Question

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

Short answer

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

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

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.