How to Account for Post-Retirement Benefits

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  • 0:03 Post Retirement Benefits
  • 0:29 Post-Retirement…
  • 2:06 Increase in APBO
  • 3:06 Calculating Expense…
  • 4:39 Lesson Summary
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Lesson Transcript
Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

This lesson will use an example to walk you through the mechanics of accounting for post-retirement benefits. You'll also learn to calculate the accumulated post-retirement benefit obligation.

Post-Retirement Benefits

To attract the best candidates to fill job openings, companies often offer a variety of post-retirement benefits to eligible employees. These can include life and medical insurance, dental plans, vision care, legal services, and tuition reimbursement. Employees become eligible for these benefits after accumulating a specified number of years of service and reaching a certain age.

Post-Retirement Benefit Obligations

The expected post-retirement benefit obligation (EPBO) is the discounted present value of an actuarial estimate of the total amount of benefits expected to be received by plan participants. Estimating how much plan participants will receive is beyond the scope of accounting. It is based on long-term average cost trends in health care, life expectancy tables, and other factors best calculated by actuaries. It's a given in our coming examples. The accumulated post-retirement benefit obligation (APBO) is the portion of the EPBO attributed to employee service to date. Accountants calculate this one.

Let's look at a short example to see how APBO can be calculated. Newco is a company that started operations five years ago. It offered all employees post-retirement benefits after both 25 years of service and reaching the age of 55. Newco actuaries estimate the EPBO for current employees is $80,000. So EPBO at year end of 2017 is $80,000. Service to date is 5 years. Remember, the company has only been in operation for five years, so the longest date of service will be five years. And, service required is 25 years. To calculate the APBO we multiply the EPBO by the service to date divided by the service required:

$80,000 * 5 / 25 = $16,000

So, our APBO is $16,000.

Increases in APBO

The APBO will increase in the following year for two reasons. One, of course, is that every employee will have one more year of service time. The other is that there will be an interest expense since the discounted present value (PV) will change. Let's look at 2018 and use a 5% discount rate.

APBO at Jan 1, 2018 $16,000
Interest cost $800 $16,000 * 0.05 = $800
Service cost $3,200 EPBO of $80,000 at year end 2016 * 1/25 = $3,200
APBO at Dec 30, 2018 $20,000 ($16,000 + $800 + $3,200)

Calculating Expense and Liability

During 2017, Newco expected a return of $1,000 on plan assets. The actual return was $1,200. It also made a contribution to the plan funding of $1,500. It made no changes to the plan benefits during 2017 and no increases in EPBO came from the actuaries. Here is the calculation for 2017 expense:

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