Employee Benefit Plans

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Employee Benefit Plans

• CHAPTER 18

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Postretirement Benefit Plan

• Encompass all types of retiree health and welfare
  benefits including . . .
• Medical coverage,
• Dental coverage,
• Life insurance,
• Group legal services, and
• Other benefits.

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Postretirement Health Benefits and Pension
Benefits Compared

• Pension Plan Benefits
• Usually based on years of service.
• Identical payments for same years of service.
• Cost of plan usually paid by employer.
• Vesting usually required.

• Postretirement Health Benefits
• Typically unrelated to service.
• Payments vary depending on medical needs.
• Company and retiree share the costs.
• True vesting does not exist.

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Determining the Net Cost of Benefits
Estimated medical costs in each year of retirement
Retiree share of cost
Medicare payments
Less
Estimated net cost of benefits
Equals
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Determining the Net Cost of Benefits

• Estimating postretirement health care benefits
  is like estimating pension benefits, but there
  are some additional assumptions required
• Current cost of providing health care benefits
  (per capita claims cost).
• Demographic characteristics of participants.
• Benefits provided by Medicare.
• Expected health care cost trend rate.

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Postretirement Benefit Obligation
Expected (EPBO) The actuarys estimate of the
total postretirement benefits (at their
discounted present value) expected to be received
by plan participants.
Accumulated (APBO) The portion of the EPBO
attributed to employee service to date.
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Measuring the Obligation

• On December 31, our actuary estimates that the
  present value of the EPBO for Pat Wilsons
  postretirement health care costs is 10,250.
• Pat has worked for the company for six years and
  is expected to have 30 years of service at
  retirement.
• The discount rate used by the actuary is 6.
• Lets calculate the APBO.

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Measuring the Obligation
Fraction attributed to service to date


EPBO
APBO
The is the APBO at the beginning of the year.
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Measuring the Obligation
Now, lets calculate the APBO at the end of the
year. We will start by determining the ending
EPBO.
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Measuring the Obligation
EPBO Beginning of Year
EPBO End of Year


(1 Discount Rate)
10,250 1.06 10,865
APBO End of Year
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Measuring the Obligation

• APBO may also be calculated like this

The APBO increases because of interest and the
service fraction (service cost).
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Attribution

• The process of assigning the cost of benefits to
  the years during which those benefits are assumed
  to be earned by employees.

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Postretirement Benefit Expense
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Postretirement Benefit Expense
Interest accrues on the APBO as time passes. APBO
at the beginning of the year times the assumed
discount rate equals the interest cost.
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Postretirement Benefit Expense
Unlike pension plans, many postretirement benefit
plans are not funded currently. For funded
plans, the earnings on plan assets reduce
postretirement benefit expense.
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Postretirement Benefit Expense
Delayed recognition of prior service cost is
attributed to the service of active
employees from the date of the amendment to the
full eligibility date, not the expected
retirement date.
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Postretirement Benefit Expense
The amount subject to amortization is the
net gain or loss at the beginning of the year in
excess of 10 of the APBO or 10 of the plan
assets. The excess is amortized over the
average remaining service period of active
employees.
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Amortization of Deferred Net Losses or Net Gains
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Postretirement Benefit Expense
Amortization of the transition amount is part
of expense in the current period. For financial
reporting, the amortization reduces current
earnings. For income tax purposes, income is
reduced when actual payments are made. This
creates a temporary difference between financial
and tax income.
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Amortization of the Transition Obligation

• An employer may choose to recognize
• The entire transition obligation immediately,
  or
• Amortize the transition obligation on a
  straight-line basis over the plan participants
  future service periods (or 20 years if that is
  longer).

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Determining the Expense

• Lets return to our example of Pat Wilson and
  calculate the postretirement benefit expense.
  Recall these amounts . . .

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Determining the Expense
The beginning APBO (2,050) is the initial
transition liability. Because Pat Wilson has a
service life of 24 years (30 - 6), the
amortization amount is 85 (2,050 24 years
85 rounded).
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Determining the Expense
Because most postretirement health plans are not
funded, there are no fund assets, no credit for
prior service, and no net loss.
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Required Disclosures

• Changes in the APBO.
• Changes in the plan assets (if any).
• Net periodic postretirement benefit expense and
  its components.
• Reconciliation of the funded status of the plan
  with amounts reported in the balance.
• Weighted average discount rate, rate of
  compensation, and the expected long-term rate of
  return used to measure the postretirement benefit
  obligation.

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Required Disclosures

• For retiree health benefit plans, disclose . . .
• Assumed health-care cost trend rate used to
  measure benefit costs.
• The effect of a 1 increase in the health-care
  cost trend rate.

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Preretirement Compensation Plans
Now lets look at some incentive compensation
plans.
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Preretirement Compensation Plans

• Employee compensation plans frequently include
  stock-based awards such as . . .
• Stock award plans,
• Stock options, or
• Stock appreciation rights (SARs)--cash payments
  tied to the market price of shares.

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Stock Award Plans

• Restricted stock award plans usually are tied to
  continued employment of the person receiving the
  award.
• Recognize compensation expense over the service
  period for which participants receive the shares.

