Chapter 17—Employee Compensation-Payroll, Pensions, & Other Comp.

Issues

MULTIPLE CHOICE

1. Which of the following accounting principles best describes the rationale for reporting a liability
for earned but unused compensated absences?
a. Historical cost
b. Full disclosure
c. Materiality
d. Matching
ANS: D OBJ: LO 1

2. Which of the following criteria is not required for the recognition of a liability for compensated
absences under FASB Statement No. 43?
a. The amount of the obligation must be estimable.
b. Payment of the obligation must be probable.
c. Payment of the obligation will require the use of current assets.
d. The compensation either vests with the employee or can be carried forward to subsequent
years.
ANS: C OBJ: LO 1

3. Each full-time employee of Sunshine Greenhouse is entitled to ten paid sick days each year. The
sick pay is not vested, but any unused sick days can be carried over to subsequent years. Under
FASB Statement No. 43, Sunshine Greenhouse should
a. recognize sick pay as an expense when actually paid.
b. recognize an estimated current liability for unused sick pay at the end of each period.
c. recognize an estimated noncurrent liability for unused sick pay at the end of each period.
d. accrue or not accrue sick pay based on historical rates of absenteeism.
ANS: A OBJ: LO 1

4. Which of the following taxes is not included in the payroll tax expense of the employer?
a. State unemployment taxes
b. Federal unemployment taxes
c. FICA taxes
d. Federal income taxes
ANS: D OBJ: LO 1

5. Which of the following payroll taxes are paid by the employer?

a. FICA taxes
b. Federal unemployment taxes
c. State unemployment taxes
d. All of the above
ANS: D OBJ: LO 1

6. Which of the following taxes must be paid by both the employee and the employer?
a. Social security tax (FICA)
b. State unemployment tax
c. State withholding tax
d. Federal unemployment tax

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 ANS: A OBJ: LO 1
7. Laid Back Corp. follows the practice of paying all employees for vacation. The vacation pay is
not vested, but it carries over for one year if unused. Under GAAP, the obligation for earned but
unused vacation should be
a. accrued as a current liability.
b. disclosed as a contingent liability.
c. ignored until incurred.
d. accrued or not accrued according to the judgment of management.
ANS: A OBJ: LO 1

8. Which of the following statements characterizes defined contribution plans?

a. They are more complex in construction than defined benefit plans.
b. The employer's obligation is satisfied by making the appropriate amount of periodic
contribution.
c. The investment risk is borne by the employer.
d. Contributions are made in equal amounts by employer and employees.
ANS: B OBJ: LO 3

9. Which of the following statements characterizes defined benefit plans?

a. They are comparatively simple in construction and raise few accounting issues for
employers.
b. Retirement benefits are based on the plan's benefit formula.
c. Retirement benefits depend on how well pension fund assets have been managed.
d. All of the above.
ANS: B OBJ: LO 2

10. Which of the following is not an issue in accounting for defined benefit plans?
a. The amount of pension expense to be recognized
b. The amount of pension liability to be reported
c. The amount of funding (contributions) required by the plan
d. Disclosures needed to supplement the financial statements
ANS: C OBJ: LO 3

11. FASB Statement No. 87 included the concept of a minimum pension liability requiring an
employer to recognize a liability at least equal to the
a. unfunded accumulated benefit obligation.
b. unfunded projected benefit obligation.
c. fair value of pension plan assets.
d. accrued pension costs.
ANS: A OBJ: LO 4

12. When the value of the pension fund assets is greater than the projected benefit obligation, the
difference is
a. reported as prepaid pension cost.
b. reported as deferred pension cost.
c. reported as a contra equity adjustment.
d. not recognized on the balance sheet.
ANS: D OBJ: LO 4

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13. The FASB established the minimum liability requirement to reflect
a. the accumulated benefit obligation.
b. the vested benefit obligation.
c. overdue employer contributions.
d. unfunded pension cost.
ANS: D OBJ: LO 4

14. What is measured by the accumulated benefit obligation?

a. The pension expense, computed by the plan formula applied to years of service to date,
assuming future salary levels.
b. The pension expense, computed by the plan formula applied to years of service to date,
using existing salary levels.
c. The pension obligation, computed by the plan formula applied to years of service to date,
assuming future salary levels.
d. The pension obligation, computed by the plan formula applied to years of service to date,
using existing salary levels.
ANS: D OBJ: LO 4

