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CPA FAR – STUDY UNIT 11

Employee Benefits
Core Concepts

1. Types of Pension Plans

a. A pension plan is a separate accounting entity to which a sponsoring employer makes
contributions. The employer is responsible for the assets and the liabilities, and the plan
invests the assets and makes payments to beneficiaries.
b. Defined contribution plan benefits depend on (1) contributions by the employer and
employee and (2) the returns earned on investments of those contributions. The employer’s
only obligation is to make periodic deposits of the amounts defined by the plan’s formula in
return for services rendered by the employees.
1) Annual pension expense equals the amount of the contribution determined by the
plan’s formula.
c. A defined benefit plan defines a benefit to be provided to each employee. The employer is
responsible for providing the agreed benefits. They depend on (1) lifetime of the employee,
(2) years of service rendered, and (3) the employee’s compensation before retirement.
1) Future payouts are estimated using actuarial assumptions. Pension expense, funding,
and the funded status of the plan must be recognized each year.
2. Defined Benefit Plan -- Components of Pension Expense
a. The required minimum periodic pension expense (cost) consists of the following elements:
Service cost
+ Interest cost
– Expected return on plan assets
± Amortization of net gain or loss
± Amortization of prior service cost or credit
Net periodic pension expense

1) Service cost is the actuarial present value of benefits attributed by the pension benefit
formula to services rendered by employees during the current period. Service cost
increases the PBO (the pension liability).
2) Interest cost is the increase in the PBO resulting from the passage of time. It equals
the PBO at the beginning of the period, multiplied by the discount rate. Interest cost
increases the PBO (the pension liability).
3) The expected return on plan assets is the fair value of plan assets at the beginning
of the period, multiplied by the expected long-term rate of return.
4) Amortization of prior service cost (or credit). Prior service cost results when a plan
is amended or to grant additional pension benefits for services already rendered.
a) Prior service cost is recognized as a debit to OCI on the date of the plan
amendment (or credit to OCI for a past service credit).
b) Subsequent to its initial recognition, prior service cost must be amortized and
reclassified from OCI to pension expense.

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2 CPA FAR – Study Unit 11

5) Amortization of net gain or loss. The total gain or loss includes (a) liability gains and
losses and (b) asset gains and losses. These gains and losses reflect changes in
the PBO or plan assets that result from (a) experience different from that assumed or
(b) changes in actuarial assumptions. Under the corridor method, net gain or loss
is initially recognized in OCI and amortized and reclassified to pension expense in
subsequent periods.
a) Liability gain or loss can be calculated from the PBO equation.
b) Asset gain or loss is the difference between (1) the actual return on plan assets
and (2) the expected return on plan assets. When the actual return on plan
assets is greater than the expected return, an asset gain is recognized. When
the actual return on plan assets is lower than the expected return, an asset loss
is recognized.
3. Defined Benefit Plan -- Funded Status of Pension Plans
a. Below is the PBO equation:
Beginning PBO
+ Service cost
+ Interest cost
+ Prior service cost
– Prior service credit
– Benefits paid
± Changes in the PBO resulting from
(a) experience different from that assumed
(b) changes in assumptions
Ending PBO
b. Below is the plan assets equation:
Beginning fair value of plan assets
+ Contributions
– Benefits paid
± Actual return on plan assets
Ending fair value of plan assets

c. If the pension is underfunded, i.e., the PBO exceeds the fair value of the plan assets at the
reporting date, the deficit must be recognized as a liability.
d. If the pension is overfunded, i.e., the fair value of the plan assets at the reporting date
exceeds the PBO, the excess must be recognized as an asset.
4. Disclosures, Presentation, and Other Issues
a. Public entities are required to make many specific disclosures about (1) the benefit
obligation, (2) the fair value of plan assets, (3) funded status of the plans, (4) plan assets,
(5) the accumulated benefit obligation, (6) benefits to be paid, (7) estimate contributions,
(8) net periodic benefit cost, (9) net gain (loss) and reclassification adjustments, and
(10) assumptions about the discount rate.
b. The service cost component of the periodic pension cost is reported in the same line item
as other employee compensation costs and separately from other components of the
periodic pension cost.
c. Settlements are irrevocable actions that relieve the employer (or the plan) of the
responsibility for a PBO. Curtailments significantly reduce the expected years of future
service of current employees.
d. Termination benefits are provided to employees in connection with their termination of
employment.

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 CPA FAR – Study Unit 11 3

5. Postretirement Benefits Other than Pensions

a. The principles are similar to those of pension accounting.
b. The expected postretirement benefit obligation (EPBO) equals the accumulated
postretirement benefit obligation (APBO) after the full eligibility date. The EPBO for
an employee is the actuarial present value at a given date of the benefits expected to be
paid. The APBO for an employee is the actuarial present value at a given date of the future
benefits attributable to the employee’s service as of that date.
c. The funded status of the plan must be recognized as the difference between the fair value
of plan assets and the APBO.
d. The possible components of net periodic post retirement benefit cost (NPPBC) are
(1) service cost, (2) interest on the APBO, (3) return on plan assets, and (4) amortization
of the following amounts included in accumulated OCI: prior service cost or credit and the
gain or loss component.
6. Compensated Absences and Postemployment Benefits
a. Employee compensation for future absences is accrued when (1) the payment is probable,
(2) the amount can be reasonably estimated, (3) the benefits vest or accumulate, and
(4) the compensation relates to services already rendered.
b. Sick pay benefits are accrued only if the rights vest.
c. Employers who provide postemployment benefits to former or inactive employees after
employment but before retirement accrue a liability if all four criteria above are met.
7. Share-Based Payment
a. Employee compensation cost for an award classified as equity is recognized over the
requisite service period. The credit is usually to additional paid-in capital. The RSP is
most often the vesting period beginning on the grant date.
b. Total compensation cost at the end of the RSP is based on the number of equity
instruments for which the requisite service was completed. Changes in the estimate result
in recognition of the cumulative effect on prior and current periods in the calculation of
compensation cost for the period of change.
c. The cost of employee services performed in exchange for awards of share-based
compensation normally is measured at (1) the grant date fair value of the equity
instruments issued or (2) the fair value of the liabilities incurred.
d. When an entity cannot reasonably estimate the fair value of equity instruments at the
grant date, the accounting is based on intrinsic value. Intrinsic value is the fair value of an
underlying share less the exercise price of an option.
e. When an award is classified as a liability, the measurement date for liabilities is the
settlement date. After initial recognition at fair value, liabilities are remeasured at each
reporting date.

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