Chapter 19, Problem 4P

1.

To determine

Compute the amount of pension expense of Company P for 2016 and 2017.

Explanation of Solution

Pension plan: Pension plan is the plan devised by corporations to pay the employees an income after their retirement, in the form of pension.

Compute the amount of pension expense of Company P for 2016 and 2017 as follows:

Particulars	2016	2017
Service cost	$340,000	$348,000
Add: Interest cost on projected benefit obligation	$218,000 (1)	$273,800 (2)
Less: Expected return on plan assets	$0	($60,300) (4)
Add: Amortization of prior service cost	$136,250(3)	$136,250
Pension expense	$694,250	$697,750

Table (1)

Working note (1):

Calculate the interest cost on projected benefit obligation for 2016:

$\begin{array}{c}\begin{array}{l}\text{Interest cost on projected }\\ \text{benefit obligation for 2016}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Projected benefit obligation for 2016}\times \\ \text{Discount rate}\end{array}\right)\\ =\$2,180,000\times \frac{10}{100}\\ =\$218,000\end{array}$

Working note (2):

Calculate the interest cost on projected benefit obligation for 2017:

$\begin{array}{c}\begin{array}{l}\text{Interest cost on projected }\\ \text{benefit obligation for 2017}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Projected benefit obligation for 2017}\times \\ \text{Discount rate}\end{array}\right)\\ =\$2,738,000\times \frac{10}{100}\\ =\$273,800\end{array}$

Working note (3):

Calculate the amortization of prior service cost for 2016.

$\begin{array}{c}\text{Amortization of prior service cost = }\frac{\text{Projected benefit obligation}}{\text{Remaining service life}}\\ =\frac{\$2,180,000}{\text{ 16 years}}\\ =\$136,250\end{array}$

Working note (4):

Calculate the expected return on plant assets.

$\begin{array}{c}\text{Expected return on plan asset = }\left(\begin{array}{l}\text{Plant asset for 2017}\times \\ \text{Expected rate of return}\end{array}\right)\\ =\$670,000\times \frac{9}{100}\\ =\$60,300\end{array}$

2.

To determine

Prepare necessary journal entries of Company P for 2016 and 2017.

Explanation of Solution

Prepare journal entry to record the beginning liability for prior service cost for 2016:

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
January 1, 2016	Other comprehensive income: Prior service cost		2,180,000
	Accrued/prepaid pension cost			2,180,000
	(To record the beginning liability for prior service cost for 2016)

Table (2)

• Other comprehensive income: Prior service cost is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the other comprehensive income: Prior service cost account with $2,180,000.
• Accrued/prepaid pension cost is a liability account and it is increased. Therefore, credit the accrued/prepaid pension cost account with $2,180,000.

Prepare journal entry to record the pension expense for 2016:

In this case, Company P has underfunded the pension contribution by $24,250$\left(\$694,250-\$670,000\right)$, hence credit the accrued/prepaid pension cost account by $24,250.

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31,2016	Pension expense		694,250
	Cash			670,000
	Accrued/prepaid pension cost			24,250
	(To record the underfunded pension expense of $24,250)

Table (3)

• Pension expense is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the pension expense with $694,250.
• Cash is an asset account and it is decreased. Therefore, credit the cash account with $670,000.
• Accrued/prepaid pension cost is liability account and it is increased. Therefore, credit the accrued/prepaid pension cost account with $24,250.

Prepare journal entry to record the amortized prior service cost for 2016:

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31,2016	Accrued/prepaid pension cost		136,250
	Other comprehensive income: Prior service cost			136,250
	(To record the amortization of prior service cost)

Table (4)

• Accrued/prepaid pension cost is an asset account and it is increased. Therefore, debit the accrued/prepaid pension cost account with $136,250.
• Other comprehensive income: Prior service cost is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the other comprehensive income: Prior service cost account with $136,250.

Prepare journal entry to record the pension expense for 2017:

In this case, Company P has overfunded the pension contribution by $2,250$\left(\$700,000-\$697,750\right)$, hence debit the accrued/prepaid pension cost account by $2,250.

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2017	Pension expense		697,750
	Accrued/prepaid pension cost		2,250
	Cash			700,000
	(To record the pension expense and its overfunded by $2,250)

Table (5)

• Pension expense is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the pension expense with $697,750.
• Accrued/prepaid pension cost is asset account and it is increased. Therefore, debit the accrued/prepaid pension cost account with $2,250.
• Cash is an asset account and it is decreased. Therefore, credit the cash account with $700,000.

Prepare journal entry to record the amortized prior service cost for 2017:

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2017	Accrued/prepaid pension cost		136,250
	Other comprehensive income: Prior service cost			136,250
	(To record the amortization of prior service cost)

Table (6)

• Accrued/prepaid pension cost is an asset account and it is increased. Therefore, debit the accrued/prepaid pension cost account with $136,250.
• Other comprehensive income: Prior service cost is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the other comprehensive income: Prior service cost account with $136,250.

3.

To determine

Calculate the total accrued/prepaid pension cost at the end of 2017, and identify whether it is considered as an asset or a liability.

Explanation of Solution

Calculate the total accrued/prepaid pension cost as the end of 2017, and identify whether it is considered as an asset or a liability as follows:

Accrued/prepaid pension cost
December 31, 2016	$136,250	January 1, 2016	$2,180,000
December 31, 2017	$136,250	December 31, 2016	$24,250
December 31, 2017	$2,250
Total	$274,750	Total	2,204,250
		Clos. Bal.	$1,929,500

In this case, the total accrued/prepaid pension cost at the end of 2017 shows the credit balance, hence it is considered as the accrued pension cost liability ($1,929,500).