Pensions
Practice as You Learn
Intermediate Accounting 2
Practice as You Learn
You will be asked to do the following things:
1) Compute pension expense
2) Compute the PBO at the end of the period
3) Compute the FMV of plan assets at the end of the period
4) Record all journal entries for the period (See Key Things to Know)
Some professors may ask you to do a pension spreadsheet.
The pension spreadsheet is just 1) to 4) above presented side by side.
Memorize the following formulas:
Compute Pension Expense for the current year:
| Service Cost: current year (given) + Interest Cost on PBO (beginning PBO x discount rate) – Estimated Return on Plan Assets (beginning FMV x expected return %) + Amortization of Prior Service Cost (PSC divided by service life) +- Amortization of (Gain)/Loss on Plan Assets = Total Pension Expense for the period (reported on the income statement) |
Change in PBO:
Beginning PBO
+ Service Cost
+ Interest Cost
+ Prior Service cost: (current year total only)
+- (Gain)/loss on PBO (current year total only)
– Payment of retirement benefits
= Ending PBO
Change in Fair Market Value of Plan Assets:
Beginning FMV of assets
+ Contributions
– Payments to retirees
+ – Actual Return on assets
= Ending FMV of Assets
Practice Problem 1 – Pensions
Pension plan information for the company follows:
For the Current Year Ended:
| Discount rate | 6% |
| Expected return on plan assets | 8% |
| Actual return on plan assets | 2% |
| Service cost | 310,000 |
| Service life | 8 years |
At the Beginning of the Current Year:
| PBO | 2,300,000 |
| ABO | 1,800,000 |
| Plan assets fair market value | 2,000,000 |
| Unrecognized prior service cost | 200,000 |
| Unrecognized net gain on assets | 530,000 |
At the End of the Current Year:
| Cash contribution to pension trust | 275,000 |
| Benefit payments to retirees | 220,000 |
A. Calculate pension expense for the current year
B. Calculate the fair market value of assets at the end of the current year
C. Calculate the pension benefit obligation at the end of the current year
D. Record all required entries for the current year related to the pension plan
E. Prepare a pension spreadsheet for this company for the current year
Answer
A. Write the 5 components of pension expense and then calculate the components:
| Service Cost: current year | 310,000 |
| + Interest Cost on PBO | 138,000 |
| + Amortization of Prior Service Cost | 25,000 |
| – Estimated Return on Plan Assets | (160,000) |
| +- Amortization of (Gain)/Loss on Assets | (37,500) |
| = Total Pension Expense for the period | 275,500 |
Interest Cost = Beginning PBO x Discount Rate
2,300,000 x 6%
Amortization of Prior Service Costs =
PSC of 200,000 / 8 years service life
Estimated Return on Plan Assets =
Beginning FMV Assets x Estimated Return
2,000,000 x 8%
| The largest amount: PBO or FMV of assets | 2,300,000 |
| x 10% | .10 |
| = Amount is must be larger than | 230,000 |
| Compare to unrecognized gain | 530,000 |
| = Amount to amortize | 300,000 |
| / service life | 8 years |
| = Include gain in pension expense | 37,500 |
Gains are subtracted and losses are added to pension expense
B. Compute the change in fair market value of plan assets:
| Beginning FMV of assets | 2,000,000 |
| + Contributions | 275,000 |
| – Payments to retirees | (220,000) |
| + – Actual Return on assets | 40,000 |
| Ending FMV of Assets | 2,095,000 |
Actual return = 2,000,000 x 2% = 40,000
C. Change in PBO:
| Beginning PBO | 2,300,000 |
| + Service Cost | 310,000 |
| + Interest Cost | 138,000 |
| +- (Gain)/loss on PBO (this year only) | 0 |
| + Prior Service cost: current year added | 0 |
| – Payment of retirement benefits | (220,000) |
| Ending PBO | 2,528,000 |
A gain or loss is included when the actuary changed factors in the current year that changed the amount owed. This situation did not occur this year.
Prior Service cost is included when the plan is amended in the current year to increase benefits earned during prior year services. This situation did not occur this year.
D. Required journal entries:
Record pension expense:
| Pension Expense 275,500 Plan Assets 160,000 OCI – Gain on assets 37,500 PBO 448,000 OCI – PSC 25,000 |
Record the company contribution:
| Plan Assets 275,000 Cash 275,000 |
Benefit Payments:
| PBO 220,000 Plan Assets 220,000 |
Record the difference in actual and estimated return on assets:
| OCI – Loss on Assets 120,000 Plan Assets 120,000 |
(Actual 40,000 – 160,000 estimated = 120,000 less than estimated)
E. Pension Spreadsheet for the current year
| Pension Expense |
Pension B. Oblig. |
Plan Assets |
OCI |
|
| Beginning Balance | 2,300,000 | 2,000,000 | 330,000 | |
| Service Cost | 310,000 | 310,000 | ||
| Interest Cost | 138,000 | 138,000 | ||
| Amortization of PSC | 25,000 | |||
| Estimated Return on Assets | (160,000) | 160,000 | ||
| Amort of G/L on assets | (37,500) | (37,500) | ||
| Contributions | 275,000 | |||
| Payments to Retirees | (220,000) | (220,000) | ||
| CY G/L PBO actuary changes | ||||
| CY PSC | ||||
| Diff in Actual/Est. Return | (120,000) | (120,000) | ||
| ___________ | ___________ | ___________ | ___________ | |
| Ending Balance | 275,500 | 2,528,000 | 2,095,000 | 172,500 |
| Pension Benefit Obligation | 2,528,000 |
| Fair Market Value of Plan Assets | 2,095,000 |
| Underfunded Liability | 433,000 |