Accounting for the Cost of Pension Plans 73 which should be recognized annually whether or not funded. Therefore, accounting for pension cost should not be discretionary. 17. All members of the Board believe that the entire cost of benefit payments ultimately to be made should be charged against income subsequent to the adoption or amendment of a plan and that no portion of such cost should be charged directly against retained earnings. Differences of opinion exist concerning the measure of the cost of such ultimate payments. The Board believes that the approach stated in Paragraph 12 is preferable for measuring the cost of benefit payments ultimately to be made. However, some members of the Board believe that the approach stated in Paragraph 13, in some cases with the modifications described in Paragraph 14, is more appropriate for such measurement. The Board has concluded, in the light of such differences in views and of the fact that accounting for pension cost is in a transitional stage, that the range of practices would be significantly narrowed if pension cost were accounted for at the present time within limits based on Paragraphs 12, 13 and 14. Accordingly, the Board believes that the annual provision for pension cost should be based on an accounting method that uses an acceptable actuarial cost method (as defined in Paragraphs 23 and 24) and results in a provision between the minimum and maximum stated below. The accounting method and the actuarial cost method should be consistently applied from year to year. a. Minimum. The annual provision for pension cost should not be less than the total of (1) normal cost, (2) an amount equivalent to interest on any unfunded prior service cost and (3) if indicated in the following sentence, a provision for vested benefits. A provision for vested benefits should be made if there is an excess of the actuarially computed value of vested benefits (see definition of vested benefits in the Glossary, Appendix B)' over the total of (1) the pension fund and (2) any balance The actuarially computed value of vested benefits would ordinarily be based on the actuarial valuation used for the year even though such valuation would usually be as of a date other than the balance sheet date. 74 Opinions of the Accounting Principles Board year or sheet pension accruals, less (3) any balance-sheet pension prepayments or deferred charges, at the end of the year, and such excess is not at least 5 per cent less than the comparable excess at the beginning of the year. The provision for vested benefits should be the lesser of (A) the amount, if any, by which 5 per cent of such excess at the beginning of the year is more than the amount of the reduction, if any, in such excess during the (B) the amount necessary to make the aggregate annual provision for pension cost equal to the total of (1) normal cost, (2) an amount equivalent to amortization, on a 40-year basis, of the past service cost (unless fully amortized), (3) amounts equivalent to amortization, on a 40-year basis, of the amounts of any increases or decreases in prior service cost arising on amendments of the plan (unless fully amortized) and (4) interest equivalents under Paragraph 42 or 43 on the difference between provisions and amounts funded.2 b. Maximum. The annual provision for pension cost should not be greater than the total of (1) normal cost, (2) 10 per cent of the past service cost (until fully amortized), (3) 10 per cent of the amounts of any increases or decreases in prior service cost arising on amendments of the plan (until fully amortized) and (4) interest equivalents under Paragraph 42 or 43 on the difference between provisions and amounts funded. The 10 per cent limitation is considered necessary to prevent unreasonably large charges against income during a short period of years. 18. The difference between the amount which has been charged against income and the amount which has been paid should be shown in the balance sheet as accrued or prepaid pension cost. If the company has a legal obligation for pension cost in excess of amounts paid or accrued, the excess should be shown in the balance sheet as both a liability and a deferred charge. Except to the extent indicated in the preceding sentences of this paragraph, unfunded prior service cost is not a liability which should be shown in the balance sheet. 2 For purposes of this sentence, amortization should be computed as a level annual amount, including the equivalent of interest. Accounting for the Cost of Pension Plans ACTUARIAL COST METHODS 75 Discussion 19. A number of actuarial cost methods have been developed to determine pension cost. These methods are designed primarily as funding techniques, but many of them are also useful in determining pension cost for accounting purposes. Pension cost can vary significantly, depending on the actuarial cost method selected; furthermore, there are many variations in the application of the methods, in the necessary actuarial assumptions concerning employee turnover, mortality, compensation levels, pension fund earnings, etc., and in the treatment of actuarial gains and losses. 