Question

Davis Corporation is a medium-sized manufacturer of paperboard containers and boxes. The corporation sponsors a noncontributory, defined benefit pension plan that covers its 250 employees. Sid Cole has recently been hired as president of Davis Corporation. While reviewing last year’s financial statements with Carol Dilbeck, controller, Cole expressed confusion about several of the items in the footnote to the financial statements relating to the pension plan. In part, the footnote reads as follows. Note J. The company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee’s compensation during the last four years of employment. The company’s funding policy is to contribute annually the maximum amount allowed under the federal tax code. Contributions are intended to provide for benefi ts expected to be earned in the future as well as those earned to date. The net periodic pension expense on Davis Corporation’s comparative income statement was \(72,000 in 2017 and \)57,680 in 2016. The following are selected figures from the plan’s funded status and amounts recognized in the Davis Corporation’s Statement of Financial Position at December 31, 2017 (\(000 omitted). Actuarial present value of benefi t obligations: Accumulated benefi t obligation (including vested benefi ts of \)636) \( (870) Projected benefi t obligation \)(1,200) Plan assets at fair value 1,050 Projected benefi t obligation in excess of plan assets $ (150) Given that Davis Corporation’s work force has been stable for the last 6 years, Cole could not understand the increase in the net periodic pension expense. Dilbeck explained that the net periodic pension expense consists of several elements, some of which may increase or decrease the net expense. Instructions (a) The determination of the net periodic pension expense is a function of five elements. List and briefly describe each of the elements. (b) Describe the major difference and the major similarity between the accumulated benefit obligation and the projected benefit obligation. (c) (1) Explain why pension gains and losses are not recognized on the income statement in the period in which they arise. (2) Briefly describe how pension gains and losses are recognized.

Short answer

The financial positionof an organization can be determined byreviewing thefinancial statements and thecompany's financial ratios. Every organization should be financially stable to sustain itself in the market.

Step-by-step solution

(a) The determination of the net periodic pension expense

Pension benefits are those benefits an employee in an organization receives in compensation. These benefits are paid until the time of retirement. Following are the components of the pension expense:

(1) Service costs: It measures the present value of the pension benefits earned by an employee.

(2) Interest cost: It is earned on the defined benefit obligation, which represents the liability for the company.

(3) Actual return on plan assets measures the reduced value of the interest implied on the pension expense.

(4) Prior service cost measures the cost incurred beforehand the number of employees' service.

(5) Gains and losses arise due to the variation in the amounts of benefit obligation and the plan assets.

(b) Difference between the accumulated benefit obligation and the projected benefit obligation

The accumulated benefit obligation is strictly based on the annual pension expense incurred by an organization for its employees. On the other hand, the defined projected benefit obligation measures the current pension expense.

Similarity between the two concepts

One of the most similar things in the accumulated benefit obligation and the projected benefit obligation is that both methods consider the total number of years of service of an employee.

(c) Explanation:

1. Pension gains and losses are not recognized under the income statement.

The amount of pension gains and losses are not recognized under the income statement because the value of gain or loss arises due to the change in assets' actual and fair value. These amounts reflect an inability of an organization to provide compensation, the number of years of service, and the retirement age. Therefore, it does not get recognized under the income statement.

2. Recognition of pension gains and losses

The recognition of pension gains and losses works according to the corridor approach of the IASB. It aims at decreasing the volatility of pension gains and losses.