Light

8.3 Other Postretirement Benefits Accounting

5 min read•july 30, 2024

(OPRBs) are a crucial part of employee compensation packages. Unlike pensions, OPRBs typically include health care, life insurance, and other non-pension benefits for retirees. These benefits are often unfunded, posing financial challenges for employers.

Accounting for OPRBs involves complex calculations and disclosures. Employers must measure the (APBO) and recognize the . This process requires careful consideration of and future healthcare costs.

Accounting for Other Postretirement Benefits

Measurement of OPRB Obligations

Accounting for OPRBs is governed by (formerly SFAS 106), which requires employers to recognize the cost of providing OPRBs over the service lives of employees
Employers must measure and recognize the accumulated postretirement benefit obligation (APBO), which represents the actuarial present value of all future OPRB costs attributed to employee service rendered to date
The APBO is calculated using actuarial assumptions about future events, such as:
- Employee turnover and retirement rates
- Life expectancy and mortality rates for retirees
- Future increases in healthcare costs
- Discount rates used to calculate the present value of future benefits
The APBO is remeasured each year to reflect changes in actuarial assumptions and the passage of time

Recognition of OPRB Costs

The net periodic postretirement benefit cost is recognized each period and includes several components:
- : The actuarial present value of benefits attributed to services rendered by employees during the period
- : Increase in the APBO due to the passage of time (i.e., the unwinding of the )
- : Increases or decreases in the fair value of plan assets, if any
- : Deferred gains or losses from plan amendments recognized over the remaining service period of active employees
- : Deferred gains and losses resulting from changes in actuarial assumptions or differences between actual and expected returns on plan assets
Employers must provide extensive disclosures about their OPRB plans in the notes to the financial statements, including:
- The of the plan (i.e., the difference between the APBO and the fair value of plan assets)
- The components of net periodic benefit cost for the period
- for each of the next five years and in aggregate for the following five years

Pensions vs Other Postretirement Benefits

Differences in Accounting Treatment

Both pensions and OPRBs are forms of deferred compensation that employers provide to their retired employees, but there are several key differences in the accounting treatment:
- Pensions are typically funded in advance, with the employer making regular contributions to a trust fund, while OPRBs are usually unfunded and paid on a pay-as-you-go basis
- The APBO for OPRBs includes the expected cost of future benefits for both vested and non-vested employees, while the (PBO) for pensions only includes vested benefits
- Actuarial gains and losses are recognized immediately in for pensions, but they are deferred and amortized over time for OPRBs

Similarities in Accounting Treatment

The calculation of the service cost and interest cost components of net periodic benefit cost is similar for both pensions and OPRBs:
- Service cost represents the present value of benefits earned by employees during the current period
- Interest cost represents the increase in the benefit obligation due to the passage of time
Employers must provide similar disclosures for both pensions and OPRBs in the notes to the financial statements, including:
- The funded status of the plan at the end of the period
- The components of net periodic benefit cost recognized during the period
- Expected future benefit payments for each of the next five years and in aggregate for the following five years

Journal Entries for Other Postretirement Benefits

Recording Net Periodic Benefit Cost

At the end of each period, employers must record the net periodic postretirement benefit cost and update the APBO
The basic journal entry to record net periodic benefit cost is:
- Debit: Net Periodic Postretirement Benefit Cost (an operating expense account)
- Credit: Cash (for any benefits paid directly to retirees during the period)
- Credit: (a balance sheet liability account)
The Accrued Postretirement Benefit Liability represents the cumulative difference between the APBO and the fair value of any plan assets, and it is reported as a long-term liability on the balance sheet

Recording Contributions to Plan Assets

If the employer makes contributions to a funded OPRB plan, the journal entry to record the contribution is:
- Debit: Plan Assets (a balance sheet asset account)
- Credit: Cash
Contributions to plan assets increase the funded status of the plan and reduce the Accrued Postretirement Benefit Liability

Recording Gains and Losses

Gains and losses that are not immediately recognized in net periodic benefit cost are recorded in other comprehensive income (OCI) and then amortized over time
The journal entry to record gains and losses in OCI is:
- Debit/Credit: Other Comprehensive Income - Postretirement Benefits (an equity account)
- Credit/Debit: Accrued Postretirement Benefit Liability
Amortization of prior service costs and deferred gains/losses is recorded as a component of net periodic benefit cost each period, with a corresponding reduction in the balance of the OCI account

Key Terms to Review (20)

Accrued postretirement benefit liability: Accrued postretirement benefit liability refers to the obligation a company has to provide benefits to employees after they retire, which are not part of their pension plans. This liability is recognized over the employees' service period, reflecting the company's commitment to cover future healthcare and other non-pension benefits. Accurate accounting of this liability is crucial for financial reporting and helps companies manage their long-term obligations effectively.

Accumulated postretirement benefit obligation: The accumulated postretirement benefit obligation (APBO) is the present value of future benefits that a company is obligated to pay to its retirees for postretirement benefits, such as healthcare and life insurance, based on employees' service up to the measurement date. This term highlights the financial responsibility companies have for these benefits and how they need to be accounted for on financial statements, impacting overall liabilities and employee benefits planning.

Actual return on plan assets: The actual return on plan assets refers to the increase or decrease in the value of pension plan investments over a specific period, reflecting the performance of those investments. This measure is important for determining how well a company's pension fund is performing in relation to its obligations and for assessing the overall financial health of the plan. It plays a crucial role in calculating pension expense and understanding funding status.

Actuarial assumptions: Actuarial assumptions are the estimates and projections made regarding future events that affect the financial obligations of a company, especially concerning postretirement benefits. These assumptions can include factors such as mortality rates, employee turnover, and healthcare cost trends, which help in calculating the present value of future obligations and in determining the expense recognition for these benefits over time.

