Chapter 20: Pensions Flashcards
How does GAAP measure the pension liability?
- GAAP uses the projected benefit obligation
- Full balance of benefits for vested and non-vested employees at future salaries
What are two types of employer provided retirement plans?
Types of employer provided retirement plans:
- Defined contribution
- Defined benefit
——————– Background Information ——————–
Suppose Brooks Company has a PBO of $500,000.
The fair value of the plan assets is $420,000.
—————————– Question ————————————–
What is reported on the balance sheet?
A pension liability of $80,000
——————– Background Information ——————–
Suppose Brooks Company has a PBO of $500,000. The fair value of the plan assets is $520,000.
—————————– Question ————————————–
What is reported on the balance sheet?
A pension asset of $20,000
What are the components of pension expense?
[1] Service cost [2] Interest on the liability (interest expense) [3] Amortization of prior service cost [4] Actual return [5] Gain/Loss
What is the “Service Cost” component of pension expense?
the additional benefits an employer must pay under the plan’s benefit formula as a result of employees’ current year of service.
What is the “Interest Expense” component of pension expense?
the interest for the period on the PBO outstanding during the period
What is the “Amortization of Prior Service Cost” component of pension expense?
the expensing retroactively awarded pension benefits
What is the “Actual return” component of pension expense?
Actual return: the actual return to the plan assets (interest/ dividends/ return of the plan assets)
What is the “Gain or Loss” component of pension expense?
Gain or loss: the difference between the actual return and the expected return
—————————- Background Info —————————
[1/1/2020] > Plan assets are $100,000
[1/1/2020] > PBO is $100,000
[Full Year 2020] > Annual Service Cost is $9,000
[Full Year 2020] > Statement Rate is 10%
[Full Year 2020] > Actual Return is $10,000
[Full Year 2020] > Funding Contributions are $8,000
[Full Year 2020] > Benefits Paid to Retirees are $7,000
—————————– Question ————————————-
How do we record/ reflect this information in our financial statements?
Service costs:
Dr. Pension expense 9,000
Cr. PBO 9,000
Interest costs:
Dr. Pension expense 10,000
Cr. PBO 10,000
Actual return:
Dr. Plan Assets 10,000
Cr. Pension expense 10,000
Contributions
Dr. Plan Assets 8,000
Cr. Cash 8,000
Benefits paid:
Dr. PBO 7,000
Cr. Plan Assets 7,000
NET ENTRY:
Dr. Pension Expense 9,000 = 9,000 + 10,000 – 10,000
Cr. Cash 8,000
Cr. Pension Asset/ Liab 1,000
= 9,000 + 10,000 – 10,000 – 8,000 + 7,000 – 7,000
So the memo for PBO/ Plan Assets will show:
PBO Balance of 112,000 = 100,000 + 9,000 + 10,000 – 7,000
Plan Asset Balance of 111,000 = 100,000 + 10,000 + 8,000 – 7,000
What is “Prior Service Cost” ?
[1] cost of the retroactive benefits
[2] When a company makes a change to a pension plan (or starts a new pension plan), a company
will often provide benefits to employees for years of service before the date of the initiation or
amendment to the plan
How do companies account for “Prior Service Cost” ?
- The prior service costs, or the cost of the retroactive benefits, is initially recorded as other comprehensive income.
- Then, this amount in AOCI is amortized as a component of pension expense over the remaining service lives of the employees who will benefit.
On January 1, 2021, Yearwood Company modifies its pension plan, which affects 170 employees.
The company grants $80,000 of prior service costs as part of the plan modification.
The employees are expected to retire as follows:
Group Number of Employees Year
A—————40————————————2021
B—————20————————————2022
C—————40————————————2023
D—————50————————————2024
E—————20————————————2025
—————————————————————–
Total: 170
——————————— Q1 ————————————-
How many service years are represented by the above chart?
——————————— Q2 ————————————-
How much prior service cost should be amortized each year?
——————————— Q3 ————————————-
How would we record the initial adjustment to the pension plan in the books?
What adjustment would we make the first year?
--------------------------------- Q1 ------------------------------------- A = 40 x 1 = 80 B = 20 x 2 = 40 C = 40 x 3 = 120 D = 50 x 4 = 200 E = 20 x 5 = 100 ------------------------ A + B + C + D + E = 500
——————————— Q2 ————————————-
Total cost = $80,000
Total service years = 500
Cost per year = 80,000 / 500 = $160
Year——–Service-years——Cost——Amortization
2021———170——————-160——–$27,200
2022———130——————160——–$20,800
2023———110——————-160——–$17,600
2024———70——————-160——–$11,200
2025———20——————-160——–$3,200
——————————— Q3 ————————————-
Initially:
Dr. Prior Service Cost (OCI) 80,000
Cr. PBO 80,000
End of year:
Dr. Pension Expense 27,200
Cr. Prior Service Cost (OCI) 27,200
How does the “Service Cost” component affect the balance sheet and/ or PBO/ plan assets?
Increases pension expense
