Practice Exam for Pension Accounting

206. What are the possible components of pension expense? Which of these elements would exist in every plan? Answer: 1) service cost; 2) interest cost; 3) actual return on plan assets (adjusted for gain on the plan assets); 4) amortization of prior service cost; and 5) amortization of net loss or gain Since virtually all pension funds have plan assets and a PBO, #s 1, 2, & 3 would always exist. Item 4 would only be required if prior service cost is created by plan amendments. Item 5 would probably be present in every plan unless actual and expected returns were equal and there were no changes in factors affecting the PBO computation.

205. Discuss income smoothing as the term relates to pension plans. Answer: Gains and losses can occur when either the PBO or the return on plan assets turns out to be different than expected. The gains and losses receive delayed recognition. This delayed recognition achieves income smoothing. The justification for delayed recognition is that over time these gains and losses cancel one another out. Recognition is delayed until a "corridor" amount has been exceeded, and then only a portion of the excess is included in pension expense. Fluctuations in earnings that would be caused by immediate recognition of these gains and losses are avoided. Therefore, income smoothing is achieved.

204. What is the theoretical and practical trade-off when measuring the pension liability using the projected benefit obligation compared to the accumulated benefit obligation? Answer: The PBO uses projected future compensation levels while the ABO uses current compensation levels. When the liability is measured by the PBO, reliability is sacrificed for relevancy and representational faithfulness.

178. Carolina Consulting Company has a defined benefit pension plan. The following pensionrelated data were available for the current calendar year: PBO: Balance, Jan. 1 Service cost Interest cost (5% discount rate) Gain from changes in actuarial assumptions in 2006 Benefits paid to retirees Balance, Dec. 31 Plan assets:

$240,000 41,000 12,000 (5,000) (20,000) $268,000

Balance, Jan.1 Actual return (expected return was $22,500) Contributions Benefits paid Balance, Dec. 31 ABO, Dec. 31 January 1, 2006, balances: Prepaid (accrued) pension cost (credit balance) Unrecognized prior service cost (amortization $4,000/yr.) Unrecognized net gain (amortization, if any, over 15 years)

$250,000 20,000 35,000 (20,000) $285,000 $245,000

($ 6,000) 4,000 1,000

There were no other relevant data. Required: (1.) Calculate the 2006 pension expense. Show calculations. (2.) Prepare the 2006 journal entry to record pension expense and funding. (3.) Prepare any 2006 journal entry necessary to record any additional pension liability needed. Answer: Requirement 1 Service cost $41,000 Interest cost 12,000 Actual return on plan assets ($20,000) Adjusted for $2,500 loss on plan assets (22,500) Amortization of prior service cost 4,000 Amortization of net gain (1,000) Pension expense $33,500 Computation of net gain amortization: Net gain (previous gains exceeded previous losses) 10% of $250 (greater than $240) Amount to be amortized Amortization

$40 (25) $15 15 $1

Requirement 2 Pension expense Prepaid (accrued) pension cost Cash

33,500 1,500 35,000

Requirement 3 No entry needed since the accumulated benefit obligation does not exceed the plan assets.

175.

Torch Company has a defined benefit pension plan. On December 31, 2006, the following pension-related data were available: $6,000,000 25,000,000 18,000,000 15,000,000 1,000,000

Unamortized prior service cost Projected benefit obligation Accumulated benefit obligation Plan assets Accrued pension cost

Required: (1.) Determine Torch's minimum pension liability to be reported on the December 31, 2006, balance sheet and prepare any journal entry necessary to achieve that reporting objective. (2.) Assume the same facts as in requirement 1, except that there was a prepaid pension cost of $1,000,000. Determine Torch's minimum pension liability to be reported on the December 31, 2006 balance sheet and prepare any journal entry necessary to achieve that reporting objective. Answer: 1.) ABO $(18,000,000) Plan assets 15,000,000 Minimum liability (3,000,000) Pension liability (cr) Accrued pension cost (cr) Additional liability (cr) Intangible pension asset Additional liability $(3,000,000) (1,000,000) $(2,000,000) 2,000,000 2,000,000

2.)

The minimum liability is still $3 million as shown above. The journal is now as follows: Intangible pension asset Additional liability Additional liability (cr. bal) Prepaid pension cost (dr. bal) Pension liability

4,000,000 4,000,000 $(4,000,000 ) 1,000,000 $(3,000,000)

The $3 million pension liability is reported on the balance sheet as a single amount.