15. Under FASB Statement No. 87, the minimum liability is computed using the difference between
the
a. accumulated benefit obligation and the fair value of plan assets.
b. net periodic pension cost and the current period contribution.
c. fair value of plan assets and the market-related value of plan assets.
d. projected benefit obligation and the market-related value of plan assets.
ANS: A OBJ: LO 4

16. If the actual return on pension fund assets exceeds the expected return for the period, the
difference is
a. a deferred loss.
b. a deferred gain.
c. recognized as a loss in the current period.
d. recognized as a gain in the current period.
ANS: B OBJ: LO 4

17. The projected benefit obligation is the measure of pension obligation that
a. can no longer be used under GAAP as an estimate for reporting the service cost
component of pension expense.
b. is not an allowable estimate for reporting the service cost component of pension expense
for defined benefit plans.
c. is one of several allowable estimates for reporting the service cost component of pension
expense.
d. is the only allowable estimate for reporting the service cost component of pension
expense.
ANS: D OBJ: LO 3

18. FASB Statement No. 87 states that prior service cost should be
a. offset against current service cost.
b. recognized in the period of plan adoption or amendment.
c. amortized over the expected service period.
d. recorded as a prior period adjustment.
ANS: C OBJ: LO 4

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19. Which of the following is not a component of net periodic pension cost?
a. Interest cost
b. Actual return on plan assets
c. Benefits paid to retirees
d. Amortization of prior service cost
ANS: C OBJ: LO 4

20. The FASB's conclusion relating to the computation of the service cost component of pension
expense is that
a. the projected benefit obligation computed using future salary levels provides a reasonable
measure of present pension obligation and expense.
b. the projected benefit obligation computed using present salary levels provides a reasonable
measure of present pension obligation and expense.
c. the projected benefit obligation computed using present salary levels provides a reasonable
measure of future pension obligation and expense.
d. the projected benefit obligation computed using future salary levels provides a reasonable
measure of future pension obligation and expense.
ANS: A OBJ: LO 4

21. FASB Statement No. 132 requires that the notes accompanying the financial statements include a
schedule reconciling the
a. funded status of the plan with amounts reported in the balance sheet.
b. current period employer contributions with pension expense reported in the income
statement.
c. projected benefit obligation and the accumulated benefit obligation.
d. actual return on plan assets with the expected return.
ANS: A OBJ: LO 5

22. The vested benefits of an employee in a pension plan represent benefits

a. to be paid to the retired employee in the current year.
b. to be paid to the retired employee in subsequent years.
c. to be paid from funds currently in the hands of an independent trustee.
d. that are not contingent on the employee's continuing in the service of the employer.
ANS: D OBJ: LO 3

23. Which of the following components should be included in the calculation of net pension cost
recognized for a period by an employer sponsoring a defined benefit pension plan?

Actual Return Amortization of

on Plan Assets, Unrecognized Prior Interest
If Any Service cost, If Any Cost

a. No No Yes
b. Yes No Yes
c. Yes Yes No
d. Yes Yes Yes

ANS: D OBJ: LO 4

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24. Which of the following concepts for postretirement benefit plans is comparable to the projected
benefit obligation (PBO) of pension plans?
a. Accumulated Postretirement Benefit Obligation (APBO)
b. Expected Postretirement Benefit Obligation (EPBO)
c. Actual return on plan assets
d. Expected return on plan assets
ANS: A OBJ: LO 7

25. Which of the following statements is correct?

a. Minimum (corridor) amortization of net unrecognized gain or loss is not allowed for
postretirement benefit plans.
b. Immediate recognition of gains and losses is allowed for postretirement benefit plans but
not for pension plans.
c. Immediate recognition of gains and losses is allowed for pension plans but not for
postretirement benefit plans.
d. Minimum (corridor) amortization of net unrecognized gain or loss is the only amortization
method allowed for postretirement benefit plans.
ANS: B OBJ: LO 7

26. The interest cost component for other postretirement benefits is determined using
a. the settlement rate of interest.
b. the rate of return on high quality fixed-income investments with cash flows matching the
timing and amounts of expected benefit payments.
c. both a and b.
d. neither a or b.
ANS: C OBJ: LO 7

27. International accounting standards for pension currently in effect

a. allow both the accrued benefit and projected benefit methods.
b. allow only the accrued benefit method.
c. allow only the projected benefit method.
d. do not allow either the accrued benefit or projected benefit methods.
ANS: B OBJ: LO 6

