Chapter 6

Employee Benefits (Part 2)

Accoun&ng for Defined Benefit Plan

Defined Benefit Plans

- Residual defini1on, other than Defined Contribu1on Plan.

- Funded or Unfunded
- Formal Plan or Informal Prac1ce
1
- Actuarial Assump1ons are necessary to measure the obliga1on on a discounted basis,
results to actuarial gains or losses.
- Employer’s obliga1on under this is to provide the agreed benefits, therefore the employer
bears the risk that the promised benefits will cost more than expected if actuarial or
investment experience is worse than expected.
- The re1rement benefit cost is not necessarily equal to contribu1on due for the period.

Recogni&on and Measurement

- Payment due depends on:

1. Financial Posi1on (Financial Statements)
2. Investment Performance
3. Ability and Willingness to make good any shorSall in the funds asset (Subjec1ve)

Characteris&cs

1. Benefit is definite but contribu1on is indefinite

2. Actuarial assump1ons are required to measure
3. Obliga1ons measured needs to be discounted

Steps for Accoun&ng for Defined Benefit Plan

1. Determine 2Defined Benefit Obliga1on (DBO)

2. Determine 3Fair Value of Plan Assets (FVPA)
3. Determine Surplus or Deficit
a. Surplus – FVPA > DBO = Prepaid Pension
b. Deficit – FVPA < DBO = Accrued Pension
4. Determine 4Net Defined Benefit Liability or Asset
a. Deficit = Liability
b. Surplus = Asset lower of Surplus and 5Asset Ceiling
5. Determine Defined Benefit Cost (DBC) or Other Comprehensive Income (OCI)

1
Es$mates of variables used in determining the ul$mate cost of providing post-employment benefits.
2
Represents the en$ty’s obliga$on for the accumulated re$rement benefits earned by employees to date. This is
determined using an actuarial valua$on method called the “projected unit credit method (PUCM).
3
Represents the balance of any fund set aside for the payment of the re$rement benefits.
4
The amount that is presented in the statement of financial posi$on.
5
The present value of any economic benefits available in the form of refunds from the plan or reduc$ons in future
contribu$ons to the plan.
Projected Unit Credit Method (PUCM)

- Actuarial Valua1on Method

- Some1mes known as the “accrued benefit method pro-rated on service” or as the “benefit
or years of service method”.
- Sees each period of service as giving rise to an addi1onal unit of benefit en1tlement.
- Measures each unit separately to build up the final obliga1on.
- Re1rement benefit obliga1ons are measured based on future salary levels (projected
salaries) of employees.

T-Account Presenta&on:

DBO
Actuarial Gain due to decrease in PV of DBO Beg. Bal.
6
Benefits Paid Current Service Cost (CSV) and 7Past Service
Cost (PSV)
Secled in Advance Interest Expense (Beg. Bal. x 8Discount Rate)
End. Bal. Actuarial Loss due to increase in PV of DBO

FVPA
Beg. Bal. Amount Paid
Actual Return Secled in Advance
Contribu1ons
End. Bal.

CSV XX
Add: PSV XX
Add (Less): 9Loss (Gain) on Early SeLlement XX
Service Cost XX

Interest Expense (DBO Beg. Bal x Discount XX

Rate)
Add: Interest on Effect of Asset Ceiling XX
[(Surplus – Asset Ceiling) x Discount Rate]
Less: Interest Income (FVPA Beg. Bal x XX
Discount Rate)
10
Net Interest on the Net Benefit XX

Actuarial Loss XX
Add: Difference between Interest and Change XX
in Effect of Asset Ceiling [Beg. (Surplus –
Asset Ceiling) – End. (Surplus – Asset Ceiling)]
Difference between Interest Income and
Return of PA
Less: Actuarial Gain XX
Other Comprehensive Income XX

6
The increase in the PV of DBO resul$ng from employee service in the current period.
7
The change in the PV of DBO for employee service in prior periods resul$ng from a plan amendment or
curtailment.
8
Subject to Order of Priority: 1. Discount Rate, 2. High Quality Corp. Bonds, 3. Government Bonds, 4. VOID.
9
Arises when the employer’s obliga$on to provide benefits is eliminated other than from payment of benefits
according to the terms of the plan.
10
The change in the net defined benefit during the period that arises from the passage of $me.
Reimbursements

- When it is virtually certain that another party will reimburse some or all of the expenditure
required to secle a defined benefit obliga1on
- An en1ty recognizes its right to reimbursement as a separate asset
- Measured at fair value.

Overfunding or Underfunding

1. Overfunded – net defined benefit asset

2. Underfunded – net defined benefit liability
3. FVPA ³ PV of DBO, the re1rement plan is fully funded

OffseXng

- An asset rela1ng to one plan is offset against a liability rela1ng to another plan only when
the en1ty has both:
a. A legally enforceable right to use a surplus in one plan to secle obliga1ons under
the other plan, and
b. An inten1on to either secle the obliga1ons on a net basis, or to realize the surplus
in one plan and secle its obliga1on under the other plan simultaneously.

