Post-Employment Benefits - Assignment Example

POST EMPLOYMENT BENIFITS Assumptions and Explanation: As the company is in financial trouble and in the process of internal-reorganization, usually in such a situation all the claimants (Creditors, share holders, debenture holders, employees, etc.) give up a part of their claim so that the company is in a better position to function properly and does not come down to a state of liquidation. i.e. they give up a part of their claim so as the reduce the company's liabilities. In the given scenario, we are to focus on the contribution made by the employees by giving up a part of their claim towards retirement (post employment) benefits which were to be provided by the company. They do so by letting the company switch over from its existing 'defined benefits plan' to a 'defined contribution plan' to save costs. Since the agreement is that the employees get to keep 'what is already in the defined benefit plan', we comprehend that: 1. Employees get to keep what ever has been accumulated in the 'Plan Assets'. 2. Employees give up their claim on what ever is 'excess' Projected Benefits Obligations, for which the company has not been able to provide any Plan Assets. 3. The employees give up their claim on every other liability, like whatever is pending towards Unrecognized Prior service costs, what ever would be this years service cost, interest burden on what ever is pending towards 'Projected Benefits Obligation', etc. 4. Employees get to keep what ever returns accumulate on the 'Plan Assets'. 5. Employer will contribute 3% of the payroll towards the 'retirement fund' or the 'plan assets' hence forth regardless of whatever has been accumulated in the fund, whether it is sufficient, insufficient or in excess. 6. AND hence forth, since the company moves on with a 'defined contribution plan', employer doesn't have any more liability other than payment of his annual contribution towards the fund and what ever post employment benefits are to be derived would be out of the balance in the 'fund' kept aside for that purpose. While computing the cost associated with keeping the current plan versus the cost of a defined contribution plan (where the employer pays 3% of payroll), we notice the following things: 1. Vital information regarding the amount accumulated in the 'Plan Assets' has not been provided. 2. We have been provided with what would be "amortized" this year (2007) towards Unrecognized Prior Service Costs, but we have not been provided with what is the actual amount pending towards UPSC. 3. We have been told that the employer's contribution would be 3% of payroll. But we do not know as to what are the company's expenses on salaries and wages. 4. We have no information regarding the number of employees involved in the scheme, their retirement dates, etc. All this information can influence the answer. So, where ever required, we have made suitable assumptions relating the above missing information. Answer 1: From the given information, if the company decides to go on with its existing (DBP) post employment benefits plan, from the information available, we can draw up an approximate pension worksheet, as follows: Items General Journal Entries Memo Record Annual Pension Expense Cash (Prepaid) / Accrued Cost Projected Benefit Obligation Plan Assets Unrecognized Prior Service Cost Balance, Dec. 31, 2006 810,000 Cr 340,000Dr (a) Unrecognized Prior Service Cost Balance, Jan. 1, 2007 --- (810,000+) Cr 340,000 Dr (b) Service Cost 88,000 Dr 88,000Cr (c) Interest Cost 81,000 Dr 81,000 Cr (d) Actual Return 34,000 Cr 34,000 Dr (e) Amortization of UPSC 21,000 Dr 21,000 Cr (f) Contributions X Cr X Dr Journal Entry for 2007 156,000 Dr X Cr (156,000 - X) Cr Balance, Dec. 31, 2007 0 (374,000 + X) Dr Note: In the above table, 1. Interest / Discount / Settlement Rate = 10% 2. Opening and closing balance of Unrecognized Prior Service Cost is unknown. (Shown as '') 3. Since the amount contributed by the employer cannot be determined (since the payroll figure is not known), we have denoted it to be 'X'. We have calculated the Plan Assets to be $340,000 because: 1. The figure was not given to us. 2. We assume that since the 'expected returns' were $34,000, which were at the rate of 10% p.a., the opening balance of the Plan Assets must be $340,000. While calculating the Interest Cost, we have excluded the portion of interest accrued on the opening balance of UPSC. There are two reasons for doing this: 1. The figure cannot be determined from the given data. 2. We assume that the employees must have sacrificed that portion. So, regardless of whatever might be the employer's contribution towards post employment fund (Plan Assets), his annual pension expense, as calculated above, would be $156,000 for the year 2007. While, if the employer decides to switch over to a 'defined contribution plan' where the employer pays 3% of payroll as his contribution, the agreement being that the employees get to keep what is already in the defined benefit plan (Plan Assets only), we can draw up an approximate pension worksheet as follows: Items General Journal Entries Memo Record Annual Pension Expense Cash (Prepaid) / Accrued Cost Projected Benefit Obligation Plan Assets Unrecognized Prior Service Cost Balance, Dec. 31, 2006 340,000 340,000 (a) Unrecognized Prior Service Cost 0 0 Balance, Jan. 1, 2007 --- 340,000 Cr 340,000 Dr 0 (b) Service Cost X Dr X (c) Interest Cost 34000 Dr 34000 Cr (d) Actual Return 34000 Cr 34000 Dr (e) Amortization of UPSC 0 0 (f) Contributions X Cr X Journal Entry for 2007 X Dr X Cr 0 Balance, Dec. 31, 2007 0 (374,000 + X) Cr (374,000 + X) Dr 0 Note: In the above table, 1. The employees get to keep only whatever is balance in the 'Plan Assets' or the post employment fund. 2. The company doesn't re-capture anything from the 'Plan Assets' and keeps it as it is for the employees. 3. Employees give up their claim on whatever amounts were due to the fund earlier, i.e. excessive Projected Benefit Obligation as well as Unrecognized Prior Service Cost. 4. Since they give up their claim on the UPSC, it need not be amortized and added to the cost or annual pension expenditure. 5. The only obligation the company has is to pay 3% of the payroll amount, which we have denoted by 'X', towards the fund. Answer 2 Projected employment benefit expenses for the year 2007 would be as follows: Our Company Year 2007 2007 Method / Policy adopted (DBP) $ (DCP) $ Components of the Net Pension Expense (a) Service Cost 88,000 X (b) Interest Cost 81,000 34,000 (c) Actual Return -34,000 -34,000 (d) Amortization of UPSC 21,000 0 Net Periodic Pension Expense 156,000 X In addition to this net expense, there is also a change in the obligation towards pending projected benefits and unrecognized prior service costs, which is due to the agreement between the employees and the company. This change is clear from the worksheets we have shown above. Conclusion and Comparison: After looking at both the scenarios, what we can see is that if the company continues with its existing DBP policy, it has to face the following liabilities: 1. Unrecognized Prior Service Costs (which are unknown) 2. Amount pending (falling short) towards projected benefits obligation. 3. Interests which keep accruing on these amounts every year. 4. Last but not the least, SERVICE COST, which would not exactly be predictable each year, making the liability undeterminable. Since the company is in the situation of internal re-organization, it would make sense for it to reduce the liabilities in its balance sheet to as low as possible. By going ahead with a new DCP policy, the company can reduce the above mentioned liabilities to their lowest agreed values. The only situation in which it would be better to stick to DBP rather than go ahead with DCP would be: 1. If the company's contribution (3% of payroll) denoted by 'X' would be greater than $156,000 (Liability as per DBP). 2. AND the company is in no hurry to remove these liabilities off its balance sheet. Which seem to be pretty unlikely looking at the company's balance sheet. Read More