Accounting for Generally Accepted Accounting Principles (GAAP) financial statements and accounting for business income taxes are different. This is because some recognized and presented incomes and expenses on a business's financial statements and on a business's income tax return are not same. The difference is called permanent or temporary differences. A permanent difference is the amount of tax exempt that permanently will not be recognized in the future years. However, a temporary difference is unlikely to report on the income tax return. The amount of difference that is not shown on the income statement on the first year is deferred to the next year. This asset or liability is called deferred income tax and is recorded on a balance sheet.
According to an index 1, two different statements are shown. The large differences in the two are "fine and penalties" and "depreciation." First of all, "fine and penalties" are not deductible for tax purposes that it is a permanent difference. This account is related to after tax expense that taxable income is reduced by $10,000. Since a corporate tax rate is 40%, in result the net income is increased by $4,000 ($10,000*40%). Moreover, net income can be affected depending what kind of a method is used. Income tax return uses accelerated depreciation for taxes which places more amount of depreciation on the first year and gradually fall. By using this method, the tax depreciation is greater by $12,000 than the income depreciation. The tax effect from an increase of $12,000 is result of a decrease in tax expense and net income by $4,800 (12,000*40%) after tax rate of 40% applied (Since your income is more than $40,000, tax rate is applied to 40% bracket). However, it is a temporary difference, so the amount of tax effect will be reported in the future. Consequently, since taxable income on the financial statement is $75,000, tax expense should have been $30,000, but the tax expense is $29,200 decreased by net of -$800 ($4,000-($4,800)). Then, the rest of tax liability is deferred. This tax expense of $29,200 out of $75,000 gives rise to effective rate of 38.93% (referring to an index 2). Therefore, the journal entries should be written as:
Short term investments in debt and equity securities are separated into three parts: held-to-maturity, trading, and Available-For-Sale (AFS). The text book "Intermediate Accounting" written by Kieso defines AFS you hold as "securities and other financial investments that are non-strategic, that are neither held for trading, nor held to maturity, nor held for strategic reasons, and that have a readily available market price"(2010). The key difference from the other investments is readily determinable fair values. While holding AFS, its value could be appraised. However, FASB 320-10-35-1 says "any unrealized holding gains and losses for AFS securities shall be excluded from earnings and reported in other comprehensive income until realized." Therefore, the appraised value of $4,000 ($24,000-$20,000) in 20x2 should be reported on shareholders' equity and will be realized when it is sold because of the cost principle and the revenue recognition principle. Additionally, the expectancy of an increase in value in 20x3too will not be included in income statement neither shareholders' equity.
Without (): Debit / With (): Credit
(Expected Retirement on Dec.31)
A pension plan is an arrangement preparing benefits to provide to employees after they retire for service while they were working. A pension plan can be largely divided into three plans: defined contribution plan, defined benefit plan and hybrid benefit plan. Of all, FASB chose to use a defined-benefit plan, designed to provide employees the benefits when they retire. Recently pension plans have been hugely changed according to the Statement of Financial Accounting Standard NO.158. Employer contribution varies. "Actuaries are required to estimate the employer contribution by considering employee turnover, mortality rates, interest and earning rates, early retirement frequency, future salaries" (SFAS No.158). The amount of contribution from a company is determined today as using a time value of money computation. The important thing here is the company needs to set aside a pension account separate from a company. A company might want to pour its money toward the pension fund because it is non-taxable. This money from funded assets is invested to earn an accumulation of funds to pay those benefits in the future. However, not all companies do because there will be a possibility of depreciation of the fund. Still, companies have to have enough assets, when employees retire. I will bring this topic out later.
First of all, it is important to understand components that compromise pension expense and the nature of them. The components are service cost, interest on the liability, actual return on plan assets, amortization of amendment, and gain and loss. Under matching principles suggested by GAAP, when the benefit is being derived, to match that cost to today's value is necessary. Thus, the cost of compensation related to the plan each period should be recognized. This cost is known as service cost, the amount of this is determined by actuaries. Additionally, this estimate of the pension liability is called "Projected Benefit Obligation (PBO)". The PBO does not have to be fully paid every time. If the plan's net assets exceed the total estimated future liability (overfunded), an employer has a liability on their books, while if opposite, he or she has an asset (underfunded). This amount should be recognized on the balance sheet. However, a company should have enough money to pay to an employee at retirement since an employee has a responsibility to take a risk of not paying.
The value of money reserved to the pension fund now is not same as the value at the time an employee retires, so due to a time-value of money factor interest expense accrues on the PBO by the settlement rate. Actual return on plan assets is the earning on the assets held. This amount of return on plan assets should be adjusted for interests and dividends within the fund but also changes in the market value of the fund assets. Amortization of amendment is allocated on the pension expense in the future when there is the cost of providing these retroactive benefits (amendment). Lastly, gain or loss can result from sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation.
