension expense to be better than another.6

Accounting for the Pension Fund

Until 1980, accounting practice often relied on the actuary's funding and cash-flow considerations for
measuring pension costs and accumulated pension benefits. At that time, APB Opinion No. 8 stated that
accounting for pension expense and related liabilities was separate and distinct from actuarial costing for
funding purposes. However, according to SFAS No. 35, “Accounting and Reporting by Defined Benefit
Pension Plans” (see FASB ASC 960), the status of plans for financial reporting purposes is to be determined by
actuarial methodology designed not for funding purposes but rather for financial reporting purposes.
Neither the FASB nor its predecessors had issued authoritative accounting standards specifically applicable
to pension plans. Therefore the financial reporting by those plans varied widely. FASB ASC 960 establishes
accounting and reporting standards designed to correct this shortcoming.
The primary objective of the FASB ASC 960 guidelines is to provide financial information that is useful in
assessing a pension plan's current and future ability to pay benefits when due. In attempting to accomplish this
objective, the FASB ASC 960 guidelines require that pension plan financial statements include four basic
categories of information:
 1. Net assets available for benefits
2. Changes in net assets during the reporting period
3. The actuarial present value of accumulated plan benefits
4. The significant effects of factors such as plan amendments and changes in
actuarial assumptions on the year-to-year change in the actuarial present
value of accumulated plan benefits
Information about net assets must be available for plan benefits at the end of the plan year and must be
prepared using the accrual basis of accounting.
The FASB ASC 960 guidelines also set standards for information regarding participants' accumulated plan
benefits. Accumulated plan benefits are defined as future benefit payments attributable under the plan's
provisions to employees' service rendered to date. Information about accumulated benefits may be presented at
either the beginning or the end of the plan year. Accumulated plan benefits are to be measured at their actuarial
present value, based primarily on history of pay and service and other appropriate factors.

The Employee Retirement Income Security Act

During the 1960s, several large DBPPs collapsed, leaving thousands of workers without pensions. For
example, when the Studebaker Corporation closed its automobile manufacturing plants in 1963, 7,000 workers
lost virtually all of their retirement benefits. Subsequently, in 1974, Congress passed the Employee Retirement
Income Security Act (ERISA), also known as the Pension Reform Act of 1974. The basic goals of this
legislation were to create standards for the operation of pension funds and to correct abuses in the handling of
pension funds. ERISA does not require employers to establish pension plans, and it generally does not require
that pension plans provide a minimum level of benefits. Instead, it regulates the operation of a pension plan
once it has been established by establishing guidelines for employee participation in pension plans, vesting
provisions, minimum funding requirements, financial statement disclosure of pension plans, and the
administration of the pension plan.
One of the major provisions of ERISA was the creation of the Pension Benefit Guarantee Corporation
(PGBC). The PGBC is an independent agency of the United States government to encourage the continuation
and maintenance of voluntary private DBPPs, provide timely and uninterrupted payment of pension benefits,
and keep pension insurance premiums at the lowest level necessary to carry out its operations. The major goal
of the PBGC is to pay pension to participants of failed pension plans. This is accomplished through an
insurance program. The PBGC is not funded by general tax revenues. Its funds come from four sources:

 Insurance premiums paid by sponsors of DBPPs

 Assets held by the pension plans it takes over
 Recoveries of unfunded pension liabilities from insolvent pension plan
 Investment income
Shortly after ERISA was enacted, the FASB undertook a study of the impact of ERISA on accounting for
pension costs. The conclusions of this study were originally contained in FASB Interpretation No. 3, which was
superseded by SFAS No. 87 (see FASB ASC 715). In essence, FASB Interpretation No. 3 stated that ERISA is
concerned with pension funding requirements and that accounting for pension costs was not affected by ERISA.
The provisions of FASB ASC 715 are also not affected by ERISA. Accounting standards for pension costs are
concerned with periodic expense and liability recognition, whereas the provisions of ERISA are concerned
mainly with the funding policies of pension plans.

