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3.2 Composition of net periodic benefit cost
Publication date: 31 Oct 2023
us Pensions guide
The amount to be recognized in an employer's financial statements as the cost of a defined benefit plan is comprised of the following components:
- Service cost – the cost of benefits earned during the period
- Interest cost – interest on the benefit obligation (PBO or APBO)
- Expected return on plan assets – expected long-term rate of return applied to plan assets
- Amortization of prior service cost/credit – amortization of the cost or benefit of previous plan amendments that are initially recognized in other comprehensive income
- Amortization of gains and losses – amortization of gains and losses arising from the annual remeasurement of the plan that are initially recognized in other comprehensive income
- Amortization of transition obligation or asset – net funded status at the time of the initial adoption of FAS 87 (circa 1987, which is now codified in ASC 715). Relatively few plans have any remaining unamortized transition asset.
3.2.1 Presentation of net periodic benefit cost
The service cost component is considered employee compensation and should be presented within income from operations in the same financial statement line items as other compensation. This is also the portion of net periodic benefit cost that is eligible for capitalization as part of the cost of inventory or self-constructed assets if the entity capitalizes labor costs for those purposes. The remaining components of net periodic pension cost are reported separately (in one or more line items) outside of operating income, if a subtotal is presented for income from operations.
3.2.2 Net periodic benefit cost and gains and losses
Net periodic benefit cost is determined at the beginning of the year, based on beginning-of-the-year plan balances (end-of-prior-year valuation) and the expected value of benefits to be accrued in the current year. In theory, if interest rates do not change, there is no change in employee demographics or other actuarial assumptions and assets perform exactly as expected, the accrual of net benefit cost for the period would produce the necessary net benefit asset or obligation at the end of the period. For example, an entity may estimate that $100 of pension cost should be recognized during the year to arrive at the expected balance of the plan's net obligation at the end of the year. This $100 would be recognized as pension cost over the course of the year.
Inevitably, actual experience will differ from the estimates and assumptions included in the net periodic benefit cost determined at the beginning of the year. Thus, at the end of the year when the annual measurement of the plan is performed, any difference between the net funded status (net asset or liability) of the plan and the amount accrued via net periodic benefit cost is a gain or loss. For example, if net periodic benefit cost was determined to be $100 at the beginning of the year but the net liability of the plan actually increases by $110 during the year, the $10 difference is an "experience loss," because actual experience differs from the original estimate.
Under the delayed recognition principles of ASC 715, that experience loss is not required to be recognized immediately. Most employers initially defer these losses and amortize them in subsequent periods (see PEB 3.2.7). However, some employers have adopted a policy of immediate recognition of gains and losses, in which case the difference arising on the annual remeasurement would be immediately charged to income in the period of the remeasurement (annual or otherwise).
Cost recognition is independent of cash flows related to the plan. Contributions to the plan by the employer and payment of benefits by the plan impact the net obligation or asset but do not directly affect the determination of net periodic benefit cost.
3.2.3 Service cost
Service cost represents the cost of benefits attributable to service performed by employees for the entity during the year. The measurement of service cost is based on the same assumptions and concepts as the projected benefit obligation (PBO) or expected postretirement benefit obligation (EPBO) and generally requires the use of a benefit/years-of-service attribution approach (see PEB 2.5). Service cost is the actuarial present value of projected benefits attributed to the current period based on the pension benefit formula, including the effect of a substantive commitment to amend the plan, if any (see PEB 2.2.2).
3.2.4 Interest cost
Interest cost represents the portion of net benefit cost attributable to the cost of "carrying" the pension obligation from one period to the next. The projected benefit obligation is measured at present value, using a discount rate representing the time value of money (see PEB 2.4.1). Thus, the interest cost component of pension cost is the increase in the projected benefit obligation due to the passage of time. Stated another way, interest cost represents accretion of interest on the projected benefit obligation using the discount rate.
The interest cost component is not considered to be interest under ASC 835-20, Capitalization of Interest, for purposes of interest capitalization on self-constructed assets.
3.2.5 Expected return on plan assets
Pension plans may be funded or unfunded and most postretirement benefit plans are unfunded. For plans that are funded—i.e., investments set aside to fund benefit payments meet the definition of plan assets—the expected return on those assets is a component of net periodic pension cost.
