Question

Sachs Brands's defined benefit pension plan specifies annual retirement benefits equal to 1.2% × service years × final year's salary, payable at the end of each year. Angela Davenport was hired by Sachs at the beginning of 2007 and is expected to retire at the end of 2041 after 35 years' service. Her retirement is expected to span 18 years. Davenport's salary is $90,000 at the end of 2021 and the company's actuary projects her salary to be $280,000 at retirement. The actuary's discount rate is 8%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) At the beginning of 2022, the pension formula was amended to: 1.35% × Service years × Final year's salary The amendment was made retroactive to apply the increased benefits to prior service years.

Required:

1. What is the company's prior service cost at the beginning of 2022 with respect to Davenport after the amendment described above?

2. Since the amendment occurred at the beginning of 2022, amortization of the prior service cost begins in 2022. What is the prior service cost amortization that would be included in pension expense?

3. What is the service cost for 2022 with respect to Davenport?

4. What is the interest cost for 2022 with respect to Davenport?

5. Calculate pension expense for 2022 with respect to Davenport, assuming plan assets attributable to her of $100,000 and a rate of return (actual and expected) of 10%.

Answer 1

SOLUTION:

1. PRIOR SERVICE COST:

PBO without amendment cost = (1.2% × service years × final year's salary) × PVAF(8%, 18 years) × PV(8%, 20 years)

= (1.2% × 15 × 280,000) × 1-(1+0.08)^-18 / 0.08 × 1 / (1+0.08)²⁰

= 50,400 × 9.3719 × 0.21

= 99,192

Note: ( 2007 to 2015 = 15 years and 35 years - 15 years = 20 years)

PBO with amendment cost = (1.35% × service years × final year's salary) × PVAF(8%, 18 years) × PV(8%, 20 years)

    = (1.35% × 15 × 280,000) × 1-(1+0.08)^-18 / 0.08 × 1 / (1+0.08)²⁰

⁼   56,700 × 9.3719 × 0.21

= 111,591

Prior Service Cost = 111,591 - 99,192

= $ 12,399

2. PRIOR SERVICE COST AMORTIZATION:

Prior Service Cost = $ 12,399

Expected remaining service = 20 years

Prior service cost amortization = 12,399 / 20 years

= $ 619.95

3. SERVICE COST:

Service Cost = (1.35% × service years × final year's salary) × PVAF(8%, 18 years) × PV(8%, 19 years)

= (1.35% × 1 × 280,000) × 1-(1+0.08)^-18 / 0.08 × 1 / (1+0.08)¹⁹

= 3,780 × 9.3719 × 0.23

Service Cost = $ 8,147.92

Note: ( 20 - 1 = 19 years)

4. INTEREST COST:

Interest Cost = PBO with amendment × Actuary Discount Rate

= 111,591 × 8%

Interest Cost = $ 8,927.28

5. PENSION EXPENSE:

Service Cost = $ 8,147.92

Interest Cost = $ 8,927.28

Return on Plan Asset = 100,000 * 10% = $ 10,000

Amortization of Prior Service Cost = $ 619.95

Pension Expense = 8,147.92 + 8,927.28- 10,000 + 619.95

Pension Expense = $ 7,695.15