Sreoshi Sarkar, Nitika Goendi, Saurabh Kumar Deloitte Consulting
2 nd TechTalk on Employee Benefits-
ACTUARIAL VALUATIONS UNDER US- GAAP
October 31, 2020
1700 - 1830 IST
Polling Question 1
How would you rate your knowledge on pension valuations under US GAAP?
1. US GAAP ….sorry, what is that?
2. I have some fundamental knowledge 3. I am at an intermediate level
4. I consider myself an expert
What to Expect
Topic Slide No.
Employee Defined Benefit landscape in US 5
Relevant Codifications 7
Basics of Accounting Valuation 9-15
- Pension Expense - Pension Disclosure
US GAAP vs IND AS 19/IAS19 17-19
Special Accounting 21-29
Employee Defined Benefit landscape in US
Employee Defined Benefit Landscape in US
Defined Benefit (DB) Pension Plans:
A defined benefit plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service
Defined Benefit Pension:
• Flat Dollar Plan – Set dollar amount for each year you work for the employer
• Final Average Pay Plan – Benefit is calculated using average earnings leading up to retirement
• Career Average Pay Plan– Benefit is calculated based on average earnings during the entire period you were a member of the plan
• Cash Balance Plan – Participants receive a set percentage of their yearly compensation plus interest charges until retirement, which they can convert into an annuity at retirement or take a lump sum
Post Retirement Medical and Life Insurance Plans:
These are other than pension benefits which retirees receive post employment
Supplemental Executive Retirement Plan (SERP):
SERP is a set of benefits that is available to top-level employees in addition to those covered in the company's
Relevant Codifications
Relevant Codifications
ASC 715 Compensation — Retirement Benefits
• 715-10 Overall:
– ASC 715-10 discusses the overall scope of ASC 715 and the other Subtopics within ASC 715
• 715-20 Defined Benefit Plans—General:
– ASC 715-20 notes that it “provides guidance on the disclosure and other accounting and reporting requirements related to single-employer DB pension and other postretirement benefit plans
• 715-30 Defined Benefit Plans—Defined Benefit Pension:
– This Subtopic focuses on an employer’s accounting for a single-employer DB pension plan.
• 715-60 Defined Benefit Plans—Other Postretirement:
– A postretirement benefit is part of the compensation paid to an employee for services rendered.
• 715-70 Defined Contribution plans
• 715-80 Multiemployer Plans
ASC710 - Deferred Compensation Contracts
ASC 712 Compensation — Nonretirement Postemployment Benefits (Severance or other one-time
Basics of Accounting Valuation
Balance Sheet and Income Statement
The Balance Sheet (sometimes referred to as the Statement of Financial Position) reports the Assets, Liabilities and Stockholder’s Equity of a company as of a specific date.
• Balance Sheet Equation: Assets = Liabilities + Stockholder’s Equity
• Funded Status of the plan (Assets – PBO) and AOCI (Accumulated Other Comprehensive Income) are Balance Sheet Items
The Income Statement (sometimes referred to as the Statement of Profit and Loss) measures a company’s financial performance over a specific period of time.
• The values in the Income Statement will be applied to the Balance Sheet items at the beginning of the period to arrive at the Balance Sheet items at the end of the period.
• Expense is an Income Statement Item
What is the Pension “Expense”?
(1) Service Cost (SC) (2) Interest Cost (IC)
(3) Expected Return on Assets (EROA) (4) Amortization of Transition (Asset) /
Obligation
(5) Amortization of Prior Service Cost / (Credit) (6) Amortization of Unrecognized (Gain) / Loss
Net Periodic Pension Cost (NPPC)
= (1) + (2) – (3) +(4) + (5) +(6)
Net Periodic Pension Cost -
The annual amount of expense or income an employer must recognize on the income statement to reflect the “cost” of the pension plan(s)“Components” of Net Periodic Pension Cost:
Polling Question 2
A frozen DB pension plan (no future accruals) has 10 actives and 100 retiree
participants/annuitants in payment. What should be the amortization period for recognition of unrecognized (gain) / Loss?
1. Average Expected Future Service for 10 active participants 2. Average Life Expectancy for 100 retiree participants
3. Average Life Expectancy for all the plan participants 4. None of the above
Amortizations of Prior Service Cost/(Credit) and (Gain)/Loss
Prior Service Cost/ (Credit)
(PSC)
Arises when there is a plan amendment that increases or decreases benefits for past service.