170. Pension data for Sam Adams Inc. include the following for the current calendar year: Discount rate, 8% Expected return on plan assets, 10% Actual return on plan assets, 9% Service cost $400,000 January 1: PBO ABO Plan assets Amortization of prior service cost Amortization of net gain December 31: Cash contributions to pension fund Benefit payments to retirees

3,000,000 2,000,000 3,200,000 30,000 7,000 $275,000 310,000

Required: (1.) Determine pension expense for the year. (2.) Prepare the journal entry to record pension expense and funding for the year. Answer: 1) Service cost $400,000 Interest cost (8% x $3,000,000) 240,000 Expected return (10% x $3,200,000) (320,000) Amortization of prior service cost 30,000 Amortization of net gain (7,000) Pension expense $343,000 2) Pension expense Prepaid (accrued) pension cost Cash 343,000 68,000 275,000

162. The following information relates to Hatami Company's defined benefit pension plan

during 2006: Plan assets at fair value, January 1 Expected return on plan assets Actual return on plan assets Contributions to the pension fund (end of year) Amortization of unrecognized loss Pension benefits paid (end of year) Pension expense $600,000,000 50,000,000 40,000,000 90,000,000 0 32,000,000 60,000,000

Required: Determine the balance of pension plan assets at fair value on December 31, 2006. Answer: (in millions) Plan assets beginning of 2006 $600 Actual return 40 Cash contributions 90 Retiree benefits (32) Plan assets end of 2006 $698

161. Jetson Company determined its pension expense to be $15 million in 2006. Following are two independent situations: (1.) Jetson contributed $8 million to the pension fund at the end of 2006. (2.) Jetson contributed $18 million to the pension fund at the end of 2006. Required: Prepare the appropriate journal entries to record Jetson's pension expense and contribution in each situation. Answer: 1) Pension expense (given) 15,000,000 Prepaid (accrued) pension cost 7,000,000 Cash (given) 8,000,000 2) Pension expense (given) Prepaid (accrued) pension cost Cash (given) 15,000,000 3,000,000 18,000,000

23-27. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase. Terms: A. Accumulated benefit obligation B. Accrued pension cost C. Funded status D. Interest cost

E. Pension Benefit Guaranty Corp. F. Plan assets G. Prepaid pension cost H. Projected benefit obligation I. Service cost J. Time cost

Phrases: 23. ____ Created by "ERISA" legislation 24. ____ Created only by the passage of time 25. ____ Cumulative employer's contributions in excess of recognized pension expense. 26. ____ Current pay levels implicitly assumed. 27. ____ Difference between PBO and plan assets. Answer: 23-E; 24-D; 25-G; 26-A; 27-C

56. Pension expense is decreased by: A) Amortization of prior service cost. B) Amortization of unrecognized net gain. C) Benefits paid to retired employees. D) Prior service cost.

57. The PBO is increased by: A) An increase in the average life expectancy of employees. B) Amortization of prior service cost. C) An increase in the actuary's assumed discount rate. D) A return on plan assets that is lower than expected.

59. Interest cost is calculated by multiplying the: A) ABO by the expected return on the plan assets. B) ABO by the discount rate. C) PBO by the expected return on plan assets. D) PBO by the discount rate.

60. The accounting for defined contribution pension plans is easy because each year: A) The employer records pension expense equal to the amount paid out to retirees. B) The employer records pension expense based on an amount provided by the actuary. C) The employer records pension expense equal to the annual contribution. D) The employer records pension expense based on the earnings of the plan assets.

61. The annual pension expense for what type of pension plan(s) is recorded by a journal entry that includes a debit to pension expense, a credit to cash and a debit (credit) to

prepaid (accrued) pension cost? A) A defined benefit plan only. B) A defined contribution plan only. C) Both a defined benefit and a defined contribution plan. D) This is not the correct entry.

73. Consider the following: I. present value of vested benefits at present pay levels II. present value of nonvested benefits at present pay levels III. present value of additional benefits related to projected pay increases Which of the above constitutes the accumulated benefit obligation? A) I & II. B) I, II, III. C) II & III. D) II only.

74. Consider the following: I. present value of vested benefits at present pay levels II. present value of nonvested benefits at present pay levels III. present value of additional benefits related to projected pay increases Which of the above constitutes the projected benefit obligation? A) III only. B) I, II. C) I, II, III. D) II only.

75. Consider the following: I. present value of vested benefits at present pay levels II. present value of nonvested benefits at present pay levels III. present value of additional benefits related to projected pay increases Which of the above constitutes the vested benefit obligation? A) I & II. B) I, II, III. C) II. D) I only.

76. Interest cost will: A) Increase the PBO and increase pension expense. B) Increase pension expense and reduce plan assets. C) Increase the PBO and reduce plan assets. D) Increase pension expense and reduce the return on plan assets.

79. Compared to the PBO, the ABO usually is: A) More relevant. B) More representationally faithful. C) More reliable. D) More material.

80. The projected benefit obligation is computed by actuaries using: A) Future value concepts. B) Present value concepts. C) Market value concepts. D) Fair value concepts.

81. The component of pension expense that results from amending a pension plan to give recognition to previous service of currently enrolled employees is called:

A) B) C) D)

Prior service costs. Previous service costs. Retiree service costs. Transition costs.

82. Payment of retirement benefits: A) Increases the PBO. B) Increases the ABO. C) Reduces the GBO. D) Reduces the PBO.

83. An underfunded pension plan means that: A) PBO is less than plan assets. B) PBO exceeds plan assets. C) ABO is less than plan assets. D) ABO exceeds plan assets.