Chapter 17, Problem 17.22E

(1)

To determine

Pension expense: Pension expense is an expense to the employer paid as compensation after the completion of services performed by the employees.

Pension expense includes the following components:

• Service cost
• Interest cost
• Expected return on plan assets
• Amortization of prior service cost
• Amortization of net loss or net gain

International Financial Reporting Standards (IFRS): IFRS are a set of international accounting standards which are framed, approved, and published by International Accounting Standards Board (IASB) for the preparation and disclosure of international financial reports.

Generally Accepted Accounting Principles (GAAP): These are the guidelines necessary to create accounting principles approved Financial Accounting Standards Board (FASB) for the implementation of financial information reporting in the Country U.

To compute: Pension expense of L Construction for the year 2016

Explanation of Solution

As per International Accounting Standard Number: 19 of IFRS, the following components are recorded as pension expense on the income statement:

• Service cost
• Past service cost (Prior service cost under GAAP)
• Net interest cost

As per International Accounting Standard Number: 19 of IFRS, the following components are recorded as pension expense on the statement of comprehensive income:

• Loss (gain) on defined benefit obligation (DBO)
• Loss (gain) on plan assets

Determine net pension cost of L Construction for the year 2016, as per IFRS.

Particulars	Amount ($)	Amount ($)
Profit and Loss (Income Statement):
Service cost:
Service cost	$60,000,000
Past service cost	12,000,000
Service cost		$72,000,000
Net interest cost (income):
Net interest cost		9,000,000
Other Comprehensive Income (OCI):
Re-measurement cost:
Loss (gain) on plan assets		(9,000,000)
Net pension cost		$72,000,000

Table (1)

Working Notes:

Compute net interest cost.

$\begin{array}{c}\begin{array}{l}\text{Net interest }\\ \text{cost }\left(\text{income}\right)\end{array}\}\text{ = Interest rate × Net pension }\left(\text{liability}\right)\text{asset}\\ \text{= Interest on beginning DBO – Interest on beginning plan assets}\\ \text{= }\left(\text{7}\text{.5\%×\$360,000,000}\right)\text{–}\left(\text{7}\text{.5\%×\$240,000,000}\right)\\ \text{= \$9,000,000}\end{array}$ (1)

Compute loss (gain) on plan assets.

$\begin{array}{c}\begin{array}{l}\text{Loss }\left(\text{gain}\right)\text{ on}\\ \text{ plan assets}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Actual return – }\\ \left(\text{Interest rate × Beginning balance of plan assets}\right)\end{array}\right\}\\ \text{=\$27,000,000–}\left(\text{7}\text{.5\%×\$240,000,000}\right)\\ \text{=\$27,000,000–\$18,000,000}\\ \text{=\$}\left(\text{9,000,000}\right)\end{array}$ (2)

(2)

To determine

To journalize: Entries related to net pension cost, funding, and retiree benefits paid in 2016.

Explanation of Solution

Journalize the entry related to service cost of pension cost.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		Service cost		72,000,000
		DBO (2018 Service Cost)			60,000,000
		DBO (Past Service Cost)			12,000,000
		(To record service cost)

Table (2)

• Service cost is an expense account. Expenses decrease Equity value, and a decrease in equity is debited.
• DBO is a liability account. Service cost increases DBO, and an increase in liability is credited.
• DBO is a liability account. Past service cost increases DBO, and an increase in liability is credited.

Journalize the entry related to net interest cost of pension cost.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		Net interest cost		9,000,000
		Plan Assets		18,000,000
		DBO			27,000,000
		(To record net interest cost)

Table (3)

• Net interest cost is an expense account. Expenses decrease Equity value, and a decrease in equity is debited.
• Plan Assets is an asset account. The return on assets increases plan assets, and an increase in assets is debited.
• DBO is a liability account. Interest cost increases DBO, and an increase in liability is credited.

Working Notes:

Refer to Equation (1) for value and computation of net interest cost.

Compute expected return on plan assets.

$\begin{array}{c}\text{Expected return on plan assets = Interest rate × Beginning balance of plan assets}\\ \text{=7}\text{.5\%×\$240,000,000}\\ \text{=\$18,000,000}\end{array}$

Compute interest cost.

$\begin{array}{c}\text{Interest cost = Beginning balance of PBO × Interest rate}\\ \text{= \$360,000,000×7}\text{.5\%}\\ \text{= \$27,000,000}\end{array}$

Journalize the entry related to loss (gain) on plan assets of pension cost.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		Plan Assets		9,000,000
		Re-measurement Gain on Plan        Assets–OCI			9,000,000
		(To record loss (gain) on plan assets)

Table (4)

• Plan Assets is an asset account. The gain on return on assets increases plan assets, and an increase in assets is debited.
• Re-measurement Gain on Plan Assets–OCI is a gain or revenue account. Gains and revenues increase shareholders’ equity, and an increase in shareholders’ equity is credited.

Note: Refer to Equation (2) for value and computation of loss (gain) on plan assets.

Journalize the amount funded to pension funds of plan assets.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		Plan Assets		60,000,000
		Cash			60,000,000
		(To record plan assets being funded)

Table (5)

• Plan Assets is an asset account. Since cash is contributed to plan assets, assets are increased, and an increase in assets is debited.
• Cash is an asset expense account. Since cash is contributed by the company, asset amount is decreased and a decrease in asset is credited.

Journalize the amount of pension paid.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		DBO		37,000,000
		Plan Assets			37,000,000
		(To record the pension being paid and liability reduced)

Table (6)

• DBO is a liability account. Since the pension benefits are paid to retirees, the liability to pay decreases, and a decrease in liability is debited.
• Plan Assets is an asset account. Since cash is paid to retirees, assets are decreased, and a decrease in assets is credited.