Page 312 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

298 The Complete Guide to Executive Compensation

retirement plans may only be taken at the time the individual has income and, therefore, a
tax liability. The maximum tax deduction to the employer for a qualified, defined-contribu-
tion plan is 15 percent of the covered payroll. The maximum for a defined-benefit plan is
dependent upon the nonfunded past service liability. The maximum tax deduction, if the
employer has both a qualified defined-benefit and a defined-contribution plan, is 25 percent
of covered payroll.
Retirement plans that fall within the “employee benefit” category (i.e., they apply to all
employees) are tax-qualified plans. Why? Because the company wants a tax deduction when
it makes a plan contribution, and employees do not understand why they should be taxed
until they receive the plan benefits. The only way to do this is with a qualified plan. Plans
that cover executives include both qualified and nonqualified, the latter beginning where the
former ends. Both types will be reviewed in this chapter, because together they constitute the
executive’s retirement benefit.
Companies are required to file various documents with the Department of Labor, in
addition to making such information available to plan participants.

Accounting

The accounting requirements for pension benefits to retired employees could be a book by
themselves. Lack of space permits only a few highlights. Since even these may be subject to
interpretation, one should definitely review the subject with inside and outside auditors.
Let’s begin with Financial Accounting Standards Board (FASB) statement FAS 35,
“Accounting and Reporting by Defined Benefit Plans.” It dates back to 1980 and, essen-
tially, was the first promulgation of Generally Accepted Accounting Procedures (GAAP) on
the subject of pension plans. The American Institute of Certified Public Accountants
(AICPA) incorporated accounting and reporting guidelines for defined-contribution plans.
FAS 35 requires financial statements using accrual accounting to report net assets available
for plan benefits. Records detailing activity should include contributions, claims, distribu-
tions, participant accounts, and investments, to name a few.
The next two FASB statements that significantly affect how pension plans will be viewed
by accountants are FAS 87, “Employers’ Accounting for Pensions,” and FAS 88, “Employers’
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits.”
FAS 87 requires that the cost of the pension reflected on the balance sheet include the
projected benefit obligation, factoring in such items as discount or settlement rate, rate of
salary increase, earnings on plan assets, prior service cost, and unrecognized gains and losses.
Two of the measurements reflected on the balance sheet that show the funding status of
defined-benefit plans are the accumulated benefit obligation (ABO) and the projected bene-
fit obligation (PBO). The ABO shows benefits accrued to date, typically separated between
vested and nonvested participants. The PBO reports the actual present value of future bene-
fits in addition to the ABO. Comparing these two amounts with the reported fund balance
indicates the amount the fund is over- or underfunded.
FAS 88 specifies the differences in accounting treatment for settlement and curtailments.
Previously unrecognized gains or losses are recognized immediately under a “settlement;”
however, prior service cost is not accelerated. With a “curtailment,” the situations are reversed;
previously unrecognized prior service cost is recognized immediately, but unrecognized gains
or losses are unaffected.