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The Kensington Company started a defined benefit pension plan on January 1, 20X1. The plan requires no contribution from the employee and offers immediate full vesting. Employees are given credit for up to 6 years of service prior to the initiation of the plan. Retirement benefits are equal to 3.0% of the average of the last 3 years of an employee's earnings, for each year of service that qualifies for benefits. The following information relates to the pension plan. The settlement rate is 6%. The assumed rate of return on plan assets is 8%. Benefits are paid to retirees at the end of each year. Annual pension funding is equal to $15,800. Funding takes place at the end of each year. On January 1, 20X1, the pension is initially funded with $30,000. Laustin D. Woods is the only employee currently covered by the pension plan. Mr. Woods worked for the company for 11 years prior to the initiation of the plan. Mr. Woods is expected to work 12 years while earning pension benefits before retiring. The company estimates that Mr. Woods will collect pension benefits for 14 years after he retires. Mr. Woods' expected compensation over the last 4 years of his employment are as follows: Retirement year $121,000 1 st year prior to retirement year 116,000 2 nd year prior to retirement year 110,000 3 rd year prior to retirement year 103,000 Mr. Woods elected to receive early withdrawals or payments from the pension plan in 20X1, 20X2, and 20X3 of $1,200 at the end each year (prior to retirement while working for Kensington). Required: Calculate net pension expense for 20X1, 20X2 ACC440 - External Financial Reporting II Chapter 17, Pensions and Other Post Retirement Benefits Basic Pension Information - Fieldstone Manufacturing 1.) 2.) 3.) 4.) 5.) Defined benefit, noncontributory pension plan with immediate full vesting. Retirement benefits are paid at the end of each retirement year. No credit for employee service prior to the date the pension plan becomes effective. Assumed discount rate of 10%. Pension plan pays retirement benefits equal to 2% for each year of service that qualifies for pension credit, based on the average of the employee's last three highest salaries. 6.) A pension fund is not established. Employee Information - I. M. Olde 1.) 2.) 3.) 4.) Will retire at age 65. Has an expected retirement period of 10 years. Is 60 years old at the time the pension plan becomes effective. Employed by Fieldstone Manufacturing for 15 years before the pension plan becomes effective. 5.) Average of three highest annual salaries is expected to be $70,000. Questions 1.) What is the annual retirement benefit that I. M. Olde earns for each year of employment? 2.) Compute the service cost for year 1 for Fieldstone Manufacturing. At this time, what is the projected benefit obligation (PBO)? 3.) Prepare the journal entries necessary on Fieldstone Manufacturing's books for year 1 and year 2 to record Olde's pension benefits. 4.) Assume now that Fieldstone Manufacturing makes annual contributions of $6,771 to fund the pension plan. The assets are expected to earn a return of 12%. Prepare the journal entries necessary on Fieldstone's books for year 1 and year 2 to record I. M. Olde's pension benefits. 5.) Assume now that I. M. Olde is to be given credit for his prior years of service (15 years). The prior service cost is not funded prior to the retirement date. Fieldstone Manufacturing will fund amounts equal to $13,000, $14,000 and $15,000 in years 1, 2 and 3 respectively. a.) Compute the annual retirement benefit that I. M. Olde earns as a result of this credit for prior year service. b.) What is the present value of this annual retirement benefit at the plan inception date? What does this number represent at the plan inception date? c.) Prepare the journal entries necessary on Fieldstone's books for year 1, year 2 and year 3 to record Olde's pension benefits. d.) Prepare the reconciliation schedule Fieldstone would present in its financial statements at the end of year 1 and year 2. ACC440 - External Financial Reporting II Chapter 17, Pensions and Other Post Retirement Benefits 6.) Continuing with the new assumptions made in #5, the assumed return on plan assets was 12% while actual return on plan assets for year 2 was 8%. Also assume that the PBO was increased by $14,000 due to revisions of actuarial estimates. a.) Calculate pension expense for year 2. b.) Prepare the journal entries necessary on Fieldstone's books for year 2 to record Olde's pension benefits. c.) Prepare the reconciliation schedule Fieldstone would present in its financial statements at the end of year 2. 