 Hello and welcome to this session. This is Professor Farhat and this session we're going to look at a comprehensive example dealing with Pension so at this point if you don't understand how pension work the various component of pension expense how the PBO work by all means Go to farhatlectures.com view the prior recording So this basically this example would illustrate all the concepts that you have learned in this chapter So if you if you get follow with this example, then you are good to go I would say when it comes to accounting for pension So let's take a look at the data that we are giving So we are giving three-year data for Jackson company Jackson company adopted an acceptable accounting for its defined benefit pension on January 1st 2016 with the following beginning balances They immediately put 200,000 away Under plan asset and they believe they will have a PBO as of today $250,000 So this is what they start with simply simply put they started with a underfunded plan of 50,000 Okay, in 2016 they have they have we have three years 2016 2017 and 2018 in 2016 the annual service cost was 16,000 the settlement rate and the expected return is 10% actual return on the plan asset is only 18,000 annual Annual funding contribution we wrote a check to the plan Administrator for 16,000 and the company paid benefit of 14,000. This is 2016. So let's work with 2016 So notice we're going to start with 2016 and if you know anything about this example That looks like straightforward this example 2016 Then we're going to be adding a little bit more in 2017 more complication a little bit more in 2018 So let's start with this simple year 2016 2016 we started with again where they have a pension liability of 50,000 at the beginning of the year Why because when we started the plan we immediately put away 200,000 but our obligation was 250 Then the employee worked the year Work one one additional year for us. Therefore, we have an increase in pension expense an increase in PBO of 16,000 Interests on the liability, which is how do you come up with 25,000? We said the settlement rate is 10 percent 250 times 10 So this is going to also increase the PBO Our return on asset Return the expected return is 20,000. Why 20,000? It's it's the plan asset times the expected return, but we only returned 18,000 Well, we thought we're gonna get we thought we're gonna get 20,000. We expect it to get at least 20,000 Let's make put it this way that that was the expected the actual was only 18 It means we're gonna have to put an additional 2000 because we always use the expected But we're gonna do what we're gonna do with that remaining 2000. That's gonna be a loss an OCI simply put Now we have a loss an OCI an expected loss of 2000 And again a loss in OCI is a debit loss and OCI is a debit So we debit OCI 2000 simply put for that Contribution this is the check that we wrote so our cash goes down And our plan asset goes up because we submitted a payment to the to the plan asset And we paid 14,000. Therefore, we have less PBO and less plan assets So we pay our retirees for we did we did not really pay them the administrator paid them So let's first take a look at the balance and PBO The balance the first thing you want to do is compute the balance and PBO the balance is 277,000 Which is starting with 250 plus 16 plus 25 minus 14 and the plan asset is 220,000 so we are still underfunded by 55,000 So our liability will be under our liability will be 57,000 Therefore if we started with 50 and we need to get to 57,000 that means we have to credit Because this is the journal and we have to credit pension liability 7,000 We add up all our expense. Our pension expense is 21,000 Cash is credit 16 and here we debit because it's a loss because we incurred the loss We debit OCI 2000 and obviously we credit the liability 2000. So let's take a look at the journal entry The pension expense is the total of the pension expense OCI is a debit of 2000 because we have an unexpected loss And the pension liability is 7,000. How do we come up with the 7,000? Once again I started with the pension liability of 50,000. I needed 57. What I'm missing is 7 And I paid 16,000 and cash always make sure Your debits And your credits are equal which is they are equal to each other. So this was 2016 now bear in mind So when you start 2017 when you start 2017, this is what you are When you start 2017, this is what you are starting with you are starting with a pension Liability of 57,000 pbo of 227 and plan asset of 220 So now we are going we're going to be working with 2017 data Okay 2017 data, let's review the 2017 data annual service cost of 19 Again the settlement rate and the expected return is 10% the actual return was 22 The annual funding we're going to write a check for 40,000 We're going to pay our employees 16,400 but in 2017 we amended the plan We amended the plan and as a result now we have a prior service cost of 160,000 Why we just we amended the plan? What does amending the plan means? It means we decided to Give additional benefit to our employees and as a result our obligation went up by 160 And amortization of prior service cost of 54,000 So we're going to amortize out of this 160 54,400 just they just gave us this amount We don't worry about how we came up with it. So let's start 2017 worksheet Again 2017. We are starting with 57 of pension liability 277 of pbo and 220 of plan asset now Also, we are starting with a debit balance of 2000 and in the oci because oci This oci just want to make sure I you know this it's a balance sheet account So oci is a balance sheet account and we're starting with a 2000 debit balance The first thing we do we're gonna we're gonna add our pbo I'm not add to the pbo the prior service cost. Remember we amended the plan. It's going to hit our pbo It's not going to hit