CHAPTER 20

Accounting for Pensions and

Postretirement Benefits

LEARNING OBJECTIVES

1. Discuss the fundamentals of pension plan accounting.

2. Use a worksheet for employer’s pension plan entries.
3. Explain the accounting for past service costs.
4. Explain the accounting for remeasurements.
5. Describe the requirements for reporting pension plans in financial statements.
6. Explain the accounting for other postretirement benefits.

Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS, 3e, Instructor’s Manual 20-1
CHAPTER REVIEW
1. Chapter 20 discusses the various aspects of accounting for the cost of pension plans.
Accounting for pension costs is somewhat complicated because of the variety of social
concepts, legal considerations, actuarial techniques, income tax regulations, and varying
business philosophies that affect the development and maintenance of pension plans.
This chapter relates these issues to the recommended accounting treatment for the costs
associated with a pension plan.
Nature of Pension Plans
2. (L.O. 1) A pension plan is an arrangement whereby an employer provides benefits
(payments) to employees after they retire for services they provided while they were
working. In the accounting for a pension plan, consideration must be given to accounting
for the employer and accounting for the pension plan itself. A pension plan is said to be
funded when the employer sets funds aside for future pension benefits by making
payments to a funding agency that is responsible for accumulating the assets of the pension
fund and for making payment to the recipients as the benefits come due.
3. Pension plans can be contributory or noncontributory. In a contributory plan, the
employees bear part of the cost of the stated benefits or voluntarily make payments to
increase their benefits. If the plan is noncontributory, the employer bears the entire cost.
This chapter focuses on the accounting and reporting issues faced by employers who
sponsor pension plans. The pension fund is a separate legal and accounting entity with
its own set of books and financial statements and is not the subject of this chapter.
Instead, this chapter explains pension accounting and reporting problems of the employer
as the sponsor of a pension plan.
Types of Pension Plans
4. The most common types of pension arrangements are defined contribution plans and
defined benefit plans. In a defined contribution plan, the employer agrees to contribute a
certain sum each period based on a formula. The formula might consider such factors as
age, length of service, employer’s profits, and compensation level. The accounting for a
defined contribution plan is straightforward. The employer’s responsibility is simply to
make a contribution each year based on the formula established in the plan. Thus, the
employer’s annual cost is the amount it is obligated to contribute to the pension trust. If
the contribution is made in full each year, no pension asset or liability is reported on the
statement of financial position.
5. A defined benefit plan defines the benefits that the employee will receive at the time of
retirement. The formula that is typically used provides for the benefits to be a function of
the level of compensation near retirement and of the number of years of service. The
accounting for a defined benefit plan is complex. Because the benefits are defined in
terms of uncertain future variables, an appropriate funding pattern must be established to
insure that enough monies will be available at retirement to meet the benefits promised.
Because the problems associated with pension plans involve complicated actuarial
considerations, actuaries are engaged to ensure that the plan is appropriate for all
employee groups covered. Actuaries make predictions (actuarial assumptions) of mortality
rates, employee turnover, interest and earnings rates, early retirement frequency, future
salaries, and other factors necessary to operate a pension plan. Thus, accounting for

20-2 Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS, 3e, Instructor’s Manual
 defined benefit pension plans is highly reliant upon information and measurements
provided by actuaries.

Measures of Liability

6. Most accountants agree that an employer’s pension obligation is the deferred

compensation obligation it has to its employees for their services under the terms of the
pension plan. However, there are three ways to measure this liability. One approach is to
base the obligation on the vested benefits current employees are entitled to receive
even if they render no additional years of service. The vested benefits pension obligation
is computed using current salary levels and includes only vested benefits. A second
approach to the measurement of the pension obligation is to base the computation on all
years of service performed by employees under the plan – both vested and nonvested
using current salary levels. This measurement of the pension obligation is called the
accumulated benefit obligation. A third measurement technique bases the computation
on both vested and nonvested service using future salaries. Because future salaries are
expected to be higher than current salaries, this approach, known as the defined benefit
obligation, results in the largest measurement of the pension obligation.

7. Regardless of the approach used, the estimated future benefits to be paid are discounted
to present value. However, the profession adopted the defined benefit obligation –
the present value (without deducting any plan assets) of the expected future payments
required to settle the obligation resulting from employee service in current and prior
periods.

