Determining Pension Expense From a conceptual point of view, the pension expense Accounting Help

of a given Period is the present value of the future pension rights granted to employees as a result of their services during the period. The computation of annual pension expense is complex and involves many assumptions. The amount of this expense is computed- not by accountants” but rather by an actuary. The factors considered by the actuary  are as follows:

• Average age, retirement age, and life expectancy of employees’
• Employee turnover rates Compensation levels and estimated rate of pay increases
• Expected rate ,of return to be earned on pension fund assets.

As a step in determining the pension expense for the year, the actuary estimates the, employer’s total pension liability as of year-end. The estimates are updated annually, and estimating errors in prior years are “adjusted” in the current year. for example, assume that the actuarial ‘firm of Gibson & Holt computes a pension expense for Cramer Cable Company of $400,000 for 2001. This amount represents the present value of pension rights granted to Cramer’s employees for the work they performed during the year. To fully fund this obligation, Cramer transfers $400,000 to National Trust Co., the trustee of the company’s pension plan.

An entry summarizing Cramer’s fully funded pension expense for 2001 is as follows:

Pension Expense 400,000 Cash 400,000 Pension expense for.the year as determined by actuarial firm of Gibson & Holt; fully funded by payments to National Trust Co. Postretirement Benefits Other Than Pensions In addition to pension plans, many companies have promised their employees other types of postretirement benefits, such as continuing health insurance.

In most respects, these pension postretirement benefits are accounted for in the same manner as are pension benefits. Most companies. however, do I10t fully fund their obligations for on pension postretirement benefits. Thus recognition of the annual expense often includes a credit to an unfunded liability for part of the cost. Continuing with our illustration of Cramer Cable Company. assume that Gibson & Holt computers for the company a $250,000 on pension postretirement benefits expense for 2001. Unlike its pension expense, however, Cramer does not fully fund its on pension obligations.

For 2001, only $140,000 of the total amount was paid in cash: The entry to summarize this expense for the year is: Any portion of the unfunded’Iiability that the company intends to fund during the next year is classified as a current liability; the remainder is Classified as a long-term liability.Unfunded Postretirement Costs Are Noncash Expenses Postretirement costs are recognized as expense as workers earn the right to receive these benefits. If these costs are fully funded, the company makes cash payments within the current period equal to this expense. But if these benefits are not funded, the cash payments are not made until after the employees retire. Thus an unfunded retirement plan involves a long lag between the recognition of expense and the related cash’ payments. Unfunded retirement benefits often are called a noncash expense.

That is, the expense is charged against current earnings, but there are no corresponding cash payments in the period. In the journal entry above. notice that expense exceeds the cash outlays by $110,000 ($250,000 – $]40.000 = $110,000). This corresponds to the growth in the unfunded liability. GM’s unfunded postretirement costs raise questions about the future benefits ‘these workers are entitled to receive. ‘lacy Pick/Stock Boston Unfunded Liabilities for Postretirement Costs: Can They Really Be Paid? Many of America’s largest and best-known corporations have obligations for unfunded postretirement benefits that can only be described as tenor of stockholders’ equity Until recently, companies were not required to show their unfunded liability for postretirement  costs in their balance sheets. Instead, they charged benefit payments for retired workers directly to expense. This “pay-as-you-go” treatment, however, fails to achieve the matching principle. It is the cost of benefits earned by today’s workers that are helping the company produce revenue, not the cost of benefits paid to workers who have ready retired.The FASB recently changed the rules for measuring, postretirement costs. Companies now must estimate the present value of the retirement benefits earned each year by their employees.

This estimated amount is recognized as expense, and any unfunded portion is recorded as a liability ‘Now that these liabilities are included in the financial statements, many people are stunned by their size. They wonder-with just cause-whether General Motors and other large ‘corporations can really pay Liabilities this large. Interesting question. Let us suggest some things to consider in evaluating a company’s ability to pay its unfunded liability for postretirement costs. First, remember that this liability represents only the present value of the estimated future payments. The future payments are expected to be substantially more than the amount shown in the balance sheet. Next, this liability may continue to grow, especially if the company has more employees today than in the past. On the other hand, this liability does hot have to be paid all at once. It will be paid over a great many years-the life span of today’s workforce.

Posted on November 21, 2015 in Liabilities

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