17

Employee Compensation—Payroll, Pensions, and Other Compensation Issues

Overview

Employee compensation is an accounting issue that affects every company. The issues that affect every company are relatively straightforward and easy to apply. That being the case, they don’t make up the bulk of this chapter. Instead, most of this chapter deals with employer-provided pensions of the defined benefit variety. Due to the costs, and risks, to the employer, defined benefit pensions are not common in newer or smaller companies. However, they still exist for many large companies that have been in existence for long periods of time. The accounting for these plans is anything but straightforward and easy to apply. The disclosures related to these pensions are far more extensive than the numbers that show up on the face of the financial statements at the current time. In fact, the bulk of the calculations required are for the disclosures. The full amounts of the pension assets and pension liabilities are not shown on the balance sheet. As of the beginning of 2009, the difference between the total pension assets and liabilities need not be shown on the balance sheet, either. Rather, an account called “Prepaid/Accrued Pension Cost” is the only account dealing with pensions that usually appears on the balance sheet. It frequently doesn’t have a balance nearly as large as the true difference between the total pension assets and total pension liability. However, this may change in the near future. Occasionally, when a pension plan is underfunded, a minimum pension liability must be established which is reflected on the balance sheet. The pension liability isn’t fully accrued with just a minimum pension liability, however. The minimum pension liability is based on the accumulated benefit obligation (ABO), which is generally a much smaller obligation than the projected benefit obligation (PBO). Other benefits are provided to retirees besides pensions. The accounting for them is similar to pensions, but there are some differences.

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Learning Objectives

Refer to the Review of Learning Objectives at the end of the chapter. It is crucial that this section of the chapter is second nature to you before you attempt the homework, a quiz, or exam. This important piece of the chapter serves as your CliffsNotes or “cheat sheet” to the basic concepts and principles that must be mastered. If after reading this section of the chapter you still don’t feel comfortable with all of the Learning Objectives covered, you will need to spend additional time and effort reviewing those concepts that you are struggling with. The following “Tips, Hints, and Things to Remember” are organized according to the Learning Objectives (LOs) in the chapter and should be gone over after reading each of the LOs in the textbook.

Tips, Hints, and Things to Remember

LO1 – Account for payroll and payroll taxes, and understand the criteria for recognizing a liability associated with compensated absences. How? The accounting for payroll taxes is fundamentally the same as the accounting for salaries you have previously encountered. The difference, here, is that more items are added to the journal entry. Instead of the simple entry of debiting Salaries Expense and crediting Cash or Salaries Payable, additional credits are added to the entry for the various state, local, and federal taxes. In addition, two entries are generally needed. One is for the employee’s portion and includes not only wages, but also the withholding on the employee’s wages that the employer is going to remit to the government(s) on the employee’s behalf. The other entry is for the employer’s portion of the obligations, usually seperately labeled as Payroll Tax Expense instead of Salary Expense, and includes employer taxes like FICA, FUTA, and SUTA. How? Vacation time is accounted for the same as salaries—on an accrual basis. If vacation is earned, but not yet paid out, the expense for it should still be accrued with a debit to Salary Expense or Wages Expense and a credit to Vacation Wages Payable. The salary used for the calculation of the accrual is the wage rate in place when earned. If the vacation time is paid out when the employee is making a higher wage, then the higher wage is paid out, and the difference between the payout and the reversal of the payable becomes an additional wages expense at the time of payment.

Chapter 17 17-3

LO2 – Compute performance bonuses, and recognize the issues associated with postemployment benefits. How? The variety of bonuses that can possibly be earned and paid make it impossible to state that one simple formula is all you need to know. Performance bonuses can, literally, be based on almost anything. The key thing to keep in mind is that bonuses need to be accrued when earned—not necessarily when paid. The debit is to some sort of operating expense and the credit is to Bonus Payable or Cash.

LO3 – Understand the nature and characteristics of employer pension plans, including the details of defined benefit plans. How? It is important to be able to distinguish between all of the components of pensions and what the components are made up of. For this learning objective, the key ones to get down are the projected benefit obligation (PBO) and the fair value of the pension fund (FVPF). Don’t worry about the pension expense or the prepaid/accrued pension cost much yet as they aren’t usually as simple as LO3 suggests. The prepaid/accrued pension cost, for instance, doesn’t frequently equal just the PBO less the FVPF. The prepaid/accrued pension cost also includes the unamortized prior service cost and unamortized net loss and, hence, it is usually a much smaller liabililty (or larger asset) than would be the case if it was merely the funded status of the pension. The formulas for the PBO and FVPF are important to know. Rather than memorize them, try to think through them. They do make sense. For the PBO, the calculation is as follows: Beginning PBO balance + Current year costs for interest and service – Retirement benefits paid ± Any changes in actuarial assumptions = Ending PBO For the FVPF, the calculation is as follows: Beginning FVPF balance + Employer contributions – Retirement benefits paid ± Actual return on plan assets = Ending FVPF

