Chapter 20 Continued Service Cost Interest Cost Projected

20-32

P20-10 (continued)

3. Service cost $183,000

Interest cost on projected benefit obligation

4. 2010

Jan. 01 Other Comprehensive Income:

Prior Service Cost 88,000

Accrued/Prepaid Pension Cost 88,000

5. Liability: Accrued pension cost $110,090

P20-11

Employee Expected Years of Service Years

1. Numbers

Future Service Rendered

1-5 3 15

6-10 6 30

20-33

P20-11 (continued)

1. (continued)

ofNumber

yearsService

remainingAverage ÷=

2.

Year

Cumulative

Net Loss

Corridor

Excess

Net Loss

Amortized Net

Loss (Gain)

2010

$29,000

$47,000a

–

—c

3. 2010 2011

4. 2010

Dec. 31 Pension Expense 175,500

Cash 175,000

Accrued/Prepaid Pension Cost 500

5. Liability (end of 2010): Accrued pension cost $65,500

20-34

P20-12

1. Service cost $ 8,000

Interest cost 12,900a

2. Other Comprehensive Income: Prior Service Cost 129,000

Accrued Postretirement Benefit Cost 129,000

20-35

E19-16

1. and 2.

Date

Service

Costa

Projected

Benefit

Obligationb

Interest

Costc

Cash

Paymentd

Plan

Assetse

Expected

(and Actual)

Return on

Plan Assetsf

Amortization

of Prior

Service Costg

Pension

Expenseh

12/31/10

$ 81,590

–

$ 81,590

–

$ 81,590

aFor current year (using 10% discount rate). Annual benefits earned x Present value of annuity for period of

retirement x Present value of $1 for remaining period of employment. In 2010, ($2,000 x 60) x 7.366687 x

0.092296. In 2013, the annual benefits are increased to $144,000 ($80,000 x 0.03 x 60).

bAt end of year (using 10% discount rate). Total benefits earned to date x Present value of annuity for period

20-35

20-36

2. 2010

Dec. 31 Pension Expense 81,590

Cash 81,590

2014

Dec. 31 Pension Expense 156,767

Cash 151,809

Accrued/Prepaid Pension Cost 4,958

31 Accrued/Prepaid Pension Cost 2,575

Other Comprehensive Income:

Prior Service Cost 2,575

3. Liability: Accrued pension cost $64,969*

20-37

ANSWERS TO CASES

C20-1

The following items related to a defined benefit pension plan may be included in the

financial statements of the sponsoring company:

1. Pension expense. The pension expense reported on the income statement is computed

as follows: service cost + interest on the projected benefit obligation – expected return on

2. Accrued pension cost. A liability, accrued pension cost, is reported on the balance sheet

when the projected benefit obligation is more than the fair value of the pension plan

assets.

C20-2 (AICPA adapted solution)

1. The two accounting issues resulting from the nature of the defined benefit pension plan

are as follows:

2. Carson should determine the service cost component of the net pension cost as the

20-38

C20-2 (continued)

4. Carson should determine the expected return on plan assets component of the net

C20-3 (AICPA adapted solution)

1. The interest cost component of the net pension cost for a period is the increase in the

2. Prior service cost is the cost of retroactive benefits (increased benefits based on services

rendered in prior periods) granted at the date of adoption or amendment of a pension

plan. Essex should record the initial recognition of prior service cost as a decrease in other

3. Essex must accrue compensation for future vacations if all of the following conditions are

met:

(a) Essex’s obligation relating to employees‘ rights to receive compensation for future

vacations is attributable to employees’ services already rendered.

C20-4

1. Pension Expense. The conceptual issues related to pension expense involve (a) the

definition of an expense and (b) the components of pension cost (expense).

a. An expense is an outflow of assets or incurrence of a liability during a period from

20-39

C20-4 (continued)

2. Pension Liabilities. The conceptual issue related to a pension plan liability involves (a) the

definition of a liability and (b) when to and what amount to record as the liability.

a. A liability is a probable future sacrifice of economic benefits arising from a present

obligation of the company to transfer assets or provide services in the future as a result

3. Pension Plan Assets. The conceptual issue related to a pension plan asset involves the

disclosure of assets used in the pension plan. An asset is a probable future economic

benefit obtained and controlled by a company as a result of a past transaction or event.

C20-5

The accounting principles for OPEBs and those for pensions are very similar. They both

1. Although the attribution period is defined in the same way, the effect is different because

the benefit formulas for most pension plans link benefits to years of service and salary

2. The interest component of the net postretirement benefit expense is based on the

3. The OPEB liability (or asset) is the difference between the accumulated postretirement

20-40

C20-5 (continued)

4. There are a number of additional disclosures not required for pensions, including: (a) the

assumed healthcare cost trend rates, (b) the effect of a 1% increase and a 1% decrease

in the assumed healthcare cost trend rates on the aggregate of the service cost and the

C20-6

1. Pension expense is based on the expected return on plan assets rather than the actual

2. Gains and losses offset each other in the calculation of the net gain or loss. Therefore, the

amortization is less each period than if the more common accounting policy of

immediately recognizing losses and amortizing gains was followed.

3. The cumulative net gain or loss is amortized only if it exceeds the corridor amount (10% of

4. The fair market value of plan assets may be based on a market related value which

C20-7

GAAP for pension expense, requires management judgment in several aspects of its

application. This flexibility is appropriate since all companies do not operate in the same

environment, or have the same philosophy towards risk. However, flexibility can be

20-41

C20-7 (continued)

Since the discount rate is a market-based rate, it will have to be based on current market

C20-8

1. The following items in the advertisement raise issues:

a. The FASB does not establish “regulations.” Instead it establishes accounting

“principles.” However, for a company that reports to the SEC, the principles may be

perceived as regulations.

2. Companies may reduce benefits when they adopt GAAP for several reasons. First, and

most rationally, the computation of the costs incurred in OPEBs may make management

C20-9 (In millions)

1. (a) The company’s pension expense for 2007 is $113 (p. 108).

C20-9 (continued)

3. (a) The benefit obligation for pensions at December 31, 2007 is $3,517 (p. 106).

5. The increase in the discount rate in 2007 (a) decreased the benefit obligations and (b)

decreased the pension expense because the service cost and the interest cost were

lower.

C20-10

Note to Instructor: This case does not have a definitive answer. From a financial reporting

perspective, GAAP is identified and summarized. From an ethical perspective, various

issues are raised for discussion purposes.

From a financial reporting perspective, the issue involves whether a company can select

From an ethical perspective, the issue involves whether it is appropriate to influence

pension expense. The primary stakeholders are the company’s employees and retirees,