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.
CHAPTER REVIEW
1. Chapter 20 discusses the various aspects of accounting for the cost of pension plans.
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
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.
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
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
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
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 –
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
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
1. Apply an actuarial valuation method.
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
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
Fair value of plan assets, January 1, 2019 ……………………. £4,200,000
Plus: Contributions to plan during period ………………………. 300,000
Plus: Actual return…………………………………………….. 210,000
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
a. The left–hand “General Journal Entries” columns of the worksheet record entries in the
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
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
Pension Worksheet for 2019
General
Journal
Entries
Memo
Record
Items
Annual
Pension
Expense
Cash
Pension
Asset/
Liability
Defined
Benefit
Obligation
Plan
Assets
Balance Jan. 1, 2019
—
100,000
Cr.
100,000
Dr.
(a) Service cost
9,000 Dr.
9,000 Cr.
(b) Interest expense
10,000 Cr.
8,000
8,000
112,000
Cr.
111,000
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
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
Pension Worksheet for 2020
General
Journal
Entries
Memo
Record
Items
Annual
Pension
Expense
Cash
Pension
Asset/
Liability
Defined
Benefit
Obligation
Plan
Assets
Balance Dec. 31,
2020
1,000 Cr.
112,000
Cr.
100,000
Dr.
Balance Jan. 1,
2020
193,600
Cr.
(g) Service cost
(h) Interest expense
(i) Interest revenue
(j) Contributions
(k) Benefits
Journal entry for
Balance Dec. 31,
214,460
134,100
(f) Additional PSC
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
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
2021 Entries and Worksheet
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%
The pension reconciliation schedule is as follows:
Defined benefit obligation (Credit) €(265,000)
The 2021 worksheet would be completed as follows:
General
Journal
Entries
Memo
Record
Items
Annual
Pension
Expense
Cash
OCI –
Gain/Loss
Pension
Asset/
Liability
Defined
Benefit
Obligation
Plan
Assets
Balance Jan. 1, 2021
80,360 Cr.
214,460
Cr.
134,100
Dr.
(l) Service cost
13,000
(m) Interest expense
21,446
(n) Interest revenue
Cr.
13,410 Dr.
(o) Contributions
24,000
Cr.
24,000 Dr.
(p) Benefits
10,500 Dr.
10,500 Cr.
(q) Asset loss
1,410 Cr.
(r) Liability loss
26,594
Dr.
8,000 Cr.
Journal entry for
2021
21,036
Dr.
24,000
Cr.
28,004
Dr.
25,040 Cr.
26,594 Cr.
Dec. 31, 2016
Balance Dec. 31,
28,004
159,600
Accumulated OCI,
18. The IASB is silent as to whether the Accumulated Other Comprehensive Income
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
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)
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
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
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.
3. Types of pension plans.
a. Defined contribution plans: employer’s contribution is defined; there is no
4. The role of actuaries in pension accounting.
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. Net Defined Benefit Obligation (Asset).
6. The net defined benefit obligation (asset) is also referred to as the funded status
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
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
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
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
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
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)
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