- The cost is generally spread by amortizing over the expected future service of active participants
- If almost all participants are inactive or no active participants, use total life expectancy
- Faster amortization methods are not permitted
(Gain) / Loss
Arises because actuarial assumptions are not borne out in practice (asset returns, salary increases, retirements)
- Full (gain)/loss is not required to be expensed each year, reduces volatility in expense - At a minimum, amortization in expense of (gain)/loss outside 10% corridor must be
expensed
- Corridor is equal to: 10% of max (PBO and Market Related Value of Assets) - Amortization period is expected future service of active participants
- If the plan is frozen, or almost all participants are inactive or no active participants, use their life expectancy
- Faster amortization methods are allowed and must remain consistent over time
Amortizations of (Gain) / Loss (Cont’d)
Numerical Example:
PBO =INR 41,550,000 MVA = INR 45,650,000
Average expected future service for active employees = 9.51 years Actuarial (Gain)/Loss subject to Amortization = INR 12,000,000
Actuarial (Gain)/Loss Subject to Amortization 1 12,000,000 Corridor (10% of Greater of PBO or MVA) 2 4,565,000 Net (Gain)/Loss in Excess of Corridor (1-2) 7,435,000
Amortization Years 3 9.51
Amortization of Net (Gain)/Loss for the Year (1-2)/3 781,809
Accumulated Other Comprehensive Income
• Amounts Recognized in Accumulated Other Comprehensive Income (AOCI)
− Net (Gain)/Loss = Prior year (gain)/loss – recognized during the year + actuarial (gain)/loss + difference between actual and expected return on assets
− Prior Service Cost / (Credit) = Prior year PSC – recognized during the year + new PSC arising during the year
− Transition (Asset)/Obligation = Prior year T(A)/O - recognized during the year
− The Total Recognized in AOCI is the sum of Net (Gain) / Loss and Unrecognized amounts
Disclosure Requirements
• Specialist’s credentials
• Amounts Recognized in Statement of Financial Position, Funded Status
• Current/non-current amounts of the benefit asset or liability
• Amounts Recognized in Accumulated Other Comprehensive Income (AOCI) / Accumulated Unrestricted Net Assets (AUNA) [for non-profit plans]
• Components of Net Periodic Pension Cost (NPPC)
• Reconciliation of Benefit Obligation including gains and losses, Reconciliation of Plan Assets
• Changes in AOCI
• Plan Assets Allocation
• Schedule of Expected Contributions & Expected Benefit Payments
• Summary of Census Data
US GAAP vs IND AS 19/IAS 19
US GAAP and IND AS 19/IAS 19 Key Differences
AREA US GAAP IND AS 19 / IAS 19
Balance Sheet
Presentation Funded status on balance sheet, G/L, prior service cost
not yet recognized in income are in OCI Balance sheet = funded status
Expense Recognition - Gain/Loss
The guidance permits deferring gains/losses through the use of the corridor approach (or any systematic method that results in faster recognition than the corridor
approach). Gains/losses are recognized within statement of P/L as components of NPPC.
Gains/losses are recognized immediately in OCI. There is no option to recognize gains/losses in profit or loss (except for other long-term benefits). In addition, the
“corridor and spreading” option—which allows delayed recognition of gains and losses—is not allowed
Expense Recognition – expected
return on plan assets
Expected return is based on an expected
rate of return on plan assets. Plan assets are measured at fair value for disclosure
purposes. However, for purposes of determining the expected return on plan assets and the related accounting for gains and losses, plan assets can be
measured by using either fair value or a calculated value
Interest income is calculated by applying the discount rate to the asset of the plan. Measurement is based on the fair value of plan assets.
US GAAP and IND AS 19/IAS 19 Key Differences
AREA US GAAP IND AS 19 / IAS 19
Expense Recognition – Prior Service Costs/Credits
Requires prior service costs to be initially recognized in OCI and then amortized through net income over future periods (expected future service to eligibility or life expectancy, as appropriate)
Requires immediate recognition in income for the effects of plan amendments that create an increase (or
decrease) to the benefit obligation
Plan Assets Can use Fair Value or Market Related Value of Assets
(which recognizes G/L over ≤ 5 years) Must use Fair Value, bid price for securities quoted in an active market
Deferred
Compensation Arrangements
Multiple attribution models are acceptable Must use projected unit credit
US GAAP and IND AS 19/IAS 19 Key Differences
AREA US GAAP IND AS 19 / IAS 19
Discount Rate The discount rate is based on the rate at which the benefit obligation could be effectively settled.