17-4 Chapter 17

LO4 – Use the components of the prepaid/accrued pension costs and changes in the components to compute the periodic expense associated with pensions. How? The key to your putting this chapter together is your understanding of Exhibit 17-10. There are several items in this exhibit that should be noted. The first is the amount by which Thornton’s pension is over- or under-funded. Funding status can be determined by simply taking the difference between the PBO and FVPF. In Thornton’s case for 2013, the pension is underfunded by $405,342 ($2,003,692 – $1,598,350). Notice that this amount is much larger than the liability shown on the balance sheet of only $196,800. The PBO is not shown on the balance sheet. Next, notice that each amount, other than beginning and ending balances, show up in at least two columns. Completing a pension work sheet is not a bad idea as you are working through a problem for this reason. If you only list an item once, you know you have forgotten it somewhere. In other words, creating a pension work sheet may help you complete your work and make sure that you haven’t forgotten anything. Finally, this exhibit shows every component you are likely to encounter (in an academic setting or on the CPA Exam, anyway) as part of the pension expense (service cost, interest cost, actual return, benefits paid, and amortization). Actual return will usually be a reduction in the pension expense. Amortization can occasionally be a reduction in the pension expense. All of the other items will increase pension expense for a given period.

LO5 – Prepare required disclosures associated with pensions, and understand the accounting treatment for pension settlements and curtailments. Why? Similar to the discussions on disclosures for leases we had in Chapter 15, disclosures for pensions provide the details that most users of the financial statements really need. The accounts that show up on the face of the financial statements—Pension Expense and Prepaid/Accrued Pension Cost—tell the user very little. Look to the disclosure notes for the FVPF and the PBO (and therefore, by taking the difference between the two, the funding status of a pension). These two numbers are usually more important than anything involving pensions on the financial statements. It is in the disclosures that one can find all of the components that go into the summary numbers that make up pension expense.

Chapter 17 17-5

LO6 – Explain the differences in accounting for pensions and postretirement benefits other than pensions. How? Pension accounting and other postretirement benefit accounting are very similar. The three main differences are:

1. Other postretirement benefits are not usually funded. 2. Salary level isn’t the factor for “service cost.” 3. There is no minimum liability recognition (similar to the international pension

standards). The following sections, featuring various multiple choice questions, matching exercises, and problems, along with solutions and approaches to arriving at the solutions, is intended to develop your problem-solving and critical-thinking abilities. While learning through trial and error can be effective for improving your quiz and exam scores, and it can be a more interesting way to study than merely re-reading a chapter, that is only a secondary objective in presenting this information in this format. The main goal of the following sections is to get you thinking, “How can I best approach this problem to arrive at the correct solution—even if I don’t know enough at this point to easily arrive at the proper results?” There is not one simple approach that can be applied to all questions to arrive at the right answer. Think of the following approaches as possibilities, as tools that you can place in your problem-solving toolkit—a toolkit that should be consistently added to. Some of the tools have yet to even be created or thought of. Through practice, creative thinking, and an ever-expanding knowledge base, you will be the creator of the additional tools.

Multiple Choice

MC17-1 (LO1) Which of the following accounting principles best describes the rationale for reporting a liability for earned but unused compensated absences? a. historical cost b. matching c. materiality d. comparability MC17-2 (LO1) Which of the following taxes is NOT included in the payroll tax expense of the employer? a. state unemployment taxes b. federal unemployment taxes c. FICA taxes d. federal income taxes

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MC17-3 (LO2) Peach, Inc., has an incentive compensation plan under which the sales manager receives a bonus equal to 10 percent of the company’s income after deductions for the bonus and income taxes. Income before the bonus and income taxes is $400,000. The effective income tax rate is 30 percent. How much is the bonus (rounded to the nearest dollar)? a. $40,000 b. $30,108 c. $28,000 d. $26,168 MC17-4 (LO3) Which of the following statements characterizes defined benefit plans? a. Retirement benefits are based on the plan’s benefit formula. b. They are comparatively simple in construction and raise few accounting

issues for employers. c. Retirement benefits depend on how well pension fund assets have been

managed. d. All of the above. MC17-5 (LO3) The vested benefits of an employee in a pension plan represent benefits a. to be paid to the retired employee in the current year. b. to be paid to the retired employee in subsequent years. c. to be paid from funds currently in the hands of an independent trustee. d. that are not contingent on the employee's continuing in the service of the

employer. MC17-6 (LO3) The following information relates to the defined benefit pension plan of the Baying Company for the year ending December 31, 2011: Projected benefit obligation, January 1 $4,600,000 Projected benefit obligation, December 31 4,729,000 Fair value of pension fund, January 1 5,035,000 Fair value of pension fund, December 31 5,565,000 Expected return on plan assets 450,000 Amortization of deferred gain 32,500 Employer contributions 425,000 Benefits paid to retirees 390,000 Settlement interest rate 11% The actual return on the pension fund for the year is a. $105,000. b. $495,000. c. $503,500. d. $530,000.

