Thought to Ponder: Chapter 10 - cdn.ymaws.com fileGranof, et al. –7th edition Chapter 10 | Learning Objectives •Why pensions are important •Distinctions between defined contribution

3/7/2016

1

Granof, et al. – 7th edition Chapter 10 |

Chapter 10 Pensions and Other Fiduciary Activities

© 2016 John Wiley & Sons, Inc. All rights reserved. 1


Thought to Ponder: Chapter 10“The trust funds that the federal government has aren't the same as those you find in the private sector. You can't trust the federal government's and they aren't funded!”

David Walker, former Comptroller General of the United States and President & CEO of the Peterson G. Foundation


3/7/2016

2


Learning Objectives•Why pensions are important

•Distinctions between defined contribution and defined benefit pension plans

•The relationships between an employer and its pension trust

•Main issues faced by government employers in accounting for pension plans

•How pension plans are accounted for

•Postemployment health care benefits

•Accounting for• issues presented by agency funds

• issues presented by investment trust funds

• investment gains and losses

• Assets held in fiduciary funds

•What is an endowment

•Distinguish between permanent and fiduciary funds



Why is pension accounting important?

•Magnitude of assets and liabilities involved• California Public Employees’ Retirement System as of June 30, 2014 was $301.8 billion

•It has direct impact on public policy

•One of the most controversial issues of our era

•Pension is the sum of money paid to retired or disabled employees based on their years of employment. • Although employees earn pension during years of employment, employers do not have to make

actual cash payments until they retire.

• Benefits received and cash payments may be mismatched by many years

•Difficult accounting issues• Amount of eventual cash payments to the employees may depend on variables unknown at the time

employees provide service

• It is not obvious how eventual costs of benefits should be allocated to particular years when employees provide their services


3/7/2016

3

Granof, et al. – 7th edition Chapter 10 |© 2016 John Wiley & Sons, Inc. All rights reserved. 5

FUNDED STATUS OF STATE DEFINED BENEFIT PLANS – TEN BEST AND TEN WORST

Wisconsin 106.9% Illinois 47.5%

South Dakota 103.6% Kentucky 50.3%

Delaware 97.9% Connecticut 50.4%

Oregon 97.7% New Jersey 55.8%

New York 97.2% Alaska 56.4%

Washington 94.2% Hawaii 56.7%

North Carolina 93.5% Pennsylvania 57.1%

Tennessee 93.2% New Hampshire 58.2%

Florida 89.5% Rhode Island 61.5%

Idaho 86.0% Kansas 61.6%

The funded status is the ratio of the plans’ total cash and investment

holdings to its pension obligations. These data were drawn from

2013 Survey of Public Pensions: State Data of the U.S. Census

Bureau.


Defined Contribution PlanEmployer makes series of pension contributions.

Employer defines inputs and contributions normally expressed as a percentage of each employee’s salary.

Employer reports annual expense for the amount that it is obligated to contribute to pension fund.

Employer has no pension related liab on its B/S

Employer has a lower risk

Defined Contribution plans are more portable.

Employee bears all the investment risks

Pension fund, very often is managed by a third party that is totally independent of the employer.


3/7/2016

4


Defined Benefit Pension PlanEmployer specifies the benefits – the actual payments that the employee will receive.

Employer guarantees ONLY the outputs and not the inputs.

Interperiod equity: Pension costs must be allocated to the periods in which the employees perform their services and earn their pension benefits.

Amount to be contributed to meet future pension obligations are calculated by actuaries.

Actuarial cost method: allocation of total cost of expected benefits over the total years of employee service.

Liabilities of the Defined Benefit Pension plan are in substance those of the employer.

Both funding and accounting decisions relating to defined benefit pension plans are complex because of

the uncertainties as to the amounts to be paid to the retirees

the amounts earned on fund investments

Uncertainty about employee life expectancy

Uncertain future wage and salary rates



Defined Benefit Pension Plans (cont’d)

Financial Reporting: According to GASB, the main objective in pension plan

accounting and reporting is to provide useful information for assessing the stewardship of plan resources and the ongoing ability of the plan to pay benefits.

GASB standards provide guidance for defined benefit plans that are either:

(1) included as part of an employer's financial report OR

(2) included in stand-alone reports

GASB Standards distinguish between two categories of pension information:

(1) current financial information about plan assets, and activities and

(2) actuarially determined information about the funded status of the plan and progress in accumulating assets


3/7/2016

5


Distinction among single, agent multiple-employer and cost-sharingSingle employer plansEstablished by a single employer and cover only its own employees

Agent multiple-employer planEstablished by a sponsoring organization (state or county) for employees of governments within its

jurisdiction

Under one type, assets are pooled

Separate accounts are maintained and actuarial computations are made for each employer

Sponsoring agent merely provides admin and investments services

Accounting is same as for single employer plans

Cost-sharing multiple-employer planEmployees of all participating governments place in common pool

Employers share all risks and costs and contribute at same rate

Assets may be used to pay any employee’s benefits



Relationship between employer and pension plan

•Pension plan is an arrangement in which pension investments are held and managed.

