78 Opinions of the Accounting Principles Board may be unusual or recurring at irregular intervals (for example, substantial investment gains or losses, changes in the actuarial assumptions, plant closings, etc.). 26. In dealing with actuarial gains and losses, the primary question concerns the timing of their recognition in providing for pension cost. In practice, three methods are in use; immediate-recognition, spreading and averaging. Under the immediate-recognition method (not ordinarily used at present for net losses), net gains are applied to reduce pension cost in the year of occurrence or the following year. Under the spreading method, net gains or losses are applied to current and future cost, either through the normal cost or through the past service cost (or prior service cost on amendment). Under the averaging method, an average of annual net gains and losses, developed from those that occurred in the past with consideration of those expected to occur in the future, is applied to the normal cost. 27. The use of the immediate-recognition method sometimes results in substantial reductions in, or the complete elimination of, pension cost for one or more years. For Federal income tax purposes, when the unit credit actuarial cost method is used, and in certain other instances, actuarial gains reduce the maximum pension-cost deduction for the year of occurrence or the following year. 28. Unrealized appreciation and depreciation in the value of invest:nents in a pension fund are forms of actuarial gains and losses. Despite short-term market fluctuations, the overall rise in the value of equity investments in recent years has resulted in the investments of pension funds generally showing net appreciation. Although appreciation is not generally recognized at present in providing for pension cost, it is sometimes recognized through the interest assumption or by introducing an assumed annual rate of appreciation as a separate actuarial assumption. In other cases, appreciation is combined with other actuarial gains and losses and applied on the immediate-recognition, spreading or averaging method. 29. The amount of any unrealized appreciation to be recognized should also be considered. Some actuarial valuations rec Accounting for the Cost of Pension Plans 79 ognize the full market value. Others recognize only a portion (such as 75 per cent) of the market value or use a moving average (such as a five-year average) to minimize the effects of short-term market fluctuations. Another method used to minimize such fluctuations is to recognize appreciation annually based on an expected long-range growth rate (such as 3 per cent) applied to the cost (adjusted for appreciation previously so recognized) of common stocks; when this method is used, the total of cost and recognized appreciation usually is not permitted to exceed a specified percentage (such as 75 per cent) of the market value. Unrealized depreciation is recognized in full or on a basis similar to that used for unrealized appreciation. Opinion 30. The Board believes that actuarial gains and losses, including realized investment gains and losses, should be given effect in the provision for pension cost in a consistent manner that reflects the long-range nature of pension cost. Accordingly, except as otherwise indicated in Paragraphs 31 and 33, actuarial gains and losses should be spread over the current year and future years or recognized on the basis of an average as described in Paragraph 26. If this is not accomplished through the routine application of the method (for example, the unit credit method - see Paragraph 27), the spreading or averaging should be accomplished by separate adjustments of the normal cost resulting from the routine application of the method. Where spreading is accomplished by separate adjustments, the Board considers a period of from 10 to 20 years to be reasonable. Alternatively, an effect similar to spreading or averaging may be obtained by applying net actuarial gains as a reduction of prior service cost in a manner that reduces the annual amount equivalent to interest on, or the annual amount of amortization of, such prior service cost, and does not reduce the period of amortization. 31. Actuarial gains and losses should be recognized immediately if they arise from a single occurrence not directly related to the operation of the pension plan and not in the ordinary course of the employer's business. An example of such occur 80 Opinions of the Accounting Principles Board rences is a plant closing, in which case the actuarial gain or loss should be treated as an adjustment of the net gain or loss from that occurrence and not as an adjustment of pension cost for the year. Another example of such occurrences is a merger or acquisition accounted for as a purchase, in which case the actuarial gain or loss should be treated as an adjustment of the purchase price. However, if the transaction is accounted for as a pooling of interests, the actuarial gain or loss should generally be treated as described in Paragraph 30. 32. The Board believes unrealized appreciation and depreciation should be recognized in the determination of the provision for pension cost on a rational and systematic basis that avoids giving undue weight to short-term market fluctuations (as by using a method similar to those referred to in Paragraph 29). Such recognition should be given either in the actuarial assumptions or as described in Paragraph 30 for other actuarial gains and losses. Ordinarily appreciation and depreciation need not be recognized for debt securities expected to be held to maturity and redeemed at face value. 33. Under variable annuity and similar plans the retirement benefits vary with changes in the value of a specified portfolio of equity investments. In these cases, investment gains or losses, whether realized or unrealized, should be recognized in computing pension cost only to the extent that they will not be applied in determining retirement benefits. EMPLOYEES INCLUDED IN COST CALCULATIONS Discussion 34. Under some plans employees become eligible for coverage when they are employed; other plans have requirements of age or length of service or both. Some plans state only the conditions an employee must meet to receive benefits but do not otherwise deal with coverage. Ordinarily actuarial valuations exclude employees likely to leave the company within a short time after employment. This simplifies the actuarial calculations. Accordingly, actuarial calculations ordinarily exclude Accounting for the Cost of Pension Plans 81 employees on the basis of eligibility requirements and, in some cases, exclude covered employees during the early years of service. 35. If provisions are not made for employees from the date of employment, pension cost may be understated. On the other hand, the effect of including all employees would be partially offset by an increase in the turnover assumption; therefore, the inclusion of employees during early years of service may expand the volume of the calculations without significantly changing the provisions for pension cost. Opinion 36. The Board believes that all employees who may reasonably be expected to receive benefits under a pension plan should be included in the cost calculations, giving appropriate recognition to anticipated turnover. As a practical matter, however, when the effect of exclusion is not material it is appropriate to omit certain employees from the calculations. Opinion COMPANIES WITH MORE THAN ONE PLAN 37. A company that has more than one pension plan need not use the same actuarial cost method for each one; however, the accounting for each plan should conform to this Opinion. If a company has two or more plans covering substantial portions of the same employee classes and if the assets in any of the plans ultimately can be used in paying present or future benefits of another plan or plans, such plans may be treated as one plan for purposes of determining pension cost. DEFINED-CONTRIBUTION PLANS Opinion 38. Some defined-contribution plans state that contributions will be made in accordance with a specified formula and that benefit payments will be based on the amounts accumulated from such contributions. For such a plan the contribution ap 82 22 Opinions of the Accounting Principles Board plicable to a particular year should be the pension cost for that year. 39. Some defined-contribution plans have defined benefits. In these circumstances, the plan requires careful analysis. When the substance of the plan is to provide the defined benefits, the annual pension cost should be determined in accordance with the conclusions of this Opinion applicable to defined-benefit plans. INSURED PLANS Opinion 40. Insured plans are forms of funding arrangements and their use should not affect the accounting principles applicable to the determination of pension cost. Cost under individual policy plans is ordinarily determined by the individual level premium method, and cost under group deferred annuity contracts is ordinarily determined by the unit credit method. Cost under deposit administration contracts, which operate similarly to trustfund plans, may be determined on any of several methods. Some elements of pension cost, such as the application of actuarial gains (dividends, termination credits, etc.), may at times cause differences between the amounts being paid to the insurance company and the cost being recognized for accounting purposes. The Board believes that pension cost under insured plans should be determined in conformity with the conclusions of this Opinion. 41. Individual annuity or life insurance policies and group deferred annuity contracts are often used for plans covering small employee groups. Employers using one of these forms of funding exclusively do not ordinarily have ready access to actuarial advice in determining pension cost. Three factors to be considered in deciding whether the amount of net premiums paid is the appropriate charge to expense are dividends, termination credits and pension cost for employees not yet covered under the plan. Usually, the procedures adopted by insurance companies in arriving at the amount of dividends meet the re |