[MUSIC] Welcome to module 8. Module 8 is a review of all the topics we've talked about in modules 1 through 7 of this course. This is a quick review just to highlight some of the more important matters that we've discussed. Of course, it's a good idea to go back and look at the examples, if you feel you need to. So let's start with our introduction to pensions. Let's start with defined benefit plans. We talked about how defined benefit plans put the risk with the employer, with the plan because there's a defined benefit that's paid to the employees. And this is regardless of the performance of the portfolio of investments that you may have in a particular account. So it has two components. There's a benefit obligation. And if the plan is funded, there are plan assets. If the plan is unfunded, there are no planned assets. Some plans are funded, most pension plans are funded, at the current time a lot of medical plans are unfunded. That's a little bit separate, but pension plans are generally funded to some extent or another. That's apparently because the benefits are protected by law. The contributions are tax deductible and there's penalties for not having a plan sufficiently funded. So here are some of the fundamental accounting features we talked about, the three fundamental accounting features. Net presentation on the state of a financial position, the obligation and the assets are netted, so you have a net asset or liability on the statement of financial position. There's delayed recognition of amounts and earnings. Some amounts that effect earnings are recognized immediately in both earnings and on the statement of financial position. Some are only recognized on the statement of financial position, the other set of the entry being other comprehensive income. And then there is net periodic benefit cost. And that periodic benefit cost means it's net of the investment performance on the assets. So you have your service cost, your interest cost which is non-limiting discount. And then that's presented net of the investment return. Now in addition to some items, that net presentation of the service cost and the return on the plan assets, there's also delayed recognition in earnings for certain amounts. And this includes actuarial changes or sometimes these are called re-measurements of the plan. This is due to changes in actuarial assumptions such as the discount rate. It can also be a difference between the expected and actual return on plan assets. You can have a change in mortality. All of these are changes in estimates. And these are recognized in other comprehensive income, also there are planned amendments that make a change to the plan. Once upon a time these planned amendments used to be generally increases in pension benefits. Lately it's been going in the other direction as there's mainly decreases in planned assets. And so you have negative amendments, these are called prior service costs or prior service credits. So the net periodic benefit cost aggregates all these separate items. There's the service costs, the current year's costs of benefits, the interest cost. Because it's deferred when you're going to pay it. These costs are discounted, so there's an unwinding of the discount each period. It's not truly interest. The expected results of investing in plan assets, these go into net periodic cost. Remember, it's not the actual results, it's the expected results. Why the expected results, this is a long term average. And then any amortization of items with delayed recognition. So there are some items that aren't included in that periodic benefit cost. These amounts are initially recognized in other comprehensive income. And these are the two different amounts. One is actuarial gains and losses. These rises from changes in assumptions, discount rates, re-measurements. Certainly as the interest rates start to go up in the near future, we can expect that the actual real gains as the obligations go down from the effect of being discounted with a higher rate. So we can expect thousand years to come after many years of losses as interest rates were in fact climbing. And then prior service costs and credits. Prior service costs and credits are, again, amendments to a plan that give you either a payment or take away a benefit that you had previously earned from previous service. And you recall, we will classify those entries in OCI. These amounts they may reclassify or they may sometimes just offset in future periods. The prior service cost is amortized. So the prior service cost is treated just like an asset, actually. It's like it's depreciated into the future net periodic benefit cost over time. So it was always considered unrecognized once upon a time. And now it is recognized but recognized in OCI, and then it's amortized into earnings usually over the remaining service life of the employees. And then there's the minimum amortization. This is for the actuarial gains. You may not need to amortize them unless they go outside of a bound. There's a ceiling that's plus or minus 10% of the greater of the pension obligation or the plan assets. Any amounts that are in there we would consider that corridor, we consider it to be normal fluctuations that will probably reverse in future periods. So there's no reason to deal with them. If it goes outside that corridor, we do have a minimum amortization that's done, again, based upon service life or if most of the employees are inactive through the remaining lives of the participants. And then asset measurement is always done at fair value. And that's as of the measurement date. There is a market related fair value that's used for calculating expected return, but that's beyond the scope of what we're going to go into here. So those are the major components. You've got the obligation measurement with actuarial assumptions. The assets measured at fair value. The net amount recognized in the balance sheet. The net periodic benefit cost, which includes a service cost. The cost today of the future benefits. Interest cost, the unwinding of that discount. Offset by the expected return on plan assets. You have amounts that are not included in net periodic benefit costs, but rather in OCI. If it's a prior service cost, it will amortize into net periodic benefit cost on a regular basis. If it's a actuarial re-measurement effect, it may reclassify or may not. It may just be offset in future periods as with normal fluctuations, noise, sort of in the measurement. Or if it's outside the corridor, then it's required to be remeasured. And also then there is individual retirement account that we talked about. Sometimes companies will enter into a plan with either a single employee or few individuals, usually these are for senior management. Those are accounted for individually. What does that mean? Well, you don't have all these deferrals. You don't have these amounts that are recognized outside of net income. Everything is accrued immediately and goes right into the measurement of the obligation. And that's a quick introduction and a quick review of defined benefit pensions.
