Bouter Corporation Limited (BCL) began operations in 1990 and

Bouter Corporation Limited (BCL) began operations in 1990 and in 2000 adopted a defined benefit pension plan for its employees. By January 1, 2010, the accrued benefit obligation was $510,000. The Prepaid/Accrued Pension account on the December 31, 2009 balance sheet was reported as a $190,000 liability balance.

On January 2, 2010, BCL agreed to a new union contract that granted retroactive benefits for services that employees had provided in years before the pension plan came into effect. The actuary informed BCL's chief accountant that, using its normal discount rate of 6%, benefits relating to these past services would cost the company $240,000. The expected average remaining service life of the group expected to receive benefits under this plan at this date was 21 years, the same as the group's period to full eligibility.

On January 1, 2010, the fair value of the pension plan assets was $320,000. The actuary estimates that these assets should earn a long-term rate of return of 7%, although, due to a downturn in the market, the actual return reported for the 2010 year was a loss of $9,500. The workforce is made up of a relatively young group of employees, so payments to those who had retired came to only $48,000 during the year, with these payments being made close to year end. The actuary also reported that the current service cost for BCL's employees for 2010 was $107,500. It is the company's policy, on advice from the actuary, to contribute amounts to the pension plan equal to each year's current service cost and the amount of any expense related to past service costs. This payment was made just before BCL's fiscal year end of December 31, 2010.

At the end of 2010, the actuary revised some key estimates, resulting in an actuarial loss of $15,500 related to the accrued obligation. Assume that the ABO amounts under the funding and accounting basis are the same.

Instructions

(a) Calculate the pension expense that should be reported for BCL's year ended December 31, 2010, under both the immediate recognition approach and the deferral and amortization approach under PE GAAP.

(b) Reconcile the difference in pension expense between the immediate recognition approach and the deferral and amortization approach under PE GAAP.  (c) Calculate the amount in the pension account to be reported on the December 31, 2010 balance sheet under both the immediate recognition approach and the deferral and amortization approach under PE GAAP.

(d) How does the method of accounting for the pension plan (immediate recognition versus deferral and amortization under PE GAAP) impact cash flows in light of the company's policy regarding its contributions to the pension plan?

(a) Pension expense under the immediate recognition approach:

Service cost                                $ 107,500

Interest on benefit obligation ($750,000 x 6%) 45,000

Actuarial loss related to benefit obligation   15,500

Actual loss on plan assets                           9,500  

Past service cost expense                     240,000

                                             $417,500

    Pension expense under the defer and amortize approach:

Service cost                                $ 107,500

Interest on benefit obligation ($750,000 x 6%) 45,000

Expected return on plan assets ($320,000 x 7%) (22,400) * 

Amortization of Past service cost ($240,000 / 21) 11,429

                                            $ 141,529

*Actual return of ($9,500) – expected return of $22,400 = actuarial loss on assets in 2010 of $31,900.

(b)  Reconciliation of Pension Expense

Immediate Recognition Approach expense:                                                                                   $417,500                 

Difference in past service cost

    Less: Past service cost:                                     ($240,000)

    Add:  Amortization of past service cost:         11,429          (228,571)

Difference in return on plan assets

   Less: Actual loss on plan assets:                     (9,500)

   Less: Expected return on plan assets:                       (22,400)             (31,900)

Difference in actuarial loss related to benefit obligation

    Less: Actuarial loss on accrued obligation:                           (15,500)

Deferral and Amortization Approach Expense:                 $141,529

Note for Instructors:  In reality, there will be other differences usually because the ABO for funding purposes is usually lower than the ABO for accounting purposes and this will affect the interest cost.

(c) Continuity Schedule of Accrued Benefit Obligation under the immediate recognition approach:

    Accrued benefit obligation, 1/1/10           $510,000

    Recognition of Past service costs            $240,000

Interest cost ($510,000 + $240,000) x 6%       45,000

Service cost                                  107,500

Benefits paid out                            (48,000 )

Actuarial loss related to benefit obligation     15,500

ABO, 12/31/10                               $870,000

    Plan assets, 1/1/10                          $320,000

    Actual return on assets                        (9,500)

    Contributions ($107,500 + $240,000)                  347,500

    Benefits paid out                          (48,000 )

Plan assets, 12/31/10                                 $610,000

    Amount  reported on the balance sheet:

    Accrued benefit obligation                   $(870,000)

    Plan assets at fair value                      610,000

    ABO in excess of plan assets                  (260,000)

    Accrued pension liability                    ($260,000)

(c) Continuity Schedule of Accrued Benefit Obligation under the deferral and amortization approach:

    Accrued benefit obligation, 1/1/10           $510,000

    Recognition of past service costs            $240,000

Interest cost ($510,000 + $240,000) x 6%       45,000

Service cost                                  107,500

Benefits paid out                            (48,000 )

Actuarial loss related to benefit obligation     15,500

ABO, 12/31/10                               $870,000

    Plan assets, 1/1/10                          $320,000

Actual return on plan assets                         (9,500)

    Contributions ($107,500 + $11,429)                     118,929

    Benefits paid out                            (48,000 )

Plan assets, 12/31/10                                 $381,429

    Amount  reported on the balance sheet:

    Accrued benefit obligation                   $(870,000)

    Plan assets at fair value                      381,429

    ABO in excess of plan assets                  (488,571)

    Unrecognized past service costs (240,000 – 11,429) 228,571

    Unrecognized actuarial loss (15,500 + 31,900)       47,400

    Accrued pension liability                    ($212,600)

An easier method is as follows:Jan. 1/10 balance of balance sheet account                               =            $190,000 cr.

From expense entry                    =   141,529 cr.

From contributions entry              =    118,929 dr.

Balance, Dec. 31/11                   =  $212,600 cr.

(d) The immediate recognition approach results in a cash outflow of $347,500 as both the current year’s service cost ($107,500) and the entire past service cost ($240,000) are funded in the current year.  The entire $240,000 of past service cost is funded in the current year because it was expensed in the current year in accordance with the advice from the actuary

    The deferral and amortization approach results in a cash outflow of $118,929 from the current year service cost ($107,500) and the amortization of the past service cost ($11,429).

    Note to Instructors/Students: In reality, the funding would not likely vary depending on the accounting policy chosen.  Often, pension funding is determined by minimum funding requirements set out in legislation, although the advice of the actuary and the cash position of the company can be important variables in the decision.