7.) How would the solution for question #6 change if benefits of $11,200 were paid in year 3? ACC440 - External Financial Reporting II Chapter 17 - Pensions and Post Retirement Benefits Question #1 60 65 1 2 1 3 2 12/31/X1 Financial Statements 4 3 75 10 n 4 $1,400 / year 1 year x 2% x $70,000 = $1,400 for every year of service Question #2 Present value of an Ordinary Annuity (assume that pension benefits are paid at the end of the year), 10n, 10% $1,400 x 6.14457 = $8,602 $8,602 x .68301 = $5,875 Present value of a single sum, 4n, 10%; to value the benefit annuity as of the end of the period of service (financial statement date) ACC440 - External Financial Reporting II Chapter 17 - Pensions and Post Retirement Benefits Question #3 + + + +/- Service cost Interest cost (10%) Return on Plan Assets Amortization of Prior Service Cost Amortization of Gains / Losses Pension Expense Year 2 Service Cost Year 1 5,875 5,875 Year 2 6,463 588 7,051 Off-Balance Sheet account $8,602 x .75132 = $6,463 Present value of a single sum, 10%, 3n Year 3 Service Cost $8,602 x .82645 = $7,109 Present value of a single sum, 10%, 2n Year 3 7,109 1,293 8,402 PBO 5,875 5,875 6,463 588 12,926 7,109 1,293 21,327 Y1 SC 12/31/Y1 Y2 SC Y2 IC 12/31/Y2 Y3 SC Y3 IC 12/31/Y3 Journal Entries Year 1 Pension Expense Pension Liability 5,875 5,875 Year 2 Pension Expense Pension Liability 7,051 7,051 Year 3 Pension Expense Pension Liability 8,402 8,402 ACC440 - External Financial Reporting II Chapter 17 - Pensions and Post Retirement Benefits Question #4 + + + +/- Service cost Interest cost (10%) Return on Plan Assets Amortization of Prior Service Cost Amortization of Gains / Losses Pension Expense Y1 Funding 12/31/Y1 Y2 ROPA Y2 Funding 12/31/Y2 Y3 ROPA Y3 Funding 12/31/Y3 Plan Assets 6,771 6,771 813 6,771 14,355 1,723 6,771 22,848 * $6,771 x 12% = $813 ** $14,355 x 12% = $1,723 Year 1 5,875 5,875 Year 2 6,463 588 (813) * 6,238 Year 3 7,109 1,293 (1,723) ** 6,679 PBO 5,875 5,875 6,463 588 12,926 7,109 1,293 21,327 Y1 SC 12/31/Y1 Y2 SC Y2 IC 12/31/Y2 Y3 SC Y3 IC 12/31/Y3 Journal Entries Year 1 Pension Expense Pension Asset Cash 5,875 896 6,771 Year 2 Pension Expense Pension Asset Cash 6,238 533 6,771 Year 3 Pension Expense Pension Asset Cash 6,679 92 6,771 Pension Asset 896 533 1,429 92 1,521 PBO PA Funded Status Year 1 (5,875) 6,771 896 Year 2 (12,926) 14,355 1,429 Year 3 (21,327) 22,848 1,521 ACC440 - External Financial Reporting II Chapter 17 - Pensions and Post Retirement Benefits Question #5 a 60 15n 65 1 2 5n Prior Years 3 4 75 10 n $21,000 / year 15 years x 2% x $70,000 = $21,000 per year Question #5 b Present value of an Ordinary Annuity (assume that pension benefits are paid at the end of the year), 10n, 10% $21,000 x 6.14457 = $129,036 $129,036 x .62092 = $80,121 1/1/Y1 PBO Present value of a single sum, 5n, 10%; to value the benefit annuity as of the prior service award date (inception of plan, 1/1/Y1). $80,121 / 5 year = $16,024 per year. Amortize the present value of the Prior Service Award over the expected remaining average service period of pension plan participants. ACC440 - External Financial Reporting II Chapter 17 - Pensions and Post Retirement Benefits Question #5 c Service cost Interest cost (10%) Return on Plan Assets Amortization of Prior Service Cost Amortization of Gains / Losses Pension Expense Year 2 6,463 9,401 (1,560) 16,024 30,328 Year 3 7,109 10,987 (3,427) 16,024 30,693 Funding + + + +/- Year 1 5,875 8,012 16,024 29,911 13,000 14,000 15,000 Y1 Funding 12/31/Y1 Y2 ROPA Y2 Funding 12/31/Y2 Y3 ROPA Y3 Funding 12/31/Y3 Plan Assets 13,000 13,000 1,560 14,000 28,560 3,427 15,000 46,987 PBO 80,121 5,875 8,012 94,008 6,463 9,401 109,872 7,109 