Events of an ongoing Defined Benefit plan which are non-routine are termed as Special events. Curtailment and settlement are examples of special events. This article includes a brief explanation about special events and their accounting treatment under US GAAP (ASC Topic 715) and IFRS.
I] Curtailment
A curtailment is an event that significantly reduces the expected years of future service of present employees or eliminates the accrual of defined benefits for some or all their future services for a significant number of employees. For example
1) Termination of employees’ services earlier than expected, which may or may not involve closing a facility or discontinuing a component of an entity
2) termination or suspension of a plan so that employees do not earn additional defined benefits for future services. In some situations, future service may lead to vesting of benefits (accumulated based on past service).
The most common curtailment event in the small plan arena is when benefit accruals are frozen. Plan freezes occur when an employer amends the plan to stop benefit accruals related to future service. An amendment to a defined benefit pension plan to permanently eliminate all future benefit accruals is considered a “hard freeze.” In other situations, employers may eliminate benefits for future service, but continue to consider salary increase in determining the defined benefit related to past service, which is considered a “soft freeze.”
Example:- An entity operates a defined benefit plan in which employees accrue 2% of their final salary for each year of service. The entity reduces workforce during the year by shutting down a non-performing unit. This is a curtailment event where defined benefit obligation decreases since initial projected future salary increases will not materialize. Such impact is recognized under curtailment gain/loss, in this example, it will be a curtailment gain.
Accounting treatment of Curtailment :
- Curtailment gain/loss is calculated as the difference in present benefit obligation (re-measured using latest assumptions) before and after the event.
- Under IFRS- Immediate recognition of entire curtailment gain/loss in pension expense (P&L).
- Under US GAAP-
- In case of Curtailment gain, it is first adjusted against unrecognized actuarial loss in Accumulated Other Comprehensive Income (AOCI) and any excess curtailment gain is recognized in Net Periodic Benefit Cost (NPBC).
- If there is an existing unrecognized actuarial gain in AOCI, then entire curtailment gain flows into NPBC.
- In case of Curtailment loss, it is first adjusted against unrecognized actuarial gain in Accumulated Other Comprehensive Income (AOCI) and any excess curtailment loss is recognized in Net Periodic Benefit Cost (NPBC).
- If there is an existing unrecognized actuarial loss in AOCI, then entire curtailment loss flows into NPBC.
II] Settlement
A Settlement event occurs when an enterprise or plan sponsor decides to make a permanent reduction in plan obligations. It is generally defined as an irrevocable action relieving the plan of primary responsibility for a pension or postretirement benefit obligation, and eliminates significant risks related to the obligation and the assets used to complete/pay-off the settlement.
Examples of transactions that constitute a settlement include making lump-sum cash payments to plan participants in exchange for their rights to receive specified pension benefits and purchasing nonparticipating annuity contracts to cover vested benefits.
Example- An entity operates a pension plan that provides a pension of 2% of final salary for each year of service. The benefits become vested after five years of service. The employer has decided to settle the benefit amount of all the employees as per the plan. The lump sum amount paid to the employees is considered as a settlement.
Accounting treatment of Settlement:
- Under IFRS
- Settlement gain or loss is generally measured as the difference between the Projected Benefit Obligation (PBO) being settled and the actual settlement amount (Lump sum amount or cost of annuity purchase).
- Immediate recognition of settlement gain/loss in pension expense (P&L).
- Under US GAAP-
- Accounting entry of settlement gain/loss is recognized if the settlement cost within a plan year exceeds a typical threshold that is the sum of the service cost and interest cost components of Net Periodic Benefit Cost (NPBC) for that period.
- Settlement gain or loss is calculated on pro-rata basis of previously unamortized gain or losses on the entire plan in AOCI, where –
- Difference between PBO settled and Assets used to settle the PBO becomes the gain/loss due to the event and it is added to both unrecognized gain/loss and PBO before settlement.
- Re-measured unrecognized gain/loss and PBO are used to calculate settlement ratio.
- Settlement gain or loss is equal to – Unrecognized Gain/Loss * Settlement ratio
- Settlement gain/loss is recognized in NPBC as an expense.
III] Past Service Cost
Past Service Cost is the change in the present value of the defined benefit obligation for employees’ service in prior periods, resulting in the current period from the introduction of, or changes to, post- employment benefits or other long-term employee benefits.
Example- An entity operates a pension plan that provides a pension of 2% of final salary for each year of service. The benefits become vested after five years of service. On 1 st January 2023 the entity improves the pension to 2.5% of final salary for each year of service starting from 1 st January 2019. At the date of the improvement, the present value of the additional benefits for service from 1 st January 2019 to 1 st January 2023 is recognized as Past Service Cost.
Accounting treatment of Past Service Cost:
- Past service cost may be either positive (when benefits are introduced or changed so that the present value of the defined benefit obligation increases) or negative (when existing benefits are changed so that the present value of the defined benefit obligation decreases).
- Under IFRS- Immediate recognition of all past service costs in pension expense (P&L)
- Under US GAAP- Prior service cost (whether for vested or unvested benefits) is recognized in AOCI at the date of the adoption of the plan amendment and amortized portion is recognized through NPBC over future periods.
- Past service cost is amortized over one of the following periods-
- The participants’ remaining years of service (for pension plans, except where all or almost all plan participants are inactive).
- The participants’ remaining years of service to full eligibility date (for other postretirement benefit plans, except where all or almost all plan participants are inactive).
- The participants’ life expectancy (for plans that have all or almost all inactive participants).
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