20. The principal actuarial cost methods currently in use are described in Appendix A. These methods include an accrued benefit cost method and several projected benefit cost methods. a. Under the accrued benefit cost method (unit credit method), the amount assigned to the current year usually represents the present value of the increase in present employees' retirement benefits resulting from that year's service. For an individual employee, this method results in an increasing cost from year to year because both the present value of the annual increment in benefits and the probability of reaching retirement increase as the period to retirement shortens; also, in some plans, the retirement benefits are related to salary levels, which usually increase during the years. However, the aggregate cost for a total work force of constant size tends to increase only if the average age or average compensation of the entire work force increases. b. Under the projected benefit cost methods (entry age normal, individual level premium, aggregate and attained age normal methods), the amount assigned to the current year usually represents the level amount (or an amount based on a computed level percentage of compensation) that will provide for the estimated projected retirement benefits over the service lives of either the individual employees or the employee group, depend 76 Opinions of the Accounting Principles Board ing on the method selected. Cost computed under the projected benefit cost methods tends to be stable or to decline year by year, depending on the method selected. Cost computed under the entry age normal method is usually more stable than cost computed under any other method. 21. Some actuarial cost methods (individual level premium and aggregate methods) assign to subsequent years the cost arising at the adoption or amendment of a plan. Other methods (unit credit, entry age normal and attained age normal methods) assign a portion of the cost to years prior to the adoption or amendment of a plan, and assign the remainder to subsequent years. The portion of cost assigned to each subsequent year is called normal cost. At the adoption of a plan, the portion of cost assigned to prior years is called past service cost. At any later valuation date, the portion of cost assigned to prior years (which includes any remaining past service cost) is called prior service cost. The amount assigned as past or prior service cost and the amount assigned as normal cost vary depending on the actuarial cost method. The actuarial assignment of cost between past or prior service cost and normal cost is not indicative of the periods in which such cost should be recognized for accounting purposes. 22. In some cases, past service cost (and prior service cost ansing on amendment of a plan! is funded in total; in others it is funded in part, in still others it is not funded at all. In practice, the funding of such cost is inthuenced by the Federal income tax laws and related regulations, which generally limit the annual deduction for such cost to 10 per cent of the initial amount. There is no tax requirement that such cost be funded, but there are requirements that effectue prohibit the funded cost tom exaring the total of past service cost and prior service ast arang on apunt of the plan. The practical effect of De ta mg, menee a that on a comulative basis normal cost pla an assent agra akost to the unfunded prior MYLAP ON Puat de nuded Fading of additional amounts is Avete dacron or PT & ARss However, pre sa apex werden genre to lows and related regulations er artolig fram ENARR Accounting for the Cost of Pension Plans 77 Opinion 23. To be acceptable for determining cost for accounting purposes, an actuarial cost method should be rational and systematic and should be consistently applied so that it results in a reasonable measure of pension cost from year to year. Therefore, in applying an actuarial cost method that separately assigns a portion of cost as past or prior service cost, any amortization of such portion should be based on a rational and systematic plan and generally should result in reasonably stable annual amounts. The equivalent of interest on the unfunded portion may be stated separately or it may be included in the amortization; however, the total amount charged against income in any one year should not exceed the maximum amount described in Paragraph 17. 24. Each of the actuarial cost methods described in Appendix A, except terminal funding, is considered acceptable when the actuarial assumptions are reasonable and when the method is applied in conformity with the other conclusions of this Opinion. The terminal funding method is not acceptable because it does not recognize pension cost prior to retirement of employees. For the same reason, the pay-as-you-go method (which is not an actuarial cost method) is not acceptable. The acceptability of methods not discussed herein should be determined from the guidelines in this and the preceding paragraph. ACTUARIAL GAINS AND LOSSES Discussion 25. Actuarial assumptions necessarily are based on estimates of future events. Actual events seldom coincide with events. estimated; also, as conditions change, the assumptions concerning the future may become invalid. Adjustments may be needed annually therefore to reflect actual experience, and from time to time to revise the actuarial assumptions to be used in the future. These adjustments constitute actuarial gains and losses. They may be regularly recurring (for example, minor deviations between experience and actuarial assumptions) or they |