Lecture note Government and not-for-profit accounting: Concepts and practices (7/e) – Chapter 10: Pensions and other fiduciary activities

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Lecture note Government and not-for-profit accounting: Concepts and practices (7/e) – Chapter 10: Pensions and other fiduciary activities. Chapter 10 - Pensions and other fiduciary activities. In this chapter, the learning objectives are: Why pensions are important, distinctions between defined contribution and defined benefit pension plans, the relationships between an employer and its pension trust, main issues faced by government employers in accounting for pension plans,...
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Lecture note Government and not-for-profit accounting: Concepts and practices (7/e) – Chapter 10: Pensions and other fiduciary activities. Chapter 10 - Pensions and other fiduciary activities. In this chapter, the learning objectives are: Why pensions are important, distinctions between defined contribution and defined benefit pension plans, the relationships between an employer and its pension trust, main issues faced by government employers in accounting for pension plans,....

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Click icon to add picture Chapter 10 Pensions and Other FiduciaryActivities Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 1 All rights reserved. Thought to Ponder: Chapter 10 “The trust funds that the federal government has aren't the same as those you find in the private sector. You can't trust the federal government's and they aren't funded!” David Walker, former Comptroller General of the United States and President & CEO of the Peterson G. Foundation Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 2 All rights reserved. Learning Objectives •Why pensions are important •Distinctions between defined contribution and defined benefit pension plans •The relationships between an employer and its pension trust •Main issues faced by government employers in accounting for pension plans •How pension plans are accounted for •Postemployment health care benefits •Accounting for • issues presented by agency funds • issues presented by investment trust funds • investment gains and losses • Assets held in fiduciary funds •What is an endowment Granof, et aDistinguish between permanent and fiduciary funds, Inc. Chapter 10 | 3 All rights reserved. Why is pension accounting important? •Magnitude of assets and liabilities involved • California Public Employees’ Retirement System as of June 30, 2014 was $301.8 billion •It has direct impact on public policy •One of the most controversial issues of our era •Pension is the sum of money paid to retired or disabled employees based on their years of employment. • Although employees earn pension during years of employment, employers do not have to make actual cash payments until they retire. • Benefits received and cash payments may be mismatched by many years •Difficult accounting issues • Amount of eventual cash payments to the employees may depend on variables unknown at the time employees provide service • It is not obvious how eventual costs of benefits should be allocated to particular years when Granof, et al. – employees provide their services 6 John Wiley & Sons, Inc. Chapter 10 | 4 All rights reserved. Defined Contribution Plan Employer makes series of pension contributions. Employer defines inputs and contributions normally expressed as a percentage of each employee’s salary. Employer reports annual expense for the amount that it is obligated to contribute to pension fund. Employer has no pension related liab on its B/S Employer has a lower risk Defined Contribution plans are more portable. Employee bears all the investment risks Pension fund, very often is managed by a third party that is totally independent of the employer. Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 5 All rights reserved. Defined Benefit Pension Plan Employer specifies the benefits – the actual payments that the employee will receive. Employer guarantees ONLY the outputs and not the inputs. Interperiod equity: Pension costs must be allocated to the periods in which the employees perform their services and earn their pension benefits. Amount to be contributed to meet future pension obligations are calculated by actuaries. Actuarial cost method: allocation of total cost of expected benefits over the total years of employee service. Liabilities of the Defined Benefit Pension plan are in substance those of the employer. Both funding and accounting decisions relating to defined benefit pension plans are complex because of the uncertainties as to the amounts to be paid to the retirees the amounts earned on fund investments Granof, et al. – 7tUncertainty about employee life expectancySons, Inc. Chapter 10 | 6 All rights reserved. Defined Benefit Pension Plans (cont’d) Financial Reporting: According to GASB, the main objective in pension plan accounting and reporting is to provide useful information for assessing the stewardship of plan resources and the ongoing ability of the plan to pay benefits. GASB standards provide guidance for defined benefit plans that are either: (1) included as part of an employer's financial report OR (2) included in stand-alone reports GASB Standards distinguish between two categories of pension information: (1) current financial information about plan assets, and activities and (2) actuarially determined information about the funded status of the plan and progress in accumulating assets Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 7 All rights reserved. Distinction among multiple-employer single, agent and cost-sharing Single employer plans Established by a single employer and cover only its own employees Agent multiple-employer plan Established by a sponsoring organization (state or county) for employees of governments within its jurisdiction Under one type, assets are pooled Separate accounts are maintained and actuarial computations are made for each employer Sponsoring agent merely provides admin and investments services Accounting is same as for single employer plans Cost-sharing multiple-employer plan Employees of all participating governments place in common pool Employers share all risks and costs and contribute at same rate Assets may be used to pay any employee’s benefits Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 8 All rights reserved. Relationship between employer and pension plan •Pension plan is an arrangement in which pension investments are held and managed. •Commonly, pension plan takes form of trust fund (trust assets are legal separate from sponsor) •If maintained by employer, must be included in financial statements (like fiduciary funds) •If plan is maintained by outside party, employer must disclose information about its financial conditions. Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 9 All rights reserved. GASB Statements No 67 and 68 The GASB in 2012 issued Statement No. 67, Financial Reporting for Pension Plans and Statement No. 68 Accounting and Financial Reporting for Pensions. These two statements became effective respectively for years beginning after June 15, 2013 and 2014. Per GASB Statement No. 68, the government employer is required to report as its pension liability the difference between the total pension liability and the net plan position. This difference is referred to as the net pension liability Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 10 All rights reserved. How should the employer measure its pension obligation? Pension liability Difference between total pension liability and net plan position Difference is also called net pension liability Total pension liability is determined by actuary Three steps to calculate total pension liability Actuary must first estimate amount that will be required to make cash payments to employees during their years of retirement Actuary must discount these payments to the valuation date (a current or near-current date) Actuary must allocate cost over the total periods of past, present, and future Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 11 All rights reserved. How is the discount rate determined? Most controversial aspect of pension accounting Lower the discount rate, greater the total pension liability Higher the discount rate, the lower the total pension liability Should be a single rate that reflects: The long-term expected rate of return on plan investments to the extent that plan’s fiduciary net position is projected to be sufficient to meet future benefit payments A yield or index rate on high-quality 20 year municipal bonds to extent that plan’s net position is projected to be insufficient to meet future benefit payments Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. Chapter 10 | 12 All rights reserved. How should pension expense in full accrual statements be determined Pension expense can be seen as the change during that year in the net pension liability Difference between total pension liability and fiduciary net position Changes in the Total Pension Liability is affected by the following factors The amount allocated per the actuarial cost method Interest on the total pension liability Benefit payments to retirees Changes in pension benefits Changes in actuarial assumptions Differences between expected and actual experience

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