Other Postretirement Benefits

The issue of other postretirement benefits is addressed in SFAS No. 106, “Employers' Accounting for
Postretirement Benefits Other Than Pensions”7 (see FASB ASC 715). This pronouncement dealt with the
accounting for all benefits, other than pension benefits, offered to retired employees; these benefits are
commonly referred to as other postretirement benefits (OPRBs). Although its provisions apply to a wide
variety of postretirement benefits—such as tuition assistance, day care, legal services, and housing subsidies—
the most significant OPRBs are retiree health care benefits and life insurance. Based on the notion that
management promises OPRBs in exchange for current services, the Board felt that OPRBs are similar to
DBPPs and as such deserve similar treatment. Consequently, the FASB ASC 715 guidelines require that the
cost of OPRBs be accrued over the working lives of the employees expected to receive them. However, owing
to the controversial nature surrounding measurement and reporting issues related to the employer's obligation
for OPRBs, the Board decided not to require minimum liability balance sheet disclosure.
Although on the surface OPRBs are similar to DBPPs, they have characteristics that necessitate different
accounting considerations and that have been the source of considerable controversy:

1. Defined benefit pension payments are determined by formula, whereas the

future cash outlays for OPRBs depend on the amount of services, such as
medical care, that the employees will eventually receive. Unlike pension
plan payments, there is no cap on the amount of benefits to be paid to
participants. Hence, the future cash flows associated with OPRBs are much
more difficult to predict.
2. Unlike defined pension benefits, additional OPRB benefits cannot be
accumulated by employees' OPRBs with each year of service.
3. OPRBs do not vest. That is, employees who leave have no further claim to
future benefits. Employees have no statutory right to vested health care
benefits. Defined benefits are covered by stringent minimum vesting,
participation, and funding standards, and they are insured by the Pension
Benefit Guaranty Corporation under ERISA. Health and other OPRBs are
explicitly excluded from ERISA.
The FASB ASC 715 guidelines stipulate that periodic postretirement benefit expenses comprise the same six
components as pension expense. Nevertheless, there are measurement differences owing to the foregoing
differences between the characteristics of OPRBs and those of DBPPs. The determination of the return on
assets and the amortization of gains and losses for OPRBs and DBPPs are the same. We concentrate on those
components that are treated differently.

Service Cost
The service cost component of net periodic pension cost is that portion of the ending projected benefit
obligation attributable to employee service during the current period. The basis for computing OPRB service
cost is the expected postretirement benefit obligation (EPBO), which is defined as the actuarial present value of
the total benefits expected to be paid assuming full eligibility is achieved. 8 Measurements included in the
calculation of the EPBO include estimated effects of medical cost, inflation, and the impact of technological
advancements and future delivery patterns. The service cost component for OPRBs is the ratable portion of the
EPBO attributable to employee service in the current period.

Interest
Interest is calculated by applying the discount rate by the accumulated postretirement benefit
obligation (APBO). The APBO is that portion of the EPBO attributable to employee service rendered to the
measurement date. Once the employee is fully eligible to receive OPRB benefits, the APBO and the EPBO are
equivalent.

Amortization of Prior Service Costs

For OPRBs, prior service cost is the increase in the APBO attributed to an increase in benefits to employee
service rendered in prior periods. SFAS No. 106 required that prior service cost be recognized over the life
expectancy of the employees when most participants are fully eligible to receive benefits. If employees are not
fully eligible, prior service cost is amortized to the date of full eligibility. OPRB gains on decreases in benefits
are required to be offset against both unrecognized prior service cost and unrecognized transition obligations.

Amortization of the Transition Obligation

The transition obligation for other postretirement benefits is the difference between the APBO and the fair
value of funded OPRB assets. The transition amount may be recognized immediately, or it may be amortized
over the average remaining service lives of active participants. The employer may elect a minimum
amortization period of 20 years. The amount of amortization allowed is constrained. The cumulative expense
recognized as a result of electing to defer recognition of the transition amount may not exceed the cumulative
expense that would occur on a pay-as-you-go basis.

