Question

Davis Corporation is a medium-sized manufacturer of paperboard containers and boxes. The corporation sponsors a noncontributory, defined benefit pension plan that covers its 250 employees. Sid Cole has recently been hired as president of Davis Corporation. While reviewing last year’s financial statements with Carol Dilbeck, controller, Cole expressed confusion about several of the items in the footnote to the financial statements relating to the pension plan. In part, the footnote reads as follows.

    Note J. The company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee’s compensation during the last four years of employment. The company’s funding policy is to contribute annually the maximum amount allowed under the federal tax code. Contributions are intended to provide for benefits expected to be earned in the future as well as those earned to date.

The net periodic pension expense on Davis Corporation’s comparative income statement was $72,000 in 2017 and $57,680 in 2016.

The following are selected figures from the plan’s funded status and amounts recognized in the Davis Corporation’s Statement of Financial Position at December 31, 2017 ($000 omitted).
Actuarial present value of benefit obligations:   
Accumulated benefit obligation (including vested benefits of $636)   
$ (870)
Projected benefit obligation   
$(1,200)
Plan assets at fair value   
1,050
Projected benefit obligation in excess of plan assets   
$ (150)

Given that Davis Corporation’s work force has been stable for the last 6 years, Cole could not understand the increase in the net periodic pension expense. Dilbeck explained that the net periodic pension expense consists of several elements, some of which may increase or decrease the net expense.
Instructions

(a) The determination of the net periodic pension expense is a function of five elements. List and briefly describe each of the elements.

(b) Describe the major difference and the major similarity between the accumulated benefit obligation and the projected benefit obligation.

(c)

(1) Explain why pension gains and losses are not recognized on the income statement in the period in which they arise.

(2) Briefly describe how pension gains and losses are recognized.

Answer 1

answer a

1. when a pension plan is adopted, credit is often given for employee service rendered in prior years.

2. The gains and losses component arises from the change in the amount of either the projected benefit obligation or the plan assets. This component is amortized.

answer B

The major similarity between the accumulated benefit obligation and the projected benefit obli-gation is that they both represent the present value of the benefit attributed by the pension benefit formula to employee service rendered prior to a specific date.

All things being equal, when an employee is about to retire, the accumulated benefit obligation and the projected benefit obligation would be the same.The major difference between the accumulated benefit obligation and the projected benefit obli-gation is that the former is based on present salary levels and the latter is based on estimated future salary levels.

Assuming salary increases over time, the projected benefit obligation should be higher than the accumulated benefit obligation.

answer c.

1. Pension gains and losses, sometimes called actuarial gains and losses, result from changes in the value of the projected benefit obligation or the fair value of the plan assets. These changes arise from the deviations between the estimated conditions and the actual experience, and from changes in assumptions.

The volatility of these gains and losses may reflect an unavoidable inability to predict compensation levels, length of employee service, mortality, retirement ages, and other relevant events accurately for a period, or several periods. Therefore, fully recognizing the gains or losses on the income statement may result in volatility that does not reflect actual changes in the funded status of the plan in that period.

2. in order to decrease the volatility of the reporting of the pension gain or losses, the FASB has adopted.