Question

Nerwin, Inc. is a furniture manufacturing company with 50 employees. Recently, after a long negotiation with the local labor union, the company decided to initiate a pension plan as a part of its compensation plan. The plan will start on January 1, 2017. Each employee covered by the plan is entitled to a pension payment each year after retirement. As required by accounting standards, the controller of the company needs to report the pension obligation (liability). On the basis of a discussion with the supervisor of the Personnel Department and an actuary from an insurance company, the controller develops the following information related to the pension plan. Average length of time to retirement 15 years Expected life duration after retirement 10 years Total pension payment expected each year after retirement for all employees. Payment made at the end of the year. $700,000 per year The interest rate to be used is 8%.

Instructions On the basis of the information above, determine the present value of the pension obligation (liability).

Short answer

The present value of pension obligation is $2,175,629.37.

Step-by-step solution

Calculation of expected annual pension payments

$\begin{array}{rcl}\mathrm{Expected}\mathrm{annual}\mathrm{pension}\mathrm{payment}& =& \mathrm{payment}\mathrm{made}\mathrm{at}\mathrm{the}\mathrm{year}\times \mathrm{PVAF}\\ & =& 700,000\times 6.71008\\ & =& \$4,497,056\end{array}$

Present Value of Pension Obligations

$\begin{array}{rcl}\mathrm{Present}\mathrm{value}\mathrm{of}\mathrm{pension}\mathrm{obligation}& =& \mathrm{Expected}\mathrm{annual}\mathrm{pension}\mathrm{payment}\times \mathrm{PVAF}\\ & =& 4,697,056\times 0.46319\\ & =& 2,175,629.37\end{array}$