Chapter 17 17-7

MC17-7 (LO4) The following information relates to Blazing Gold, Inc., at December 31, 2011: Fair value of pension fund $1,520,000 Accumulated benefit obligation 1,960,000 Projected benefit obligation 2,040,000 Unrecognized prior service cost 24,000 Accrued pension cost 0 The total pension liability shown on the balance sheet at December 31, 2011, for Blazing Gold, Inc., is a. $0. b. $440,000. c. $464,000. d. $520,000. MC17-8 (LO4) On January 1, 2011, Cathode Corporation adopted a defined benefit pension plan. The plan’s service cost of $300,000 was fully funded at the end of 2011. Prior service cost was funded by a contribution of $120,000 in 2011. Amortization of prior service cost was $48,000 for 2011. What is the amount of Cathode’s prepaid pension cost at December 31, 2011? a. $0 b. $72,000 c. $120,000 d. $168,000

MC17-9 (LO5) Which of the following is NOT a required disclosure note for pensions? a. an estimate of the amount of cash to be paid in benefits (from the pension

fund assets) and the amount of cash to be contributed by the company to the pension fund for the next five years

b. the accumulated benefit obligation c. a reconciliation between the beginning and ending balances for the

projected benefit obligation and fair value of the pension fund d. the vested benefit obligation

17-8 Chapter 17

Matching

Matching 17-1 (LO1, LO2, LO3) Listed below are the terms and associated definitions from the chapter for LO1 through LO3. Match the correct definition letter with each term number. ___ 1. compensated

absences ___ 2. pension plan ___ 3. post-retirement

benefits other than pensions

___ 4. single-employer pension plans

___ 5. noncontributory pension plans

___ 6. contributory pension plan

___ 7. defined contribution pension plans

___ 8. defined benefit pension plans

a. pension plans that specify the employer’s contributions based on a formula that includes such factors as age, length of service, employer’s profits, and compensation levels; the pension expense is the amount funded each year

b. pension plans that define the benefits that employees will receive at retirement; in these plans, it is necessary to determine what the contribution should be to meet the future benefit requirements

c. an agreement, usually written, that provides for benefits to employees upon retirement from active employment; usually includes provisions as to how the benefits are to be funded, who receives benefits, the amount of benefits to be paid, and restrictions on investments of pension plan assets

d. plans in which the employer bears the total cost of the plan

e. a pension plan in which employees make contributions to the plan and thus bear part of the cost

f. pension plans established for an individual employer; FASB Statement No. 87 primarily refers to this type of plan

g. payments by employers for vacation, holiday, illness, or other personal activities

h. includes health insurance, life insurance, and disability payments; current standards require these items to be accrued in a manner similar to pension costs

Chapter 17 17-9

Matching 17-2 (LO3) Listed below are the terms and associated definitions from the chapter for LO3. Match the correct definition letter with each term number. ___ 1. pension fund ___ 2. vested benefits ___ 3. actuarial

present value ___ 4. net periodic

pension expense

___ 5. accumulated benefit obligation (ABO)

___ 6. projected benefit obligation (PBO)

___ 7. settlement interest rate

___ 8. service cost

a. a component of net periodic pension expense representing the actuarial present value of benefits accruing to employees for services rendered during that period

b. used to compute the interest component of net periodic pension expense and is used to discount projected and accumulated benefit obligations to their present values; the rate implicit in the current prices of annuity contracts that could be purchased to settle the benefits owed to employees; the SEC has suggested that the appropriate one is the return on highly rated fixed income debt securities

c. amounts set aside to meet the employer’s future pension obligation

d. the actuarial present value of pension benefits based on the plan formula for employee service earned to date using the existing salary structure; used to compute the minimum liability

e. the present value of pension obligations determined by using stated actuarial assumptions and estimates

f. the actuarial present value of pension benefits using the benefits/years of service approach that requires assumptions about future compensation levels, such as increases over time by interest, amendments to plan, additional service years, and changes in actuarial assumptions

g. the amount recognized in an employer’s financial statements as an expense of a pension plan for a period; components are service cost, interest cost, actual return on plan assets, pension gain or loss, amortization of unrecognized prior service cost, and amortization of deferred gain or loss in excess of the corridor amount

h. the amount of pension benefits an employee will retain if employment with the employer is terminated