Expected return on plan assets represents the portion of net benefit cost attributable to the expected increase in the value of plan assets over the course of the year. The expected return on plan assets is the product of the expected long-term rate of return on plan assets and the market-related value of plan assets (see PEB 2.6.5). The expected rate of return is estimated based on market conditions and the nature of the assets (see PEB 2.4.2). Estimates typically incorporate considerations of financial markets, which can be volatile, changes in the macroeconomic environment, and the entity’s overall investment strategy for postretirement benefit plans. If the return on plan assets is taxable to the plan trust or other holder of those assets, the expected long-term rate of return should be reduced to reflect the related income taxes expected to be paid under existing tax law. A similar reduction should be made for the cost of managing the assets. Calculation of the expected return on plan assets should take into account changes in the level of plan assets expected to occur throughout the year due to expected contributions and benefit payments. For example, if the employer's contribution for the year is expected to be made two months before the next measurement date, then the expected return on plan assets should include an amount related to the expected return on that contribution only for those two months.
The actual return on plan assets—i.e., the actual investment performance during the year—is based on the fair value of the plan assets at the end of the year, compared to the fair value of plan assets at the beginning of the year, adjusted for contributions and benefit payments during the year. The difference between the expected return accrued as part of net periodic benefit cost and the actual return determined upon remeasurement is a gain or loss. Unless an employer has elected a policy of immediate recognition of gains and losses (see PEB 3.2.7), any gain or loss arising on remeasurement is reflected as a change in the net pension asset or obligation and an offsetting increase or decrease in OCI. Gains and losses accumulated in OCI are subject to amortization in future periods as described in PEB 3.2.7.
3.2.6 Amortization of prior service cost
Prior service cost arises from a plan amendment (including initiation of a plan) that grants increased benefits for service rendered in prior periods. It is measured by the increase in the projected benefit obligation at the date the amendment is adopted (generally the approval date, not the effective date, of the amendment). If the amendment is deemed significant, the employer should perform an interim remeasurement of the benefit obligation and plan assets and would also develop a new measure of net periodic benefit cost for the period from the remeasurement through the end of the fiscal year. If an amendment is not deemed to be significant, the effects of the amendment would be determined as of the date of the next annual measurement date. ASC 715 does not define the term "significant." The determination of whether an event is significant is often a highly judgmental matter. Employers should consider the specific facts and circumstances surrounding the event and their past practice of defining significance for previous events.
Pursuant to ASC 715-30-35-11 and ASC 715-60-35-15 prior service cost must be initially deferred and subsequently amortized as a component of net periodic pension cost, generally by assigning an equal amount of the cost to each remaining year of service for the plan participants continuing to render service to the employer (active plan participants). Importantly, a policy of immediate recognition of the cost of plan amendments is prohibited by ASC 715-30-35-16. If all, or substantially all, of a plan’s participants are inactive at the time of the amendment, the prior service cost should be amortized over the remaining life expectancy of plan participants (see PEB 3.2.6.4 for additional discussion of inactive plan participants).
The guidance in ASC 715-30-35-13 for defined benefit pension plans allows amortization of prior service cost over the average remaining service periods of active employees, while the guidance in ASC 715-60-35-15 through ASC 715-60-35-17 for OPEB plans requires that prior service cost be amortized over the period benefited, which is generally the average remaining years of service to the full eligibility date (see PEB 2.5.3) for active employees expected to receive benefits. More rapid amortization is permitted depending on the facts and circumstances and in some circumstances may be required, as discussed in PEB 3.2.6.1. Amortization of prior service cost should begin immediately after the date the plan amendment is adopted (see PEB 4.6.2 for a discussion of when a plan amendment is considered to be adopted). The amortization schedule for prior service cost is developed at the time of each plan amendment so prior service cost arising from different plan amendments will have different amortization schedules. Sometimes plan amendments can reduce benefits attributable to prior service. See PEB 3.2.6.5 for the impact on amortization of prior service cost in such cases.
ASC 715-30-55-97 shows the amortization of prior service cost and provides one example of a systematic determination of the amount of prior service cost to assign to each expected future year of service. Following that approach results in a declining pattern of amortization of the prior service cost from a particular plan amendment because some employees have shorter remaining service lives than the overall average remaining service period. As noted in ASC 715-30-55-13, alternative approaches that mathematically will result in more rapid amortization (for example, straight-line amortization of prior service cost over the average remaining service periods of active employees) is acceptable. ASC 715-30-55-100 illustrates the application of the straight-line amortization method.