With these explosions in mind, making a pension plan work sheet is needed. The purpose of the retirement planning worksheet is to provide an organized overview of a retirement plan. Accounting for pensions under Statement No. 87 says that "several significant items of the pension plan are unrecognized in the accounts and the financial statements."The work sheet is divided into financial statement accounts and off-balance sheet accounts (memo). Financial statement accounts are all entries related to pension expense as described previously. Contribution to the plan and benefits paid to employees in the worksheet is denoted by debiting plan asset and crediting cash and by debiting PBO and crediting plan assets. Some entries which are sitting or waiting in Other Comprehensive Income (OCI) are required to amortize. Prior services costs and net gain or loss which is only if they exceed a 10% threshold amortize into annual pension expense and the rest of them amortize over the future years. Sometimes company faces sudden and large changes in the market value of plan assets and changes in actuarial assumptions that affect the amount of the projected benefit obligation. In this case, "If these gains of losses influence fully the financial statements in the period of realization or incurrence, substantial fluctuations in pension expense result (Kieso 2010)." Thus, this method is needed to reduce the volatility associated with pension expense by using smoothing techniques. Smoothing techniques dampen and in some cases fully get rid of the fluctuations. There are some ways to eliminate the fluctuations, but the Financial Accounting Standards Board (FASB) chooses the actuary's approach to make less wide swings which might occur in the actual return. "The market-related asset value (MRAV) of the plan assets is either the fair value of plan assets or a calculated value that recognizes changes in fair value in a systematic and rational manner" (Source needed). Your company adopted MRAV of averaging in gains and losses over a period of four years by adding in 25% of each of the last four years' gains and losses. The details will be explained more with the planning retirement plan of your company below.
In the worksheet, in year 20x1, first of all whether the pension plan is unfunded or overfunded, the difference of PBO and plan asset should be shown on balance sheet under a pension liability account, but because in this case there is no difference because nothing is needed to record. Next, the components of pension expense such as service, interest, and actual return are debited and are credited to PBO except the fact that actual return are opposite since it increases the plan asset and this reduces pension expense. A plan amendment and amortization of prior service cost of individual A entries are under AOCI. $4000 of a plan amendment is recorded due to an increase in benefits to individual A. However, as described previously, the amount of any entries should be adjusted to annual expense. Since a plan amendment is granted on July 1, 20x1 and individual A's expectancy of the retirement is two years, six months should be amortized. A plan amendment amortizes $166.67 per month ($4000/24), so $1,000 reduces the liability. Also, the expected return can be calculated as plan assets multiplied by the long-term rate of return (6%). Only $600 is expected but actual return is $5,000. The difference between the expected and actual return should be recognized as a gain. The difference of $4,400 is recognized on the AOCI gain or loss entry. Finally the journal entry for the year of 20x1 is below:
AOCI (G/L) $ 1,692
In the year 20x2, now $5,000 is underfunded and almost all entries are same but amortization PSC of B, C, and D. According to an index 2, employees' service years are shown. The cost per year can be calculated by dividing a plan amendment into service years ($9,000/15=$600). Because the total service year in 20x2 is 4, by multiplying cost per service year, $2,400 of annual amortization for this amendment can be figured out. Moreover, amortization of the amendment of individual A for this year as the monthly amortization was $166.67 ($4,000/24) is $1,000 total ($4,000/24*12). AOCI losses are from an unexpected loss of $1,452 and amortization of loss. This year's obligation is $20,000 and its plan asset is $15,000, and the 10% of the larger between the two is the corridor. Also, AOCL(G/L) from the last year were $4,400. That means this year of the corridor is $20,000. By subtracting AOCI loss from Corridor and dividing this by the average remaining work-life of employees, the minimum amortization of loss for current year can be found. The current year amortization is $240, so adding these up, this year's AOCI loss is $1,692. Therefore, the journal entry for 20x2 is below:
Section 412(c) of the International Revenue Code states:
The value of the plan's assets shall be determined on the basis of any reasonable actuarial method of valuation which takes into account fair market value and which is permitted under regulations prescribed by the Secretary."
, if employees raise the pension benefits payable, For example, if employees raise the pension benefits payable, service cost is charged later.
(check ìš”ë§ service cost)
BUT THE NET ASSET/ LIABILITY IS
ON THE SPONSOR BOOKS!!
The expected return on plan assets is the expected rate of return multiplied by the fair value of the plan assets or a market related asset value of the plan assets
Market-related asset value of the plan assets is a calculated value that recognizes changes in the fair value of the plan assets in a systematic and rational manner.
The market-related asset value of the plan asset is either the fair value of plan assets or a calculated value that recognizes changes in fair value in a systematic and rational manner.
Market-related values based on a calculated value and the fair value of plan assets are equal