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Matching 17-3 (LO3, LO4) Listed below are the terms and associated definitions from the chapter for LO3 and LO4. Match the correct definition letter with each term number. ___ 1. fair value of the

pension fund ___ 2. prepaid/

accrued pension cost

___ 3. prior service cost

___ 4. actual return on pension plan assets

___ 5. expected service period

___ 6. pension gain or loss

___ 7. expected return on pension plan assets

a. a component of net periodic pension expense that is the sum of (a) the difference between the actual return on plan assets and the expected return on plan assets and (b) the amortization of the unrecognized net gain or loss arising in a prior period from a change in the value of either the projected benefit obligation or the plan assets because of an experience different from that assumed or from a change in an actuarial assumption

b. the difference between annual pension contributions and annual pension costs; if contributions exceed costs, the balance is reported as an asset on a company’s balance sheet; if costs exceed contributions, the difference is reported as a liability

c. a component of net periodic pension expense measured by the difference between the fair value of pension plan assets at the end of the period and the fair value at the beginning of the period, adjusted for contributions and payments of benefits during the period

d. the pension fund’s market value at a given measurement date that increases each year by employer contributions to the fund and decreases by the retirement benefits paid; also changes by the amount of earnings on the pension fund, including changes in its market value

e. an amount calculated as a basis for determining the extent of delayed recognition of the effects of changes in the fair value of pension plan assets; determined based on the pension plan’s expected long-term rate of return and market-related value

f. the present value of the increased benefits granted by a pension plan’s amendment (or initial adoption of a plan); recognized as a component of net periodic pension expense through amortization over the future service life of the covered employees

g. estimated number of years an employee will work before receiving pension benefits; can be estimated as the average computed life based on the total expected future years of service divided by the number of employees; may be computed by the formula [N(N + 1)/2] × D, where N equals the number of years over which service is to be performed and D is the decrease in number of employees through retirement or termination of services per year

Chapter 17 17-11

Matching 17-4 (LO4, LO5, LO6) Listed below are the terms and associated definitions from the chapter for LO4 through LO6. Match the correct definition letter with each term number. ___ 1. unrecognized

net pension gain or loss

___ 2. corridor amount ___ 3. minimum

pension liability ___ 4. additional

pension liability ___ 5. deferred

pension cost ___ 6. settlement of a

pension plan ___ 7. curtailment of a

pension plan ___ 8. full eligibility

date ___ 9. market-related

value of the pension fund

a. a noncurrent asset resulting from recognition of an additional pension liability for underfunded pension plans; the balance in this account should not exceed the unrecognized prior service cost

b. an event that significantly reduces the expected number of years of future services of present employees or eliminates for a significant number of employees the accrual of defined benefits for their future services

c. value of pension plan assets used in computing the expected return; either of the following can be used: (1) the fair market value of pension plan assets as of the beginning of the year or (2) a weighted-average value based on the market value of plan assets over a preceding period not exceeding five years

d. net amount of pension liability that must be reported when a plan is underfunded; measured as the difference between the accumulated benefit obligation and the fair value of the pension plan assets

e. the date at which an employee attains full eligibility for the benefits that employee is expected to earn under the terms of a postretirement benefit plan

f. the cumulative net pension gain or loss that has not been recognized as a part of net periodic pension expense

g. an irrevocable action taken by an employer that relieves the employer of primary responsibility for all or part of the pension obligation; examples include purchasing from an insurance company an annuity that would cover employees’ vested benefits or a lump-sum payment to employees in exchange for their rights to receive specified pension benefits

h. computed as the difference between the minimum pension liability and accrued pension cost or as the sum of the minimum pension liability and the prepaid pension cost

i. an amount established as a minimum before amortization of pension gains and losses is required; only amortization of unrecognized pension gains and losses that exceed 10% of the greater of the projected benefit obligation or the market-related asset value as of the beginning of the period is included in the net periodic pension expense

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Problems

Problem 17-1 (LO1) On June 30, 2011, payroll data from the records of Reverie Enterprises showed: Payroll: Factory wages $125,000 Office salaries 82,500 Sales salaries 98,000 Payroll deductions: Income tax withholding $47,800 FICA tax (7.5%) ? Wages and salaries not subject to FICA tax: Factory wages $28,000 Office salaries 40,000 Sales salaries 45,000 Wages and salaries not subject to federal and state unemployment taxes: Factory wages $60,000 Office salaries 80,000 Sales salaries 72,000 Provide the journal entries necessary to: 1. Record the payment of the payroll on June 30, 2011. 2. Record the employer's payroll tax liabilities. (The federal unemployment tax rate is

0.8 percent; the state unemployment tax rate is 5.4 percent.) Round all numbers to the nearest dollar. Problem 17-2 (LO3) The following data relate to the defined benefit pension plan of the Cigaro Corporation for the years 2010–2012:

Year Net Periodic

Pension Expense Employer

Contributions Benefits Paid

to Retirees

Actual Return on Fund Assets

2010 $255,000 $300,000 $105,000 $120,000 2011 300,000 300,000 114,000 150,000 2012 315,000 300,000 120,000 156,000

On December 31, 2009, the books of Cigaro Corporation reflected accrued pension cost of $30,000. The fair value of pension fund assets at that date was $1,380,000. The pension fund is administered by an independent trustee.