While employers have some latitude in selecting an amortization method, once adopted, the method should be used consistently for all plan amendments and constitutes an accounting policy. ASC 715-30-35-15 indicates that, once an amortization period has been established for a particular plan amendment, it may be revised only if a curtailment occurs or if events indicate that (a) the period benefited is shorter than originally estimated or (b) the future economic benefits of the plan amendment have been impaired. In practice, both of those conditions are uncommon. The amortization period would not necessarily be revised because of ordinary variances in the expected future service period of employees.
Example PEB 3-1 addresses the amortization period for prior service cost affecting both active and retired employees.
EXAMPLE PEB 3-1
Amortization period for prior service cost affecting both active and retired employees
Amortization period for prior service cost affecting both active and retired employees
PEB Corporation has a pension plan in which 90% of the participants are active employees and the remaining 10% are retirees. PEB Corporation amends its plan to provide increased benefits, which results in prior service cost. The plan amendment impacts both active employees and retirees. The retiree population has an average remaining life expectancy of 15 years. The active employee population has an average remaining service period of 8 years.
Should the prior service cost associated with the retirees be recognized over their average remaining life expectancy (15 years) or the average remaining future service period of active plan participants (8 years)?
Analysis
All of the prior service cost for this amendment should be amortized over the average remaining future service period of active plan participants (8 years).
A fundamental tenet of defined benefit plan accounting is that the plan is a single unit of account—a single net asset or liability is recognized and a single aggregate net periodic benefit cost is determined. Thus, an amendment to the plan, even if it only affects a certain subset of the plan participants, should be accounted for following the guidance in ASC 715-30-35-10 and ASC 715-30-35-11 (i.e., recognized during the future service periods of those employees active at the date of the amendment who are expected to receive benefits under the plan). Only when all or almost all of a plan’s participants are inactive (see PEB 3.2.6.4 for further discussion), should the cost of retroactive plan amendments be amortized based on the remaining life expectancy instead of the remaining service period, as described in ASC 715-30-35-11. Accordingly, unless all or almost all of a plan's participants are inactive (not just those impacted by the amendment), the costs of retroactive plan amendments are to be amortized over the future service periods of active plan participants.
3.2.6.1 Collective bargaining arrangements
An exception to amortization over remaining service periods occurs in situations when a history of regular plan amendments and other evidence may indicate that the period during which the employer expects to realize economic benefits from an amendment granting retroactive benefits is shorter than the entire remaining service period of the active employees. For example, in many collective bargaining arrangements, pension or healthcare benefits are typically a feature of each contract negotiation and the period between contracts may be relatively short. In those situations, the amortization of prior service cost should reflect the period benefited (a more rapid rate of amortization). However, ASC 715-30-35-16 prohibits an accounting policy to recognize the cost of all plan amendments immediately in net periodic pension costs.
Notwithstanding the guidance to consider a shorter period of benefit, ASC 715-30-55-51 does not require the presumption that prior service costs arising from plan amendments negotiated in a collective bargaining environment be amortized over the period between each contract. Rather, each specific situation should be evaluated as to the economic period benefited. The plan’s history and other evidence should be evaluated to determine the period during which the employer expects to receive economic benefit. For example, uncertainty may exist regarding the entity's ability and/or intent to continue its past practice of regular plan amendments because of changed economic conditions. The shorter the period expected to be benefited, the more appropriate straight-line amortization may be; for longer periods, a method that allocates a greater proportion of cost to earlier periods using an expected years of future service concept is likely more appropriate.
3.2.6.2 Amendments that replace other accrued employee benefits
Not all pension benefit increases are subject to amortization. ASC 715-60-55-111 indicates that pension benefit increases provided to compensate for the elimination of postretirement benefits other than pensions represent a cost of settling the postretirement benefit obligation. Therefore, that cost should be accounted for as an increase in accrued pension liability or a decrease in prepaid pension asset with an offsetting reduction in the obligation for other postretirement benefits.
3.2.6.3 Amendments that do not give rise to prior service cost
Plan amendments would not give rise to prior service cost if they are previously anticipated as part of a substantive commitment (see ASC 715-30-55-19). Plan amendments that increase benefits only for future services also do not give rise to prior service cost; the increased benefits will be accrued as future service is rendered.
3.2.6.4 Amortization of prior service cost–inactive participants
If all or almost all participants are inactive at the time of a plan amendment, amortization of the newly arising prior service cost is based on the average remaining life expectancy of the inactive participants rather than on the future service periods of the active participants. A question arises in this context as to what constitutes an “inactive” plan participant.
