Question

In examining the costs of pension plans, Helen Kaufman, CPA, encounters certain terms. The components of pension costs that the terms represent must be dealt with appropriately if generally accepted accounting principles are to be reflected in the financial statements of entities with pension plans. Instructions (a) (1) Discuss the theoretical justification for accrual recognition of pension costs. (2) Discuss the relative objectivity of the measurement process of accrual versus cash (pay-as-you-go) accounting for annual pension costs. (b) Explain the following terms as they apply to accounting for pension plans. (1) Market-related asset value. (2) Projected benefit obligation. (3) Corridor approach. (c) What information should be disclosed about a company’s pension plans in its financial statements and its notes?

Short answer

Accounting principles are those rules an organization should follow while reporting the amount under each financial statement during the fiscal year.

Step-by-step solution

(a) Discussions

1. Accrual recognition of pension costs:

The accrual recognition of the total pension cost of an organization strictly depends upon the total pension expense incurred. These types of costs are incurred during the employment service of an employee.

2. Accrual versus cash (pay-as-you-go) accounting:

The cash (pay-as-you-go) accounting concept does not consider the total pension cost earned during the year. It is magnified at the end of the computation of annual pension costs. The Accrual accounting concept always provides a greater source of objectivity than the cash accounting concept.

(b) Explanation of the following terms

1. Market-related asset value:

The market-related asset value or the fair value of the assets determines the actual value of plan assets during a period of an accounting year. Organizations generally use the actuarial value of the plan assets to report an accurate pension value.

2. Projected benefit obligation:

Projected benefit obligation is defined under the IAS 19, where the pension benefits depend upon the number of years of service of an employee and its future expected salary.

3. Corridor approach:

The corridor approach is used to calculate the unrecognized net gain or loss earned from the pension obligation during the year. The rate of corridor approach as prescribed under IASB is 10%.

(c) Information to be disclosed under the pension plans

(1) The components of the pension expense.

(2) The amount of defined benefit obligation and the fair value of plan assets

(3) A detailed study of the pension plan and the accounting principles used.

(4) The discount rates and settlement rates measure the pension benefit amount.

(5) The total contributions made by the employer and the employee.