Disclosure
The FASB ASC 715 guidelines require the disclosure of plan details, including the funding policy and amounts
and types of funded assets, the components of net periodic cost, and a reconciliation of the funded status of the
plan with amounts reported in the statement of financial position. Recognizing the sensitivity of the
assumptions used to measure OPRB costs, the FASB ASC 715 guidelines also require disclosure of the
following information:

1. The assumed health care cost trend rates used to measure the EPBO
2. The effects of a one-percentage-point increase in the assumed health care
cost trend rates

Postemployment Benefits
In addition to postretirement benefits, employers often provide benefits to employees who are inactive owing
to, for example, a layoff or disability, but not retired. SFAS No. 112, “Employers' Accounting for
Postemployment Benefits” (see FASB ASC 712), indicated that these benefits are compensation for services
rendered and as such should be accounted for as a contingency under the provisions of SFAS No. 5,
“Accounting for Contingencies” (see FASB ASC 450). Hence, a loss contingency should be accrued when the
payment of postemployment benefits is probable, the amount of the loss contingency can be reasonably
estimated, the employer's obligation is attributable to employee services already rendered, and the employee's
rights to postemployment benefits vest or accumulate.

SFAS No. 132

SFAS No. 132, “Employers' Disclosures about Pensions and Other Postretirement Benefits—An Amendment
of FASB Statements No. 87, 88, and 106” (see FASB ASC 715-20-50), standardizes the disclosure
requirements for pensions and other postretirement benefits, requires the disclosure of additional information
on changes in the benefit obligation and fair value of plan assets in order to facilitate financial analysis, and
eliminates certain other disclosure requirements contained in SFAS Nos. 87, 88, and 106. The benefits to
financial statement users include the disclosure of disaggregated information on the six components of periodic
pension cost and other postretirement benefits and information on changes in the projected benefit obligation
and plan assets. The statement suggests a combined format for the presentation of both pensions and other
postretirement benefits.

SFAS No. 158

In 2005 the FASB, in conjunction with the IASB, added a two-phase review of accounting for pension plans to
its agenda. The objective of the first phase was to address the fact that information about the financial status of
a company's DBPPs and OPBPs is reported in the notes to the financial statements but not in the  balance sheet.
The second phase of the project, which is to begin after completing the first phase, will comprehensively
address a broad range of financial accounting and reporting issues in the area of postretirement benefits.
The FASB's Phase One review revealed that existing standards on employers' accounting for DBPPs and
OPRPs failed to communicate the funded status of those plans in a complete and understandable way. That is,
the assets and liabilities of DBPPs and OPBPs were not disclosed on the benefit provider's balance sheet and
were reported only in the footnotes. Specifically, current standards allowed an employer to

1. Delay the recognition of events that affected the costs of providing

postretirement benefits, such as changes in plan assets and benefit
obligations, and recognize a liability that was sometimes significantly less
than the underfunded status of the plan.
 2. Recognize an asset in its statement of financial position, in some situations,
for a plan that was underfunded.
3. GAAP also allowed the deferral of actuarial gains and losses that have the
potential to fluctuate significantly. Because the procedures outlined in SFAS
Nos. 87 and 106 were designed to smooth the amounts reported for pension
plans, financial statements often reported an asset on the balance sheet,
giving the impression the plan was overfunded when in fact a funding
deficit was reported in the footnotes. The Board concluded that presenting
this information in the footnotes made it more difficult for users of financial
statements to assess an employer's financial position and ability to satisfy
postretirement benefit obligations.
The FASB's Phase One review of pension accounting resulted in SFAS No. 158, “Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB Statements No. 87, 88,
106, and 132(R)” (see FASB ASC 715-20-65). The FASB ASC 715-20-65 guidelines require recognition of the
overfunded or underfunded status of a DBPP or OPBP as an asset or liability in a company's statement of
financial position and to recognize changes in that funded status in the year in which the changes occur through
comprehensive income. That is, a company is required to

