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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Recognizing pension expense

The annual examination of Felton Company's financial statements by its external public accounting firm (auditors) is nearing completion. ’The following conversation took place between the controller of Felton Company (Francie) and the audit manager from the public accounting firm (Sumana):

Sumana. You know, Francie. we are about to wrap up our audit for this fiscal year. Yet, there is one item still to be resolved Francie: What’s that?

Sumana. Well, as you know, at the beginning of the year. Felton began a defined benefit pension plan This plan promises your employees an annual payment when they retire, using a formula based on their salaries at retirement and their years of service I believe that a pension expense should be recognized this year, equal to the amount of pension earned by your employees.

Francie: Wait a minute I think you have it all wrong The company doesn't have a pension expense until it actually pays the pension in cash when the employee retires After all some of these employees may not reach retirement, and if they don’t, the company doesn't owe them anything

Sumana. You're not really seeing this the right way The pension is earned by your employees dunng their working years You actually make the payment much later—when they retire. It's like one long accrual—much like incurring wages in one period and paying them in the next Thus. I think you should recognize the expense in the period the pension is earned by the employees.

Francie: Let me see if I’ve got this straight I should recognize an expense this penod for something that may or may not be paid to the employees in 20 or 30 years, when they finally retire. How am I supposed to determine what the expense is for the current year? The amount of the final retirement depends on many uncertainties, salary levels, employee longevity, mortality rates, and interest earned on investments to fund the pension. I don’t think an amount can be determined even if I accepted your arguments.

Evaluate Sumana’s position. Is she right, or is Francie correct?

To determine

Pension Expense: Pension is a cash payment given to the employees at the time of their retirement. The pension benefits are accrued based on years of service, annual compensation and age, and based on the employer’s pension plan. There are mainly to basic types of pension plans:

  • Defined contribution pension plan
  • Defined benefits pension plan

To evaluate: Ms. S’s position and find out whether she or Ms. F is correct.

Explanation

Ms. S is correct regarding the treatment of pension expense. The pension is earned by the employees during their working period. It is the part of the employee’s compensation to be paid by the company after the employees’ retirement.

In other words, the pension expense is an accrued expense which is incurred in the current period but paid later. The payment of the expense is deferred until retirement. Thus, such expense is required to be recorded by Ms. F in her books of accounts equal to the amount of pension income earned by the employee for that particular period.

However, Ms...

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