One interpretation is based solely on employment status. This interpretation is based on a common use of the word "inactive," suggesting that a plan participant who is working for the reporting entity is active and a plan participant who is no longer working for the reporting entity is inactive. Under another interpretation, participants are considered inactive if they are no longer earning additional defined benefits under the plan. This would include participants who are retired or are otherwise no longer working for the reporting entity (i.e., former employees), since their lack of current service to the reporting entity generally means they are not able to earn additional defined benefits under the plan. In addition, this interpretation would include current employees who are participants in the plan, but for whom future services do not earn them additional defined benefits under the plan (e.g., as the result of a permanent hard freeze of benefits under the plan). This interpretation is supported by ASC 715-30-55-49, which implies that the determination of whether a plan participant who is currently employed by and working for the reporting entity is inactive would be made by reference to whether the participant is earning additional defined benefits under the plan. This guidance uses the phrase "inactive" even though participants are still working for the reporting entity, which suggests that the determination of inactive may depend on whether the participants will earn additional benefits under the plan, not whether the participants are providing services to the reporting entity (i.e., employed by and working for the reporting entity). Whichever interpretation a reporting entity chooses should be consistently applied to each plan sponsored by the reporting entity.
In the context of a defined benefit OPEB plan, the equivalent of an “inactive” participant is a participant who is already fully eligible for benefits (i.e., future service does not affect the amount of their benefit).
ASC 715-30-55-48 indicates that there is no specific quantitative threshold that constitutes "all or almost all" participants. We generally expect that at least 90% of plan participants would need to be inactive in order to use this alternative amortization period.
3.2.6.5 Negative plan amendments
There can be situations when a plan amendment will reduce the projected benefit obligation (resulting in what is often called negative prior service cost or a prior service credit). In those cases, the reduction should be used to first reduce any existing prior service cost included in accumulated other comprehensive income. The excess should be amortized to net periodic pension cost on the same basis as the cost of benefit increases (prior service cost). If a plan amendment eliminates defined benefits for future services for a significant number of employees, it would be considered a curtailment, and all prior service cost included in accumulated other comprehensive income related to years of service no longer expected to be rendered would be recognized in computing the gain or loss on curtailment. See PEB 4.4 for further discussion relating to curtailments.
ASC 715 does not provide guidance on the ordering assumption (e.g., LIFO, FIFO, or pro rata) to be used to reduce prior service cost included in AOCI when the aggregate amount accumulated in AOCI exceeds the reduction in the projected benefit obligation resulting from the negative plan amendment. Since amortization of prior service cost from plan amendments is determined for each amendment at the date of the amendment, at any point in time each plan amendment will be amortized over a different period and in differing proportions. Thus, the order in which the reduction in the PBO arising from the negative plan amendment is applied to prior service cost from prior plan amendments will directly affect the amount of prior service cost amortized in each future period. Unless the plan amendment reducing the pension obligation is specifically related to a prior amendment (i.e., essentially reversing that plan amendment or a portion of it), ASC 715-30-55-54 states that any systematic method, applied on a consistent basis, would be acceptable.
3.2.6.6 Initial recognition and reporting in OCI
Prior service costs and credits that arise during the year are recognized as a component of other comprehensive income (OCI). These amounts are subsequently amortized out of accumulated other comprehensive income (AOCI) and become a component of net benefit cost using the recognition provisions in ASC 715. As the prior service cost or credit is amortized into net periodic benefit cost, a reclassification adjustment is recognized in other comprehensive income, as described in ASC 220-10-45-15. Therefore, total comprehensive income (which is comprised of net income and other comprehensive income) should reflect no net impact from the amortization of the prior service cost or credit. Similarly, the amortization of prior service cost or credit has no impact on the accrued benefit liability as the effects of the underlying plan amendments have already been recognized on the balance sheet.
3.2.7 Amortization of gains and losses
A gain or loss can result from a change in either the value of plan assets different from that assumed (i.e., the expected return on plan assets) or the projected benefit obligation resulting from actuarial experience different from that assumed, as well as changes in discount rates or healthcare cost trend rates. ASC 715 does not make a distinction between gains and losses arising from investment activities related to plan assets and those arising from changes in actuarial assumptions and experience different from what was assumed. Gains and losses arise at the time a remeasurement of the plan occurs. Unless a reporting entity has chosen to immediately recognize those gains and losses (see PEB 3.2.7.1 below), they are charged or credited directly to accumulated other comprehensive income (AOCI).
