Reporting post-employment benefits can be complex for companies.
This article explains key concepts and provides examples to simplify accounting for pensions, retiree health insurance, severance, and other post-employment benefits.
You'll learn definitions, accounting framework, treatments for defined benefit pensions, retiree health insurance, severance pay, and more. Clear guidance and examples make this post-employment benefits accounting primer easy to follow.
Introduction to Post-Employment Benefits
This section provides an overview of key aspects related to post-employment benefits.
Defining Post-Employment Benefits
Post-employment benefits refer to various forms of compensation provided to employees after their employment ends. Common types of post-employment benefits include:
- Pensions: Employer-sponsored retirement plans that provide monthly payments to retired employees. These can be either defined benefit plans or defined contribution plans.
- Retiree health insurance: Health insurance coverage provided to former employees after they retire. This is usually subsidized by the former employer.
- Severance pay: Lump-sum payment made to employees upon termination of employment, usually based on years of service and salary level.
- Deferred compensation: Non-qualified retirement plans allowing executives to set aside money on a pre-tax basis.
Types of Post-Employment Benefits
The main categories of post-employment benefits are:
- Defined benefit pension plans: Employer promises a specified monthly benefit at retirement based on salary history and years of service.
- Defined contribution pension plans: Employer and employee contributions are defined, but the ultimate retirement benefit depends on investment performance. Common examples are 401(k) and 403(b) plans in the US.
- Retiree health insurance: Group health insurance for retirees, often subsidized by the former employer. Coverage levels and premium subsidies can vary significantly.
- Severance pay: Payment to employees upon dismissal or resignation, calculated based on salary, years of service, and circumstances of departure.
- Deferred compensation: Allows executives to set aside money on a pre-tax basis, to be paid out at a later date, usually after retirement.
Exploring the Meaning of Post-Employment Benefits
Post-employment benefits serve several important purposes:
- Retirement security: Pensions and other savings arrangements help ensure former employees can maintain their standard of living after ending their careers.
- Health insurance: Retiree health coverage protects older individuals from potentially catastrophic medical costs after losing employer-based health insurance.
- Transition assistance: Severance pay provides a temporary financial bridge for displaced workers.
- Recruitment and retention: By offering post-employment benefits, employers can attract and retain top talent who value retirement and health security.
Post-Employment Benefits Accounting Framework
In the US, the Financial Accounting Standards Board (FASB) provides guidance on accounting for post-employment benefits under Accounting Standards Codification (ASC) 715 and ASC 712. Internationally, International Accounting Standard (IAS) 19 covers post-employment benefit accounting.
Key areas addressed include measuring defined benefit plan obligations, accounting for plan assets, reporting the funded status, and recognizing the costs of providing post-employment benefits.
What are the postemployment benefits other than pensions?
OPEB stands for Other Postemployment Benefits and refers to benefits earned by employees during their employment, but received after their employment has ended. Some common examples of OPEB include:
- Post-employment healthcare benefits such as medical, dental, vision, hearing, etc., whether provided through a pension plan or separately
- Other benefits such as death benefits, life insurance, disability, long-term care, etc., when provided separately from a pension plan
So in essence, OPEB encompasses various non-pension benefits that employees may be entitled to after their employment.
When it comes to accounting for OPEB, companies are required to estimate and record the future costs of these benefits during the years the employee provides service. This ensures that the full compensation costs are reflected in the company's financial statements.
The two most common types of OPEB are:
- Retiree health benefits: These include health insurance and other healthcare related benefits provided to eligible retirees, such as dental, vision, prescription drugs etc. Companies may pay part or all of the cost of coverage.
- Retiree life insurance: Companies may provide basic and supplemental life insurance for retirees. They pay a portion or all of the premiums.
Accounting for retiree benefits can be complex as it requires making assumptions about elements such as the discount rate, healthcare cost trend rates, rate of retirement, life expectancy, etc. Companies need to periodically review these assumptions to ensure proper liability and expense recognition. Proper OPEB accounting leads to more transparent financial reporting.
What are postretirement benefits other than pensions?
Other post-retirement benefits are non-pension benefits provided to employees after they retire, such as life insurance, medical insurance, and deferred compensation arrangements.
These benefits represent future obligations that a company must account for. Under US GAAP accounting standards, companies must recognize the liability and related expense for postretirement benefits over the employees' years of service, rather than waiting until the benefits are paid out.
For example, if a company provides retiree health insurance, it must estimate and accrue the expected costs over the working lives of employees. This ensures that the future obligations are captured on the balance sheet rather than only recognizing costs as premiums are paid each year during retirement.
The accounting aims to match the costs of postretirement benefits to the periods during which the employees provide service, rather than skewing expenses toward the retirement years. This leads to more accurate financial reporting over the long term.
What other postemployment benefits may include?