10,987 127,968 Y1 SC Y1 IC 12/31/Y1 Y2 SC Y2 IC 12/31/Y2 Y3 SC Y3 IC 12/31/Y3 Accumulated Other Other Comprehensive Income Unrecognized Prior Service Cost 80,121 16,024 64,097 12/31/Y1 16,024 48,073 12/31/Y2 16,024 32,049 12/31/Y3 Journal Entries Year 1 Other Comp Inc - Prior Serv Cost Pension Liability 80,121 Pension Expense 29,911 Other Comp Inc - Prior Serv Cost Pension Asset / Liability Cash 80,121 16,024 887 13,000 As calculated above Current year amortization of Prior Service Award Plug to balance entry Funded amount Year 2 Pension Expense 30,328 Other Comp Inc - Prior Serv Cost Pension Asset / Liability Cash Pension Asset / Liability 80,121 887 81,008 304 81,312 331 80,981 16,024 304 14,000 Year 3 Pension Expense 30,693 Pension Asset / Liability 331 Other Comp Inc - Prior Serv Cost Cash 16,024 15,000 Question #5 d Footnote disclosure reconciliation schedule Projected Benefit Obligation Plan Assets Funded Status (Pension Asset / Liability) Year 1 (94,008) 13,000 Year 2 (109,872) 28,560 Year 3 (127,968) 46,987 (81,008) (81,312) (80,981) ACC440 - External Financial Reporting II Chapter 17 - Pensions and Post Retirement Benefits Question #6 a & b + + + +/- Funding Y1 Funding 12/31/Y1 Y2 ROPA Y2 Funding 12/31/Y2 Y3 ROPA Y3 Funding 12/31/Y3 Plan Assets 13,000 13,000 1,040 14,000 28,040 3,365 15,000 46,405 Other Comp Income Gain/Loss 14,000 Y2 Variance 520 12/31/Y2 14,520 711 12/31/Y3 13,809 Year 2 6,463 9,401 (1,560) 16,024 30,328 Year 3 7,109 12,387 (3,365) 16,024 711 32,866 13,000 Service cost Interest cost (10%) Return on Plan Assets Amortization of Prior Service Cost Amortization of Gains / Losses Pension Expense Year 1 5,875 8,012 16,024 29,911 14,000 15,000 PBO 80,121 5,875 8,012 94,008 6,463 9,401 14,000 123,872 7,109 12,387 143,368 Y1 SC Y1 IC 12/31/Y1 Y2 SC Y2 IC 12/31/Y2 Actuarial Adjustment 12/31/Y2 Y3 SC Y3 IC 12/31/Y3 Actuarial Adjustment Actual return is equal to $1,040; projected return is equal to $1,560. The difference is a differed loss. * Corridor Approach To determine if any Unrecognized Gains or Losses must be recognized through amortization, the corridor approach is used to evaluate the account balance. The test is performed using beginning balances for the Unrecognized Gain / Loss account, the Projected Benefit Obligation (PBO) account, and the Plan Assets (PA) account. The corridor is determined by selecting the greater of the beginning PBO balance or the beginning PA balance. The larger balance is then multiplied by 10% (this is according to the FASB standard and in no way is related to the settlement rate). The amount calculated is the maximum amount of gain or loss that can exist before triggering recognition. If the balance in the Other Comp Income - (G/L) account exceeds the corridor, the amount by which the balance exceeds the corridor is amortized over the remaining average service life of the plan participants. Year 3 Year 3 is the first year that has a non-zero beginning balance in the Unrecognized Gain / Loss account and therefore requires corridor analysis to calculate pension expense. 1/1/Y3 PBO = $123,872 PBO is larger; $123,872 x 10% = $12,387 1/1/Y3 Plan Assets = $28,040 Corridor = $12,387 versus Unrecognized loss of $14,520 Amortize excess loss of $2,133 over 3 years (Y3, Y4, Y5) = $711 per year Journal Entries Year 1 Other Comp Inc - Prior Serv Cost Pension Asset / Liability 80,121 Pension Expense 29,911 Other Comp Inc - Prior Serv Cost Pension Asset / Liability Cash 80,121 16,024 887 13,000 As calculated above Current year amortization of Prior Service Award Plug to balance entry Funded amount Year 2 Pension Expense 30,328 Other Comp Inc (G/L) 14,520 Other Comp Inc - Prior Serv Cost Pension Asset / Liability Cash Pension Asset / Liability 80,121 887 81,008 14,824 95,832 1,131 96,963 16,024 14,824 14,000 Year 3 Pension Expense 32,866 Pension Asset / Liability Other Comp Inc - Prior Serv Cost Other Comp Inc (G/L) Cash 1,131 16,024 711 15,000 Question #5 d Footnote disclosure reconciliation schedule Projected Benefit Obligation Plan Assets Funded Status (Pension Asset / Liability) Year 1 (94,008) 13,000 Year 2 (123,872) 28,040 Year 3 (143,368) 46,405 (81,008) (95,832) (96,963)