1. Recognize the funded status of a benefit plan in its statement of financial

position. This amount is to be measured as the difference between plan
assets at fair value and the projected benefit obligation
2. Recognize, as a component of other comprehensive income, the net of tax,
the gains or losses, and the prior service costs or credits that arise during the
period but were not recognized as components of net periodic benefit cost
3. Measure DBPP and OPBP assets and obligations as of the date of the benefit
provider's fiscal year-end
4. Disclose in the notes to financial statements additional information about
certain effects on net periodic benefit cost for the next fiscal year that arise
from delayed recognition of the gains or losses, prior service costs or credits,
and transition asset or obligation
These adjustments can result in a reduction of the book value of shareholder equity for many companies that
have DBPPs or OPBPs. One study estimated a total reduction in shareholder equity at December, 31, 2006, of
$217 billion, or approximately 6 percent.9
SFAS No. 158 completed Phase One of FASB's two-stage project. It does not affect the income statement.
Phase Two of the project will reconsider all aspects of accounting for DBPPs or OPBPs, including the
measurement of plan assets and plan obligations. In Phase Two the FASB is considering requiring companies to
disclose the gross pension assets and gross liabilities on their balance sheets, whereas SFAS No. 158 requires
only disclosure of the net difference on the balance sheet at this time. The FASB is currently monitoring the
work of the IASB (discussed below) to determine the next steps on the project.
The combined effects of the accounting standards for retirement benefits are to provide investors with
additional information about the future cash flows associated with these retirement benefits. The individual
components of periodic pension cost have been found to convey different amounts of information to financial
statement users. Service cost, interest cost, and the expected return on plan assets have been found to provide
information on a company's sustainable information, whereas the other components of pension cost were not
found to provide significant additional information. 10 Similarly, the disclosure of the APBO for other
postretirement benefits was found to be negatively correlated with the price of a company's stock.11
However, the implementation of the accounting standard for postretirement benefits also has had economic
consequences. Before that time, employers accounted for OPRBs on a pay-as-you-go basis, postponing any
recognition of expense until the postretirement period. Owing to the magnitude of these expenditures,
particularly in light of rising health care costs, requiring firms to change from a cash basis to an accrual basis
would have had a major impact on financial reporting. A Wall Street Journal article described the new standard
for accounting for OPRBs as “one of the most significant changes in accounting ever . . . that could cut
corporate profits by hundreds of billions of dollars.” 12 Because of the pronouncements, some have argued that
these benefit provisions might cause management to curtail or even eliminate OPRBs—and in fact, that is what
happened.13 The reduction or elimination of OPRBs could significantly affect an individual's ability to finance
future health and life insurance costs. Ultimately, it could also result in additional costs to the federal
government, and therefore to the taxpayer, through increased Medicare payments.

Financial Analysis of Pension and Other Postretirement Benefits

The major analysis question concerning pensions and other postretirement benefits is whether they have been
adequately funded. Several companies, such as US Airways, have faced reorganizations and even bankruptcy
because their pension obligations have not been fully funded. Hershey has a defined benefit pension plan and
offers another postretirement benefit plan.
Disclosure of the information for pensions under the provisions of SFAS Nos. 87, 132, and 158 is extracted
from the company's footnotes to the fiscal year 2011 financial statements.
We sponsor a number of defined benefit pension plans. Our policy is to fund domestic pension
liabilities in accordance with the minimum and maximum limits imposed by the Employee Retirement
Income Security Act of 1974 (“ERISA”) and federal income tax laws. We fund non-domestic pension
liabilities in accordance with laws and regulations applicable to those plans.

We have two post-retirement benefit plans: health care and life insurance. The health care plan is
contributory, with participants' contributions adjusted annually. The life insurance plan is non-
contributory.
Tootsie Roll also offers a defined benefit pension plan and provides postretirement health care and life
insurance benefit plans.

