 Hello and welcome to this session in which we would look at the components of pension expense. Specifically, we're going to be looking at gains slash losses. In the prior session, we looked at service cost, amortization of prior service cost, interest on liability, actual return on plan asset. In this session, we are going to look at gains slash losses. In a way, gains and losses are related to the actual gains or actual return on the plan assets, which we'll see how in a moment. So here's what's going to happen. We might have unexpected swing in pension expense. Why? Why would we have unexpected? Unexpected means unusual. Well, could be a couple of reasons. One is you could have sudden and large changes in the fair value of plan asset. Remember, you have assets sitting in the plan asset. You have assets such as stocks, bonds, real estate investments, so on and so forth. So you have assets sitting here. As a result, in some years, the stock market could go up and in some years, the stock market could go down, up, down, up, down, so on and so forth. So as a result of these unexpected or sudden and large changes, you will have a large increase in your return or a large decrease, which is a loss. Well, as a result, we should not be recording those large increases and sudden increases because it's going to have a large swing on pension expense. That's one reason. The other reason is you could have changes in actuarial assumption that affect the PBO, the projected benefit obligation. Remember the PBO is your liability. Now your liability, the number is given by the actuary. So who knows? In some years, the actuary might say you need to increase your PBO substantially. Why? Well, employees are living longer. You hire too many employees this year. Or your PBO goes down because a lot of your employees left. A lot of employees are not living as longer. Well, just some assumptions made by the actuarial scientists that you are using. So because of these sudden and large changes, we cannot record those large and sudden changes in the pension expense because it's going to increase or reduce pension expense. It's going to make pension expense that goes on the income statement volatile. So to reduce volatility, what we do is we use what's called a smoothing technique. And this is what we need to learn about this smoothing technique. So how do we use this smoothing technique? How do we smooth gains and losses on plan asset? Well, the first thing is we use expected return on plan asset. Notice, up to this point, when we work in exercise, we always said the actual return was $20,000 or the actual return was $70,000 or $60,000. Well, we don't use the actual return. We're going to use expected return. For example, maybe we would make the assumption that our return is based on the historical S&P, 8% per year. So every year, we would use 8% of the plan asset, 8% times the plan asset. This is our expected return. And our actual return could have been 15% if it's a good year, or if it allows a year, it could have been zero or negative. It doesn't matter. We use the expected return to compute the pension expense. We don't use the actual return. Why? Because the actual return could fluctuate substantially. So what do we do with the actual return? With the actual asset gains or asset losses because they could go up or they could go down. Do we ignore them? No, we don't. The expected return. We book that in the pension expense. The actual gains and losses are kept on the balance sheet in OCI, other comprehensive income. We combine them with gains and losses from prior years because in some years we could have gains. They sit in OCI. The other year we could have loss. We go back to where we were. Notice we started here. We went up. Then we went down. So if this is on OCI, as far as the income statement, nothing really happened. One year it went up. One year it went down. We're back to the same line. Then it went down. Then it went back up. So the assumption is over the years the return will even out. That's the assumption if we keep them in OCI. Then if they go out of control, which means too large, we're going to be using what's called a corridor approach. So we are going to take some of those gains and losses, sudden gains and losses and book them on the income statement when they get too large. Using what's called the corridor approach. Now before we look at the corridor approach, most likely you are watching. You are an accounting student taking this course. And if you are great, you have arrived. What you should do, you should subscribe to my material, farhatlectures.com. Resources such as lectures, multiple choice, through faults and exercises that's going to help you do better in your exam. If you are a CPA candidate, I don't replace your CPA review course. I'm going to give you additional resources that's going to help you do better on your CPA. Please connect with me on LinkedIn, YouTube. If you're watching this recording, just please click on the like button. It doesn't cost you anything. Share it with other. Connect with me on Instagram, Facebook, Twitter and Reddit. So what is the corridor approach or the corridor amortization? Well, here's what's going to happen. We're going to be using this approach to amortize the accumulated gains and losses. We cannot have both, either gain or losses. When those gain and losses get to be too large. Now when do we know it's too large? How do we decide this gain or loss is too large? Well, we're going to take this OCI figure, whether it's a gain or a loss and compare it to the beginning PBO and to the plant asset. If that number is 10% larger than the beginning PBO or the plant asset, well, that number is too large then. This is how we determine it's too large. So any accumulated OCI, whether it's a gain or a loss, above 10%, this is the amount that we amortize. Let's take a look at some numbers real quick to kind of clarify this point. So let's assume you have in year X1, you have 800,000 in PBO, 900,000 in plant asset. Well, we'll choose the larger of the two. The larger of the two is 900,000. We'll take 900,000 multiplied by 10%. We have this number, 90,000. What does that mean? It means as long as your losses or your gains are within, so this is zero. This is the zero line. Those are the gains and let's assume this is 90,000. This is plus and this is minus. As long as your gains and losses are between negative 90 and positive 90, there's nothing you can do. Keep that number on the, keep those figures, keep those gains and losses on the balance sheet. Year two, 840, your PBO, 810 is your plant asset now. As long as you are within plus 84, minus 84. Year three, 910 versus 980, 10% of the larger is 980. So as long as you are within plus 98,000, minus 98,000, you're in good shape. Notice in year four, it becomes 1.4 plant asset, PBO 1.2. Now we are looking at 140 and negative 140. So this is what we mean by the, this is not a good graph, but this is what we mean by the corridor approach. As long as you are within this corridor, just keep those gains and losses on the balance sheet as part of OCI. You only have to worry about them when they get above. So if your gains and losses for year four are, your gains and losses are 160, your gains or your losses are 160, above 140. It doesn't matter above or below 140. Then we have to amortize that access. So this is what we mean by the corridor approach. Let's work an example to illustrate this point. Let's assume Adam had a PBO of 3.2 million, plant asset of 3.6. This is sort of January 1st. Adam also had a net actuarial loss of 600,000 in OCI January 1st. And the average remaining life of the Adam employee is 10 years. So let's see. Which one is the larger, 3.2 or 3.6? Obviously, it's 3.6. We multiply 3.6 by 10%. This is the corridor. If we have more gains and losses than 360, we have to do something about them. Look how much we have. We have 600,000. Well, what's the access? 600 minus 360, we have access losses subject to amortization 240. Now we're not going to take the whole thing and expense it now. We're going to take 240 times, I'm sorry, not times, divided by 10 years. And this happens to be, I should have used another number because we used here. The corridor approach is 10%. This is 10 years, happened to be 10 years. Let me change this to actually 5, just kind of so I don't want you to think that 10 is the number that we use. So I'm going to use 5. Therefore, we are going to amortize to pension expense 48,000. So now 48,000 of the losses will hit pension expense. Why? Because the losses in OCI are too large. We need to kind of start to reduce them. Therefore, we're going to reduce them by 48,000 this year. Obviously, OCI will be reduced by 48,000, obviously. What should you do now? Go to farhatlectures.com. Subscribe if you're not a subscriber. Work MCQs, true, false, and exercises. That's going to help you reinforce the concept. Your accounting education is extremely important. Invest in yourself, invest in your career. It's going to pay you dividends for years. Don't shortchange yourself. Good luck, study hard, and of course, stay safe.