Termina&on Benefits

- Provided as a result of either:

a. The en1ty’s decision to terminate the employee before normal re1rement
date, or
b. The employee’s decision to accept the employer’s offer of benefits in exchange
for termina1on.
- Arises from the employer’s act of termina1ng an employee rather than from employee
service.
- Accordingly, benefits resul1ng from termina1on at the employee’s request without the
employer’s offer are NOT termina1on benefits but rather post-employment benefits.

Recogni&on

- Termina1on benefits are recognized as a liability and expense at the earlier of the
following dates:
1. When the en1ty can NO longer withdraw the offer of those benefits, and
2. When the en1ty recognizes restructuring costs that involve payment of termina1on
benefits.

Measurement

- Termina1on benefits are accounted for according to their nature.

1. Payable within 12 mos. are accounted as short-term benefits
2. Payable beyond 12 mos. are accounted for as other long-term benefits
 3. Enhancement to post-employment benefits are accounted for as post-employment
benefits.

Example Illustra&on #1

Date: 01/01/20x1

Service Termina1on: 5 years

Lumpsum: 1,000,000

Discount Rate: 5% (Actuarial Valua1on)

Requirement: Obliga1ons Build Up (Closing Obliga1on)

20x1 20x2 20x3 20x4 20x5

Previous Year 0 200,000 400,000 600,000 800,000
Current Year 200,000 200,000 200,000 200,000 200,000
TOTAL 200,000 400,000 600,000 800,000 1,000,000
*1,000,000 ÷ 5 = 200,000

Current Service Cost (CSV)

ALributed to 200,000 200,000 200,000 200,000 200,000
Current Year
Mul&ply: PV of 1 @ 5%, PV of 1 @ 5%, PV of 1 @ 5%, PV of 1 @ 5%, 1
Discount PV n=4 (0.8227) n=3 (0.8638) n=2 (0.9070) n=1 (0.9524)
Factor
CSV 164,540 172,768 181,406 190,476 200,000

20x1 20x2 20x3 20x4 20x5

Opening 0 164,540 345,535 544,218 761,905
Obliga&on
Add: Interest 0 (164,540 x (345,535 x (544,218 x (761,905 x
(5%) 5%) 8,227 5%) 5%) 27,211 5%) 38,095
17,276.75
Add: CSV 164,540 172,768 181,406 190,476 200,000
Less: Benefit 0 0 0 0 0
Paid
Closing 164,540 345,535 544,218 761,905 1,000,000
Obliga&on

Example Illustra&on #2

Date: 01/01/20x1

Discount Rate: 10%

Final Salary Each Year: ­ 7%

Termina1on of Service Rate: 4%

Salary for Year 1: 1,000,000

Requirement: Obliga1ons Build Up (Closing Obliga1on)

Future Salary 1,000,000 x 11FV Factor (FV @ 1,402,552

7%, n=4) 1.402552

11
To compute for FV = 1 + Rate xx = (years)
 Obliga&ons Incurred per Year
20x1 20x2 20x3 20x4 20x5
Previous Year 0 56,102 112,204 168,306 224,408
Current Year 56,102 56,102 56,102 56,102 56,102
Total 56,102 112,204 168,306 224,408 280,510
∗ 1,402,552 × 4% = 56,102

Current Service Cost (CSV)

ALributed to 56,102 56,102 56,102 56,102 56,102
Current Year
Mul&ply: PV of 1 @ PV of 1 @ PV of 1 @ PV of 1 @ 1
Discount PV 10%, n=4 10%, n=3 10%, n=2 10%, n=1
Factor (0.6830) (0.7513) (0.8264) (0.9091)
CSV 38,318 42,150 46,365 51,002 56,102

20x1 20x2 20x3 20x4 20x5

Opening 0 38,318 84,301 139,096 204,008
Obliga&on
Add: Interest 0 (38,318 x (84,301 x (139,096 x (204,008 x
(10%) 10%) 3,832 10%) 8,430 10%) 13,910 10%) 20,400
Add: CSV 38,318 42,150 46,365 51,002 56,102
Less: Benefit 0 0 0 0 0
Paid
Closing 38,318 84,301 139,096 204,008 280,510
Obliga&on

Example Illustra&on #3

Acob Company accounts for DBO, the following are given for the computa1on of:

1. Net Benefit Asset (Liability) for 2025

2. Net Benefit Asset (Liability) for 2026

FVPA 01/01/20x5 4,000,000

Return on Plan Assets 480,000
Contribu&ons to the Fund 120,000
PV of DBO 01/01/20x5 3,500,000
CSV 1,100,000
Benefits Paid for the Period 300,000
Decrease in DBO due to Actuarial 1,000,000
Assump&ons
Discount Rate 10%
Asset Ceiling 600,000

Requirement 1:

FVPA 01/01/20x5 4,000,000

Less: PV of DBO 01/01/20x5 3,500,000
Net Asset 500,000

Requirement 2:

DBO Beg. Bal. 3,500,000

Add: CSV 1,100,000
Add: Interest Expense (3,500,000x 10%) 350,000
Less: Benefits Paid 300,000
 Less: Actuarial Gain 1,000,000
DBO End. Bal. 3,650,000

FVPA 01/01/20x5 4,000,000

Add: Actual Return 480,000
Add: Contribu&ons 120,000
Less: Benefits Paid 300,000
FVPA End. Bal. 4,300,000

FVPA 01/01/20x6 4,300,000

Less: PV of DBO 01/01/20x6 3,650,000
Net Asset (Surplus) 650,000

Whichever is LOWER between Surplus and Asset Ceiling

Surplus 650,000
Asset Ceiling 600,000
Net Asset 600,000

Example Illustra&on #4

Naces Company accounts for DBO, the following are given for the computa1on of:

a. Net Benefit Asset (Liability)

b. Effect of Asset Ceiling
c. Interest Expense on Effect of Asset Ceiling

FV of PA 01/01/20x5 2,500,000
Asset Ceiling 01/01/20x5 350,000
High Yield Corp. Bonds 10%

Case 1: DBO 01/01/20x5 is 2,000,000

c.

FVPA 01/01/20x5 2,500,000

Less: DBO 01/01/20x5 2,000,000
Net Asset 500,000

d.

Net Asset 500,000

Less: Asset Ceiling 350,000
Effect of Asset Ceiling 150,000

e.

Effect of Asset Ceiling 150,000

Mul&ply: High Yield Corp. Rate 10%
Interest Expense 15,000

Case 2: DBO 01/01/20x5 is 3,000,000

a.

FVPA 01/01/20x5 2,500,000

 Less: DBO 01/01/20x5 3,000,000
Net Liability (500,000)

b. Zero
c. Zero

Example Illustra&on #5

Castro Basketball Corp. has the following:

FVPA 01/01/20x5 1,000,000

DBO 01/01/20x5 1,200,000
PSC 500,000
CSV 700,000
Decrease in Actuarial Assump&on (A. Loss) 100,000
Benefits Paid 200,000
Actual Return on Plant Assets 300,000
Contribu&ons 550,000
Discount Rate 10%

Compute for the following:

1. FVPA End of the Year

2. DBO End of the Year
3. Interest Expense (P/L)
4. Defined Benefit Cost (DBC)
5. Other Comprehensive Income (OCI)

1.

FVPA 01/01/20x5 1,000,000

Add: Actual Return 300,000
Add: Contribu&on 550,000
Less: Benefits Paid 200,000
FVPA 12/31/20x5 1,650,000

2.

DBO 01/01/20x5 1,200,000

Add: PSV 500,000
Add: CSV 700,000
Add: Interest Expense (1,200,000 x 10%) 120,000
Add: Actuarial Loss 100,000
Less: Benefits Paid 200,000
DBO 12/31/20x5 2,420,000

3.

FVPA 01/01/20x5 1,000,000

Less: DBO 01/01/20x5 1,200,000
Net Liability (Deficit) (200,000)
Mul&ply: Discount Rate 10%
Net Interest Expense 20,000
 4.

PSV 1,000,000
Add: CSV 300,000
Add: Interest Expense DBO 550,000
Less: Interest Income FVPA (1,000,000 x 10%) 200,000
Defined Benefit Cost (DBC) 1,220,000

5.

Interest Income FVPA 100,000

Less: Actual Return 300,000
Remeasurement Gain (200,000)
Add: Actuarial Loss 100,000
Other Comprehensive Income (OCI) (100,000)

ILLUSTRATION
Defined Benefit Obliga&on (DBO) P/L OCI
DBO Beg. Balance XX
Add: Interest XX XX
Expense (BB x Disc
Rate)
Add: CSV XX XX
Add: PSV XX XX
Add: Actuarial Loss XX XX
(Increase)
Less: Benefits Paid XX
12
Less: SeLlement @ XX XX (XX)
CA
Less: Actuarial Gain XX XX
(Decrease)
DBO End. Bal. XX

Plan Assets (PA) P/L OCI

PA Beg. Bal XX
Add: Interest Income XX (XX)
(BB x Corp. Rate)
13
Add: Actual Return XX XX (XX)
Add: Contribu&ons XX
Less: Benefits Paid XX
Less: SeLlement @ XX
PAID
PA End. Bal. XX
TOTAL P/L & OCI XX XX

Asset Ceiling

FVPA > DBO Asset, Surplus & Prepaid Pension; Whichever

is 14LOWER between
a. Surplus
b. Asset Ceiling

12
Difference between Se\lement in DBO and Se\lement in FVPA
13
Difference between Interest Income and Actual Return will equal to Remeasurement Gain (Loss)
14
Equals to Effect of Asset Ceiling and if mul$plied to discount rate it equates to Interest Expense (Asset Ceiling)
 FVPA < DBO Liability, Deficit & Accrued Pension

Net Interest

Interest Expense of DBO XX

Add: Interest on Effect of Asset Ceiling XX
Less: Interest Income of FVPA XX

Remeasurement

FVPA XX
Less: DBO XX
Effect in Asset Ceiling XX