our expense. Okay, 160,000 and we're going to put 160,000 in pc and prior service cost Now that's going to give us the balance adjusted balance as of the beginning of the year And we're going to add the service cost the service cost for this year was 19,000 Interest on the obligation is 437,000. How 43,700 how do you come up with this? It's your pbo including prior service cost times 10 Gives me 43,700 return on asset That's 22,000 and guess what happened here. Guess what happened here this year return on asset was 22,000 But if I take how do I come up with the expected return? I'll take my plan asset To let's take this one 220 and I multiply it by 10% if I do so I'll get 22,000 in my actual return was 22,000 It's very unusual that this happens, but this is to simplify things So the return on asset was 22,000, which is equal to the actual return. That's fine Then we amortize out of this 160. They're telling us you are going to expense 54,400 again. How did he come up with this just told us this number So we're going to amortize this amount. So we're going to add it to our pension expense and reduce it From p prior service cost notice. We're going to be reducing it from the 160 Okay, then the contribution we contributed for 40,000. So we wrote a check for 40,000 reduce cash and increase The plan asset by 40,000 Okay, then we paid 16,400. That's not on our record. That's on the on the Administrator. So the first thing you do once again, the first thing you should do is Add up what happened to what's your pbo Your pbo is 483 483 300 your plan asset is 265 600 So you should have a liability of 277 100 You should have a liability of 277 100. Well, you started your liability with 57,000 you started with liability with 57,000 and you need to have 277 700 now because your pbo is greater than your plan asset by 277 100 Therefore the first entry is you need a credit of 160 700 for the pension liability Then what we do is you just go through the Go through the figures and you have to find out what else do you need to do You have to debit pension expense. This is a debit to pension expense 95,100 you credit You credit cash cash is credit cash is credit cash is credit For the amount that you paid which is 40,000 and the prior service cost You started with 160 you reduced it by 54,400 and this is your first year. Therefore, you're going to have a prior service cost 105 600 and since you did not have any Basically a beginning balance. There is no beginning balance and prior service costs Just hit the just the entry will be debit to prior service cost of 105 600 to do what to start the balance 105 600 And for the gain and losses nothing really happened. So there is we don't There is no entry for the gain and loss. We still have 2000. So your entry will consist of the pension expense Other comprehensive income again. How did you come up with the other comprehensive income figure? Well, we started with 160 Then we amortized 54 400 So basically our balance should be 105 600 Why the balance should be that much because we did not have a beginning balance You just just hit oci debit oci 105 600 to establish the balance Now this balance will stay with us for next year because now it's established Again the pension liability how they come up with this 160 700 Again, your goal was to have 217 700 as a PBO and you started with 57 000 therefore what you were missing is a credit of 160 700 and it's 160 700 And you paid cash 40 000. So this is the entry for 2017 Now now remember what's going to be with you for next year what you're going to be starting with which is So you make sure you know this when you start next year, which is 20 2019 You're gonna you're gonna have you're gonna have A PBO of 483 300 the PA of 265 600. This is the PA. You're gonna have Pension liability of 217 700 again A loss actually not again a loss of 2000 and a prior service cost the debit balance of 10 105 600 why because that's a loss. Okay Now, let's take a look at 2019 data and 2019 I'm sorry 2018 at 2019 your annual service cost is 26 Your settlement rate is still 10 percent your actual return was 24 000 your annual funding is 48 You paid benefit of 21 000 And amortization of prior service cost is 41 600. So you're gonna be amortizing 41 600 And there is a change change an actuarial assumption december 31st PBO so at the end of the year by the time we got to the end of the year The actuary came and I said look your PBO now is it doesn't matter what you are thinking Your PBO should be 520 000 you guys remember The actuary can do this the actuary can tell us your plan now has changed So simply put your PBO at the end of the year is 520 So, you know your how much you're ending PBO is if it doesn't come come up to that you have to plug that figure You have to plug that figure and we're gonna see how so this is something new. We're gonna be working with this example Okay, this is something. So let's go ahead and So those are beginning balances Prior service cost a loss of 2000. Those are both debit We have a credit in the liability and this is the PBO and this is the pa service cost was 26 000 debit. I'm sorry, uh, put it under pension expense and put it under PBO interest cost is for 48,000 330 which is the PBO times 10 percent your return on asset is 24 000 and What's your return on asset that should be how much it should it should have been let me see It should have been Let me just 265 600 times 10 percent. It should have been 26,560 So notice you only earned 24 000 your actual return was 24, but you should have earned 265 60 again You have an unexpected loss another debit to OCI of 2,560. So I want you to kind of follow this OCI Let's see. This is your OCI you started with 2000 and you're going to hit OCI by 25 60. Okay Amortization of prior service cost Of 41 600. So again, we're going to reduce