FAR · Select balance sheet accounts · 6 practice questions
Net Periodic Pension Cost: Components, Signs, and Presentation
Service cost follows employee compensation; other pension cost components go outside operating income when that subtotal is shown. Sort each item by where it belongs and check its effect on pension cost.
Try one first
Hint
Separate pension funding items from income statement cost components, and distinguish expected from actual asset returns.
Answer B. Net periodic pension cost for a defined benefit plan includes five items: service cost, interest cost, expected return on plan assets, amortization of prior service cost, and amortization or recognition of net gain or loss. The key distinction is that the periodic cost uses expected asset return and recognized amortization amounts, not raw funding or unamortized balances.
Why not A: This choice comes from using the plan's actual investment performance in periodic cost. Net periodic pension cost uses expected return on plan assets, while differences between actual and expected return feed gains or losses rather than replacing the expected-return component.
Why not C: This choice uses the underlying accumulated items instead of the recognized periodic pieces. Net periodic pension cost includes amortization of prior service cost and amortization or recognition of net gains or losses, not the full balances themselves.
Why not D: This choice confuses funding with expense recognition. Employer contributions affect plan funding and cash flows, but they are not one of the five components of net periodic pension cost.
Sort it
Is it service cost? Use the same line as the covered employees' other compensation.
Is it interest cost, expected return, or recognized amortization? Present it outside any operating income subtotal.
Is it a new actuarial gain or loss or new prior service cost? Recognize it first in OCI.
Is it a cash contribution, plan asset balance, or actual return? Exclude it from the pension cost formula.
| Item | Goes to |
|---|---|
| Production employees' service cost; all related goods were sold | Operating compensationAdd it to pension cost and report it in cost of goods sold because the related goods were sold. |
| Expected return on plan assets | Non-service pension costSubtract it from pension cost. Its negative sign does not move it into operating income. |
| New actuarial loss caused by a lower discount rate | OCI, not current pension costThe remeasurement loss enters OCI when it arises, not current pension cost. |
| Employer cash contribution to the pension trustee | Not a pension cost componentFunding changes cash and plan assets. It does not determine pension expense. |
| Interest cost on the projected benefit obligation | Non-service pension costAdd it to pension cost. Interest on the projected benefit obligation is a non-service component. |
| Prior service cost from a new amendment increasing benefits | OCI, not current pension costThe new amendment cost enters OCI first. Only later amortization enters pension cost. |
| Amortization of prior service cost from an earlier benefit increase | Non-service pension costAdd it to pension cost. This is current expense recognition, not the original amendment amount. |
| Year-end fair value of plan assets | Not a pension cost componentThis balance helps measure funded status. It is not a periodic expense component. |
| Administrative employees' service cost | Operating compensationAdd it to pension cost and report it with administrative compensation in SG&A. |
| Amortization of a net actuarial gain | Non-service pension costSubtract it from pension cost. Amortizing a deferred gain reduces current expense. |
| Actual investment return on plan assets | Not a pension cost componentDo not substitute this for expected return. The actual-versus-expected difference is initially recognized in OCI. |
| Amortization of a net actuarial loss | Non-service pension costAdd it to pension cost. Reclassification from accumulated OCI makes this a current expense component. |
| The shortfall when actual return is below expected return | OCI, not current pension costThe shortfall is an actuarial loss initially recognized in OCI. Expected return still reduces pension cost. |
Key points
- Remember: Sort by component, not by sign; only service cost follows compensation.
- To solve for missing service cost, subtract the net non-service amount from total pension cost.
- A negative total means net pension income; do not force the result to zero.
- Disclose pension cost by component in the pension note, including expected return.
How the exam traps you
- Using actual asset return in pension cost. Use expected return. The actual-versus-expected difference is a gain or loss initially recognized in OCI.
- Adding expected return because it is listed with costs. Subtract expected return; it reduces pension cost.
- Putting the whole pension cost total below operating income. Keep service cost with employee compensation. Only non-service components belong outside operating income.
Question 2
Hint
Compare net periodic pension cost with cash contributed, then apply that net change to the beginning pension-related balance.
Answer A. Net periodic pension cost increases the pension-related liability, while cash contributions reduce it. The year 1 net increase in the liability is $15,000, computed as $86,000 less $71,000. Added to the beginning accrued liability of $24,000, the ending accrued pension liability is $39,000.