Components of Pension Expense

8. The net defined benefit obligation (asset) (also referred to as the funded status) is
the deficit or surplus related to a defined pension plan. The deficit or surplus is often
referred to as the funded status of the plan. If the defined benefit obligation is greater
than the plan assets, the pension plan has a deficit. Conversely, if the defined benefit
obligation is less than the plan assets, the pension plan has a surplus.

Companies should either report a pension asset or pension liability related to a pension
plan on the statement of financial position (often referred to as the net approach).
Some believe that companies should report separately both the defined benefit
obligation and the plan assets on the statement of financial position. This approach is
often referred to as the gross approach.

9.  Accounting for pension plans requires measurement of the cost and its identification with
the appropriate time periods. The determination of pension cost is very complicated
because it is a function of a number of factors. These factors are identified and described
below.

Service Cost. This is either current service cost or past service cost. This component
is reported in the statement of comprehensive income in the operating section of the
statement and affects net income. To determine current service cost and the related
increase in the defined benefit obligation, companies must:

Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS, 3e, Instructor’s Manual 20-3
 1. Apply an actuarial valuation method.
2. Assign benefits to period of service.
3. Make actuarial assumptions.

Net Interest. Because a pension is a deferred compensation arrangement, it is recorded on a

discounted basis. Net interest is computed by multiplying the discount rate by the
defined benefit obligation and the plan assets.

Remeasurement. Remeasurements are gains and losses related to the defined benefit
obligation (changes in discount rate or other actuarial assumptions) and gains or
losses on the fair value of the plan assets (actual rate of return less interest revenue
included in the finance component). This component is reported in other comprehensive
income, net of tax. These remeasurement gains or losses therefore affect
comprehensive income but not net income.

In summary, pension expense is comprised of two components: (1) service cost and
(2) net interest.

Pension plan assets are usually investments in shares, bonds, other securities, and real
estate that a company holds to earn a reasonable rate of return.

Actual Return on Plan Assets is the increase in the pension fund assets arising
from interest, dividends, and realized and unrealized changes in the fair value of the
plan. Benefits paid to retired employees decrease plan assets.
Computation of the year-end plan assets is illustrated by the following schedule:

Fair value of plan assets, January 1, 2019.......................... £4,200,000

Plus: Contributions to plan during period............................. 300,000

Plus: Actual return…………………………………………….. 210,000
Less benefits paid during the period.................................... (250,000)
Plan assets, December 31, 2019......................................... £4,460,000

If the actual return on the plan assets is positive (gain) during the period, it is subtracted
in the computation of ending plan assets. If the actual return is negative (loss) during the
period, it is added in the computation of ending plan assets.

The Pension Worksheet

10. (L.O. 2) In illustrating the accounting for these factors the text material makes use of
a work sheet approach. The worksheet is unique to pension accounting and is utilized to
record both the formal entries and memo entries that are necessary to keep track of all
the employer’s relevant pension plan items and components. The format of the worksheet
is as follows:

20-4 Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS, 3e, Instructor’s Manual
 a. The left-hand “General Journal Entries” columns of the worksheet record entries in the
formal general ledger accounts. The right-hand “Memo Record” columns maintain
balances in the defined benefit obligation and the plan assets. The difference between
the DBO and the plan assets is the Pension Asset/Liability which is shown in the
statement of financial position.

b. On the first line of the worksheet, the beginning balances (if any) are recorded.
Subsequently, transactions and events related to the pension plan are recorded, using
debits and credits and using both sets of records as if they were one for recording the
entries. For each transaction or event, the debits must equal the credits. The ending
balance in the Pension Asset/Liability column should equal the net balance in the memo
record. The work sheet approach to accumulating balances for pension accounting is a
most effective means of keeping track of complicated computations.