Gains and losses accumulated in AOCI are required, at a minimum, to be amortized as a component of net periodic pension cost if they exceed a defined "corridor." Unlike prior service cost, the amount of net gain or loss to be amortized as part of net periodic benefit cost and their amortization period is recalculated at each measurement date. The "corridor" is defined as the greater of 10% of the projected benefit obligation or 10% of the market-related value of plan assets as of the beginning of the year. If the amount of a net gain or loss does not exceed the corridor amount, it will never become a component of net periodic pension cost unless the corridor itself narrows because the balances it is based on decline.
The concept of a corridor was originally intended to acknowledge the long-term nature of pension and postretirement benefit obligations and the likelihood that net assets or liabilities could move significantly from period to period given the leverage of some of the long-term assumptions. Thus, it is intended to reduce period-to-period volatility in pension cost resulting from short-term market swings by providing a reasonable opportunity for gains and losses to offset over time without affecting pension cost. If, however, the gains and losses accumulate to an absolute value that exceeds 10% of the greater of the PBO or plan assets (i.e., outside the corridor), some amortization (recognition in net benefit cost) is required. In those cases, the minimum amortization is the net gain or loss in excess of the corridor divided by the average remaining service period of active employees expected to receive benefits. See PEB 3.2.7.2 for a discussion of the amortization period when all or almost all plan participants are "inactive." Additionally, as discussed in PEB 2.6.5, asset gains and losses not yet reflected in market-related value are not included in the amount subject to amortization.
As the net gain or loss is amortized, a reclassification adjustment is recognized in other comprehensive income, as described in ASC 220-10-45-15. Therefore, there is no net impact on total comprehensive income (which comprises net income and other comprehensive income) from the amortization of the net gain or loss.
3.2.7.1 Changes to the method of recognizing gains and losses
As an alternative to the minimum amortization (excess outside the 10% corridor; see PEB 3.2.7), ASC 715 provides that any systematic method of amortization may be used in lieu of the minimum amortization method if the following criteria are met:
- The minimum amortization is used in any period in which it is greater than the amount determined by the alternative method
- The alternative method is applied consistently
- The alternative method is applied similarly to both gains and losses
- The alternative method is disclosed
Some common alternative methods for the recognition of gains and losses in excess of the minimum amortization required by ASC 715 that we have seen in practice include:
- Immediate recognition of the full net gain or loss in the income statement,
- Immediate recognition of amounts in excess of the corridor in the income statement, or
- Recognition over periods shorter than the average remaining service period or average remaining life expectancy, as applicable.
Any change in the method of recognizing gains and losses is considered to be a change in accounting principle under ASC 250, Accounting Changes and Error Corrections, that must be justified on the basis of preferability and applied retrospectively to all periods presented. We generally believe that any method that results in recognizing gains and losses in net income sooner (i.e., moves the recognition of gains and losses closer to immediate recognition) is preferable. Conversely, we believe it is difficult to support the preferability of any change that further delays the recognition of gains and losses in net income, including the change to a longer amortization period.
An employer that implements an immediate recognition approach generally would recognize in net income the full amount of the net gain or loss that is measured at the time the benefit obligation and plan assets are remeasured. As such, when the annual measurement is performed at year-end, the full amount of the net gain or loss would be recognized in the fourth quarter. If the employer remeasures the benefit obligation and plan assets at an interim period (e.g., due to a significant plan event), it would recognize in that period the full amount of the net gain or loss measured.
A policy of immediately recognizing gains and losses upon remeasurement does not require a quarterly "mark to market" adjustment (i.e., the plan assets and obligation are not remeasured each quarter outside of significant plan events). Public companies, however, should provide appropriate "early warning" disclosures in the MD&A of earlier quarterly filings to the extent the fourth quarter adjustment is expected to be material. ASC 715 indicates that the corridor should be calculated as of the beginning of the year for purposes of amortizing the net gain or loss in AOCI. For employers that immediately recognize gains and losses outside the corridor, we believe it would be appropriate to use the corridor determined as of the measurement date since it would be based on the most recent measurements available.
See PEB 3.2.10 for further discussion of pension accounting changes under ASC 250.
Example PEB 3-2 addresses the interplay of an interim remeasurement for a plan amendment with a reporting entity’s accounting policy to immediately recognize gains and losses outside of the corridor.