•Commonly, pension plan takes form of trust fund (trust assets are legal separate from sponsor)

•If maintained by employer, must be included in financial statements (like fiduciary funds)

•If plan is maintained by outside party, employer must disclose information about its financial conditions.


3/7/2016

6


GASB Statements No 67 and 68The GASB in 2012 issued Statement No. 67, Financial Reporting for Pension Plans and Statement No. 68 Accounting and Financial Reporting for Pensions.

These two statements became effective respectively for years

beginning after June 15, 2013 and 2014.

Per GASB Statement No. 68, the government employer is required to report as its pension liability the difference between the total pension liability and the net plan position. This difference is referred to as the net pension liability



How should the employer measure its pension obligation?Pension liability

Difference between total pension liability and net plan position

Difference is also called net pension liability

Total pension liability is determined by actuary

Three steps to calculate total pension liability

Actuary must first estimate amount that will be required to make cash payments to employees during their years of retirement

Actuary must discount these payments to the valuation date (a current or near-current date)

Actuary must allocate cost over the total periods of past, present, and future


3/7/2016

7


How is the discount rate determined?Most controversial aspect of pension accounting

Lower the discount rate, greater the total pension liability

Higher the discount rate, the lower the total pension liability

Should be a single rate that reflects:

The long-term expected rate of return on plan investments to the extent that plan’s fiduciary net position is projected to be sufficient to meet future benefit payments

A yield or index rate on high-quality 20 year municipal bonds to extent that plan’s net position is projected to be insufficient to meet future benefit payments



How should pension expense in full accrual statements be determinedPension expense can be seen as the change during that year in the net pension liability

Difference between total pension liability and fiduciary net position

Changes in the Total Pension Liability is affected by the following factors

The amount allocated per the actuarial cost method

Interest on the total pension liability

Benefit payments to retirees

Changes in pension benefits

Changes in actuarial assumptions

Differences between expected and actual experience


3/7/2016

8


How should pension expense in full accrual statements be determinedChanges in the plan fiduciary net position is affected by the following factors

Contributions of the employer

Investment earnings

Benefit payments to retirees

Administrative and other miscellaneous costs

GASB exceptions to the rule pension expense is equal to change in net pension liability

Changes in actuarial assumptions

Difference between expected and actual experience with regard to economic or demographic factors

Difference between actual and projected investment earnings on plan assets



How should pension plan be accounted for?Per GASB Statement No. 67, pension plan should prepare two basic statements

Statement of fiduciary net position

Essentially a balance sheet, reports on plan’s assets, liabilities and deferred inflows and outflows

Statement of changes in fiduciary net position

Statement provides information on inflows and outflows of financial resources during the period


3/7/2016

9


Statement of Fiduciary PositionMain assets of pension plan are its investments

Plan assets should be reported at FV

Receivables are usually short term and consist of contributions due from employers and other entities

Main liabilities are benefits currently due and payable and investment and admin fees not yet paid

Difference between assets and liabilities is reported as net position restricted for pensions



Statement of Changes in Fiduciary Net PositionAdditions consist of investment income and contributions from employers and other contributing entities

Investment income is generally interest, dividends, and other returns from investments

Principal deductions are benefit payments to retireesGenerally also include various investment and admin expenses


3/7/2016

10


Types of disclosuresGASB requires extensive disclosures on F/S of both employer and plan

Required disclosures includeDescription of plan including benefit terms, classes of employees, number of active and inactive

employees and contribution requirements

Information about net pension liability, assumptions, alternative measures of net pension liability calculated using discount rate 1% higher and 1% lower than was actually used

Particulars as to pension plan’s assets, liabilities, and deferred inflows and outflow of resources

Details as to changes in total and net pension liability, including beginning and ending balances, service cost, interest, contributions, benefit payments, and investment earnings

Disclosures required as RSIChanges in total and net pension liability

Net pension liability as percentage of covered-employee payroll

Actuarially determined contribution, if calculated



How should OPEB be accounted for?Postemployment benefits are similar to pensions

They are a form of compensation provided to employees in exchange for services employees provide

The annual OPEB expense should be change during the year in the net liability

GASB allows small governments to simplify their calculations of annual required contribution


3/7/2016

11


Fiduciary Funds (NOTGovernmental funds)

1) Account for both nonexpendable and expendable resources

2) Resources held for the benefit of parties outside the government (i.e. government is acting as a trustee for a beneficiary)

Beneficiary examples: employees and their survivors, individual citizens, other governments etc.