International Accounting Standards

The IASB has issued two standards for retirement benefits: IAS No. 19, “Retirement Benefit Costs” and IAS
No. 26, “Accounting and Reporting by Retirement Benefit Plans.”
The objective of IAS No. 19 is to prescribe the accounting and disclosure for all forms of consideration given
by an entity in exchange for service rendered by employees. Consequently, it covers a much wider range of
issues than the guidelines contained at FASB ASC 715 and includes such benefits as sabbatical leave, bonuses,
and housing allowances. The underlying principle of the standard is that the cost of providing employee
benefits should be recognized in the period in which the benefit is earned by the employee, rather than when it
is paid or payable. IAS No. 19, as amended in 1998, delineates the procedures to account for both defined
contribution and defined benefit pension plans. With respect to defined contribution plans, the amount
contributed is to be recognized as a current period expense. This treatment is consistent with U.S. GAAP. For
defined benefit plans, service cost must be recognized as a current period expense. Past service costs,
experience adjustments, the effects of changes in actuarial assumptions, and plan adjustments are generally to
be recognized as expenses (or income) in a systematic manner over the remaining working lives of the current
employees. The preferred method of determining costs under defined benefit plans is the accrued benefit
valuation method; however, the projected benefit valuation method is an acceptable alternative. This treatment
allows for more variation in measuring pension cost than is available under U.S. GAAP, and IAS No. 19 does
not address the minimum liability issue contained in SFAS No. 87.
The IASB is currently engaged in a project to amend IAS No. 19. In March 2008 it published a discussion
paper containing the Board's preliminary views on the subject. After reviewing the responses to that discussion
paper, the IASB decided to issue three separate exposure drafts as follows:

1. The appropriate discount rate for measuring employee benefits. IAS No.

19 requires an entity to determine the rate used to discount employee
benefits by reference to market yields on high-quality corporate bonds. The
IASB proposal would remove the requirement to use the government bond
rate when there is no deep market in high-quality corporate bonds. Instead,
 an entity would be required to estimate the rate for a high-quality corporate
bond using the guidance on determining fair value in IAS No. 39.
2. The recognition and presentation of changes in the defined benefit
obligation and in plan assets, disclosures, and other issues raised in the
comment letters that can be addressed expeditiously.
3. Accounting for contribution-based promises, potentially as part of a
comprehensive review of pension accounting.
Later in 2009, the IASB decided that the proposed amendment to discount rate would not be finalized because
there was not sufficient support among board members to ratify the amendment.
In April 2010, the IASB published an exposure draft of proposed amendments to IAS No. 19 to amend the
accounting for defined benefit plans such as pensions and postemployment medical care. The exposure draft
proposed improvements to the recognition, presentation, and disclosure of defined benefit plans. The exposure
draft did not address measurement of defined benefit plans or the accounting for defined contribution plans.
Among the amendments proposed to IAS No. 19 are

 Immediate recognition of all estimated changes in the cost of providing

defined benefits and all changes in the value of plan assets. This would
eliminate the various methods currently allowed by IAS No. 19, including
the corridor method, that allows deferral of some gains or losses.
 A new presentation approach that would clearly distinguish between
different types of gains and losses arising from defined benefit plans.
Specifically, the exposure draft proposed that the following changes in
benefit costs should be presented separately:
 Service cost: in profit or loss
 Finance cost (i.e., net interest on the net defined benefit liability): as
part of finance costs in profit or loss
 Remeasurement: in other comprehensive income
The effect of presenting these items separately is to remove from IAS No. 19 the option for entities to recognize
in income all changes in defined benefit obligations and in the fair value of plan assets.
In June 2011, after reviewing the comments on the exposure draft, the IASB published an amended IAS No.
19. The IASB noted that accounting for employee benefits, particularly pensions and other postretirement
benefits, has been a complex and difficult area and that the initial plans for a full review of pension accounting
had to be deferred in light of competing priorities, ultimately leaving the IASB to proceed alone on improving
specific aspects of the existing requirements of IAS No. 19. Prior to the amendment, IAS No. 19 permitted
choices on how to account for actuarial gains and losses on pensions and similar items, including the corridor
approach, which resulted the deferral of gains and losses. The exposure draft proposed eliminating the use of
the corridor approach and instead mandating all remeasurement impacts be recognized in other comprehensive
income and had proposed extending these requirements to all long-term employee benefits. The final
amendment requires the other comprehensive income presentation changes for pensions only; all other long-
term benefits are required to be measured same manner as outlined in the original IAS No. 19, with changes in
the recognized amount being reflected in net income.
The amendment also changes the treatment for termination benefits, specifically the point in time when an
entity would recognize a liability for termination benefits. The final amendments do not specifically adopt the
U.S. GAAP requirements and allow the recognition time frame to be extended in some cases. As a result, IAS
No. 19 is amended as follows:

 Requires recognition of changes in the net defined benefit liability (asset)

including immediate recognition of defined benefit cost, disaggregation of
defined benefit cost into components, recognition of remeasurements in
 other comprehensive income, plan amendments, curtailments, and
settlements
 Introduces enhanced disclosures about defined benefit plans
 Modifies accounting for termination benefits, including distinguishing
benefits provided in exchange for service and benefits provided in exchange
for the termination of employment and affect the recognition and
measurement of termination benefits
 Clarifies miscellaneous issues, including the classification of employee
benefits, current estimates of mortality rates, tax and administration costs,
and risk-sharing and conditional indexation features
 Incorporates other matters submitted to the IFRS Interpretations Committee
The amendment to IAS No. 19 is applicable on a modified retrospective basis to annual periods beginning on or
after January 1, 2013, with early adoption permitted. There had been no further discussion on accounting for
defined contribution pension plan at the time this text was published.
The objective of IAS No. 26 is to specify the measurement and disclosure principles to be used for reporting
the results of retirement benefit plans. It stipulates that all retirement plans should include in their reports a
statement of changes in net assets available for benefits, a summary of significant accounting policies, and a
description of the plan and the effect of any changes in the plan during the period. IAS No. 26 establishes
separate standards for reporting defined contribution plans and defined benefit plans. For defined contribution
plans, the statement indicates that the objective of reporting is to provide information about the plan and the
performance of its investments. As a result, information should be provided concerning significant activities
affecting the plan, changes relating to the plan, investment performance, and a description of the plan's
investment policies. For defined benefit plans, IAS No. 26 indicates that the objective is to provide information
about the financial resources and activities that will be useful in assessing the relationship between plan
resources and future benefits. Accordingly, information should be provided concerning significant activities
affecting the plan, changes relating to the plan, investment performance actuarial information, and a description
of the plan's investment policies. These requirements are similar to U.S. GAAP for reporting on pension plan
assets, as outlined in FASB ASC 715.

Cases

 Case 14-1 Pension Benefits

Pension accounting has become more closely associated with the method of determining pension benefits.

Required:

a. Discuss the following methods of determining pension benefits:

i. Defined contribution plan
ii. Defined benefit plan
b. Discuss the following actuarial funding methods:
i. Cost approach
ii. Benefit approach

 Case 14-2 Pension Accounting Terminology

SFAS No. 87, “Employers Accounting for Pensions,” requires an understanding of certain terms.

Required:
 a. Discuss the following components of annual pension cost:
i. Service cost
ii. Interest cost
iii. Actual return on plan assets
iv. Amortization of unrecognized prior service cost
v. Amortization of the transition amount
b. Discuss the composition and treatment of the minimum liability provision.

 Case 14-3 Application of SFAS No. 87

Carson Company sponsors a single-employer defined benefit pension plan. The plan provides that pension
benefits are determined by age, years of service, and compensation. Among the components that should be
included in the net pension cost recognized for a period are service cost, interest cost, and actual return on plan
assets.

Required:

a. What two accounting problems result from the nature of the defined benefit
pension plan? Why do these problems arise?
b. How should Carson determine the service cost component of the net pension
cost?
c. How should Carson determine the interest cost component of the net
pension cost?
d. How should Carson determine the actual return on plan assets component of
the net pension cost?

 Case 14-4 Accounting for Other Postretirement Benefits

Postretirement benefits other than pensions (OPRBs) are similar to defined benefit pension plans in some
respects and different in others.

Required:

a. Discuss the characteristics of OPRBs that make them different from defined
benefit pension plans.
b. Discuss how the accounting for OPRBs differs from the accounting for
defined benefit pension plans.
c. In what respects are OPRBs similar to defined benefit pension plans?
Explain.
d. In what respects is the accounting for OPRBs similar to, or the same as, the
accounting for defined benefit pension plans? Explain.

