Chapter 17 Pensions and Other Postretirement Benefits
DETERMINING PENSION EXPENSE
COMPONENTS OF PENSION EXPENSE
1. Service Cost
Service cost reflects in increase in the PBO as a result of employee service during the current
year.
2. Interest Cost
Interest accrued on the beginning PBO for the current year.
3. Return on Plan Assets
Expected return on plan assets for the current year. The difference between the actual return
and expected return in included in the calculation of deferred net loss or net gain.
4. Amortization of Prior Service Cost
Prior service cost results from retroactive credit for prior service when plan is adopted or
amended. The increase is cost is amortized over the future service period of the employees
affected, normally the average remaining service life of the active employees.
5. Amortization of Deferred Net Loss or Net Gain
Increases or decreases in PBO as a result of change in underlying assumptions and the
difference between actual and expected return on plan assets. Amortization is only recorded
if the net loss or net gain at the beginning of the year exceeds the greater of 1) 10% of the
PBO, or 2) 10% of plan assets. This excess amount is amortization over the remaining
service period of the active employees.
Recording the Periodic Expense and Periodic Funding
Pension expense is calculated based on accounting estimates and assumptions as described
above. Cash contributions to the pension plan asset trust fund are determined by an actuary with
the objective of providing funding for the future obligations. The difference between pension
expense and cash contributions are recorded as prepaid pension cost (if a debit) or accrued
pension cost (if a credit).
Example: The following information is available for the pension plan of Spencer Company for
the year 2003:
Actual and expected return on plan assets
Benefits paid to retirees
Contributions to fund
Interest/discount rate
Prior service cost amortization
Projected benefit obligation, January 1, 2003
Service cost
$12,000
40,000
95,000
0
8,000
500,000
60,000
Pension expense for 2003 will be computed as follows:
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Chapter 17 Pensions and Other Postretirement Benefits
Pension Expense for 2003
Service cost
Interest cost
Expected (actual) return on plan assets
Amortization of prior service cost
Total
$60,000
50,000
(12,000)
8,000
$106,000
The journal entry to record pension expense for the year will be:
Account
Debit
$106,000
Credit
Pension expense
Cash
$95,000
Prepaid (accrued) pension cost
11,000
To record pension expense, pension contribution and accrued penstion cost
for the year ended December 31, 2003.
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