Chapter 17 17-13

1. Prepare the summary journal entries relating to the pension plan that would be

required on the books of Cigaro Corporation for 2010, 2011, and 2012. 2. Determine the balance of the Prepaid/Accrued Pension Cost account at December

31, 2012. 3. Compute the fair value of pension fund assets as of December 31, 2012. Problem 17-3 (LO4, LO5) The following information relates to the defined benefit pension plan of Tempesta Company: Projected benefit obligation, January 1, 2011 $280,000 Projected benefit obligation, December 31, 2011 307,500 Accumulated benefit obligation, January 1, 2011 240,000 Accumulated benefit obligation, December 31, 2011 256,000 Benefits paid to retirees during 2011 22,000 Contributions by employer during 2011 37,500 Settlement interest rate 10% 1. Compute the amount of service cost for 2011. 2. Prepare the reconciliation between the beginning and ending balances for the

projected benefit obligation disclosure as required by GAAP.

Solutions, Approaches, and Explanations

MC17-1 Answer: b Approach and explanation: Accrual accounting is all about the matching principle. Costs should be recognized against the revenues they help produce—regardless of when the cash was paid for the costs or when the cash is received for the revenues. It is when salary, vacation time, bonuses, pensions, etc., are earned that the expense should be recognized—not when they are paid in the following year or years later. The expenses are matched with the revenues they help generate (through the employee’s services). When an employee takes the vacation later, they are not earning revenue for the company in that later period by taking the vacation. MC17-2 Answer: d Approach and explanation: Federal income taxes, whether they be those withheld from the employee’s paycheck or those paid by a corporation on their earnings, are not part of payroll tax expense. The federal income taxes withheld from employee paychecks serve to reduce the amount of cash the employer pays the employee. They are subsequently remitted to the federal government by the employer. They remain an expense of the employee—not the employer.

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State unemployment taxes (SUTA) can be on both the employee and the employer, although they are usually on just the employer. In either case, the employer will be paying for at least part, if not all, of them and, hence, record payroll tax expense. FICA is split between the employee and employer. Federal unemployment taxes (FUTA) are paid for by just the employer. MC17-3 Answer: d Approach and explanation: Remember when you were sitting in algebra class wondering when you would ever use it? Well, this is just such an opportunity. In a multiple-choice situation, like this, you can always plug in the choices to find out which one fits. If the question was open ended, you wouldn’t have that luxury. The try-and-plug-all-four-choices method can be slower though. Therefore, you should probably always start with an algebraic equation. In this case it is:

B = 0.10 × (I – B – T) where B = Bonus I = Income before the bonus and taxes T = Taxes Substituting what was given in the problem for the letters results in:

B = 0.10 × {$400,000 – B – [($400,000 – B) × 0.30]}

B = $40,000 – 0.10B – $12,000 + 0.03B

1.07B = $28,000

B = $26,168 If algebra isn’t your strong point, and you opt for the trial-and-error method, how can you possibly cut down the number of trials you go through? Start with a middle choice and then, based on your result, you can eliminate the choices above or below it. Using that method, let’s start with choice c. Income before the bonus and taxes $400,000 Choice c bonus amount 28,000 Income before taxes $372,000 Income taxes @ 30 percent 111,600 Net income $260,400

Chapter 17 17-15

Does net income equal 10 times the bonus? No, the bonus is too high [at 11 percent of net income ($28,000/$260,400)]. Therefore, choice c and any choice that is higher than choice c cannot be correct. That leaves only choice d. Try it, if you have time, just to check and make sure you are correct. Income before the bonus and taxes $400,000 Choice d bonus amount 26,168 Income before taxes $373,832 Income taxes @ 30 percent 112,150 Net income $261,682 Choice d checks out as the bonus is 10 percent of net income ($26,168/$261,682). It is a good idea to check yourself by doing a partial income statement, as done above, if the question was open ended as well. MC17-4 Answer: a Approach and explanation: There are two things to watch out for on this question. The first is the word “benefit.” Circle, underline, or highlight it so that you don’t forget that you are dealing with defined benefit plans and not defined contribution plans when looking at the choices. You may also want to write “NOT contribution” in the margin for extra emphasis. The next thing to watch out for is choice d. When seeing the “all of the above” option, many students let their guard down a bit. They tend to skim over the choices—especially if the first one seems correct—to just get a feel for whether they all sound correct, and if they do, then they opt for choice d. Before reading any of the choices, you should clarify your objective in your head. You are looking for sentences that describe defined benefit plans—not defined contribution plans. Therefore, as you read each choice you should indicate next to them which kind of plan they describe with a B for benefit or a C for contribution. This will help you to not hastily choose choice d, whether or not it is correct. Choice a describes defined benefit plans so put a B next to choice a. Choice b describes defined contribution plans so put a C next to choice b. Choice c also describes defined contribution plans so it earns another C. Since you have two Cs and only one B, you can cross off choice d. If you ended up with two Bs and only one C, then you’d need to more closely exam the choices to see which one you misclassified. Here is a brief summary of the characteristics of defined benefit plans:

They are based on the plan’s benefit formula. They are more difficult to set up, manage, and account for.