3) Measurement focus: Economic Resources

4) Basis of Accounting: Full Accrual

5) Funds excluded from government-wide statements.

(because the resources of those funds are not

available to support the City’s own programs)



Endowment FundDefinition: a contribution for which the donor requires

that only the income from the investment may be expended,

while the principal is preserved in perpetuity (i.e. remains intact.)

Endowments accounted for in nonexpendable fiduciary (or trust).

Endowment may also be accounted for in a permanent fund.

Examples of who maintains endowments:oUniversities

oPrivate foundations (Ford, Carnegie, Gates)

oChurches and synagogues

oMunicipalities


3/7/2016

12


Permanent Funds (a governmental fund)

1) Accounts for nonexpendable resources

2) Resources benefit government

3) Measurement focus: Current Financial Resources

4) Basis of Accounting: Modified Accrual ◦ Reported as Nonspendable in the Governmental Funds balance sheet

5) Not all governmental entities have Permanent Funds and these funds may be major or non-major funds.

6) Funds included in government-wide statementsExample: City of Boston, has

three non-major permanent funds.



Fiduciary Funds -Additional Information4 major types:1) Private-Purpose Trust Funds

1) Trust funds other than investment pools and pensions in which resources are held for benefit of outsiders

2) Investment Trust Funds1) Used to account for investment pools in which a sponsoring government holds and invests the cash of

other governments

3) Pension Trust Funds1) Include both defined benefit and defined contribution plans

4) Agency Funds1) Funds used to account for resources held by an organization in a purely custodial capacity


3/7/2016

13


Investment Income &Investment Gains/Losses Investment Income

Income from permanent (nonexpendable trust) funds is intended to benefit other funds.

Issue: should income be reported as

A) revenue strictly in the receiving fund OR

B) a nonreciprocal transfer-out from the permanent (nonexpendable) fund and a nonreciprocal transfer-in to the recipient (expendable) fund.



Investment Gains/LossesWITH Donor Stipulations:

ACTION:

oDonors may stipulate whatever they want.

oUsual stipulations are that gains be reinvested and not expended.

ISSUE: None.

REPORTING: Whatever is consistent with donor stipulations.

o i.e. if donor stipulation or law mandates gains permanently restricted, then reported as additions to permanently restricted net assets.

o If donor stipulation or law mandates gains temporarily restricted, then reported as additions to temporarily restricted net assets.


3/7/2016

14


Investment Gains/Losses (Cont’d)WITHOUT (absence) donor or legal stipulations:

ACTION

oRecipient institution can appropriate gains for current use.

ISSUE:

o In the absence of donor restrictions, should investment gains/losses be recognized as:

A) Expendable income OR Nonexpendable principal

REPORTING: (in the absence of donor or legal restrictions)

oGASB:

oGains: should be reported as unrestricted assets and hence expendable

Losses: Unaddressed by GASB, Government may allocate losses between expendable &

nonexpendable resources

o FASB: (Conflicting Standards)

Gains/Losses: report as increases or decreases in unrestricted net assets

Losses: (2 steps)

Charge temporarily restricted net assets until it is depleted.

Charge any remainder losses to unrestricted net assets.



Non-profits Vs. GovernmentNon-profit:

◦ Interest income and investment gains—reported in statement of activities as increases in temporarily restricted resources.

◦ Interest income and investment gains are expendable.

◦ Investment income is aggregated and reported on a single line.


3/7/2016

15


Trust Funds - OverviewDefinition: To account for assets the government holds as an agent or trustee for individuals,

organization, or other governmental units (a beneficiary).

Basis of accounting either

A) Full Accrual OR

B) Whatever basis is prescribed by state law or donor.

Investments:

o GAAP requires that most be “marked to market” (i.e. reported at fair value)

o GASB Statement No. 31

Nonexpendable trust fund income: o Most states have adopted a version of either the Uniform Management of Institutional Funds Act

or the Uniform Prudent Investors Act.

o Permits a “prudent” portion of unrealized gains/losses to be used as distributable income.



Pension Trust Funds – ExamplesFor the City of Houston, Pension trust funds are used to account for the operation of the

employee pension retirement programs. The funds include: Houston Firefighters’ Relief and Retirement, Houston Municipal Employees’, and Police Officers’ funds.

The City of Chicago (CAFR 2014) has four single-employer defined benefit pension plans and eligible city employees participate in one of the four plans. These plans are the Municipal Employees’, the Laborers’ and Retirement Board Employees’, the Policemen’s; and Firemen’s Annuity and Benefit Funds of Chicago.