EXAMPLE PEB 3-2
Interplay of an interim remeasurement with a reporting entity’s accounting policy to immediately recognize gains and losses outside of the corridor
Interplay of an interim remeasurement with a reporting entity’s accounting policy to immediately recognize gains and losses outside of the corridor
PEB Corporation maintains a defined benefit pension plan for its employees. PEB Corporation has elected an accounting policy to immediately recognize all pension gains and losses in excess of the corridor.
On December 8, 20X1 PEB Corporation's Board of Directors amended the plan so that PEB Corporation's defined benefit plan would be frozen in March 20X2 and no additional benefits would accrue after that time. This was communicated to the employees and the plan amendment is therefore considered adopted on December 8, 20X1.
Ordinarily, PEB Corporation measures their plan assets and obligations as of the date of the financial statements (December 31) in accordance with ASC 715-30-35-62. However, management determined that the amendment is a significant event that requires a remeasurement at the date of the amendment. Since the previous year-end measurement date, discount rates have decreased and asset returns have underperformed expectations.
How should PEB Corporation account for the gain or loss arising upon remeasurement at the date of the amendment?
Analysis
Freezing a defined benefit plan constitutes a curtailment under ASC 715 (see PEB 4.4). In order to determine the effects of the curtailment, the plan first needs to be remeasured as of the date of the event with current actuarial assumptions updated for current circumstances (prior to incorporating the effects of the amendment) and the current fair value of plan assets. Once that remeasurement is complete, PEB Corporation can remeasure the plan's obligations considering the amendment to the plan and determine the effects of the curtailment on the plan (the difference between the PBO arising from those two measurements).
The remeasurement (prior to considering the amendment) will likely result in an unrecognized net loss in excess of the corridor given the negative market developments. The curtailment is expected to result in a gain from the reduction in the projected benefit obligation (the elimination of the value of projected future salary increases on the benefits accrued to date). Any gain arising from the curtailment is first offset against any unrecognized net loss and could result in the remaining unrecognized net loss being within the corridor and not subject to recognition under PEB Corporation's policy.
Thus, the sequencing of accounting events here is critical. Under PEB Corporation's accounting policy of immediate recognition of gains and losses outside the corridor, which must be applied consistently to all remeasurement events, the loss arising from the interim remeasurement prior to determining the effects of the curtailment would be recognized to the extent it exceeded the corridor. Any curtailment gain would first be offset against any remaining net loss (reflecting amounts within the corridor in this fact pattern) and then the remainder would be recognized in net income as a curtailment gain.
3.2.7.2 Amortization of gains and losses – inactive participants
When all or almost all plan participants are inactive, gains and losses subject to amortization should be amortized over the average remaining life expectancy of the inactive participants rather than the average remaining service period of active participants. ASC 715-30-55-48 indicates that there is no specific threshold for determining "all or almost all" and that judgment is required based on the facts and circumstances of the particular plan. However, the analysis should be based on the number of participants, not another unit of measure. We expect that at least 90% of participants would be inactive in order to use this alternative amortization period.
Question PEB 3-1 addresses the definition of an “inactive” participant.
Question PEB 3-1
PEB Corporation adopts an amendment to freeze the benefits provided under its defined benefit plan. The result of this amendment is that no participants in PEB Corporation's plan will accrue additional pension benefits for service provided in future years. However, a substantial majority of the plan participants are active employees; retirees currently make up a minority of the plan’s population.
For purposes of determining the amortization period for gains and losses subject to amortization, are all or substantially all of PEB’s plan participants inactive?
PEB Corporation adopts an amendment to freeze the benefits provided under its defined benefit plan. The result of this amendment is that no participants in PEB Corporation's plan will accrue additional pension benefits for service provided in future years. However, a substantial majority of the plan participants are active employees; retirees currently make up a minority of the plan’s population.
For purposes of determining the amortization period for gains and losses subject to amortization, are all or substantially all of PEB’s plan participants inactive?
PwC response
As described in PEB 3.2.6.4, we believe that there are two acceptable interpretations of “inactive” in this context.
One interpretation is based solely on employment status. This interpretation is also supported by ASC 715-30-55-50, which indicates that, in the event all employees covered by a plan are terminated but not retired, the minimum amortization of a net gain or loss included in AOCI should be determined based on the average remaining life expectancy of the inactive participants. This indicates that a participant who is no longer working for the reporting entity is considered to be inactive. Under this interpretation, PEB Corporation would use the average remaining service period to determine the amount of gain or loss to amortize.
