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

What is Qualified pension plan?

A qualified pension plan is an employer-sponsored retirement plan that qualifies for special tax treatment under Section 401(a) of the Internal Revenue Code.

There are many different types of qualified plans, but they all fall into two categories. A defined benefit plan (e.g., a traditional pension plan) is generally funded solely by employer contributions and provides you with a specified level of retirement benefits. A defined contribution plan (e.g., a profit-sharing or 401(k) plan) is funded by employer and/or employee contributions. The benefits you receive from the plan depend on investment performance.

How does it differ from a non-qualified plan?

A non-qualified plan is a type of tax-deferred, employer-sponsored retirement plan that falls outside of employee retirement income security act (ERISA) guidelines. Non-qualified plans are designed to meet specialized retirement needs for key executives and other select employees. These plans also are exempt from the discriminatory and top-heavy testing that qualified plans are subject to.

What types of assumptions must a company make when accounting for a defined benefit pension plan?

There are two primary types of assumptions:

Economic assumptions : dealing with current interest rates, salary increases, inflation and investment
markets. How will market forces affect the cost of the plan?

Demographic assumptions : about the participant group make-up and expected behavior and life expectancy. How will participant behavior affect the cost of the plan?

Key Factors

Economic assumptions

1. Interest Rate
2. Expected Long - term Rate of Return on Assets
3. Salary Scale
4. Inflation

Demographic Assumptions

1. Withdrawal or Termination Assumptions
2. Mortality Assumptions
3. Retirement Assumptions
4. Disability Assumptions

Are assumptions also needed when accounting for a defined contributions plan?

There is need to make some estimates which injects uncertainty into the measurement of an employer’s obligation for pension benefits and the amount of funds the employer must set aside to ensure adequate funding of its obliga-
tion

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