Accounting Homework Question:
Pension Amendment Case
Charles Rubin is a 30-year old employee of General Motors. Charles was pleased with recent negotiations between his employer and the United Auto Workers. Among other favorable provisions of the new agreement, the pact also includes a 13% increase in pension payments for workers under 62 with 30 years of service who retire during the agreement. Although the elimination of a cap on outside income earned by retirees has been generally viewed as an incentive for older workers to retire, Charles sees promise for his dream of becoming a part-time engineering consultant after retirement. What has caught Charles’s attention is the following excerpt from an article in the financial press:
General Motors Corp. will record a $170 million charge due to increases in retirement benefits for hourly United Auto Workers employees.
The charge stems from GM’s new tentative labor contract with the UAW. According to a filing with the Securities and Exchange Commission, the charge amounts to 22 cents a share and is tied to the earnings of GM’s Hughes Electronics unit.
The company warned that its “unfunded pension obligation and pension expense are expected to be favorably impacted as a result of the recently completed labor negotiations.”
Taking advantage of an employee stock purchase plan, Charles has become as active GM stockholder as well as employee. His stockholder side is moderately concerned by the article’s reference to the unfavorable impact of the recently completed labor negotiations.
Required:
1. When a company modifies its pension benefits the way General Motors did, what name do we give the added cost? How is it accounted for?
2. What does GM mean when it says its “unfunded pension obligation and pension expense are expected to be unfavorably impacted as a result of the recently completed labor negotiations?
The other half of the question:
These two questions are Required:
1. When a company modifies its pension benefits the way General Motors did, what name do we give the added cost? How is it accounted for?
2. What does GM mean when it says its “unfunded pension obligation and pension expense are expected to be unfavorably impacted as a result of the recently completed labor negotiations?
1. When a company modifies its pension benefits, such as the increase in pension payments for workers like Charles, the added cost is known as a pension amendment cost. It is accounted for by recognizing an expense in the financial statements. In this case, General Motors will record a $170 million charge for the increased retirement benefits for hourly United Auto Workers employees.
To account for the pension amendment cost, General Motors will likely follow the Generally Accepted Accounting Principles (GAAP) requirements. They will record the cost as an expense on the income statement. The expense is then recognized over the employees' service period, reflecting the increase in pension benefits.
2. When GM says that its "unfunded pension obligation and pension expense are expected to be unfavorably impacted as a result of the recently completed labor negotiations," it means that these modifications to the pension benefits will result in increased costs for the company.
The "unfunded pension obligation" refers to the portion of the pension benefits that are not covered by the pension plan's assets. If the pension plan does not have sufficient assets to cover all the future pension payment obligations, it creates an unfunded liability for the company. The labor negotiations and the resulting pension amendments may increase the company's unfunded pension obligation.
The "pension expense" refers to the cost incurred by the company in providing pension benefits to its employees. The pension expense includes two components: the service cost (the cost of providing benefits for the current period based on employee service) and the interest cost (the increase in the pension obligation due to the passage of time). The labor negotiations and pension amendments may cause an increase in the pension expense for General Motors.
Overall, GM expects these labor negotiations to result in higher costs for the company related to the pension benefits, which can have an unfavorable impact on its financials.