2019 Entries and Worksheet

11. To illustrate the use of a worksheet, the following facts apply to Zarle Company for the
year 2019:
Plan assets, 1/1/19........................................................ €100,000
Defined benefit obligation, 1/1/19................................. €100,000
Annual service cost for 2019......................................... 9,000
Discount rate for 2019................................................... 10%
.....................................Contributions (funding) in 2019 8,000
Benefits paid to retirees in 2019................................... 7,000

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Pension Worksheet for 2019
General Journal Entries Memo Record
Annual Pension Defined
Pension Asset/ Benefit Plan
Items Expense Cash Liability Obligation Assets
100,000 100,000
Balance Jan. 1, 2019 --- Cr. Dr.
(a) Service cost 9,000 Dr. 9,000 Cr.
(b) Interest expense 10,000 Dr. 10,000 Cr.
(c) Interest revenue 10,000 Cr. 10,000 Dr.
8,000
(d) Contributions Cr. 8,000 Dr.
(e) Benefits 7,000 Dr. 7,000 Cr.

8,000
Journal entry for 2019 9000 Dr. Cr. 1,000 Cr.*
Balance Dec. 31, 1,000 112,000 111,000
2019 Cr.** Cr. Dr.

* €9,000 - 8,000 = €1,000

**€112,000 - 111,000 = €1,000

12. (L.O. 3) Past service cost (PSC) is the change in the present value of the defined
benefit obligation resulting from a plan amendment or a curtailment. For example, a plan
amendment arises when a company decides to provide additional benefits to existing
employees for past service. Conversely, the company may decide that it is necessary to
reduce its benefit package retroactively for existing employees, thereby reducing their pension
benefit. A curtailment occurs when the company has a significant reduction in the number of
employees covered by the plan. The IASB decided that any changes in the defined benefit
obligation or plan assets should be recognized in the current period.

2020 Entries and Worksheet

13. To illustrate the use of a worksheet with amortization of unrecognized past service costs,
the following facts apply to Zarle Company for the year 2020:

Present value of past service benefits granted l/l/20.... €81,600

Annual service cost for 2020......................................... 9,500
Discount rate for 2020................................................... 10%
Contributions (funding) in 2020..................................... €20,000
Benefits paid retirees in 2020........................................ 8,000

The journal entry for 2020 would be as follows:

Pension Expense...............................................99,360
Cash....................................................................... 20,000
Pension Asset/Liability........................................... 79,360
Pension Worksheet for 2020
General Journal Entries Memo Record

20-6 Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS, 3e, Instructor’s Manual
 Annual Pension Defined
Pension Asset/ Benefit Plan
Items Expense Cash Liability Obligation Assets
Balance Dec. 31, 112,000 100,000
2020 1,000 Cr. Cr. Dr.
(f) Additional PSC
1/1/2020 81,600 Dr. 81,600 Cr.
Balance Jan. 1, 193,600
2020 10,000 Dr. Cr.
(g) Service cost 9,500 Dr. 9,500 Cr.
(h) Interest expense 19,360 Dr. 19,360 Cr.
(i) Interest revenue 11,100 Cr. 11,100 Dr.
20,000
(j) Contributions Cr. 20,000 Dr.
(k) Benefits 8,000 Dr. 8,000 Cr.
Journal entry for 20,000 79,360
2020 99,360 Dr. Cr. Cr.
Balance Dec. 31, 80,360 214,460 134,100
2020 Cr. Cr. Dr.

The pension reconciliation schedule is as follows:

Defined benefit obligation (Credit) €(214,460)

Plan assets at fair value (Debit) 134,100
Pension asset/liability (Credit) (80,360)

Remeasurements

14. (L.O. 4) Because of the concern to companies that pension plans would have
uncontrollable and unexpected swings in pension expense, the profession decided to
reduce the volatility by using smoothing techniques. IASB believes that the most
informative way is to recognize the remeasurement in other comprehensive income.

Remeasurements are generally of two types:

1. Gains and losses on plan assets.
2. Gains and losses on the defined benefit obligation .

Asset gains (occurring when actual return is greater than interest revenue) require a debit
to plan assets for the asset gain of and credit to Other Comprehensive Income (G/L) for
the same amount, while asset losses (occurring when actual return is less than interest
revenue) require a debit to Other Comprehensive Income (G/L) for the asset loss and
credits plan assets. Liability gains (resulting from unexpected decreases in the liability
balance) and liability losses (resulting from unexpected increases) are reported in Other
Comprehensive Income and is usually combined in the same account used for asset gain
or losses.