28. Which of the following is not correct?

a. International accounting standards for pensions (IFRS 19) do not include any provisions
for the recognition of an additional minimum liability.
b. International accounting standards for pensions (IFRS 19) do not allow for the recognition
of a net pension asset in some circumstances.
c. International accounting standard for pensions (IFRS 19) include the same 10% corridor
amount in calculating the amortization of deferred gains and losses as found in U.S.
GAAP.
d. International accounting standards for pensions (IFRS 19) recognized pension gains and
losses immediately as part of comprehensive income.
ANS: D OBJ: LO 6

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29. Wright, Inc. has an incentive compensation plan under which the sales manager receives a bonus
equal to 10 percent of the company's income after deductions for bonus and income taxes.
Income before bonus and income taxes is $400,000. The effective income tax rate is 30 percent.
How much is the bonus (rounded to the nearest dollar)?
a. $40,000
b. $30,108
c. $28,000
d. $26,168
ANS: D OBJ: LO 2

30. Washington Corporation provides an incentive compensation plan under which its president is to
receive a bonus equal to 10 percent of Washington's income in excess of $100,000 before
deducting income tax but after deducting bonus. If income before income tax and bonus is
$320,000 and the effective tax rate is 40 percent, the amount of the bonus should be
a. $20,000.
b. $22,000.
c. $32,000.
d. $44,000.
ANS: A OBJ: LO 2

31. During the first week of January, Sam Jones earned $200. Assume that FICA taxes are 7.65
percent of wages up to $50,000, state unemployment tax is 5.0 percent of wages up to $13,000,
and federal unemployment tax is 0.8 percent of wages up to $13,000. Assume that Sam has
voluntary withholdings of $10 (in addition to taxes) and that federal and state income tax
withholdings are $18 and $6, respectively. What amount is the check, net of all deductions, that
Sam received for the week's pay?
a. $150.70
b. $141.70
c. $140.10
d. $155.20
ANS: A OBJ: LO 1

32. During the first week of January, Sam Jones earned $200. Assume that FICA taxes are 7.65
percent of wages up to $50,000, state unemployment tax is 5.0 percent of wages up to $13,000,
and federal unemployment tax is 0.8 percent of wages up to $13,000. Assume that Sam has
voluntary withholdings of $10 (in addition to taxes) and that federal and state income tax
withholdings are $18 and $6, respectively. What is the employer's payroll tax expense for the
week, assuming that Sam Jones is the only employee?
a. $6.32
b. $26.90
c. $10.00
d. $19.05
ANS: B OBJ: LO 1

33. Northwest Company determined that it has an obligation relating to employees' rights to receive
compensation for future absences attributable to employees services already rendered. The
obligation relates to rights that vest, and payment of the compensation is probable. The amounts
of Northwest's obligations as of December 31 are reasonably estimated as follows:

Vacation pay ......................................... $110,000

Sick pay ............................................. 80,000

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 In its December 31 balance sheet, what amount should Northwest report as its liability for
compensated absences?
a. $0
b. $80,000
c. $110,000
d. $190,000
ANS: D OBJ: LO 1

34. The following information relates to the defined benefit pension plan for the McDonald Company
for the year ending December 31, 2005.

Projected benefit obligation, January 1 ............... $4,600,000

Projected benefit obligation, December 31 ............. 4,729,000
Fair value of plan assets, January 1 .................. 5,035,000
Fair value of plan assets, December 31 ................ 5,565,000
Expected return on plan assets ........................ 450,000
Amortization of deferred gain ......................... 32,500
Employer contributions ................................ 425,000
Benefits paid to retirees ............................. 390,000
Settlement rate ....................................... 10%

Service cost for the year would be

a. $59,000.
b. $94,000.
c. $129,000.
d. $390,000.
ANS: A OBJ: LO 4

35. The following information relates to the defined benefit pension plan of the McDonald Company
for the year ending December 31, 2005:
Projected benefit obligation, January 1 ............... $4,600,000
Projected benefit obligation, December 31 ............. 4,729,000
Fair value of plan assets, January 1 .................. 5,035,000
Fair value of plan assets, December 31 ................ 5,565,000
Expected return on plan assets ........................ 450,000
Amortization of deferred gain ......................... 32,500
Employer contributions ................................ 425,000
Benefits paid to retirees ............................. 390,000
Settlement rate ....................................... 10%