Why not B: This answer comes from reversing the annual difference and then offsetting the beginning liability. A prepaid asset would arise only if funding exceeded pension expense enough to overcome the opening accrued liability, which did not happen here.
Why not C: This comes from reversing the direction of both the yearly change and the ending classification. When pension expense exceeds cash funding, the pension-related balance moves toward a larger accrued liability, not a prepaid asset.
Why not D: This results from correctly finding the $15,000 excess of expense over funding, but then subtracting it from the beginning liability. Because expense exceeded contributions, the existing accrued liability should increase, not decrease.
Question 3
Hint
Place service cost in the same caption as the employees' regular compensation expense.
Answer A. Service cost is presented in the same income statement line item as other compensation costs for the employees who earned the benefits. Because the plan covers only production employees and all production was sold, the related service cost belongs in cost of goods sold within operating income.
Why not B: This answer comes from assuming pension service cost is always a general overhead item. It fails because service cost is assigned based on the employees generating it, and these employees work in production.
Why not C: This answer comes from confusing service cost with the other components of net periodic pension cost. It fails because service cost is the component presented with operating compensation costs, not in a separate nonoperating line.
Why not D: This answer comes from treating all pension cost like a period cost of selling the product. It fails because the covered employees are production workers, so their service cost follows production compensation, not selling functions.
Question 4
Hint
Classify each component by whether it creates current-period pension cost or offsets that cost.
Answer D. Service cost and interest cost increase net periodic pension cost. Expected return on plan assets reduces pension cost because it offsets the cost of providing benefits. Amortization of prior service cost from increased benefits is added as that deferred cost is recognized in expense over time.
Why not A: This answer comes from reversing the sign of interest cost. Interest cost reflects the increase in the projected benefit obligation due to the passage of time, so it increases pension cost rather than reducing it.
Why not B: This answer comes from treating expected return as another cost component. Expected return on plan assets is not added to pension cost; it offsets pension cost and therefore is subtracted.
Why not C: This answer comes from treating amortization of prior service cost as a reduction. Because the plan amendment increased benefits, the prior service cost is a deferred cost that is recognized by increasing pension expense over time.
Question 5
Hint
Roll forward the actuarial loss balance in accumulated OCI: beginning balance, plus amounts recognized in OCI, minus amounts reclassified to expense.
Answer A. The accumulated OCI balance is rolled forward by adding current-year actuarial losses recognized in OCI and subtracting amounts reclassified from OCI into pension expense. Birch starts with a $300,000 loss, adds $80,000, and subtracts $50,000. The ending accumulated OCI balance is a net actuarial loss of $330,000.
Why not B: This comes from adding the $80,000 current-year actuarial loss but ignoring the $50,000 amortization. That fails because the amortized amount no longer remains in accumulated OCI at year-end.
Why not C: This comes from adding both the $80,000 current-year actuarial loss and the $50,000 amortization to the beginning balance. That fails because amortization moves part of the loss out of accumulated OCI and into pension expense.
Why not D: This comes from subtracting both the $80,000 current-year actuarial loss and the $50,000 amortization from the beginning balance. That fails because a current-year actuarial loss increases the accumulated OCI loss balance, not decreases it.
Question 6
Hint
Separate service cost from the other net periodic pension cost components, then net the non-service pieces using their proper signs.
Answer C. Only non-service components are presented outside operating income. Those are interest cost, expected return on plan assets, and amortization of prior service cost. Netting those amounts gives $70,000 minus $50,000 plus $20,000, or $40,000 expense.
Why not A: This comes from adding interest cost, expected return, and amortization as if all increased expense. Expected return on plan assets reduces net periodic pension cost, so it must be subtracted.
Why not B: This results from netting only interest cost and expected return on plan assets. That omits amortization of prior service cost, which is also a non-service component presented outside operating income.
Why not D: This comes from including service cost in the amount outside operating income. Service cost is presented with other compensation-related operating costs, not in the non-operating pension amount.
Common questions
What are the five components of net periodic pension cost?
Add service cost, interest cost, and prior service cost amortization. Subtract expected return on plan assets; add net loss amortization or subtract net gain amortization.
Where is pension service cost reported on the income statement?
Report it with compensation for the employees earning the benefits, such as cost of goods sold or SG&A. Present other components separately, outside operating income when that subtotal is shown.
Does pension expense use expected or actual return?
Use expected return on plan assets as a reduction of expense. The difference between actual and expected return is initially recognized as a gain or loss in OCI.
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