Question

LGD Consulting is a medium-sized provider of environmental engineering services. The corporation sponsors a noncontributory, defined benefit pension plan. Alan Barlow, a new employee and participant in the pension plan, obtained a copy of the 2021 financial statements, partly to obtain additional information about his new employer’s obligation under the plan. In part, the pension disclosure note reads as follows: 

 

In attempting to reconcile amounts reported in the disclosure note with amounts reported in the income statement and balance sheet, Barlow became confused. He was able to find the pension expense on the income statement but was unable to make sense of the balance sheet amounts. Expressing his frustration to his wife, Barlow said, “It appears to me that the company has calculated pension expense as if they have the pension liability and pension assets they include in the note, but I can’t seem to find those amounts in the balance sheet. In fact, there are several amounts here I can’t seem to account for. They also say they’ve made some assumptions about interest rates, pay increases, and profits on invested assets. 

I wonder what difference it would make if they assumed other numbers.” Barlow’s wife took accounting courses in college and remembers most of what she learned about pension accounting. She attempts to clear up her husband’s confusion. 

 

Required: 

Assume the role of Barlow’s wife. Answer the following questions for your husband. 

1. Is Barlow’s observation correct that the company has calculated pension expense on the basis of amounts not reported in the balance sheet? 

2. What amount would the company report as a pension liability in the balance sheet? 

3. What amount would the company report as a pension asset in the balance sheet? 

4. Which of the other two amounts reported in the disclosure note would the company report in the balance sheet? 

5. The disclosure note reports a net actuarial gain as well as an actuarial loss. Does the loss in 2021 indicate that the PBO is higher or is lower than previously expected due to some unspecified change in an actuarial assumption. How are these related? What do the amounts mean? 

6. Losses and gains are reported in the statement of comprehensive income as they occur. These amounts accumulate as a net gain or net loss in the balance sheet as part of what account?

Answer 1

Projected Benefit Obligation (PBO)

PBO is a pension obligation in accounting. The PBO is the discounted present value of total retirement benefit earned so far by an employee. It uses estimated future compensation level to apply the pension formula.

 

Pension Expense

This is one of the expenses to a company like wages and salaries which is paid for the employees for their services. 

 

Pension expense includes the following elements:

1. Service cost

2. Interest cost

3. Expected return on plan assets

4. Amortization of prior service cost

5. Amortization of net loss or net gain

 

Requirement 1:

Yes, the company has calculated the pension expense on the basis of amounts not reported in the balance sheet. The company’s balance sheet does not contain the amount of projected benefit obligation and pension assets. It does not reflect the balance on a “net basis”.

 

Requirement 2:

In 2015, the plan asset is underfunded by $30,000

[$3,786,000(PBO) - $3,756,000(Plan assets)]

 

Hence, the company would report $30,000 as a pension liability in 2015 balance sheet.

 

Note: The Company would not report any pension liability in 2016 balance sheet.

 

 

Requirement 3:

In 2016, the plan asset is overfunded by $405,000

[$4,559,000(Plan assets) - $154,000(PBO)]

 

Hence, the company would report $405,000 as a pension asset in 2016 balance sheet.

 

Note: The Company would not report any pension asset in 2015 balance sheet.

 

 

Requirement 4:

The company would report the amount of “net gain” and “prior service cost” as components of “accumulated other comprehensive income” in shareholders’ equity section of the balance sheet.

 

Requirement 5:

When the actual return and expected return either on plan assets or PBO turn out to be different, then gain and losses occur.

 

The loss in 2016 indicates that the actual return on PBO is higher than the expected return due to some unspecified change in actuarial assumption. This loss is reported as Other Comprehensive Income (OCI) in the statement of comprehensive income.

 

A net gain and a net loss includes in the pension expense only if it exceeds the amount equal to 10% of PBO, or 10% of plan assets, whichever is higher. In case of Company L, this is appeared. Hence, the amortized portion of net gain is included in the pension expense.

 

 

Requirement 6:

Net actuarial gain or loss is the component of pension expense which represents deferred recognition.

The company would report the amount accumulate as “net gain or loss” as components of “accumulated other comprehensive income” in shareholders’ equity section of the balance sheet.