The actual return on plan assets for the year is

a. $105,000.
b. $495,000.
c. $503,500.
d. $530,000.
ANS: B OBJ: LO 4

36. The following information relates to Irasly Inc. at December 31, 2005:
Fair value of plan assets ............................. $1,520,000
Market related asset value ............................ 1,440,000
Accumulated benefit obligation ........................ 1,960,000
Projected benefit obligation .......................... 2,040,000
Unrecognized prior service cost ....................... 24,000
Prepaid/accrued pension cost .......................... 0

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 The total pension liability at December 31, 2005, for Irasly Inc. is
a. $0.
b. $440,000.
c. $480,000.
d. $520,000.
ANS: B OBJ: LO 4

37. On January 1, 2005, Cubs Corporation adopted a defined benefit pension plan. The plan's service
cost of $150,000 was fully funded at the end of 2005. Prior service cost was funded by a
contribution of $60,000 in 2005. Amortization of prior service cost was $24,000 for 2005. What
is the amount of Cub's prepaid pension cost at December 31, 2005?
a. $36,000
b. $60,000
c. $84,000
d. $90,000
ANS: A OBJ: LO 4

38. The following information relates to the defined benefit pension plan of the McDonald Company
for the year ending December 31, 2005:

Projected benefit obligation, January 1 ............... $4,600,000

Projected benefit obligation, December 31 ............. 4,729,000
Fair value of plan assets, January 1 .................. 5,035,000
Fair value of plan assets, December 31 ................ 5,565,000
Expected return on plan assets ........................ 450,000
Amortization of deferred gain ......................... 32,500
Employer contributions ................................ 425,000
Benefits paid to retirees ............................. 390,000
Settlement rate ....................................... 10%

The net amount of the gain or loss component to be included in pension cost for 2005 would be
a. $77,500.
b. $47,500.
c. $32,500.
d. $12,500.
ANS: D OBJ: LO 4

39. On January 1, 2005, Crowther Co. estimated a projected benefit of $440,000 based on a
settlement rate of 12 percent. Pension benefits paid to retirees totaled $60,000. Service costs for
2005 amounted to $148,000. The fair value of the plan assets were $350,000 and $400,000 on
December 31, 2004, and December 31, 2005, respectively. The projected benefit obligation at
December 31, 2005, was
a. $528,000.
b. $580,800.
c. $630,800.
d. $640,800.
ANS: B OBJ: LO 4

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40. Chester Company has a defined benefit plan. The fair value of plan assets on January 1, 2005,
was $1,500,000. No unrecognized net loss or gain existed. On December 31, 2005, the fair value
of the plan assets was $1,860,000. Benefits paid to retirees equaled $300,000. Company
contributions to the plan totaled $360,000. The settlement rate was 8 percent, and the expected
long-term rate of return on plan assets was 10 percent. The actual return on plan assets was
a. $150,000.
b. $180,000.
c. $224,000.
d. $300,000.
ANS: D OBJ: LO 4

41. Trueblu Corporation is a publicly held company that supplies tourniquets to medical emergency
centers. The company maintains a noncontributory defined benefit pension plan for its
employees. The Trueblu's actuary has provided the following information for the year ended
December 31, 2005:

Projected benefit obligation .......................... $800,000

Accumulated benefit obligation ........................ 700,000
Fair value of plan assets ............................. 820,000
Service cost .......................................... 240,000
Interest on projected benefit obligation .............. 24,000
Amortization of unrecognized prior service cost ....... 60,000
Expected and actual return on plan assets ............. 82,000

Prior contributions to the defined benefit pension plan equaled the amount of net periodic pension
cost accrued for the previous year end. If no contributions have been made for 2005 pension cost,
what amount should Trueblu report in its December 31, 2005 balance sheet for accrued pension
cost?
a. $218,000
b. $242,000
c. $324,000
d. $406,000
ANS: B OBJ: LO 4

42. On January 1, 2005, Dibble Co. amended its defined benefit plan resulting in an increase in the
projected benefit obligation of $700,000. As of the date of the amendment, Dibble Co. had 100
employees. Ten employees are expected to leave at the end of each of the next ten years. The
minimum amount of amortization for prior service cost in 2006 (second year) is:
a. $140,000.
b. $127,273.
c. $114,545.
d. $101,818.
ANS: C OBJ: LO 4

