Hello everyone. Today I want to walk you through an exercise, an example that will take us a little bit, one further step in the pension puzzle, mainly prior service cost. What is the story of prior service costs? Prior service cost is a result of making commodification. The company, the entity have made a modification in the formula that it will calculate the expected retirement benefit or pensions. As a result of most of the time, it will increase the benefit, instead of multiplying 1.5 percent, I'll use 1.7 percent because normally the equation, as we have talked about before, 1.5 percent or whatever percent times the number of service years times the salary at retirement so because of any of those three components has changed and added additional benefits to my retirees, then obviously, there is a huge cost that is incurred specially if that prior service cost is implemented or decided to be implemented retro actively, retrospectively. Actually, all the past will be benefit all the services that were in the past that the employees are provided will benefit because of the applying this changing the formula retro spectrum. Obviously this cost that happened in the current year should not be hitting the pension expense because it will be a huge lump-sum so the way we do it, we hang in there, we put it, reserve it in what we call accumulated or OCI item, and then we start amortizing it over the years, over the remaining service years of the working employees so the idea is to get that bulk, reserve it and then amortize. Then in our example today, I am going to cover the main five transactions that I talked about. Those are the main five components. That is the basic version of the puzzle. The service cost, the interest cost, the return, actual and expected, the contributions and the benefits. Those are I referred to those five components are the basic or the first version of the pension puzzle. It's taken us five transactions as a whole and then we will add to those five what we call the prior service costs as I explain, I guess it's time to take an example. Let's go. Here you go. The following information in million dollars pertains to universal corporations defined benefit pension plan. I have projected benefit obligation, the two main accounts, and I added this accumulated other comprehensive income, the prior service costs 70 means that I had a prior service costs adjustment, before and it has in the beginning balance and it is a balance there, that is going to be amortized over the years. That is already, I'm starting with an AOCI in the prior service of 70 million. The expected long-term rate of return on plan assets is 10 percent, while the actual return on plan assets was 36 million. Obviously, the 10 percent will be multiplied by the beginning balance of the plant asset to get to the expected rate of return. The expected return, which is 10 percent times the 600, that would give me a 60 expected return on plan assets. The service cost for the year was 40 million and the discount rate was nine percent. The nine percent to calculate the interest cost will be multiplied by the projected benefit obligation at the beginning of the period to give me to the interest cost for the current year. So 800 times the nine percent, that's $72 million. Towards the end of the year, universal made cash contributions 184, and paid benefits to retirees, 100 million so those are the last two transactions in the five that I talked about, the five main ones. Additional information, that's the part that's the focus of my exercise today in today's lesson. Additional information, at the end of 2021, universal amended the pension formula, creating an additional service cost of 25 million so they already have 70. They made him a prior sometime in the past they made an amendment and now I am making another amendment that will actually add 25 million and they decided during this year to amortize. Now I'm going to have a 70 already there, and I have a 25 and they decided to amortize 10 million of the prior service costs to be included in the pension expense. In the current year I have an amendment and obviously I have an amortization. Let's take a look at how would we account for. I started with the structure, the main structure for the main three accounts, the projected benefit obligation, the plan assets, the pension expense and I entered the main data, the five transactions for the service cost, as you can see, the 40 million. The interest cost as an increase in the projected benefit obligation and an increase in the pension expense. The actual return was debited to the plan assets, while the pension expense was credited for the expected return. The benefits paid to retirees have decreased both the plant assets and the projected benefit obligation and finally, the contributions that were made have increased the Pension Plan and obviously the plan assets and obviously the credit will be for cash. We'll see we'll, and take a look at the journal entry in a minute. I added as you can see in the corner here, in the left bottom corner, I added the AOCI prior service cost with a beginning balance of 70 million. Now, let's take what they made that amendment universal, made an amendment that added 25 million. You will see that that huge cost will be actually increasing their projected benefit obligation because of the amendment now, I am more liable that I will have to incur that 25 million cost. But actually I did not hit the pension expense with it, but I hit the AOCI with it. That's where I want to reserve it in that OCI account accumulated other comprehensive income, and then I will amortize portion of it and that's the 10 million that they said that they decided to amortize, and here is what when I amortize the 10 million, that's the amortization and I will actually take that 10 million and import it into the pension expense for this year. Then obviously the pension expense was not affected by the huge cost that 25 million for the amendment of the plan that took place during the current year, but it was affected only by the 10 million that was amortized. Looking at this, I need to calculate the ending balances for all of them. Notice that although the projected benefit obligation, the plant assets and the AOCI, prior service cost all three of them, are real accounts, permanent accounts, meaning that they are rolling over from one year to the other. All three of them are balance sheet accounts and all of them started with a beginning balance. While the pension expense did not have a beginning balance because it's a temporary nominal account. Having said so that's the map, looking at it from a t-account. What about the journal entry? Here are the five transactions, the main five transactions that constitute the simple version of the pension puzzle. The service cost, the interest cost, and the return on plan assets and obviously closing the gap between the actual, 36 and the expected as a 24 in slumping another account, which is the accumulated other comprehensive income, and that is actually loss and that's why it's a debit because the actual return was less than what I expected so I perceive that as a loss. For today's lesson, I ended the prior service cost and here is the, obviously the debit to the Accumulated Other Comprehensive Income prior service costs and actually I have two AOCIs, you can see, the AOCI prior service cost and I have the AOCI, which is their gains or loss and that will be discussed in details later. Amortization of the prior service cost and that's what I said, that when we amortize, I import portion of the prior service costs into the pension expense for this period and that's the 10 million which was taken from the AOCI prior service cost and imported to the pension expense. Hopefully, that that gives you a good idea about the five main transactions and the issue of how to account for the amendment and the amortization of the prior service costs or the amendment for the pension plan. Thank you.
