Lesson 49 - Intermediate Accounting Course 

49. Pension Liabilities and Post-Retirement Benefits Accounting

Pension liabilities and post-retirement benefits are long-term obligations that companies must account for when providing employee benefits after retirement. Proper accounting ensures transparency in financial statements and compliance with IFRS (IAS 19) and US GAAP (ASC 715).

1️⃣ Types of Pension Plans

There are two main types of pension plans:

A. Defined Contribution Plans (e.g., 401(k) in the U.S.)

✔ The employer contributes a fixed amount to an employee's retirement account.
✔ No future liability once contributions are made.
✔ Employees bear investment risk.

Accounting Treatment:

• The employer records an expense for contributions made.
  
  

• Example entry if an employer contributes $5,000 to an employee's plan:
  
  

Pension Expense          $5,000  

    Cash                        $5,000  

B. Defined Benefit Plans (Traditional Pension)

✔ The employer guarantees a fixed payout to retirees based on salary and years of service.
✔ The company assumes investment risk and must estimate future liabilities.

Accounting Complexity:

• Requires actuarial calculations to estimate pension obligations.
  
  

• Involves discount rates, expected return on plan assets, and employee turnover rates.

2️⃣ Key Pension Accounting Terms

🔹 Projected Benefit Obligation (PBO): The present value of expected future pension payments based on salaries and service.
🔹 Plan Assets: Investments set aside to pay future pension benefits.
🔹 Funded Status: Difference between Plan Assets and PBO.
🔹 Service Cost: Additional pension benefits earned by employees during the year.
🔹 Interest Cost: Growth in pension obligations due to the passage of time.
🔹 Actuarial Gains/Losses: Changes in pension estimates due to assumptions (e.g., discount rates, life expectancy).

Pension Funded Status:

Overfunded: Plan assets exceed obligations → Recorded as a pension asset.

Underfunded: Plan assets less than obligations → Recorded as a liability.

3️⃣ Accounting for Defined Benefit Plans

A. Recording Pension Expense (Income Statement Impact)

Pension expense includes:
1️⃣ Service Cost → Increase in pension liability due to employees working another year.
2️⃣ Interest Cost → Increase in pension liability over time.
3️⃣ Expected Return on Plan Assets → Earnings from pension investments (reduces expense).
4️⃣ Actuarial Gains/Losses → Changes in estimates (recorded in Other Comprehensive Income).

B. Journal Entry for Pension Expense

Assume total pension expense for the year is $200,000:

Pension Expense                 $200,000  

      Pension Liability                     $200,000  

If the company makes a pension contribution of $150,000: 

Pension Liability                 $150,000  

      Cash                                   $150,000  

If plan assets earn more than expected, an actuarial gain is recorded in OCI (Other Comprehensive Income). 

4️⃣ Post-Retirement Benefits (Healthcare & Other Benefits)

🔸 Besides pensions, companies may offer healthcare, life insurance, or other post-employment benefits.
🔸 These are accounted for similarly to pension obligations under ASC 715 (GAAP) and IAS 19 (IFRS).
🔸 Companies estimate future costs based on medical inflation, employee demographics, and discount rates.

Example journal entry for healthcare benefits liability:

Post-Retirement Benefit Expense      $50,000  

      Post-Retirement Liability               $50,000  

5️⃣ Impact on Financial Statements

✔ Balance Sheet:

• Pension obligations appear as liabilities or assets based on funded status.
  ✔ Income Statement:
  
  

• Pension expense reduces net income.
  ✔ Cash Flow Statement:
  
  

• Employer contributions reduce cash flow from operating activities.

6️⃣ Real-World Examples of Pension Liabilities

🔹 General Electric (GE): Faced billions in underfunded pension liabilities.
🔹 IBM: Shifted from defined benefit to defined contribution plans to reduce long-term risks.
🔹 Ford & GM: Had pension shortfalls requiring large cash contributions.

7️⃣ Key Takeaways

✅ Defined Contribution Plans (401k) → Simple, no future liability.
✅ Defined Benefit Plans → Complex, long-term employer obligation.
✅ Pension liabilities depend on actuarial estimates and investment performance.
✅ Companies with large pension shortfalls face financial risk.
✅ Post-retirement healthcare benefits are additional liabilities.