San Francisco Company sponsors a single-employer IRS qualified defined benefit p

Question

San Francisco Company sponsors a single-employer IRS qualified defined benefit pension plan. The plan provides that pension benefits are determined by age, years of service, and compensation. Among the components that should be included in the net pension cost recognized for a period are service cost, interest cost, and expected return on plan assets.

Required:

What is a qualified pension plan? How does it differ from a non-qualified plan?

What types of assumptions must a company make when accounting for a defined benefit pension plan? Are assumptions also needed when accounting for a defined contributions plan? Explain.

Explain how San Fran should determine the service cost component of the net pension cost.

Explain how San Fran should determine the interest cost component of the net pension cost.

Explain how San Fran should determine the unexpected return on plan assets component of the net pension cost.

Explain the corridor method of accounting for gains and losses.

Explanation / Answer

1. Qualified pension plan is a type of retirement plan in which employers get tax break for the contribution made by them to the retirement plan of employees and also the employees are given deduction of such contributions from their taxable income. This type of retirement plan is beneficial for attracting major employees as they are provided tax benefits. On the other side, non-qualified plan is a retirement plan in which employers are not given any such tax breaks and therefore, are taxable on higher income as they are not considered deductible expense. Moreover, such contributions are taxable in the hands of employees also but they are provided benefit of deferring tax on such contributions till the retirement.

2. While contributing to the defined benefit pension plan, a company uses the estimates taken by an actuary for the calculation of same. These assumptions include the average retirement age and lifespan of the employees, the returns to be earned by the pension plan's investments and any additional taxes or levies. Any interest cost and service cost.

3.

4. Interest cost is calculated by multiplying the interest rate provided to the Projected Benefit obligation outstanding at the beginning of the year.

5. Expected return on plan assets is calculated as a percentage of expected return on fair value of the planned assets held in the beginning of the year.

6. Corridor method of accounting gains or losses is calculated by following steps:

Step 1: Take higher of the projected Benefit Obligation or fair value of planned assets.

Step 2: 10% of the amount calculated in step 1 is the corridor amotization gain or loss.

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