2021 Entries and Worksheet

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17. Continuing the Zarle Company illustration into 2021, the following facts apply to the
pension plan:
Annual service cost for 2021............................................... € 13,000
Discount rate is 10%
Actual return on plan assets for 2021.................................. 12,000
Annual Contributions (funding) in 2021............................... 24,000
Benefits paid to retirees in 2021.......................................... 10,500
Changes in actuarial assumptions establish
the end-of-year defined benefit obligation........................ 265,000

The pension reconciliation schedule is as follows:

Defined benefit obligation (Credit) €(265,000)

Plan assets at fair value (Debit) 159,600
Pension Asset/Liability (Credit) € (105,400)

The 2021 worksheet would be completed as follows:

General Journal Entries Memo Record

Annual Pension Defined

Pension OCI - Asset/ Benefit Plan
Items Expense Cash Gain/Loss Liability Obligation Assets
214,460 134,100
Balance Jan. 1, 2021 80,360 Cr. Cr. Dr.
13,000
(l) Service cost Dr. 13,000 Cr.
21,446
(m) Interest expense Dr. 21,446 Cr.
13,410
(n) Interest revenue Cr. 13,410 Dr.
24,000
(o) Contributions Cr. 24,000 Dr.
(p) Benefits 10,500 Dr. 10,500 Cr.
(q) Asset loss 1,410 Dr. 1,410 Cr.
26,594
(r) Liability loss Dr. 8,000 Cr.
Journal entry for 21,036 24,000 28,004
2021 Dr. Cr. Dr. 25,040 Cr. 26,594 Cr.
Accumulated OCI,
Dec. 31, 2016 0
Balance Dec. 31, 28,004 105,400 265,000 159,600
2021 Dr. Cr. Cr. Dr.

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18. The IASB is silent as to whether the Accumulated Other Comprehensive Income
account should be used instead of another equity account, like Retained
Earnings. Reporting Pension Plans in Financial Statements.

19. A company reports the pension asset/liability as an asset or a liability

in
the statement of financial position at the end of a reporting period. The
classification as non-current or current follows the general guidelines used for
classification of other assets or liabilities. On the income statement (or
related notes), the company must report the amount of pension expense
for the period. In addition, any actuarial gains or losses charged or credited
to other comprehensive income should be reported in the statement
of comprehensive income.

20. In the notes, a company is required to disclose information that (a) explains
characteristics of its defined benefit plans and risks associated with them, (b)
identifies and explains the amounts in its financial statements arising from
its defined benefit plans, and (c) describes how its defined benefit plans may
affect the amount, timing, and uncertainty of the company’s future cash flows.
The reconciliation of the changes in the pension assets and liabilities is a key
element of the pension disclosure package.

Other Post-Retirement Benefits

21. (L.O. 6) Companies often provide other types of non-pension postretirement

benefits, such as life insurance outside a pension plan, medical care, and legal
and tax services. The accounting for these other types of postretirement
benefits is the same as that used for pension plan reporting.
Companies with both pension and other postretirement benefit plans
must separately disclose the plan details when the plans are subject to materially
different risks.

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LECTURE OUTLINE

The material in this chapter can be covered in four class periods. Accounting for the costs of
pension plans is technically complex and conceptually challenging for most students. The use
of the pension work sheet illustrated in the textbook is very helpful in organizing and presenting
the major components of pension expense.

A. The Nature of Pension Plans. Discuss the following:

1. Definition of pension plan: an arrangement whereby an employer provides benefits

(payments) to retired employees for services they performed during their working
years.

2. (L.O. 1) Employer vs. plan accounting. Employer sponsors the plan, incurs the cost, and
makes contributions. The plan receives the contributions, administers plan assets, and
makes benefit payments to recipients.

a. Funding. Employer payments to funding agency.

b. Contributory vs. noncontributory.

(1) Contributory: employees bear part of the cost of the stated benefits.

(2) Noncontributory: employer bears entire cost.

c. Qualified pension plans.

(1) Plans that meet income tax requirements that permit deductibility of
employer’s contributions.
(2) Earnings from fund assets are tax-free.