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Stock Award PlansExample

• On January 1, 2001, Vidtel Co. awarded 10,000
  shares of its 2 par value common stock to a key
  executive.
• The shares will be forfeited if the executive
  leaves within the next five years.
• On January 1, Vidtels common stock is selling
  for 62 per share

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Stock Award PlansExample

• No entry is required on January 1, 2001, but
  total compensation is calculated as follows

Number of shares issuable
Fair value per share
Total Compensation


10,000


62.00
620,000
Compensation expense is measured on the date of
grant. Subsequent changes in the market price of
the stock do not impact compensation.
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Stock Award PlansExample

• The total compensation of 620,000 will be
  recognized over the service period of 5
  years.On December 31, 2001, through 2005, we
  will prepare the following journal entry

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Stock Award PlansExample

• On December 31, 2005, the shares will be issued
  to the executive, and the following entry will be
  made

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Stock Award PlansExample

• If the executive leaves Vidtel before December
  31, 2005, previous entries will be reversed.
• Assume our executive quits on April 4, 2003. The
  following entry would be made

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Stock Option Plans

• In most cases, employees are not awarded shares
  of stock. Rather they are given an option to buy
  shares at some time in the future.
• Options are usually granted
• for a specified number of shares,
• at a specified price,
• during a specified period of time.

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Stock Option Plans

• We estimate total compensation on the date of
  grant of the options.

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Stock Option PlansExample

• On January 1, 2001, Vidtel Co. grants options to
  four key executives.
• Each executive may purchase 1,000 shares of the
  companys 2 par common stock for 57 per share
  within the next five years, but not before
  December 31, 2003 (vesting date).
• The market price of Vidtels stock on January 1,
  2001, was 62 per share.

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Stock Option PlansExample

• Total compensation is measured on
• January 1, 2001

Compensation per share

62 - 57 5 per share
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Stock Option PlansExample

• Vidtel will recognize 4,000 (20,000 5) of
  compensation expense in each of the next five
  years.

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Stock Option PlansExample

• On December 31, 2005, all the options are
  exercised when the price of the stock is 92 per
  share.

4,000 shares 57 per share 228,000 cash
received
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Stock Option PlansExample

• If no options were exercised and all expired on
  December 31, 2005, the following entry should be
  made

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Stock Option Plans and Taxes

• For incentive plans . . .
• The recipient pays no tax at the time of the
  grant or when the options are exercised.
• Tax is paid on the difference between the market
  price and exercise price on the date of
  subsequent sale.

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Stock Option Plans

• One problem with stock option plans is that the
  employee must pay cash to exercise the options.
  In our example the four managers must raise
  228,000 in cash to exercise the options.

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Stock Appreciation Rights (SARs)

• The recipient is awarded the share appreciation
  which is the amount by which the market price on
  the exercise date exceeds the option price.

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Stock Appreciation Rights (SARs)

• SARs Payable in Shares (Equity)
• The fair value of the SARs is estimated at the
  date of grant and accrued to expense over the
  service period.
• Alternatively, the compensation may be measured
  at the end of the accounting period.

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Stock Appreciation Rights (SARs)

• SARs Payable in Cash (Liability)
• The amount of compensation, and related
  liability, is estimated each period and
  continually adjusted to reflect changes in the
  market price of stock until the compensation is
  finally paid.

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Stock Appreciation Rights (SARs)

• On January 1, 2000, Vidtel Co. granted 1,500 SARs
  to each of 3 key executives.
• Each is to receive cash for the difference
  between the exercise price (60 per share) and
  the market value of the stock on December 31 for
  each of the next 4 years.
• The first payment will be made on December 31,
  2001, for the year ended December 31, 2000.

Lets see how to account for these SARs.
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Stock Appreciation Rights (SARs)

• On December 31, 2000, Vidtel stock closed at 63
  per share.

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Stock Appreciation Rights (SARs)

• On December 31, 2000, Vidtel stock closed at 63
  per share.

13,500 4 years 3,375 Payable on
12/31/01.
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Stock Appreciation Rights (SARs)

• On December 31, 2001, Vidtel stock closed at 70
  per share.

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Stock Appreciation Rights (SARs)

• On December 31, 2001, Vidtel stock closed at 70
  per share.

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Stock Appreciation Rights (SARs)

• On December 31, 2001, Vidtel pays the SARs
  accrued at the end of 2000.

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Broad-Based (Noncompensatory) Plans

• Broad-based plans offer stock options to all
  employees rather than a select few.
• These plans do not involve compensation if . . .
• All employee meeting employment qualifications
  participate.
• Equal offers of stock to all eligible employees.
• Exercise period is reasonable.
• Only modest discount from the market price is
  available.

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Vacations, Sick Days, and Other Paid Future
Absences

• Future paid absences should be accrued when
• The obligation is related to employee services
  already performed,
• The benefit vests (is not contingent on future
  employment) or accumulates (can be carried
  forward to the next year),
• Payment is probable, and
• The amount can be reasonably estimated.

Sick Pay
Vacation
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Employee Stock Ownership Plans (ESOPs)

• The sponsoring company contributes to the ESOP
  shares of stock, or cash which is used to
  purchase the companys stock.
• Employees have an ownership interest in the
  stock, but actually receive compensation when
  they leave the company and sell their shares.

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End of Chapter 18