 Case 14-5 Pension Funding Status

Penny Pincher Company has a defined benefit pension plan for its employees. The following pension data are
available at year-end (in millions):

Accumulated benefit $142

 obligation

Projected benefit obligation 205

Fair value of plan assets 175

There is no balance in prepaid/accrued pension costs.

Required:

a. Calculate the funded status of the plan (see SFAS No. 158 for a definition of
funded status). Is the plan overfunded or underfunded?
b. If the projected benefit obligation provides the appropriate measure of the
company's obligation for pension benefits and the assets in the fund are
viewed as satisfying all or part of that obligation, what is Penny Pincher's
liability, if any, for the pension plan at year-end? Explain, citing the
Conceptual Framework's definition of liabilities in your explanation.
c. What amount will Penny Pincher have to report in its balance sheet? Is it an
asset or a liability?

 Case 14-6 Effect of the Settlement Rate on Periodic Pension Cost

Critics of SFAS No. 87 argue that its requirements result in reporting pension expense that is volatile. One of
the factors causing volatility is changing the discount rate used to calculate service cost and the projected
benefit obligation. The FASB requires use of the “settlement rate” to discount projected benefits.

Required:

a. What is the settlement rate?

b. Explain why the FASB chose the settlement rate to discount projected
benefits.
c. What alternative rate, or rates, might be preferred by opponents of the
settlement rate? Why?
d. Why might companies object to increased volatility of pension expense?
Discuss.

FASB ASC Research

For each of the following FASB ASC research cases, search the FASB ASC database for information to
address the issues. Copy and paste the FASB paragraphs that support your responses. Summarize briefly what
your responses are, citing the pronouncements and paragraphs used to support your responses.

 FASB ASC 14-1 Settlement and Curtailment of a Defined Benefit Pension Plan
Search the FASB ASC database for answers to the following questions. For each question, cut and paste your
findings, citing the source. Then write a brief summary response to the question asked.

1. What is the difference between a settlement and a curtailment of a defined

benefit pension plan? Give an example of each.
 2. Can a settlement and a curtailment occur simultaneously? If so, give an
example.
3. How would a company compute the maximum gain or loss to recognize
when a settlement occurs?
4. How would a company treat any remaining unrecognized prior service cost
under a curtailment?

 FASB ASC 14-2 Interpretations for Pension Accounting

The EITF has issued numerous interpretations of accounting for pensions. Find, cite, and copy three of these
interpretations.

 FASB ASC 14-3 Interpretations for Postretirement Benefits Accounting

The EITF has issued numerous interpretations of accounting for postretirement benefits. Find, cite, and copy
three of these interpretations.

 FASB ASC 14-4 Discount Rate on Retirement Benefits

The FASB ASC indicates that the discount rate for other postretirement benefits might not be the same as the
rate used for pension benefit obligations and discusses the reasons they might be different. Find, cite, and copy
the FASB ASC paragraphs that discuss this issue.

 FASB ASC 14-5 Excess Pension Plan Assets for Contractors

The FASB ASC indicates that contractors should consider disclosing the effect, if any, of the government's
rights with respect to any excess pension plan assets in the event of a plan termination. Find, cite, and copy the
FASB ASC paragraphs that discuss this issue.

 FASB ASC 14-6 Postretirement Health Benefits for Entities in the Coal Industry
The FASB ASC addresses the accounting and reporting for postretirement health benefits for entities in the
coal industry affected by the Coal Industry Retiree Health Benefit Act of 1992. Find, cite, and copy the FASB
ASC paragraphs that discuss this issue.

 FASB ASC 14-7 Pension Cost in Regulated Industries

The FASB ASC provides guidance for accounting for the difference between net periodic pension cost and
amounts of pension cost considered for rate-making purposes as an asset or a liability created by the actions of
the regulator. Find, cite, and copy the FASB ASC paragraphs that discuss this issue.

 FASB ASC 14-8 Postretirement Benefit Cost in Regulated Industries

The FASB ASC provides guidance for accounting for the difference between net periodic postretirement
benefit cost and amounts of postretirement benefit cost considered for rate-making purposes as an asset or a
liability created by the actions of the regulator. Find, cite, and copy the FASB ASC paragraphs that discuss this
issue.