43. Flash Inc. has a defined benefit plan for its employees. The following information relates to this
plan:
Projected benefit obligation, January 1, 2005 ......... $10,000,000
Fair value of plan assets, market-related asset value,
January 1, 2005 ....................................... 10,400,000
Service cost--2005 .................................... 800,000
Actual return on plan assets--2005 .................... 900,000
Settlement rate ....................................... 10%
Long-term rate of return on assets .................... 8%

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 There was no unrecognized prior service cost or unrecognized gains or losses. Flash's net periodic
pension cost for the year was
a. $880,000.
b. $900,000.
c. $940,000.
d. $968,000.
ANS: D OBJ: LO 4

44. The following information relates to the defined benefit pension plan of the McDonald Company
for the year ending December 31, 2005:

Projected benefit obligation, January 1 ............... $4,600,000

Projected benefit obligation, December 31 ............. 4,729,000
Fair value of plan assets, January 1 .................. 5,035,000
Fair value of plan assets, December 31 ................ 5,565,000
Expected return on plan assets ........................ 450,000
Amortization of deferred gain ......................... 32,500
Employer contributions ................................ 425,000
Benefits paid to retirees ............................. 390,000
Settlement rate ....................................... 10%

The net periodic pension cost reported in the income statement for 2005 would be
a. $11,500.
b. $24,000.
c. $36,500.
d. $59,000.
ANS: C OBJ: LO 4

45. Blaine Inc. shows the following data relating to its pension plan for 2005:

Amortization of unrecognized net loss ................. $ 16,000

Amortization of unrecognized prior service cost ....... 28,000
Expected return on plan assets ........................ 32,000
Actual return on plan assets .......................... 36,000
Interest on projected benefit obligation .............. 70,000
Service cost .......................................... 160,000

What amount should Blaine report for pension expense in 2005?

a. $206,000
b. $238,000
c. $242,000
d. $270,000
ANS: C OBJ: LO 4

46. Sutton Inc. has a defined benefit plan for its employees. The following information relates to this
plan:

Dec. 2005 Dec. 2006

Prepaid pension cost ...................... $ 200,000 $ 250,000
Fair value of plan assets ................. 5,900,000 6,200,000
Market related asset value ................ 6,000,000 6,100,000
Accumulated benefit obligation ............ 5,500,000 6,400,000
Projected benefit obligation .............. 7,000,000 8,000,000

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 There was no prepaid/accrued pension cost at January 1, 2005. The total pension liability at
December 31, 2005, for Sutton is
a. $0.
b. $1,200,000.
c. $1,500,000.
d. $400,000.
ANS: A OBJ: LO 4

47. Piston Corporation has the following pension information for the year ended December 31, 2005:

Service cost $ 225,000

Contributions to the plan 240,000
Actual return on plan assets 210,000
Projected benefit obligation (beginning of year) 2,700,000
Market-related and fair value of plan assets 1,800,000
(beginning of year)

Assuming the expected return on plan assets and the settlement rate are both 10 percent, what
amount should Piston report for pension expense for 2005?
a. $225,000
b. $285,000
c. $315,000
d. $495,000
ANS: C OBJ: LO 4

48. Sutton Inc. has a defined benefit plan for its employees. The following information relates to this
plan.

Dec. 2005 Dec. 2006

Prepaid pension cost ...................... $ 200,000 $ 250,000
Fair value of plan assets ................. 5,900,000 6,200,000
Market related asset value ................ 6,000,000 6,100,000
Accumulated benefit obligation ............ 5,500,000 6,400,000
Projected benefit obligation .............. 7,000,000 8,000,000

There was no prepaid/accrued pension cost at January 1, 2005. The net pension liability at
December 31, 2006, for Sutton is
a. $0.
b. $200,000.
c. $300,000.
d. $1,400,000.
ANS: B OBJ: LO 4

49. The following information relates to Irasly Inc. at December 31, 2005:

Fair value of plan assets ............................. $1,520,000

Market related asset value ............................ 1,440,000
Accumulated benefit obligation ........................ 1,960,000
Projected benefit obligation .......................... 2,040,000
Unrecognized prior service cost ....................... 24,000
Prepaid/accrued pension cost .......................... 0

