Chapter 17 Pensions and Other Postretirement Benefits

THE NATURE OF PENSION PLANS

Qualified Pension Plans

1. Cover at least 70% of employees
2. Cannot discriminate in favor of highly compensated employees
3. Must be funded in advance to an irrevocable trust
4. Benefits must vest within period prescribed by ERISA
5. Complies with restrictions on timing and amount of contributions and benefits

There are two types of pension plans.

1. Defined contribution pension plan-fixed annual contribution.
2. Defined benefit pension plan-fixed retirement benefit defined by plan.

Defined Contribution Pension Plans

1. Money purchase plans-employer contributes fixed percentage of employees salary
2. Thrift, Savings and 401(k) plans-permit voluntary contributions by employees.
3. Profit-sharing, incentive savings-contributions are linked to employer financial
performance

Example: Spencer Company has a 401(k) plan that specifies that the employer will contribute
up to 6% of each employees gross pay to his or her retirement fund. The plan also specifies that
the employee may contribute up to 10% of gross pay to his or her retirement fund as a matching
contribution. During the month of May Spencer Company had $50,000 of gross payroll and
withheld voluntary contributions from employee pay checks in the amount of $2,000.

The payroll and pension contribution journal entries are as follows:

Date Account Debit Credit

5/31/03 Salaries and wages 50,000
Accrued FICA and withholding 11,300
Accrued pension contributions 2,000
Cash 36,700
To record salaries and wages for May 2003

5/31/03 Pension expense 3,000

Accrued pension contributions 2,000
Cash 5,000
To record pension contribution associated with May 2003 payroll

Defined Benefit Pension Plans

1. Employer agrees to pay retirement benefits in the future.
2. Plan assets are separated from corporate assets to pay retirement benefits.
3. Periodic expense is recorded.

The pension plan involves a continuing pension obligation to the employees that is funded by
plan assets. Annual pension expense is calculated as follows:

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Chapter 17 Pensions and Other Postretirement Benefits

Components of Pension Expense

Service cost Current service during period

Interest Accrued on pension obligation
Return on plan assets Expected return on plan assets
Amortization of:
Prior service cost Service prior to plan adoption or amendment
Losses or (gains) On plan assets or plan revisions

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