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They have fixed retirement for employees, so the employer bears the risk if the

fund assets’ investments don’t perform well. They are usually funded entirely by the employer. Vesting is a factor.

MC17-5 Answer: d Approach and explanation: For retired employees who were vested, choices a and b put together are correct. Choice c could be correct but need not be, nor is it really a definition of vested benefits. Choice d is the only true definition of vesting among the choices.

MC17-6 Answer: b Approach and explanation: The first question to ask yourself is, “What goes into the fair value of the pension fund?” Remember from the How? on page 17-4 that they are the items that make sense. The value of the pension fund will go up by the actual return on the pension fund, of course, but what are the other factors? The PBO has no impact on the fair value of pension fund assets, so you can cross off the first two items. An expected return has no effect, nor does amortization, so you can cross them both off. The settlement interest rate is the discount rate used for computing the interest cost on the PBO. Since it has nothing to do with the fair value of the pension fund assets, it, too, can be eliminated. We are left with the change in the fair value of the pension fund, employer contributions, retirement benefits paid, and the actual return on pension fund. We could set them up as a T account as follows:

FVPF 5,035,000

425,000 390,000

?5,565,000

The only number that will get the ending fair value to $5,565,000 is $495,000 ($5,565,000 – $425,000 + $390,000 – $5,035,000).

Chapter 17 17-17

MC17-7 Answer: b Approach and explanation: Recall that there are two potential factors making up the pension liability that is reflected on a company’s balance sheet. One is the Prepaid/Accrued Pension Cost account. Since that account balance is given as $0, you need not worry about it. The other is the minimum pension liability which is the difference between the ABO and the FVPF. In this case, that amounts to $440,000 ($1,960,000 – $1,520,000). Unrecognized prior service cost does not show up as a liability. As it is amortized, a portion of it will show up as part of pension expense. MC17-8 Answer: b Approach and explanation: If the service cost is fully funded, then there is no asset or liability in conjunction with it. Hence, the $300,000 amount can be ignored for the purposes of calculating the prepaid pension cost at the end of the first year. If the prior service cost is funded by an amount in excess of the current year’s amortization in the first year of a plan, then an asset will result by the amount of the difference ($120,000 – $48,000). The journal entry for the year would look like this: Prepaid Pension Cost 72,000 Pension Expense 348,000

Cash 420,000 MC17-9 Answer: d Approach and explanation: Choice a is a relatively new disclosure requirement. Companies didn’t have to state an estimate for the amount of cash being paid into the fund and being paid as benefits for the next five years until 2004. They do now, so choice a is incorrect. Choice c was the disclosure mentioned on page 17-4 as being probably the first thing a user of the financial statements would want to look at with respect to pensions—even before looking at the amount of pension expense on the income statement or the prepaid/accrued pension cost on the balance sheet. After all, it is the difference between the PBO and the FVPF that determines the funding status of a pension fund. The vested benefit obligation (VBO) is a real number that can be calculated, but it isn’t a required disclosure like the ABO. The VBO is usually (significantly) less than the ABO, and the ABO is usually (significantly) less than the PBO. The VBO would never be more than the ABO or PBO. Likewise, the ABO would never be more than the PBO.

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Matching 17-1 1. g 2. c 3. h 4. f 5. d 6. e 7. a 8. b Besides Chapter 1, this is probably the most difficult chapter when it comes to terminology. Spend extra time understanding the words that are new to you in this chapter or you will have a difficult time mastering the material. Matching 17-2 1. c 2. h 3. e 4. g 5. d 6. f 7. b 8. a Matching 17-3 1. d 2. b 3. f 4. c 5. g 6. a 7. e Matching 17-4 1. f 2. i 3. d 4. h 5. a 6. g 7. b 8. e 9. c

Chapter 17 17-19

Problem 17-1 1. Factory Wages Expense 125,000 Office Salaries Expense 82,500 Sales Salaries Expense 98,000

Cash 243,262 Employees Income Tax Payable 47,800 FICA Taxes Payable 14,438

Computation of FICA Taxes Payable:

Factory wages ($125,000 – $28,000) $ 97,000 Office salaries ($82,500 – $40,000) 42,500 Sales salaries ($98,000 – $45,000) 53,000 $192,500 × .075 $ 14,438

2. Factory Payroll Tax Expense 11,305 Office Payroll Tax Expense 3,343 Sales Payroll Tax Expense 5,587

FICA Taxes Payable 14,438 Federal Unemployment Tax Payable 748 State Unemployment Tax Payable 5,049

Computation of payroll tax expense by employee group:

Factory Office Sales FICA Tax (7.5%): ($125,000 – $28,000) × 7.5% $ 7,275 ($82,500 – $40,000) × 7.5% $3,188 ($98,000 – $45,000) × 7.5% $3,975 Federal Unemployment Tax (0.8%): ($125,000 – $60,000) × 0.8% 520 ($82,500 – $80,000) × 0.8% 20 ($98,000 – $72,000) × 0.8% 208 State Unemployment Tax (5.4%): ($125,000 – $60,000) × 5.4% 3,510 ($82,500 – $80,000) × 5.4% 135 ($98,000 – $72,000) × 5.4% 1,404 $11,305 $3,343 $5,587

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Problem 17-2 1. 2010 Dec. 31 Pension Expense 255,000

Prepaid/Accrued Pension Cost 45,000 Cash 300,000

2011 Dec. 31 Pension Expense 300,000

Cash 300,000 2012 Dec. 31 Pension Expense 315,000

Prepaid/Accrued Pension Cost 15,000 Cash 300,000

2. The balance of the Prepaid/Accrued Pension Cost account on December 31, 2012,

is $0 ($30,000 – $45,000 + $15,000). 3. Fair value of plan assets as of December 31, 2009 $1,380,000 Employer contributions 900,000a

Actual return on fund assets 426,000b

Benefits paid to retirees (339,000)c Fair value of plan assets as of December 31, 2012 $2,367,000

a$300,000 × 3 = $900,000 b$120,000 + $150,000 + $156,000 = $426,000 c$105,000 + $114,000 + $120,000 = $339,000

Problem 17-3 1. Projected benefit obligation, December 31, 2011 $307,500 Projected benefit obligation, January 1, 2011 280,000 Increase in projected benefit obligation $ 27,500 Interest cost (28,000) Benefits paid to retirees 22,000 Service cost—2011 $ 21,500 2. Projected benefit obligation, January 1, 2011 $280,000 Service cost 21,500 Interest cost 28,000 Benefits paid to retirees (22,000) Projected benefit obligation, December 31, 2011 $307,500

Chapter 17 17-21

Glossary

Note that Appendix C in the rear portion of the textbook contains a comprehensive glossary for all of the terms used in the textbook. That is the place to turn to if you need to look up a word but don’t know which chapter(s) it appeared in. The glossary below is identical with one major exception: It contains only those terms used in Chapter 17. This abbreviated glossary can prove quite useful when reviewing a chapter, when studying for a quiz for a particular chapter, or when studying for an exam which covers only a few chapters including this one. Use it in those instances instead of wading through the 19 pages of comprehensive glossary in the textbook trying to pick out just those words that were used in this chapter.

accumulated benefit obligation (ABO) The actuarial present value of pension benefits based on the plan formula for employee service earned to date using the existing salary structure; used to compute the minimum liability.

actual return on pension plan assets A component of net periodic pension expense measured by the difference between the fair value of pension plan assets at the end of the period and the fair value at the beginning of the period, adjusted for contributions and payments of benefits during the period.

actuarial present value The present value of pension obligations determined by using stated actuarial assumptions and estimates.

additional pension liability An additional liability reported for underfunded pension plans. It is computed as the difference between the minimum pension liability and accrued pension cost or as the sum of the minimum pension liability and the prepaid pension cost.

compensated absences Payments by employers for vacation, holiday, illness, or other personal activities.

contributory pension plan A pension plan in which employees make contributions to the plan and thus bear part of the cost.

corridor amount An amount established as a minimum before amortization of pension gains and losses is required. Only amortization of unrecognized pension gains and losses that exceed 10% of the greater of the projected benefit obligation or the market-related asset value as of the beginning of the period is included in the net periodic pension expense. Any systematic method of amortization that exceeds the minimum may be used as long as it is consistently applied to both gains and losses and it is disclosed in the statements.

curtailment of a pension plan An event that significantly reduces the expected number of years of future services of present employees or eliminates for a significant number of employees the accrual of defined benefits for their future services.