Under another interpretation, participants are considered inactive if they are no longer earning additional defined benefits under the plan.
Whichever interpretation a reporting entity chooses should be consistently applied to each plan sponsored by the reporting entity.
Question PEB 3-2 addresses when the amortization period for gains and losses should be changed when all or almost all participants become inactive.
Question PEB 3-2
PEB Corporation adopted an amendment of its pension plan during FY20X1. As a result of this amendment, all plan participants ceased accruing additional benefits under the plan effective June 20X2 (i.e., a plan freeze). PEB Corporation defines an inactive participant as a participant who is no longer accruing benefits for future service under the plan. Consequently, all plan participants became inactive in June 20X2. PEB Corporation's annual measurement date for its pension plan is December 31.
When should PEB Corporation reassess the amortization period for unrecognized gains or losses as a result of all of its participants becoming inactive in June 20X2?
PEB Corporation adopted an amendment of its pension plan during FY20X1. As a result of this amendment, all plan participants ceased accruing additional benefits under the plan effective June 20X2 (i.e., a plan freeze). PEB Corporation defines an inactive participant as a participant who is no longer accruing benefits for future service under the plan. Consequently, all plan participants became inactive in June 20X2. PEB Corporation's annual measurement date for its pension plan is December 31.
When should PEB Corporation reassess the amortization period for unrecognized gains or losses as a result of all of its participants becoming inactive in June 20X2?
PwC response
At the next measurement date following June 20X2. The amortization period is determined as part of the overall process of calculating and assessing the overall actuarial gain/loss, which is only done in conjunction with a measurement of the plan assets and obligations. At December 31, 20X1, the participants are active. Therefore, the amortization period would be based on their average remaining service period as employees. The change in status from active to inactive of a group of participants through the ordinary operation of the plan is not considered a significant event that would require a remeasurement. As such, the change in participants’ status during 20X2 would neither require nor permit (absent a policy of more frequent interim remeasurements) a reassessment of the amortization period for deferred gains and losses. Accordingly, the amortization established at the most recent measurement date of December 31, 20X1 should continue for the remainder of the year. At the measurement date of the plan following June 20X2, the amortization period for gains and losses would be based on the remaining life expectancy of the plan participants. If there is no significant event between June 20X2 and the end of the year, the next measurement of the plan would be December 31, 20X2.
If, however, PEB Corporation had a policy of remeasuring their defined benefit plans on an interim basis or in the event of other similar events, the amortization period would be reassessed in conjunction with that full remeasurement of all of the plan assets and obligations.
3.2.8 Mandatory changes: plan amendment vs. actuarial gain/loss
The effect of changes to a plan’s terms made in response to new laws or regulations need to be carefully considered to determine whether they constitute a plan amendment, which would result in prior service cost or credit, or an actuarial gain/loss. See PEB 3.2.6 for amortization of prior service cost and PEB 3.2.7 for amortization of gains and losses. To determine the appropriate accounting, the consequences of a plan sponsor electing not to amend its plans to reflect the changes required should be assessed. For example, the consequences of not amending a plan to incorporate the changes required by the Pension Protection Act of 2006 were determined to be severe; they included a disqualification of the plan’s tax-advantaged status. Such negative consequences may essentially compel the plan sponsor to modify its plans as necessary to conform to the law. In that circumstance, we concluded that changes to the terms of the plan in response to the Pension Protection Act could be considered mandatory and the resulting impact on the plan treated as an experience gain or loss. That treatment was consistent with the guidance in ASC 715-60-35-137, which calls for the effect of the Medicare Prescription Drug, Improvement, and Modernization Act to be accounted for as a gain/loss.
However, we would not object to an employer accounting for changes to a plan due to changes in laws or regulations as a plan amendment (i.e., treating the change in the PBO as prior service cost) since, technically, the employer could choose not to modify its plans to conform to the new law and simply accept the consequences of not doing so.
3.2.9 Net periodic benefit cost — change in estimate
A change in the discount rate, the expected rate of return on plan assets, or any other actuarial assumption due to changed circumstances is considered to be a change in estimate rather than a change in accounting principle. For example, if changing market conditions indicate that the expected rate of return on plan assets should be 5% rather than 6%, the change is considered a change in accounting estimate. Additionally, changes in the approach to determining the discount rate, such as changing from a benchmark approach to a specific bond matching approach, would also be considered a change in accounting estimate as described in PEB 2.4.1.1. The effect of all changes in assumptions are reflected as actuarial gains and losses.