Other post-employment benefits (OPEBs) can include a variety of non-pension benefits provided to employees after their employment ends. Some common examples include:
- Health insurance - Employers may allow retired employees to remain on the company health plan. This is a common OPEB as retirees can face high insurance costs after leaving their job.
- Life insurance - Some companies provide retirees with a basic life insurance policy. This gives them continued coverage and protects their loved ones financially.
- Deferred compensation - This allows employees to save money from their paycheck, invested on their behalf by the company. The funds are given to the employee upon retirement.
So in summary, OPEBs encompass any non-pension benefits that employees can continue receiving after their employment ends. This most often includes health insurance, life insurance, and deferred compensation savings plans. Offering such benefits can be an attractive incentive for recruitment and retention. But accounting for them can also create complex liabilities on a company's financial statements.
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What is the accounting treatment for severance pay?
Regarding accounting, severance pay is treated as a liability until it has been paid out. When an employer offers severance pay to employees, the obligation must be recorded as a liability on the balance sheet.
Here are some key points on the accounting treatment for severance pay:
- Severance pay is considered a form of post-employment benefit, similar to pensions. It represents a future obligation that the company will need to pay out to qualifying employees.
- Under accounting standards like GAAP and IFRS, severance pay liabilities need to be accrued over the period that employees render their services. The liability is estimated based on actuarial valuations.
- The accrued severance pay liability is recorded in non-current liabilities on the balance sheet. The expense is recorded in the income statement, usually under a line item such as "general and administrative expenses".
- When severance payments are actually made, the payouts reduce the severance pay liability on the balance sheet. There is no additional expense recorded at the time of payment.
- Severance liabilities need to be tracked carefully, especially when there are changes in headcount, average salaries, average years of service, discount rates, and other actuarial assumptions. The liability needs to be remeasured periodically.
So in summary, severance pay accounting centers around accruing estimated liabilities over time, tracking any changes, recording expenses as accruals build up, and reducing liabilities when severance is paid out. Proper measurement and disclosure provides transparency into this post-employment obligation.
Accounting for Defined Benefit Pension Plans
Defined benefit pension plans provide employees with retirement income based on factors like years of service and compensation. Proper accounting for these plans is essential.
Measuring Pension Assets and Obligations
On an annual basis, companies must:
- Work with actuaries to calculate the present value of future pension obligations using actuarial assumptions about mortality, turnover, compensation increases, and discount rates
- Determine the fair value of any pension plan assets set aside to fund these obligations
By comparing pension obligations to assets, companies ascertain the overall funded status of pension plans.
Recognizing Annual Pension Costs
Key pension costs recognized annually include:
- Service cost: Present value of new benefits earned by employees in the current year
- Interest cost: Interest accrued on beginning-of-year pension obligations
- Actual return on assets: Difference between expected and actual asset returns
These costs impact annual pension expense recorded in the income statement.
Recording Pension Liabilities and Assets
- Pension obligations are recorded as liabilities on the balance sheet
- Prepaid pension assets are also recorded for any overfunded status
- Net difference between assets and obligations equals the net pension liability/asset
Changes in these balances flow through comprehensive income based on actuarial updates.
Disclosure Requirements
Companies must provide extensive disclosures on defined benefit plans including:
- Reconciliation of beginning and ending pension obligations and assets
- Key actuarial assumptions used to measure obligations
- Actual asset allocation percentages
- Expected future benefit payments to be made
These details provide transparency into the financial impact of pension plans.
Defined Benefit Pension Plan Example
As an example, Company A has the following details related to its defined benefit pension plan:
- Beginning pension obligation: $2 million
- Service cost: $100,000
- Interest cost: $150,000 (based on obligation and discount rate)
- Benefits paid: $80,000
- Actuarial loss: $200,000
- Actual return on assets: $250,000
Based on these details, Company A would record a pension expense of $250,000 on the income statement. The ending net pension liability would equal the ending obligation of $2.37 million less the fair value of assets. Required disclosures would include these reconciliation details and more.
Accounting for Other Post-Employment Benefits
This section explains accounting for common post-employment benefits like health insurance, severance pay, and deferred compensation arrangements.
Retiree Health Insurance
Companies may provide health insurance coverage to eligible retirees. Under ASC 715, companies must account for and disclose these liabilities based on actuarial estimates of the present value of future costs. Key estimates include health care cost trends, mortality rates, early retirement rates, and discount rates. Companies accrue for the liability over employees' working lives.
Accounting for Severance Pay
Under ASC 712, companies estimate and accrue severance liabilities over the service periods of employees. As PwC notes, the estimate should be based on a standardized severance benefit formula applied to different employee groups. The accrual should be adjusted as new events occur, such as significant layoffs.