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 The intangible asset on Irasly's balance sheet at December 31, 2005, is
a. $0.
b. $24,000.
c. $440,000.
d. $520,000.
ANS: B OBJ: LO 4

50. Robinson Company adopted a defined benefit pension plan on January 1, 2005. Robinson
amortizes the prior service cost over 16 years and funds prior service cost by making equal
payments to the fund trustee at the end of each of the first ten years. The service cost is fully
funded at the end of each year. The following data are available for 2005:

Service cost .......................................... $440,000

Prior service cost:
Amortized ........................................... 166,800
Funded .............................................. 228,800

If interest cost for 2005 is equal to the return on plan assets, then Robinson's prepaid pension cost
at December 31, 2005, is
a. $0.
b. $62,000.
c. $166,800.
d. $228,800.
ANS: B OBJ: LO 4

PROBLEMS

1. Employees of Harding Fabricators, Inc. earned gross wages of $140,000 during a recent two-
week period. Employee withholdings and payroll tax percentages are presented below:

Federal withholding ................................... $33,000

Hospital insurance premiums ........................... 3,050
FICA .................................................. 7.5%
State unemployment .................................... 2.0%
Federal unemployment .................................. 0.8%

Only $78,000 of wages are subject to FICA, and $36,000 are subject to unemployment taxes.

(1) Prepare the entry to record the gross payroll.

(2) Prepare the entry to record employer payroll taxes.

ANS:

(1)
Gross Payroll:
Wages Expense ............................. 140,000
Federal Income Tax Withheld ............. 33,000
Hospital Insurance Payable .............. 3,050
FICA Taxes Payable ($78,000  7.5%) ..... 5,850
Wages Payable ........................... 98,100

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 (2)
Employer Payroll Taxes:
Payroll Tax Expense ....................... 6,858
FICA Taxes Payable ...................... 5,850
State Unemployment Tax Payable .......... 720
Federal Unemployment Tax Payable ........ 288

SUT ($36,000  2%) = $720

FUT ($36,000  .8%) = $288

OBJ: LO 1

2. On August 31, 2005, payroll data from the records of Earthtec Enterprises showed:

Payroll: Factory wages .................... $125,000

Office salaries .................. 82,500
Sales salaries ................... 98,000

Payroll deductions: Income tax withholding ........... $ 47,800

FICA tax (7.5%) .................. ?

Wages and salaries not subject to FICA tax:

Factory wages .................... $ 28,000
Office salaries .................. 40,000
Sales salaries ................... 45,000

Wages and salaries not subject to federal and state

unemployment taxes:
Factory wages .................... $ 60,000
Office salaries .................. 80,000
Sales salaries ................... 72,000

Provide the entries necessary to:

(1) Record the payment of the payroll on August 31, 2005.

(2) Record the employer's payroll tax liabilities. (The federal unemployment tax rate is
0.8 percent; the state unemployment tax rate is 5.4 percent.)

ANS:

(1)
Factory Wages Expense ..................... 125,000
Office Salaries Expense ................... 82,500
Sales Salaries Expense .................... 98,000
Cash .................................... 243,262
Employees Income Tax Payable ............ 47,800
FICA Taxes Payable ...................... 14,438*

To record the payment of August 31 payroll.

* Factory wages $125,000 - $28,000 = $ 97,000

Office salaries $ 82,500 - $40,000 = 42,500
Sales salaries $ 98,000 - $45,000 = 53,000
$192,500
 .075
$ 14,438 (rounded)

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 (2)
Factory Payroll Tax Expense .................... 11,305
Office Payroll Tax Expense ..................... 3,343
Sales Payroll Tax Expense ...................... 5,587
FICA Taxes Payable ........................... 14,438
Federal Unemployment Tax Payable ............. 748
State Unemployment Tax Payable ............... 5,049
To record the employer's payroll tax liabilities.

Computation of payroll tax expense by employee group:

Factory Office Sales Total

FICA Tax (7.5%):
($125,000 - $28,000)  7.5% $ 7,275
($ 82,500 - $40,000)  7.5% $3,188*
($ 98,000 - $45,000)  7.5% $3,975 $14,438

Federal Unemployment Tax

(.8%):
($125,000 - $60,000)  0.8% 520
($ 82,500 - $80,000)  0.8% 20
($ 98,000 - $72,000)  0.8% 208 748

State Unemployment Tax

(5.4%):
($125,000 - $60,000)  5.4% 3,510
($ 82,500 - $80,000)  5.4% 135
($ 98,000 - $72,000)  5.4% 1,404 5,049
$11,305 $3,343 $5,587 $20,235
*rounded

OBJ: LO 1

3. Arctic Ice Inc. compensates its employees for certain absences. Employees can receive one day
vacation plus one day sick leave for each month worked during the year. Unused vacation days
may be carried forward, but unused sick leave expires within the year of employment. Employees
are compensated according to their current pay rate. The following data were taken from the
records for the year 2005.