Companies may look to the rate of return on high- quality, fixed-income investments with appropriate durations (the regulators have weighed in on what constitutes high quality), no guidance where no deep markets exist.
Determined by reference to market yields at the end of the reporting period on high quality corporate bonds, or Government bond yield if no deep market (or Govt. bond yields under IND AS19).
Asset Ceiling There is no limitation on the size of the net pension asset that can be recorded on the balance sheet.
Asset ceiling (IFRIC 14) based on recoverability of surplus (an asset ceiling is the present value of economic benefits available in the form of an unconditional right to a refund or reductions in future contributions to the plan).
Special Accounting
Curtailment under US GAAP
• An event which significantly reduces the expected years of future service of present employees: – Plant closing
– Restructuring (Example: Large layoff) – Divestiture
• Example of an event which eliminates the accrual of defined benefits for future services for a significant number of active participants
– Hard freeze — an amendment to a DB plan that permanently eliminates future benefit accruals.
– Soft freeze — an amendment to a DB plan that eliminate benefits for future service, but takes into account continued salary increases
• Determining if a Curtailment Occurred under US GAAP
− An employer should apply judgment in evaluating what is significant. The determination of significance is a matter of judgment; however, in general, a decrease in expected years of future service of 10% or more
Polling Question 3
A Company’s DB pension plan has 1,000 active participants. As a part of restructuring, 150 participants were laid off. Will this event trigger a curtailment?
1. Yes 2. No
3. Cannot Say ( Need More Information )
Measuring Effects of a Curtailment Under US GAAP
If there is a curtailment:
• A portion of Unrecognized Prior Service Cost (+ Unrecognized Transition Obligation) included in Accumulated Other Comprehensive Income (AOCI) will be recognized
• The PSC included in AOCI associated with years of service no longer expected to be rendered as the result of a curtailment is a loss for Pension Plans. Recognition of a portion of unrecognized prior service cost is as follows:
• Determine the proportion of the future years of service that are eliminated
• Multiply proportion by:
• Unrecognized Prior Service Cost (UPSC)
• Unrecognized Transition Obligation (UTO) (if any)
• This result is recognized
Measuring Effects of a Curtailment Under US GAAP
• The change in PBO might be recognized.
• The PBO may be decreased (a gain) or increased (a loss) by a curtailment
• To the extent that such a gain exceeds any unrecognized net loss (or the entire gain, if an unrecognized net gain exists), it is a curtailment gain
• To the extent that such a loss exceeds any unrecognized net gain (or the entire loss, if an unrecognized net loss exists), it is a curtailment loss
Before
Curtailment Effect of
Curtailment After Curtailment
PBO -2,000 400 -1,600
FVA 1,500 0 1,500
Funded Status -500 400 -100
Unrecognised PSC 300 -30 270
Unrecognised (G)/L 350 -350 0
Total AOCI 650 -380 270
Example:
- PBO reduced by 400- 10% reduction in
future service
30
(400)-350=(50)
= (20) A net gain of 20 recognized in expense
Curtailment - US GAAP and IND AS 19/IAS 19 Differences
US GAAP IND AS 19/ IAS 19
Definition A curtailment is defined as an event that
significantly reduces the expected years of future service of present employees or eliminates for a significant number of employees the accrual of defined benefits for some or all of their future service.
A curtailment occurs when an entity significantly reduces the number of employees covered by a plan. A curtailment may arise from an isolated event, such as the closing of a plant,
discontinuance of an operation or termination or suspension of a plan
Timing of
recognition Curtailment losses are recognized when they
become probable and reasonably estimable, which may be before the announcement. Curtailment gains are recognized when employees are
terminated or amendments are adopted, which may be after the commitment.
Curtailment gains/losses are recognized at the earlier of when the curtailment occurs or when the entity recognizes the related restructuring costs or termination benefits.