3.2.10 Net periodic benefit cost — change in accounting principle
There are two significant areas in ASC 715 in which acceptable alternatives are available:
- The approach to determining the market-related value of plan assets (see PEB 2.6.5)
- The gain/loss recognition approach (see PEB 3.2.7).
A change in either of these is a change in accounting principle subject to the requirements of ASC 250, Accounting Changes and Error Corrections. For example, a change in the method of computing the market-related value of plan assets from a five-year average to a three-year average would be considered a change in the method of applying an accounting principle.
To change an accounting principle not mandated by the issuance of an authoritative accounting pronouncement, the new accounting policy must be considered preferable to the existing policy. Refer to FSP 30.4 for the general requirements for justifying a change in accounting principle.
With respect to pension and OPEB accounting changes, the Basis for Conclusions in Statement of Financial Accounting Standards No. 87, Employer's Accounting for Pensions (which is the principal source of the guidance in ASC 715-30, Compensation-Retirement Benefits—Defined benefit plans--pension), indicates that the FASB believed at the time that (1) the fair value of plan assets is preferable to a calculated market-related value (MRV), and (2) immediate recognition of gains and losses is preferable to delayed recognition.
Based on these views, any method that moves MRV closer to fair value or moves the recognition of gains and losses closer to immediate recognition is usually considered preferable. For example, the following changes would generally be considered preferable:
- Changing from a five-year calculated MRV to a three-year calculated MRV or to fair value.
- Changing from the minimum amortization of gains/losses outside the 10% corridor to immediate recognition of gains/losses outside the 10% corridor
- Changing to immediate recognition of the full amount of gains and losses determined at each measurement date (i.e., eliminate use of the corridor).
Other changes may be more difficult to justify as preferable. For example, it is generally difficult to support the preferability of any change that further defers recognition of gains and losses (e.g., switching from amortization of all gains and losses to a 10% corridor approach) or that further defers the recognition of changes in the value of plan assets (e.g., changing from fair value to a calculated value for determining the market-related value of plan assets). Refer to PEB 3.2.7 for further discussion of changes to the recognition of gains and losses and to PEB 2.6.5 for changes to the determination of the market-related value of plan assets.
Pursuant to ASC 250, a change in accounting principle is reported through retrospective application of the new accounting principle to all prior periods, unless doing so is impracticable. Because of the long-term deferral mechanisms in pension accounting, in order to determine the retrospective impact and the cumulative effect on the opening balances of the earliest period presented, it may be necessary to retrospectively apply the new accounting principle to the year the current pension accounting rules (ASC 715-30) or postretirement benefit accounting rules (ASC 715-60) were initially applied and to each year thereafter. For example, for a reporting entity that adopted FAS 87 (the primary source of ASC 715-30) in 1987, a change in determining the market-related value of plan assets would conceptually be applied retroactively starting in 1987 and pension cost for each year thereafter would be recomputed under the new method up to the beginning of the year that the new method is adopted. This computation would not only result in an adjustment to the expected return on assets, but also to the amortization of gains and losses, as well as to any curtailments or settlements recorded since adoption in 1987. Similarly, a change to immediately recognize amounts in excess of the 10% corridor would require a recomputation of benefit expense since adoption of the current pension and OPEB accounting rules.
Although the need to reproduce information from many years ago could be challenging and time-consuming, it may be difficult to assert that is impracticable.
3.2.11 Amortization of transition obligation or asset
The transition obligation or asset essentially represented the initial funded status of defined benefit plans at the time of initial adoption of the guidance in ASC 715-30 and ASC 715-60. Rather than requiring that amount to be charged to retained earnings, the transition guidance permitted delayed recognition. For employers that elected the delayed recognition method, the transition amount is amortized on a straight-line basis as a component of net periodic benefit cost. Remaining unamortized amounts are included in AOCI. The amortization period is generally the average remaining service period of active plan participants at the time of adoption, but if the average remaining service period at transition was less than 20 years, ASC 715 allowed the amortization to take place over 20 years. Based on the original effective dates of ASC 715-30 and ASC 715-60, only plans with average remaining service periods greater than 30 years should have any remaining unamortized transition amount. Certain plan events could accelerate the recognition of the unamortized transition amount.
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