Amortization of gains and losses: Amortization of gains and losses refers to the systematic allocation of the effects of certain gains and losses over time, particularly in relation to other postretirement benefits. This process is crucial for recognizing the impact of changes in actuarial assumptions or investment returns on the funded status of retirement plans, ensuring that the financial statements reflect these changes appropriately over multiple reporting periods.

Amortization of prior service cost: Amortization of prior service cost refers to the systematic allocation of the costs associated with retroactive benefits granted to employees for services rendered in prior periods. This concept is particularly relevant in accounting for other postretirement benefits, where companies may recognize costs related to benefit changes that affect employees’ service years before the current period. The amortization process helps in smoothing the expense recognition over time and aligning it with the service periods benefited by the employees.

Discount rate: The discount rate is the interest rate used to determine the present value of future cash flows. It's crucial for valuing long-term liabilities like pension obligations and leases, as it impacts how much those future obligations are worth today. A higher discount rate results in a lower present value, which affects financial reporting and decision-making regarding employee benefits and lease agreements.

Expected future benefit payments: Expected future benefit payments refer to the anticipated cash outflows that a company is obligated to make in the future for postretirement benefits, such as health care or pensions, that have been earned by employees during their service. These payments are a crucial part of accounting for other postretirement benefits, as they influence the overall financial liabilities and obligations reported on a company's balance sheet. Understanding these payments helps in determining the present value of future obligations and ensuring that adequate funds are set aside to meet these commitments.

FASB ASC 715-60: FASB ASC 715-60 refers to the Financial Accounting Standards Board's Accounting Standards Codification on Other Postretirement Benefits. It provides guidelines for accounting and reporting of benefits that companies offer to employees after retirement, excluding pensions. This standard emphasizes the importance of recognizing the financial obligations associated with these benefits in order to present a company's financial position accurately.

Funded status: Funded status refers to the financial health of a pension plan, indicating whether the plan has sufficient assets to meet its future obligations to retirees. A plan is considered fully funded when its assets equal or exceed its liabilities; otherwise, it is underfunded. Understanding funded status is crucial as it impacts how companies report pension expenses, assess their long-term liabilities, and manage retirement benefits for employees.

Health care benefits: Health care benefits refer to the various forms of medical and health-related coverage provided to employees as part of their compensation packages. These benefits can include medical, dental, vision insurance, and other wellness programs, aimed at supporting the health and well-being of employees and their families. The accounting for these benefits is crucial as they represent a significant liability for organizations in terms of future payments and can impact financial statements significantly.

Interest cost: Interest cost refers to the expense incurred by a company when it recognizes the time value of money related to its pension and other postretirement benefit obligations. This cost reflects the increase in the present value of these obligations over time as the employees earn benefits, acknowledging that money available now is worth more than the same amount in the future. Understanding interest cost is crucial for accurately calculating pension expenses and managing other retirement-related liabilities.

Life insurance benefits: Life insurance benefits refer to the financial compensation that is paid out by an insurance company to the beneficiaries of the insured individual upon their death. These benefits are intended to provide financial security to the beneficiaries, helping them cover expenses such as funeral costs, outstanding debts, or living expenses. The accounting for life insurance benefits falls under the category of postretirement benefits, specifically in relation to how organizations recognize and report these obligations on their financial statements.

Net periodic benefit cost: Net periodic benefit cost refers to the total expense recognized in a given period related to other postretirement benefits, such as health care and life insurance, that employers provide to retirees. This cost includes several components, like service cost, interest cost, and amortization of prior service costs, which together represent the company's obligation towards these benefits over time.

Note disclosures: Note disclosures are additional information included in financial statements that provide context, detail, and clarification about the financial data presented. They help users of financial statements understand the assumptions, policies, and potential risks related to the numbers reported, making them essential for transparency and informed decision-making.

Other Comprehensive Income: Other comprehensive income (OCI) refers to revenues, expenses, gains, and losses that are excluded from net income on an entity's income statement. Instead of affecting the net income directly, OCI is reported separately in the equity section of the balance sheet, which affects the overall financial health of a company. This concept connects to various accounting topics, including the treatment of unrealized gains and losses on certain investments, the impact of tax allocation on comprehensive income, and the recognition of pension-related adjustments in defined benefit plans.

Other postretirement benefits: Other postretirement benefits are non-pension benefits provided by employers to their retirees, including health insurance, life insurance, and other forms of compensation that extend beyond the traditional retirement pension plans. These benefits can be significant liabilities for companies, impacting their financial statements and requiring careful accounting and reporting.

Plan assets: Plan assets refer to the resources set aside within a pension or other postretirement benefit plan to cover future obligations to employees. These assets are crucial for ensuring that the plan can meet its promised benefits, which may include retirement payouts, healthcare coverage, or other postemployment benefits. The effective management and investment of these assets directly impact the financial health of the benefit plan, influencing both the employer's balance sheet and the employees' financial security in retirement.

Projected benefit obligation: Projected benefit obligation (PBO) is a measure used in accounting for defined benefit pension plans that estimates the present value of future retirement benefits owed to employees, based on their service and salary history. This estimate incorporates assumptions about factors like salary growth, employee turnover, and mortality rates, which helps companies determine how much they need to set aside to meet future pension liabilities.

Service cost: Service cost refers to the present value of the benefits earned by employees during a given period for their service, often related to pension and other postretirement benefits. It is a critical component in measuring the total pension expense and is recognized in the financial statements to reflect the employer's obligation to its employees. Understanding service cost is essential for accurately reporting pension obligations and ensuring compliance with accounting standards.

AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.

Back

Practice QuizGlossary

Practice Quiz Glossary