3. Types of pension plans.

a. Defined contribution plans: employer’s contribution is defined; there is no promise

regarding amount of benefits to be paid out.

b. Defined benefit plans: employer is responsible for payment of defined benefits

regardless of what happens in the trust fund.

4. The role of actuaries in pension accounting.

20-10 Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS, 3e, Instructor’s Manual
 5. The pension obligation: deferred compensation obligation an employer has to its
employees.
a. Vested benefits: benefits employee is entitled to even if no further services rendered.

b. Vested benefit obligation: benefits for vested employees only at current salaries.

c. Accumulated benefit obligation:  benefits for vested and nonvested employees

at current salaries.

d. Defined benefit obligation: present value of benefits for vested and nonvested

employees at future salaries. The method used under IFRS.

B. Net Defined Benefit Obligation (Asset).

6. The net defined benefit obligation (asset) is also referred to as the funded status
and can be a deficit or surplus related to the defined benefit plan. If the defined benefit
obligation is greater than the plan assets, the pension plan has a deficit.

7. In the statement of financial position, companies report the net defined benefit
obligation/asset (funded status), which is the defined benefit obligation less the fair
value of plan assets (if any). Changes in the net defined benefit obligation (asset) are
reported in comprehensive income. Service cost (current and past) and net interest
(computed by multiplying the discount rate by the funded status of the plan) are
reported in the operating section of comprehensive income. Remeasurements are
gains and losses related to the defined benefit obligation (changes in discount rate or
other actuarial assumptions) and gains or losses on the fair value of the plan assets.
Remeasurements are reported in other comprehensive income.

C. (L.O. 2) Use a Worksheet for Employer’s Pension Plan Entries.

8. Companies may use a worksheet unique to pension accounting. This worksheet

records both the formal entries and the memo entries to keep track of all the
employer’s relevant pension plan items and components.

D. (L.O. 3) Explain the accounting for past service costs.

9. Past service cost is the change in the value of the defined benefit obligation
resulting from a plan amendment or a curtailment. Past service costs are
expensed in the period of the amendment or curtailment. As a result, a
substantial increase (decrease) in pension expense and the defined
benefit obligation often results when a plan amendment or curtailment
occurs.

E. (L.O. 4) Explain the accounting for remeasurements.

10. Remeasurements arise from (1) gains and losses on plan assets and (2) gains
and losses on the defined benefit obligation. The gains and losses on plan
assets (asset gain or loss) is the difference between the actual return and the

Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS, 3e, Instructor’s Manual 20-11
interest revenue computed in determining net interest. Asset gains occur
when actual returns exceed the interest revenue. Asset losses occur when the
actual returns are less than interest revenue. The gains or losses on the
defined benefit obligation (liability gain/loss) are due to changes in
actuarial assumptions that
affect the amount of the defined benefit obligation.

11. All remeasurements are reported in other comprehensive income. These

amounts are not recycled into income in subsequent periods.

F. (L.O. 5) Describe the requirements for reporting pension plans in financial statements.

12. A company reports the pension asset/liability as an asset or a liability in

the statement of financial position at the end of a reporting period. The
classification as non-current or current follows the general guidelines used
for classification of other assets or liabilities. On the income statement (or
related notes), the company must report the amount of pension expense
for the period. In addition, any actuarial gains or losses charged or credited
to other comprehensive income should be reported in the statement
of comprehensive income.

13. In the notes, a company is required to disclose information that (a) explains
characteristics of its defined benefit plans and risks associated with them,
(b) identifies and explains the amounts in its financial statements arising from
its defined benefit plans, and (c) describes how its defined benefit plans may
affect the amount, timing, and uncertainty of the company’s future cash flows.
The reconciliation of the changes in the pension assets and liabilities is a key
element of the pension disclosure package.

G. (L.O. 6) Explain the accounting for other postretirement benefits.

14. Companies often provide other types of non-pension postretirement

benefits, such as life insurance outside a pension plan, medical care, and legal
and tax services. The accounting for these other types of postretirement benefits
is the same as that used for pension plan reporting. Companies with both
pension and other postretirement benefit plans must separately disclose the plan
details when the plans are subject to materially different risks.

20-12 Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS, 3e, Instructor’s Manual