Deferred Compensation Plans
Some companies offer nonqualified deferred compensation plans allowing executives to defer salary or bonuses. The company incurs a liability to pay the compensation in the future. Under ASC 710, the liability is measured at the deferred amount plus or minus any investment returns. The entries involve debits to deferred compensation expense and credits to the deferred compensation liability as amounts are earned/deferred.
Other Long-Term Employee Benefits
ASC 710 also covers accounting for other long-term employee benefits like long-service leave, sabbatical leave, jubilee benefits, deferred profit-sharing, and long-term disability. Companies estimate and accrue the liability over the service lives of employees expected to receive the benefits using actuarial techniques similar to pensions.
Examples of Other Post-Employment Benefits Accounting
- Company A provides retiree health benefits to employees who retire after age 60 with 10+ years of service. Actuaries estimate the present value of future costs at $5 million. Company A would record a $5 million liability on its balance sheet and accrue the costs over the working lives of eligible employees.
- Company B has a severance policy to pay 1 week of salary per year of service for laid off employees. With an average salary of $50k and average service of 5 years, Company B would accrue a $12.5 million liability for its 250 eligible employees.
- Company C let its CEO defer $500k of salary to be paid 5 years later. With a 4% annual investment return, Company C would record $653k as its deferred compensation liability after 5 years ($500k salary deferral plus 4% annual investment gains).
Other Considerations in Post-Employment Benefits Accounting
This section covers additional aspects related to accounting for post-employment benefits, including plan amendments, settlements, terminations, and more.
Plan Amendments
When a company amends its post-employment benefit plan, it can impact the measurement and recognition of related obligations. For example, if a plan amendment improves benefits, this generally increases the plan's defined benefit obligation. The amendment would be accounted for as past service costs. Companies need to evaluate the timing and recognition of these costs based on whether benefits have already vested.
Overall, the key is for companies to understand how a plan amendment affects the timing of recognition, measurement of obligations, and impact on net periodic benefit costs. Getting the accounting treatment right is critical.
Settlements and Curtailments
Sometimes a company will settle or curtail post-employment benefit obligations before they reach maturity. Common examples include offering lump-sum payouts to eligible employees or closing a business unit that has an associated benefit plan.
Settlements and curtailments can significantly reduce a company's defined benefit obligation. However, complex accounting is involved. Companies must carefully follow standards around recognizing settlement and curtailment gains/losses. It's also key to understand timing impacts - i.e. when gains/losses should be reported.
Plan Terminations
Occasionally, companies terminate post-employment benefit plans completely. This could occur with traditional pension plans or certain health/life insurance plans.
Terminating a plan has major accounting implications. The company must re-measure plan assets and obligations at termination, reconciling the funded status. This determines the ultimate termination benefit obligation. Complex tax/regulatory factors are also involved.
Overall, companies must have robust processes to handle all accounting, reporting and disclosure requirements when terminating a post-employment benefit plan.
Impact of Regulatory Changes
Ongoing changes in accounting standards and regulations can impact the accounting for post-employment benefits. For example, moves towards mark-to-market pension accounting, changes in discount rate guidance, or revised mortality table assumptions all affect liability measurement.
As such, companies must continually monitor emerging regulations. Understanding the impact of any changes will allow a company to proactively adapt its accounting policies as needed. Advanced planning can help minimize disruption.
Conclusion and Key Takeaways
In summary, accounting for various post-employment benefits involves actuarial estimates of future obligations, accruals over service periods, and specific disclosure requirements. Proper measurement and recognition is key for accurate financial reporting.
Summary of Accounting Treatments
Here is a recap of some of the key points related to accounting for pensions and other post-employment benefits:
- Pensions and other post-employment benefits are accounted for using actuarial valuations to estimate future obligations. These estimates rely on assumptions about mortality rates, discount rates, salary increases, and more.
- Pension costs are accrued over the service lives of employees to match expenses to the periods in which they are earned.
- Gains and losses can occur which must be recognized appropriately, either immediately or amortized over future periods.
- Specific disclosures are required surrounding the assumptions used in valuations as well as reconciliations of beginning and ending balances.
- Accounting for severance benefits also relies on actuarial estimates of expected future payments which are accrued over service periods.
Properly accounting for post-employment benefits requires sound actuarial estimates and processes for updating assumptions to reflect the most recent expectations.
Best Practices in Post-Employment Benefits Accounting
Some best practices in accounting for pensions and other post-employment benefits include:
- Review all assumptions used in actuarial valuations regularly and adjust promptly for significant changes.
- Disclose all key assumptions used as well as sensitivities to changes in assumptions.
- Recognize gains/losses appropriately every year using deferral accounts or immediate recognition.
- Ensure proper oversight and governance over post-retirement benefit programs.
- Provide clear, transparent disclosures surrounding post-employment benefit obligations.
Following guidance from accounting standards, regulators, and best practices will lead to accurate financial statements with respect to post-employment benefit obligations.
