FAR · Select balance sheet accounts · 6 practice questions
Pension Prior Service Cost: OCI, Amortization, and Curtailments
A pension amendment's full past-service effect enters OCI immediately, while amortization moves it into pension expense over remaining service. Follow one amendment from initial recognition through amortization and a partial curtailment.
Try one first
Hint
Distinguish a retroactive benefit increase from current service cost and ask where that amendment first appears.
Answer C. A plan amendment granting additional benefits for prior service creates prior service cost. That amount is recognized in other comprehensive income in the period of the amendment, with the offset increasing the projected benefit obligation. It is amortized from accumulated OCI into pension expense in later periods.
Why not A: This mistake assumes the debit creates an asset. Granting extra prior-service benefits increases the pension obligation, and the offset is prior service cost in OCI rather than a deferred pension asset.
Why not B: This mistake treats the amendment like current-period service cost. Current service cost is recognized in pension expense as employees work, but a retroactive benefit increase from an amendment is first recorded in OCI.
Why not D: This mistake treats the amendment as a direct equity adjustment. GAAP records prior service cost in OCI when the amendment occurs, not in retained earnings.
The timeline
- January 1, Year 1Ridge amends its pension plan, increasing the PBO by $480,000 for past service.
Affected active employees average eight remaining service years. Use straight-line amortization and ignore taxes. Debit OCI $480,000; credit PBO $480,000.
- December 31, Year 1Recognize $60,000 of prior service cost amortization; $420,000 remains in AOCI.
$480,000 ÷ 8 = $60,000 annually. Debit pension expense and credit AOCI. Amortization does not reduce the PBO.
- December 31, Year 2Recognize another $60,000 of amortization; $360,000 remains in AOCI.
Two full years have passed: $480,000 minus $120,000 = $360,000 of unamortized prior service cost.
- January 1, Year 3Ridge closes a unit. Twenty-five percent of affected participants will render no further service that earns benefits.
The unamortized cost relates evenly to participants. Recognize 25% × $360,000 = $90,000 immediately in pension expense because of the curtailment.
- January 1, Year 3, after curtailment recognitionThe remaining prior service cost in AOCI is $270,000.
$360,000 minus $90,000 = $270,000. Only the portion tied to lost future service is accelerated.
Key points
- Remember: The full amendment enters OCI now; expense follows remaining service, unless a curtailment eliminates some of that service.
- Generally, use affected active employees' remaining service, not vesting periods or total career length.
- If all or almost all participants are inactive, use their average remaining life expectancy instead of remaining service.
- A midyear amendment still enters OCI in full; only that year's amortization is prorated.
How the exam traps you
- Recording the entire amendment as current pension expense. Record the full past-service amount in OCI first, then amortize it into expense.
- Using the vesting period or total career length for amortization. Generally, use affected active employees' average remaining service period.
- Recognizing all unamortized prior service cost after a partial curtailment. Recognize only the portion tied to future service that will no longer be rendered.
Question 2
Hint
Separate the plan amendment item from the estimate-change item. Only one is subject to corridor testing.
Answer C. Prior service cost from a plan amendment is recognized in OCI and then amortized into net periodic pension cost, generally over the average remaining service period of affected employees. An actuarial loss also starts in OCI, but it is amortized only when the net gain or loss exceeds the corridor threshold. The two items therefore do not use the same amortization trigger.
Why not A: This mistake treats OCI components as current-period pension expense. Prior service cost and actuarial loss are initially recorded in OCI, so neither is fully amortized into pension expense immediately.
Why not B: This reverses the rules. Corridor testing applies to actuarial gains and losses, while prior service cost is amortized over a service period without first applying a corridor test.
Why not D: This mistake assumes OCI amounts never reclassify into pension cost. Prior service cost is amortized, and actuarial loss can also be amortized when the corridor threshold is met.
Question 3
Hint
Ask which component is normally spread over employees' remaining service and loses that service base after a curtailment.
