Many business organizations have been concerned with providing for the retirement of employees since the late 1800s. Increase in this concern resulted in the establishment of private pension plans in most large companies and in many medium- and small-sized ones. The substantial growth of these plans, both in numbers of employees covered and in amounts of retirement benefits, has increased the significance of pension costs in relation to the financial position, results of operations, and cash flows of many companies. In examining the costs of pension plans, a CPA encounters certain terms. The components of pension costs that the terms represent must be dealt with appropriately if generally accepted accounting principles are to be reflected in the financial statements of entities with pension plans.

Instructions

(a) Define a private pension plan. How does a contributory pension plan differ from a noncontributory plan?

(b) Differentiate between “accounting for the employer” and “accounting for the pension fund.”

(c) Explain the terms “funded” and “pension liability” as they relate to: (1) The pension fund. (2) The employer.

(d) (1) Discuss the theoretical justification for accrual recognition of pension costs. (2) Discuss the relative objectivity of the measurement process of accrual versus cash (pay-as-you-go) accounting for annual pension costs.

(e) Distinguish among the following as they relate to pension plans. (1) Service cost. (2) Prior service costs. (3) Vested benefits.

Step by step solution

01

(a) Private pension plan:

A private pension plan is the type of benefit plan an organization offers to its employees who will be retired after attaining their retirement age. The amount of pension is predetermined by the organization based on the company's rules and practices.

The significant difference between a contributory pension plan and a non-contributory pension plan is that:

In a contributory plan, a particular portion of the cost of the total benefit is incurred by a company employee. In a non-contributory plan, the employee incurs the entire benefit cost.

02

(b) Difference between accounting for the employer and accounting for pension fund.

Accounting for the employer	Accounting for the pension fund
It is a process where an organization’s employer is responsible for sponsoring the defined pension plan for the employees.	It is a process where the defined pension plan for an employee is contributed by the employer and the organization’s employee along with the benefits.
This process starts by allocating the pension or the pension expense cost.	This process begins with identifying the contribution receipts from the sponsor of the employer.

03

(c) Explaining the term funded and pension liability in relation to the pension fund and the employer.

Term	The pension fund	The employer
Funded	It depicts the relationship between the pension plan's two variables, i.e., the pension fund assets and the present value of the benefit (expected).	It depicts the relationship between the monetary contribution made by the employer of the company and the actual expenses accrued.
Pension liability	It depicts the future liability of an organization where the company is liable to pay pensions to its employees.	It determines the difference between the total pension expenses and the actual contribution made by the firm to the defined pension plan.

04

(d) Explanation

1. The theoretical justification for accrual recognition of pension costs

According to the famous accounting principle of revenue or expense recognition, all of the expenses or costs related to the pension plan emerging between the company's financial year must be recognized. They should be paid to the employee of an organization upon its time after retirement.

2. Discussion of the relative objectivity of the measurement process of accrual versus cash (pay-as-you-go) accounting for annual pension costs

As per the accrual accounting concept, if the firm utilizes the actual contribution methods in ascertaining the pension cost, it will provide more significant and relative objectivity for annual pension costs. On the other hand, the cash (pay-as-you-go) accounting concept is used at the time of final identification of the pension costs in a very précised manner.

05

(e) Difference between service cost, prior service cost and the vested benefits.

Service cost	Prior service cost	Vested benefits
Service cost is the estimated present value in a defined pension plan. The benefits are predetermined by using the pension benefit formula.	Prior service costs are those expenses an organization bears before the plan amendment benefits.	Vested benefits are those benefits an organization pays to its employee that have no relation to the number of years of service.

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