Measurement Under US GAAP, such gains and losses reflect the increase or decrease in the benefit liability that exceeds the net actuarial gains or losses, in
From a measurement perspective, curtailment gains and losses under IAS 19 are based on changes in the benefit obligation, which is
Settlement Under US GAAP
A transaction that meets the following three criteria:
1. Is an irrevocable action. A transaction is irrevocable if it cannot be revoked, recalled or undone; the transaction or event is unalterable
2. Relieves employer (or plan) of primary responsibility for pension benefit obligation
3. Eliminates significant risks related to the benefit obligation and assets used to effect the settlement Examples:
• Payout of lump sums
• Purchase of annuities
Determining if a Settlement Occurred Under US GAAP
• Timing of Recognition
– A settlement will not be recognized until required assets have been transferred and the settlement is fully executed (e.g. lump sum)
• Settlement accounting is triggered if the settled amounts exceed Service Cost + Interest Cost for the year.
Measuring Effects of a Settlement Under US GAAP
Effect measured as:
• Change in Projected Benefit Obligation, Change in Plan Assets
• Recognition of proportionate amount of – Unrecognized net (gain) or loss and
– Unrecognized transition (asset) or obligation – if any
• Percent of PBO settled times [Unrecognized (gain)/loss] = Settlement (Gain) or Loss
Before Settlement Effect of Settlement After Settlement
PBO -2,000 400 -1,600
FVA 1,500 -400 1,100
Funded Status -500 0 -500
Unrecog PSC 300 0 300
Example:
Polling Question 4
Gratuity benefits of INR 3 million were paid during the fiscal year in the normal course of business. Will this trigger a settlement under US GAAP? For that fiscal year, Service cost + Interest cost = INR 2 million.
1. Yes 2. No
3. Cannot Say ( Need More Information )
Settlement - US GAAP and IND AS 19/IAS 19 Differences
US GAAP IND AS 19/ IAS 19
Definition Settlement Trigger Definition: Settlement benefit payments greater than Service Cost plus Interest Cost for the year
Only extraordinary payments are generally
considered settlements (e.g. lump sum window). If plan offers Lump Sum as a form of payment AND the actuarial assumptions include them, then it’s not considered a settlement (even if LS > SC + IC).
Measurement Settlement gain or loss is the difference between the present value of the defined benefit obligation being settled and the
settlement amount, plus a pro rata portion of previously unrecognized actuarial gains and losses
Settlement gain or loss is generally measured as the difference between the present value of the defined benefit obligation being settled and the settlement amount which is recognized in the Expense.
Key Assumptions
Key Assumptions
Economic assumptions
• Discount rate
• Long-term rate of return
• Salary increase
Demographic assumptions
• Mortality
• Turnover
• Retirement
Assumptions specific to US Pension Plans
• Cash Balance Interest Crediting Rate (applicable for cash balance plans only)
• Lump Sum Conversion (applicable where a plan allows accrued benefit payable as an annuity to be converted into a lump sum)
Assumptions specific to US Medical Plans
• Health Trend
• Per Capita Claims Costs
Discount rate
– A discount rate reflects the fiscal year-end economic conditions and the rate at which benefit obligations could be effectively settled
– The accounting literature expects that the discount rate will reflect:
• The measurement date
• Yields available on high-quality fixed income instruments
• The demographics and benefit provisions of the plan
– Different approaches taken by the Entity to support discount rates for defined benefit plans:
• Yield Curve approach
• Hypothetical Bond Portfolio (HBP)
– In general, the discount rate is expected to be determined for each plan individually, unless multiple plans have similar characteristics
– Alternative spot rate approach or Granular approach to measure the Service Cost and Interest Cost component of expense as well as the benefit obligation
• Example - The Service Cost under this method is determined by multiplying each of the projected benefit payments underlying the Service Cost by the corresponding yield curve spot rates
Expected Long-Term Rate of Return (LTRR) & Mortality
LTRR
• Should represent the average rate of earnings expected over the long term on the funds invested to provide future benefits (existing plan assets and contributions expected during the current year)
• If the target allocation of plan assets to different investment categories has changed from the prior year or is expected to change during the coming year, an entity should consider discussing with its actuaries and independent auditors whether an adjustment to its assumption about the long-term rate of return is warranted
Mortality Assumptions
• Under FASB ASC 715-30-35, the mortality assumption is expected to be based on recent tables, and to reflect the employee base covered under the plan to the extent that such plan experience is credible
• Selection of a mortality assumption generally involves a two-step process: (1) choosing an
