Chapter 17, Problem 17.16E

(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

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

To journalize: DR Industries’ pension expense

Explanation of Solution

Journalize pension expense, if service cost is $80,000,000, interest cost is $42,000,000, expected return on assets is $40,000,000 (10% of beginning plan assets of $400,000,000), amortization of prior service cost is $4,000,000 (Refer working note), and amortization of net loss is $2,000,000 (Refer working note).

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
				($ in Millions)
2016		Pension Expense		88
		Plan Assets		40
		Projected Benefit Obligation (PBO)			122
		Amortization of Prior Service Cost–OCI			4
		Amortization of Net Loss–OCI			2
		(To record pension expense)

Table (1)

• Pension Expense 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.
• PBO is a liability account. Service cost and interest cost increase PBO, and an increase in liability is credited.
• Amortization of Prior Service Cost–OCI is a contra to Prior Service Cost–OCI account. Since amortization reduces prior service cost balance, it is credited because Prior Service Cost–OCI account is debited.
• Amortization of Net Loss–OCI is a contra to Net Loss–OCI account. Since amortization reduces net loss balance, it is credited because Net Loss–OCI account is debited.

Working Notes:

Compute pension expense.

Particulars	Amount ($)
Service cost (included as PBO)	$80,000,000
Interest cost (included as PBO)	42,000,000
Expected return on the plan assets (included as plan assets)	(40,000,000)
Amortization of prior service cost	4,000,000
Amortization of net (gain) or loss–OCI	2,000,000
Pension expense	$88,000,000

Table (2)

Determine the amortization of net loss.

Beginning Cumulative Net Loss (Gain)	Beginning PBO	Beginning Fair Value of Plan assets	Corridor	Excess Net Loss (Gain)	Amortized Net Loss (Gain)
(Dollars in Millions)
$80	$600	$400	$60	$20	$2

Table (3)

Notes:

Higher of threshold of 10% of beginning PBO or 10% of beginning fair value of plan assets is referred to as corridor. Compute corridor value of the year.

Use the following formula to determine excess of value of beginning balance of gain (loss) over corridor:

$\begin{array}{l}\text{Excess of loss }\left(\text{gain}\right)\\ \text{over corridor}\end{array}\}\text{ = Beginning balance of loss }\left(\text{gain}\right)\text{–Corridor}$

Use the following formula to compute amortized net loss (gain) value:

$\begin{array}{l}\text{Amortized net }\\ \text{loss }\left(\text{gain}\right)\end{array}\}\text{ = }\frac{\text{Excess of loss }\left(\text{gain}\right)\text{ over corridor}}{\text{Average remaining service life of employees, 10 years}}$

(2)

To determine

To journalize: Gains and losses of 2016.

Explanation of Solution

Treatment of recognizing gains and losses related to plan assets: The difference between actual return and expected return on plan assets is represented as gains and losses related to plan assets. If the actual return is higher than expected return, it indicates a gain, and if actual return is lower than expected return, it indicates a loss. These gains or losses are recognized on income statement as ‘Other comprehensive income’ (OCI), and on balance sheet as ‘Accumulated other comprehensive income’ (AOCI).

Journalize the gains and losses related to plan assets.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		Loss–OCI		8,000,000
		Plan Assets			8,000,000
		(To record loss related to plan assets)

Table (4)

• Loss–OCI is a loss or expense account. Losses and expenses reduce shareholders’ equity, and a reduction in shareholders’ equity is debited.
• Plan Assets is an asset account. Since loss occurred due to excess of expected return ($40,000,000) over actual return ($32,000,000), assets are decreased by $8,000,000 $\left(\$32,000,000–\$40,000,000\right)$, and a decrease in assets is credited.

Treatment of recognizing gains and losses related to pension obligation: The decrease or increase in pension obligation due to changes in existing and revised projected benefit obligation (PBO) is represented as gains and losses related to pension obligation. If the PBO with revised estimate is higher than PBO without revised estimate, it indicates a loss. If the PBO with revised estimate is lower than PBO without revised estimate, it indicates a gain. These gains or losses are recognized on income statement as ‘Other comprehensive income’ (OCI), and on balance sheet as ‘Accumulated other comprehensive income’ (AOCI).

Journalize the gains and losses related to pension obligation.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		PBO		14,000,000
		Gain–OCI			14,000,000
		(To record gains related to PBO)

Table (5)

• Gain–OCI is a gain or revenue account. Gains and revenues increase shareholders’ equity, and an increase in shareholders’ equity is credited.
• PBO is a liability account. Gains decrease PBO, and a decrease in liability is debited.

(3)

To determine

To journalize: The amount funded to pension funds of plan assets.

Explanation of Solution

Journalize the amount funded to pension funds of plan assets.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		Plan Assets		90,000,000
		Cash			90,000,000
		(To record plan assets being funded)

Table (6)

• 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.

(4)

To determine

To journalize: The amount of pension expense paid.

Explanation of Solution

Journalize the amount of pension paid.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		PBO		38,000,000
		Plan Assets			38,000,000
		(To record the pension being paid and liability reduced)

Table (7)

• PBO 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.