The City of Atlanta has four Pension Trust Funds: General employees’ defined benefit pension fund, General employees’ defined contribution pension fund, Firefighters’ pension fund and Police officers’ pension fund.

The District of Columbia, Washington D.C. has Other Postemployment Benefit trust fund (OPEB) along with two other Pension trust funds.


3/7/2016

16



Key TermsAnnual Pension Cost is the government’s annual required contribution subject to certain technical adjustments that take into account interest on, and amortization of, any net pension obligation.

Annual Required Contributions (ARC) Employer’s annual required contribution to a defined benefit pension plan, calculated in accordance with specified GASB parameters.

Actuarial deficiencies (excesses) Difference between the annual required contributions and the actual contributions.

NOTE: Per GASB Stmt. No 27, a government’s annual pension cost of maintaining or participating in a defined benefit pension plan should be based mainly on its annual required contributions.


3/7/2016

17


Accounting – OverviewGASB pension accounting standards apply not only to general purpose government employers but also to:

◦ government-owned or affiliated healthcare entities, ◦ colleges and universities, ◦ public benefit corporations and authorities,◦ utilities, and ◦ pension plans themselves if they are also employers.

GASB standards provide guidance for: ◦ Pension expenditures/expenses◦ Pension liabilities and assets◦ Required supplementary information◦ Note disclosures

GASB requires that the pension plans include:◦ Plan assets, liabilities, and net assets available for benefits◦ Changes in Net assets◦ Contribution requirements of employers and employees

◦ Funded status of plan



Accounting-Annual Required Contribution

Minimum current criteria that an employer’s Annual Required Contribution (ARC) must satisfy include:

1) Contribution must consist of the employer’s normal cost which is the portion of the present value of pension plan benefits that is allocated to a particular year by an actuarial cost method (based on one of six specified actuarial cost methods).

2) a provision for amortizing the plan’s unfunded actuarial accrued liability.

3) Actuarial assumptions, including those pertaining to mortality, changes in compensation rates, and investment earnings.

4) Actuarial value of pension plan assets must be market related.

5) Assumptions as to investment earnings rates and future inflation should be based on long-term projections, rather than on those for a single year


3/7/2016

18


Accounting (cont’d) –Pension Expense/Expenditure

Pension expenditure and pension expense are accounting constructs and are determined

in accord with the rules established by the Board.

In governmental funds, pension expenditure is the cost that will be liquidated with

current financial resources.

In proprietary and government-wide statements, pension expense is the cost

subject to various GASB required adjustments.

Employer’s pension expenditures/expense may include one or both of the :

1) ARC Contributions AND/OR

2) Payments of pension-related debt



Agency FundsPurpose:

◦ To account for assets held by a governmental unit acting as an agent for one or more other governmental units, individuals, or private organizations (i.e. custodial in nature)

◦ Use an agency fund if:

oDollar amount of transactions dictate use of agency fund for accountability reasons

o Its use will improve financial management or accounting

oMandated by law, regulation, or GASB standards

Assets = liabilities

◦ Since it is held on behalf of another party, all the assets it has, are someone else’s.


3/7/2016

19



Agency Funds – Typical UsesSpecial assessment accounting when the government is not obligated

in any manner for special assessment debt

Tax Agency Funds

--Very common usage

Pass-through agency funds

--(but not as common since GASB Statement 24 on grant accounting

was issued).

Note: Agency fund is generally not needed for routine agency relationships

such as payroll withholding


3/7/2016

20


Pass-Through Agency Funds Used only if the intermediate (“pass through”) government has NO administrative involvement or direct financial involvement in the grant.

The pass-through government must simply be acting as a conduit before an agency fund is used.

GASB NO. 24:

o A government accounts for proceeds of pass-through grants in an agency fund ONLY if it merely transmits funds without any administrative involvement.

o If government has administrative involvement, it accounts as revenues and expenditures/expenses.



SummaryPensions are of vital concern to statement preparers and users.

Defined contribution plans are becoming increasingly popular and are simple to account for because they

employer defines the contributions and makes no guarantee about outputs.

Defined benefit plans are more complex because employer defines output and is required to contribute

sufficient amount to pay required benefits when employee retires.

Government is responsible for ensuring trust fund has enough to pay its retirees.

Per GASB, government should report on its B/S its net pension liability

Health care and other postemployment benefits present accounting challenges similar to those of pensions.

Fiduciary funds maintained to account for assets held on behalf of someone else.

Endowment funds can only expend income earned from the fund

Agency Funds are used only for significant agency relationships in which a governmental units acts as an

agent for another party.


Documents

Thought to Ponder: Chapter 10 - cdn.ymaws.com fileGranof, et al. –7th edition Chapter 10 | Learning Objectives •Why pensions are important •Distinctions between defined contribution