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Identify the five components that comprise pension expense. Briefly explain the nature of each component.

Short Answer

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The pension expense of an organization strictly depends upon its five components.These components are equally responsible for the overall enhancement of the projected defined benefit pension plan.

Step by step solution

01

The five components of the pension expense are

  1. Service cost
  2. Interest cost
  3. Actual return on plan assets
  4. Amortization of past services
  5. Gains and losses
02

Nature of each component

1. Service cost:Service cost measures the present value of pension benefits by using the pension benefit formula for the total number of years of service of an employee during the period of an accounting year.

2. Interest cost:It is calculated by multiplying the amount of projected benefit obligation with its settlement rate that measures the increase in the defined benefit obligation pension plan.

3. Actual return on plan assets:It measures the inevitable decrease in the pension cost for the investment made by an organization towards the pension plans. It is responsible for measuring the variation in the amount of plan value of assets.

4. Amortization of past services:It is a term used to measure the cost of benefits (retroactive) that are acceptable in the pension plan amendment of the organization.

5. Gains and losses:It measures the variation in the amount of defined benefit obligation and the plan assets of the organization. It arises due to the difference in the actual and the expected value of plan assets according to the actuarial assumptions.

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Most popular questions from this chapter

How does an โ€œasset gain or lossโ€ develop in pension accounting? How does a โ€œliability gain or lossโ€ develop in pension accounting?

At January 1, 2017, Wembley Company had plan assets of \(250,000 and a defined benefit obligation of the same amount. During 2017, service cost was \)27,500, the discount rate was 10%, actual return on plan assets was \(25,000, contributions were \)20,000, and benefits paid were \(17,500. Based on this information, what would be the defined benefit obligation for Wembley Company at December 31, 2017? (a) \)277,500. (c) \(27,500. (b) \)285,000. (d) $302,500.

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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 companyโ€™s pension plans in its financial statements and its notes?

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