[sleepinthegardn]

Looking for help for this pension question 🙂

Question CPA-05400

Big Books, Inc. has the following information related to its defined benefit pension plan:

December 31, Year 6:

Projected benefit obligation $1,500,000

Fair value of plan assets 1,400,000

Unrecognized prior service cost 200,000

Unrecognized net transition asset 60,000

December 31, Year 7:

Projected benefit obligation $1,740,000

Fair value of plan assets 1,670,000

Service cost 220,000

Assumptions:

Discount rate 6%

Expected return on plan assets 8%

Big Books makes an annual pension plan contribution of $200,000. The company’s employees had an average

remaining service life of 20 years on 12/31/Year 6. The company paid benefits of $70,000 in Year 7 and expects to

pay benefits totaling $170,000 to retired employees in Year 8. Big Books has an effective tax rate of 30%. The actual

return on plan assets was 10%. What would Big Books report as U.S. GAAP net periodic pension cost on its

December 31, Year 7, income statement?

a. $193,400

b. $205,000

c. $187,400

d. $211,000

Explanation

Choice “b” is correct. The Year 7 U.S. GAAP net periodic pension cost should be calculated as follows:

S Service cost $220,000

I Interest cost 90,000 = $1,500,000 x 6% = Beg PBO x discount rate

R Expected return on plan assets (112,000) = $1,400,000 x 8% = Beg FV x expected rate

A Amortization of prior service cost 10,000 = $200,000 / 20 years

G Amortization of (gains) / losses 0

E Amortization of transition asset (3,000) = $60,000 / 20 years

Net periodic pension cost $205,000

My question is, why it chose to used the expected return rather than the actual return on plan assets? I assume the information is enough here that the actual return can be squeezed:

Begining FV 1,400,000 + Contributions 200,000 + Actual return – Paid benefits 70,000 = Ending FV 1,670,000

Therefore, the actual return = 140,000.

Could someone correct me here?

Also, the information of “Big Books has an effective tax rate of 30%.” and “The actual return on plan assets was 10%.” are just distractors?

Thank you in advance :)!

Nothing good comes easy, all good things take some time - Hang in there!
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[Anonymous]

You use expected return because you use expected return.

We like pension expense to be nice and smooth. The market isn't smooth. It's volatile. Sometimes it'll give us 6% returns and sometimes it'll give us 10% and sometimes 8%. We don't want our pension expense going up and down with the market. So we just set our expected rate to 8% and stick to that for pension expense.

Actual returns don't really factor into pension expense. They're compared to expected returns, giving us pension gains and losses, which are eventually amortized into pension expense (slowly and smoothly).

So, according to your calculation (I'll trust you did them correct) actual returns are $140,000 and expected returns are $112,000. That means we have a $28,000 gain. That's an important number, just not for the question being asked. That $28,000 gain sits in OCI for now (DR Pension Liability 28,000 CR OCI – pension gain 28,000), but it doesn't touch pension expense until future years when we amortize it (using the corridor method or straight line)

[Anonymous]

dbl post

[sleepinthegardn]

Sorry for the double post.. I searched but did not find the answer (maybe I didn't search well)

Thanks to both of you!

Nothing good comes easy, all good things take some time - Hang in there!
FAR Q3/14 88
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[samdiegoCPA]

@sleepinthegardn you should join the FAR study group. We just went over your par value method question and people in there are quick to reply!

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[sleepinthegardn]

@samdiegoCPA, Wow how to join? I'd love to!!!!

Nothing good comes easy, all good things take some time - Hang in there!
FAR Q3/14 88
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[Author]

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