Answer B. A curtailment can accelerate recognition of the unamortized prior service cost tied to service that will no longer be rendered. Because the remaining future service periods disappear, that amount is recognized currently as part of the curtailment effect. Service cost is instead reduced prospectively, and interest cost continues on the remeasured obligation.
Why not A: This choice comes from focusing on the fact that future benefit accruals stop. But service cost for service that will not be rendered simply stops going forward; the curtailment does not create immediate recognition of prior service-based amounts through this component.
Why not C: This choice confuses curtailment accounting with settlement accounting. The component most directly accelerated by the loss of future service periods is prior service cost, not the amortization of accumulated actuarial losses.
Why not D: This mistake treats the curtailment like an immediate catch-up of the financing component. Interest cost remains an ongoing component based on the post-curtailment projected benefit obligation rather than an amount accelerated because future service periods vanish.
Question 4
Hint
For a years-of-service method, compare the current year's service to all future service expected when the amendment was adopted.
Answer B. Under a years-of-service method, prior service cost is allocated based on service rendered in each future period relative to total future service expected at the amendment date. Total future service years are 4 times 1 plus 6 times 4, or 28. In Year 2, only the 6 longer-service employees remain active, so amortization is 6 divided by 28 times $280,000, or $60,000.
Why not A: This result comes from using the 4 employees who retire after Year 1 in the numerator. They do not provide service in Year 2, so they are not part of Year 2 amortization.
Why not C: This reflects straight-line amortization over the average remaining service period. Rowan is using a years-of-service method, so later years are based on the service years actually remaining in those years.
Why not D: This comes from using only the 6 longer-service employees' original 24 service years as the denominator. The denominator must include all future service years expected at the amendment date, including the one-year group.
Question 5
Hint
Focus on whether the amount arises from adopting pension accounting guidance or from granting retroactive benefits under a plan formula.
Answer D. Starting a pension plan that grants credit for earlier employee service creates prior service cost. That cost is initially reported in other comprehensive income and amortized into net periodic pension cost. A new plan adoption does not create a new transition obligation under current pension accounting.
Why not A: This treats adoption of the plan as if it were adoption of pension accounting guidance. Current U.S. GAAP does not create a new transition obligation merely because an employer starts a defined benefit plan.
Why not B: This treats the obligation as if it resulted from a change in actuarial assumptions or experience. The obligation arises from the plan formula granting benefit credit, so it is not an actuarial loss.
Why not C: This treats the retroactive benefit credit as compensation earned only in the current period. Service cost measures benefits earned from employee service during the current period, not benefits credited for earlier employment.
Question 6
Hint
Separate the amendment-date entry from the later amortization out of accumulated OCI.
Answer C. A plan amendment that grants higher benefits for service already rendered creates prior service cost. The full $300,000 increase in the projected benefit obligation is recognized in other comprehensive income on the amendment date. The four-year service period affects later amortization into pension expense, not the initial amount recorded in OCI.
Why not A: This mistake prorates the increase because the amendment occurred halfway through the year. Timing within the year does not reduce the amount initially recognized in OCI for retroactive benefits granted for past service.
Why not B: This comes from taking one year's amortization and then prorating it for six months. That approach applies to reclassification from AOCI into pension expense, not to the amendment-date recognition of prior service cost.
Why not D: This reflects dividing the increase by the four-year remaining service period. That spread is used later to amortize prior service cost, but the entire increase is first recorded in OCI when the amendment occurs.
Common questions
Does prior service cost go to OCI or pension expense?
The full past-service amount enters OCI first, then amortization affects pension expense. A benefit increase debits OCI and increases the PBO; a benefit reduction credits OCI and decreases the PBO.
What period is used to amortize prior service cost?
Straight-line amortization generally uses affected active employees' average remaining service; a years-of-service method allocates cost by expected future service years. If all or almost all participants are inactive, use their average remaining life expectancy.
What happens to unamortized prior service cost after a curtailment?
Recognize immediately the portion tied to service that will no longer be rendered. A partial curtailment does not automatically remove the entire prior service cost balance from AOCI.
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