20.3 (Prior Service Cost)

Question 1

Prior service cost

Answer 1

When either initiating (adopting) or amending a defined benefit plan, a company often provides benefits to employees for years of service before the date of initiation or amendment.

Should a company report an expense for these prior service costs (PSC) at the time it initiates or amends a plan? The FASB says no.

A company should not recognize the retroactive benefits as pension expense in the year of amendment.

Question 2

Retroactive benefits

Answer 2

The employer initially records the prior service cost as an adjustment to other comprehensive income. The employer then recognizes the prior service cost as a component of pension expense over the remaining service lives of the employees who are expected to benefit from the change in the plan.

The cost of the retroactive benefits (including any benefits provided to existing retirees) is the increase in the projected benefit obligation at the date of the amendment.

Question 3

Years-of-service method (amortization)

Answer 3

First, the company computes the total number of service-years to be worked by all of the participating employees. Second, it divides the prior service cost by the total number of service-years, to obtain a cost per service-year (the unit cost). Third, the company multiplies the number of service-years consumed each year by the cost per service-year, to obtain the annual amortization charge.

Question 4

straight-line amortization

Answer 4

An alternative method of computing amortization of prior service cost is permitted. Employers may use straight-line amortization over the average remaining service life of the employees.