Earned Carry
Starting Sick Leave Forward Vacation Days Current Pay
Employee Date Taken 2005 1/1/05 Taken 2005 per Day
S. Perkins 1/6/03 5 0 7 $70
M. Jordan 6/2/04 10 6 3 60
P. Ford 11/4/05 5 0 0 48
J. Worthy 7/28/05 2 0 1 79

Compute the amount that should be reported as a liability for compensated absences on
December 31, 2005.

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 ANS:

Vacation Days Liability for

Employee Not Taken Rate per Day Compensated Absences
S. Perkins 5 $70 $ 350
M. Jordan 15 60 900
P. Ford 2 48 96
J. Worthy 4 9 316
$1,662

OBJ: LO 1

4. As an incentive, Wilson Enterprises awards an annual bonus to its branch managers. This year,
the bonus for the Glendale branch was $44,000. The bonus agreement provides that each branch
manager receives a bonus of 14 percent of the branch income after deductions for the bonus and
for income taxes. The income tax rate is 30 percent.

Determine the income for the Glendale branch before the deductions for the bonus and the
income taxes.

ANS:
Let B = Bonus, T = Income Taxes, and I = Income

Then,
B = $44,000
T = 0.30 (I - $44,000)
B = 0.14 (I - B - T)

Substituting for B and T in the last equation, and solving for I:

$44,000 = 0.14 [I - $44,000 - 0.30 (I - $44,000)]
$44,000 = 0.14 [I - $44,000 - 0.30 I + $13,200]
$44,000 = 0.14 I - $6,160 - 0.042 I + $1,848
$44,000 = 0.098 I - $4,312
$48,312 = 0.098 I
I = $492,980 (rounded)

OBJ: LO 2

5. West Communications is considering adopting a bonus plan for its executives. Two plans are
currently being evaluated. The first plan involves executives receiving a bonus of 8 percent of
company earnings calculated on income after deduction for bonus but before deduction for
income tax. The second plan involves a bonus of 12 percent calculated on income after
deductions for both bonus and income tax. Income tax is 30 percent of income after bonus.

If income before bonus and taxes for the year is estimated to be $100,000, which bonus plan
would company executives prefer?

ANS:
Plan A
B = 0.08 ($100,000 - B)
B = $8,000 - 0.08 B
1.08 B = $8,000
B = $7,407

418
 Plan B
B = 0.12 ($100,000 - B - T)
T = 0.30 ($100,000 - B)

Substituting the second equation into the first and solving for B:

B = 0.12 [$100,000 - B - 0.30 ($100,000 - B)]

B = 0.12 ($100,000 - B - $30,000 + 0.3 B)
B = $12,000 - 0.12 B - $3,600 + 0.036 B
1.084 B = $8,400
B = $7,749

Plan B results in the highest bonus for company executives assuming an income before bonus and
taxes of $100,000.

OBJ: LO 2

6. The following data relate to the defined benefit pension plan of the Youngblood Corp. for the
years 2004-2006:

Net Periodic Employer Benefits Paid Actual Return

Year Pension Cost Contributions to Retirees on Fund Assets
2004 $255,000 $300,000 $105,000 $120,000
2005 300,000 300,000 114,000 150,000
2006 315,000 300,000 120,000 156,000

At December 31, 2003, the books of Youngblood Corp. reflected accrued pension cost of
$30,000. The fair value of pension fund assets at that date was $1,380,000. The pension fund is
administered by an independent trustee.

(1) Prepare the summary journal entries relating to the pension plan that would be
required on the books of Youngblood Corp. for 2004, 2005, and 2006.
(2) Determine the balance of the prepaid/accrued pension cost account at December
31, 2006.
(3) Compute the fair value of pension fund assets as of December 31, 2006.