Room for Debate

  Debate 14-1 Articulation of Financial Statements
SFAS No. 87 required that projected benefits be used to measure pension expense, but it allowed companies to
report a minimum liability on the balance sheet using accumulated benefits. The result was that financial
statements were not articulated. For the following debate, relate your arguments to the conceptual framework,
where appropriate.

Team Debate:

Team Argue in favor of articulation between the balance sheet and the income statement.
1:

Team Argue against articulation between the balance sheet and the income statement.
2:

 Debate 14-2 Measurement of the Pension Obligation

SFAS No. 158 no longer allows companies to report the SFAS No. 87 minimum liability in the balance sheet.
Instead, the amount reported in the balance sheet is measured using projected benefits rather than accumulated
benefits. For the following debate, relate your arguments to appropriate accounting theory, including the
conceptual framework and capital maintenance theories. An article you might find helpful in supporting your
arguments is “Alternative Accounting Treatments for Pensions,” The Accounting Review (October 1982), pp.
806–823.

Team Debate:

Team Argue for the use of projected benefits for pension expense and liability purposes.
1:

Team Argue for the use of accumulated benefits for pension expense and liability purposes.
2:
1. Defined Benefit and Contribution Plans in the United States, Clarus Associates,  http://clarusassociates.com/pdf/Financial
%20Literacy.pdf.
2. Jim Abrams, Associated Press, “House OKs Short-Term Pension Crisis
Plan,” http://www.apnewsarchive.com/2003/House-OKs-Short-Term-Pension-Crisis-Plan/id-
3abd330ba1e5f0fca2aca792b5b09f8a (October 9, 2003).
3. U.S. Chamber of Commerce, “Defined Benefit Pension
Plans,” http://www.uschamger.com/issues/index/retirmentpension/definedpension.htm.
4. M. Andrejczak, “Stock Losses Take Heavy Toll on Pension Plans,” MarketWatch, Wall Street Journal (Oct. 22,
2008), http://www.marketwatch.com/story/stock-market-losses-take-heavy-toll-on-pension-plans.
5. In 1980 the FASB issued SFAS No. 35, which required companies to disclose the actuarial present value of accumulated
plan benefits and the pension plan assets available for those benefits. This pronouncement was later superseded by SFAS No.
87.
6. See, for example, W. Landsman, “An Empirical Investigation of Pension Fund Property Rights,” Accounting
Review (October 1986): 662–691; and D. S. Dhaliwal, “Measurement of Financial Leverage in the Presence of Unfunded
Pension Obligations,” The Accounting Review (October 1986): 651–661.
7. Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 106, “Employers' Accounting
for Postretirement Benefits Other Than Pensions” (Stamford, CT: FASB, 1990).
8. FASB ASC 715-60-35-09.
9. Merrill Lynch, Investment Strategy, “Market Impact of Pension Accounting Reform” (Oct. 4,
2006), http://rsch1.ml.com/9093/24013/ds/59512817.PDF.
10. M. E. Barth, W. H. Beaver, and W. R. Landsman, “The Market Value Implications of Net Periodic Pension Cost
Components,” Journal of Accounting and Economics (March 1992): 27–62.
11. B. Choi, D. W. Collins, and W. B. Johnson, “Valuation Implications of Reliability Differences: The Case of Non-
Pension Postretirement Obligations,” The Accounting Review (July 1997): 351–383.
12. “FASB Issues Rule Change on Benefits,” Wall Street Journal (Dec. 29, 1990), A3.
13. See, for example, Daniel C. Hagen, Jeffrey S. Leavitt, Michael K. Blais, and Gina K. Gunning, “New Pension Funding
and Accounting Rules Barrage Employers: Credit Agreement and SEC Disclosure Impact,” Jones Day Commentaries (Oct.
2006), http://www.jonesday.com/pubs/pubs_detail.aspx?pubID=033655bc-09d3-4185-a5f4-005e77d814af&RSS=true.
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