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deferred pension cost A noncurrent asset resulting from recognition of an additional pension liability for underfunded pension plans. The balance in this account should not exceed the unrecognized prior service cost.

defined benefit pension plans Pension plans that define the benefits that employees will receive at retirement. In these plans, it is necessary to determine what the contribution should be to meet the future benefit requirements. FASB Statement No. 87 deals primarily with this type of pension plan.

defined contribution pension plans Pension plans that specify the employer’s contributions based on a formula that includes such factors as age, length of service, employer’s profits, and compensation levels. FASB Statement No. 87 does not deal with these types of plans. The pension expense is the amount funded each year.

expected return on pension plan assets An amount calculated as a basis for determining the extent of delayed recognition of the effects of changes in the fair value of pension plan assets. The expected return on pension plan assets is determined based on the pension plan’s expected long-term rate of return and market-related value.

expected service period Estimated number of years an employee will work before receiving pension benefits. Can be estimated as the average computed life based on the total expected future years of service divided by the number of employees. The expected future years of service may be computed by the formula [N(N + 1)/2] × D, where N equals the number of years over which service is to be performed and D is the decrease in number of employees through retirement or termination of services per year.

fair value of the pension fund Value based on the pension fund’s market value at a given measurement date that increases each year by employer contributions to the fund and decreases by the retirement benefits paid; also changes by the amount of earnings on the pension fund, including changes in its market value.

full eligibility date The date at which an employee attains full eligibility for the benefits that employee is expected to earn under the terms of a postretirement benefit plan.

market-related value of pension plan assets Value of pension plan assets used in computing the expected return. Either of the following can be used as the market-related value: (1) the fair market value of pension plan assets as of the beginning of the year or (2) a weighted-average value based on the market value of plan assets over a preceding period not exceeding five years.

minimum pension liability The net amount of pension liability that must be reported when a plan is underfunded. The minimum liability is measured as the difference between the accumulated benefit obligation and the fair value of the pension plan assets.

minimum pension liability adjustment Negative equity item resulting from the adjustment to pension liability to ensure that at least a minimum pension liability is reported.

Chapter 17 17-23

net periodic pension expense The amount recognized in an employer’s financial statements as an expense of a pension plan for a period. Components of net periodic pension expense are service cost, interest cost, actual return on plan assets, pension gain or loss, amortization of unrecognized prior service cost, and amortization of deferred gain or loss in excess of the corridor amount.

noncontributory pension plans Plans in which the employer bears the total cost of the plan.

obligation discount rate The 10% discount rate used in the computation of the projected benefit obligation and viewed as the implied interest rate on this debt.

pension fund Fund set aside to meet the employer’s future pension obligation.

pension gain or loss A component of net periodic pension expense that is the sum of (a) the difference between the actual return on plan assets and the expected return on plan assets and (b) the amortization of the unrecognized net gain or loss arising in a prior period from a change in the value of either the projected benefit obligation or the plan assets because of an experience different from that assumed or from a change in an actuarial assumption.

pension plan An agreement, usually written, that provides for benefits to employees upon retirement from active employment. The plan usually includes provisions as to how the benefits are to be funded, who receives benefits, the amount of benefits to be paid, and restrictions on investments of pension plan assets.

pension-related asset/liability An account used to reflect changes in the net pension asset or liability.

post-retirement benefits other than pensions Benefits other than pensions provided by an employer to former employees. Includes health insurance, life insurance, and disability payments. Current standards require these benefits to be accrued in a manner similar to pension costs.

prepaid/accrued pension cost The difference between annual pension contributions and annual pension costs. If contributions exceed costs, the balance is reported as an asset on a company’s balance sheet. If costs exceed contributions, the difference is reported as a liability.

prior service cost The present value of the increased benefits granted by a pension plan’s amendment (or initial adoption of a plan). Recognized as a component of net periodic pension expense through amortization over the future service life of the covered employees.

projected benefit obligation (PBO) The actuarial present value of pension benefits using the benefits/years of service approach that requires assumptions about future compensation levels, such as increases over time by interest, amendments to plan, additional service years, and changes in actuarial assumptions.

service cost A component of net periodic pension expense representing the actuarial present value of benefits accruing to employees for services rendered during that period.

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settlement interest rate The interest rate used to compute the interest component of net periodic pension expense and the interest rate used to discount projected and accumulated benefit obligations to their present values. It is the rate at which pension plan obligations could be effectively settled; that is, the rate implicit in the current prices of annuity contracts that could be purchased to settle the benefits owed to employees. The SEC has suggested that the appropriate settlement rate is the return on highly rated fixed income debt securities.

settlement of a pension plan An irrevocable action taken by an employer that relieves the employer of primary responsibility for all or part of the pension obligation. Examples include purchasing from an insurance company an annuity that would cover employees’ vested benefits or a lump-sum payment to employees in exchange for their rights to receive specified pension benefits.

single-employer pension plans Pension plans established for a single employer. FASB Statement No. 87 primarily refers to this type of plan.

unrecognized net pension gain or loss The cumulative net pension gain or loss that has not been recognized as a part of net periodic pension expense.

vested benefits The amount of pension benefits an employee will retain if employment with the employer is terminated.