To:

8878

From: 4923
Date: March 25, 2014
Re:

Proposed Defined Benefit Plan: Gains and Losses

Due to our rapid growth since 2004, Monat Company is considering establishing a defined
benefit plan for employees in order to boost loyalty. The benefit plan will affect our financial
statements, particularly whenever any gains or losses are incurred. I have conducted research
into how our financial statements will be affected by any gains or losses and wish to relate my
findings to you in this memo.
Accounting Standards for Pension Benefits Losses and Gains
The authoritative guidance for accounting of losses and gains on defined pension benefit plans is
FASB Codification Topic 715, Subtopic 30, Defined Benefit PlansPension. In regard to the
accounting procedures for losses and gains the codifications states:
35-22 Asset gains and losses are differences between the actual return on plan assets
during a period and the expected return on plan assets for that period. Asset gains and
losses include both changes reflected in the market-related value of plan assets and
changes not yet reflected in the market-related value (that is, the difference between the
fair value of assets and the market-related value). Gains or losses on transferable
securities issued by the employer and included in plan assets are also included in asset
gains and losses. Asset gains and losses not yet reflected in market-related value are not
required to be amortized under paragraphs 715-30-35-24 through 35-25. (715-30-35-22)
35-23 In other words, the expected return on plan assets generally will be different from
the actual return on plan assets for the year. This Subtopic provides for recognition of that
difference (a net gain or loss) in other comprehensive income in the period it arises. The
amount recognized in other comprehensive income is also a component of net periodic
pension cost for the current period. Thus, the amount recognized in other comprehensive
income and the actual return on plan assets, when aggregated, equal the expected return
on plan assets. The amount recognized in accumulated other comprehensive income
affects future net periodic pension cost through subsequent amortization, if any, of the net
gain or loss. (715-30-35-23)
In simpler terms, a gain or loss on a defined pension plan occurs when the actual return on a plan
is either greater or lower than the expected return on the plan. If the actual return on the plan is
greater than the amount we expected then a gain will occur. If the actual return amount is lower
than the expected return on plan then a loss will occur.

Unlike other gains and losses incurred by a company, gains and losses from the defined benefit
plan will appear under other comprehensive incomenot under the other gains and losses
section of the income statement.
Rationalization
The reasoning behind its inclusion within other comprehensive income is explained in the FASB
Codification:
35-19 Because gains and losses may reflect refinements in estimates as well as real
changes in economic values and because some gains in one period may be offset by
losses in another or vice versa, this Subtopic does not require recognition of gains and
losses as components of net pension cost of the period in which they arise. (715-30-3519)
Because of the volatile nature of the pension plans value year by year, it would be not wise to
recognize the losses and gains in the periods that they arise on the income statement. For
example, during one period a loss can arise (due to economic factors) on the pension assets and
the following year a gain can occur on that same plan assets. The loss and gain during these two
periods would cancel each other out.
However, an exception to this rule occurs if the gain or loss is of a substantial amount.
35-24 As a minimum, amortization of a net gain or loss included in accumulated other
comprehensive income (excluding asset gains and losses not yet reflected in marketrelated value) shall be included as a component of net pension cost for a year if, as of the
beginning of the year, that net gain or loss exceeds 10 percent of the greater of the
projected benefit obligation or the market-related value of plan assets. If amortization is
required, the minimum amortization shall be that excess divided by the average
remaining service period of active employees expected to receive benefits under the plan.
The amortization must always reduce the beginning-of-the-year balance. Amortization of
a net gain results in a decrease in net periodic pension cost; amortization of a net loss
results in an increase in net periodic pension cost. If all or almost all of a plans
participants are inactive, the average remaining life expectancy of the inactive
participants shall be used instead of the average remaining service period. (715-30-35-19)
According to the above codification if the gain or loss is greater than 10 percent of either the
current market value of the plan assets or the obligation that company has projected for the
pension, than the difference between the values must be amortized and expensed during the
period. The amortized portion therefore will be seen as part of pension expense within the
income statement for the period. The remaining amount will remain in other comprehensive
income and shall be amortized in later periods.
Effects on the Balance Sheet

Not only do gains and losses on defined benefit plans affect the income statement but also affects
the balance sheet.
25-1 If the projected benefit obligation exceeds the fair value of plan assets, the employer
shall recognize in its statement of financial position a liability that equals the unfunded
projected benefit obligation. If the fair value of plan assets exceeds the projected benefit
obligation, the employer shall recognize in its statement of financial position an asset that
equals the overfunded projected benefit obligation. (715-30-25-1)
FASB requires that the difference between the projected benefit obligation and the fair value of
plan assets be reported on the balance sheet. If the obligation is greater than the fair value of
assets, a liability will be reported. If the obligation is lower than the fair value of plan assets then
an asset will be reported on the balance sheet.
The amortized portion of the gain and loss will be included in pension expense, which will either
raise or lower the Pension Asset/Liability account on the balance sheet.
The remaining accumulated gains and losses within other comprehensive income will be
deducted, or added, to stockholders equity section of the balance sheet. This is in accordance to
FASB Codification 220-10-45-14:
45-14 The total of other comprehensive income for a period shall be transferred to a
component of equity that is presented separately from retained earnings and additional
paid-in capital in a statement of financial position at the end of an accounting period. A
descriptive title such as accumulated other comprehensive income shall be used for that
component of equity. (220-10-45-14).
Conclusion
Due to the volatile nature of the value of pension assets gains and losses on our proposed defined
benefit plans are bound to occur. The gains and losses, however, will not impact the income
statement unless they are of a substantial amount. They will be included in other comprehensive
income which shall appear under the stock holders equity section of our balance sheet.
I hope the above information assists you on the decision whether Monat Company should
establish a defined benefit plan for our employees.
Sources: Financial Accounting Standards Board Accounting Standards Codification (accessed
March 20, 2014).