this amount by 41 600 as we reduced it It's going to hit the pension expense because now we're amortizing that prior service cost Contribution me the contribution of 48 000 We're going to reduce our cash and increase our planned asset and the administrator paid 21 000 to our retiree that's going to reduce our pvo and reduce our planned asset now Here's what's going to happen. We're pretty much done with everything Here's what we do at this point We need to have a balance of 500 and 20 000. Hold on a second How do you know it's going to be 520 000? The actually told us your balance should be 520 So when I add up all these when I add up my pbo column now, I'm working with the pbo column I'm working with this column here I'm working with this column here And I'm going to go ahead and add these figures to see how much they So let me go ahead use my calculator and add up these figures. So I'm going to take 483 483 000 300 plus 26 000 plus 48 330 minus 21 000 That's equal to all these numbers together All these numbers together Okay, let me just hide this all these numbers together are equal to All these numbers together 500 36 000 630 hold on a second And you're telling me my based on my computation my liability should be 536 630 and actually said no that's way too high your your your Your balance should be 520. What does that mean? That means I made a gain immediately I have less liability of how much the difference the difference is 16 630. So I have to reduce my pbo basically have a plus to the pbo of 16 630. Where does that go? It's a gain in my pbo. Remember any changes in actuarial Assumption hits the gain and the losses now. What's going to happen is now I have a gain of 16 630 Which is a credit to oci simply put Simply put this was the beginning balance. This was the beginning balance This was uh, yeah, this was the beginning balance. So we credit the balance 16 630. We credited 16 630 We debit it 25 60 therefore the entry and under for the gain is 14 000 o 17 Okay, let's keep on going. Let's keep on going here Okay, so what I did is I added all my pbo. It doesn't matter what I added up to I have to make it 5 20 The plan asset is 3 16 600. Therefore, I have to have a liability of 203 400 I have to have a liability of 203 400 my beginning liability is 217 Well, excellent news. My liability went down My liability used to be uh, I used to be 217 700 my liability went down to 203 to 203 What does that mean? It means this year? It's it's a good it's a good year for the company because I'm going to be debiting my liability I'm going to be debiting my liability for 14 300 Notice this is a debit. Why because my liability went down? So this is my debit and my credit to oci is 14 470 This is my Debit, uh, this is credit because I'm amortizing a loss. It's credit. I'm removing the loss. I'm reducing the loss This is credit to cash for 48 000 and my annual pension expense is 89 3 70 So let's take a look at this my journal entry my journal entry will consist of my pension expense My pension asset now my pension asset is 14 300. Why is it an asset and in the in the prior two years? What's the liability because in the prior two years my liability was going up Therefore, I needed to credit my liability this year it went down and it went down again from 270 700 Let me just do it one more time. I know i'm repeating myself. It went from 270 700 to 203 400, which is good That's why I debited my it's called now pension asset My other comprehensive income. I amortized 14 700 from other comprehensive income um, this is for the What was that for that was for the? actuarial gain and Expected losses. So remember I have lost I have losses of 2560 because my my asset did not perform well So I had expected losses then here comes my gain of 16 000 my gain was 16 000 from the from the actuarial From the actuarial gain 16 6 30 you net these out and equal to 14 070 which is a credit. It means my it's a gain it's a gain Then other comprehensive income. I amortized 41 600 from my prior service cost 41 600 and obviously my cash always Add up your debit add up your credit. So this is your journal entry now. What's going to happen when you start 2019? When you start 2019 Remember when you start 2019, I want to make sure you know what your balances are When you start 2019, you're going to have 64 000 in your prior service cost. Why 64 000 you started with 105 600 then you reduced it by 41 600 So your balance is 60 000 60 64 000 64 000 Your oci it's going to be a gain of 12 000 Let me just change the color here Your oci will be a gain of 12 000 and 70 12 000 and 70 why again just follow my t account analysis And you will see that you started with 2000 then you increased it by You increased it by 25 60 you increased the debit then you reduced it by 16 000 6 30. Therefore your balance is 12 000 0 70 which is your balance right here Your balance right here And your pension Liability will be 203 400 and your pbo 5 20 and your plan asset 3 16 600 So next year obviously you're going to have to advertise some of this 64 000 No one knows what's going to happen to this 12 000. 0 70 it may go up. It may go down Then you'll have to figure out what's going to happen to your pbo and plan asset, but this is a good Comprehensive example If you can follow this example because this example involved both prior service cost It involved actuarial gains and losses, which is the losses were for the Unexpected losses on our plan asset and the gains were the unexpected gain on the pbo suddenly Our our actuary told us well, guess what you owe less. You're gonna owe less money So if you could follow this example, I think you're gonna be good for this chapter Which is the pension a very important topic that's covered on the CPA exam If you have any questions any comments by all means email me or see me in class