ANS:

(1)
2004 Pension Cost ....................... 255,000
Prepaid/Accrued Pension Cost ....... 45,000
Cash ............................. 300,000

2005 Pension Cost ....................... 300,000

Cash ............................. 300,000

2006 Pension Cost ....................... 315,000

Prepaid/Accrued Pension Cost ....... 15,000
Cash ............................. 300,000

(2)
There is a zero balance in Prepaid/Accrued Pension Cost at December 31, 2006. ($30,000 credit -
$45,000 debit + $15,000 credit) = $0

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 (3)
Fair value of plan assets at December 31, 2003 ........ $1,380,000
Add: Contributions ($300,000  3) ................ 900,000
Actual return ($120,000 + $150,000 + $156,000) 426,000
Deduct: Benefits paid ($105,000 + $114,000 + $120,000) (339,000)
Fair value of plan assets at December 31, 2006 ........ $2,367,000

OBJ: LO 4

7. The following information relates to the defined benefit pension plan of the Ruder Co.:

Projected benefit obligation, January 1, 2005 ......... $280,000

Projected benefit obligation, December 31, 2005 ....... 307,500
Accumulated benefit obligation, January 1, 2005 ....... 240,000
Accumulated benefit obligation, December 31, 2005 ..... 256,000
Benefits paid to retirees during 2005 ................. 22,000
Contributions by employer during 2005 ................. 37,500
Settlement rate ....................................... 10%

(1) Compute the amount of service cost for 2005.

(2) Prepare the reconciliation between the beginning and ending balances for the
projected benefit obligation disclosure as required by GAAP.

ANS:

(1)
Projected benefit obligation, December 31, 2005 ....... $307,500
Projected benefit obligation, January 1, 2005 ......... 280,000

Increase in projected benefit obligation .............. $ 27,500

Less interest cost ($280,000 x 10%) ................... (28,000)
Plus benefits paid to retirees ........................ 22,000
Service cost--2005 .................................... $ 21,500

(2)
Projected benefit obligation, January 1, 2005 ......... $280,000
Service cost .......................................... 21,500
Interest cost ......................................... 28,000
Benefits paid ......................................... (22,000)
Projected benefit obligation, December 31, 2005 ....... $307,500

OBJ: LO 4, LO 5

8. On January 1, 2005, the Delhi Corp. amended its defined benefit pension plan to provide
increased retirement benefits for its 150 employees covered by the plan on that date. As a result
of the plan amendment, the projected benefit obligation as of January 1, 2005, increased by
$1,275,000. Management decided to amortize this amount on a straight-line basis over the
average remaining service life of the 150 employees. It is assumed that employees will retire at
the rate of six employees per year over the next 25 years. The prior service cost is to be funded
with equal annual contributions over a ten-year period. The first contribution is due at the end of
2005 and the assumed interest rate for funding purposes is 12 percent. The present value factor
for an ordinary annuity for ten periods at 12 percent is 5.6502.

(1) Compute the annual amount of amortization of prior service cost.

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 (2) Compute the amount of the annual contribution required to fund the prior service
cost. (Round computation to the nearest dollar.)
(3) Assume that pension cost for 2005 excluding prior service cost amounted to
$120,000 and Delhi's contributions to the pension fund totaled $110,000 in addition
to the funding of prior service cost.
(4) Prepare a summary journal entry to record all pension-related amounts for 2005.

ANS:
(1)
[N(N + 1)/2]  D = Total future years of service
[25(26)/2]  6 = 1,950

Average remaining service life = 1,950/150 = 13 years

Annual amortization of prior service cost: $1,275,000/13 = $98,077 (rounded)

(2)
Annual funding of prior service cost: $1,275,000/5.6502 = $225,656 (rounded)

(3)

Pension Cost ($120,000 + $98,077) .......... 218,077

Prepaid/Accrued Pension Cost ............... 117,579
Cash ($110,000 + $225,656) ............... 335,656

OBJ: LO 4

9. Reagan Western Wear, Inc. has a defined benefit pension plan covering its 120 employees.
Information relating to the plan follows:

Fair value of plan assets, Jan. 1, 2005 ................ $3,400,000

Fair value of plan assets, Dec. 31, 2005 ............... 3,720,000
Market-related value of plan assets, Jan. 1, 2005 ...... 2,760,000
Market-related value of plan assets, Dec. 31, 2005 ..... 2,840,000
Benefits paid to retirees during 2005 .................. 168,000
Contributions to pension fund during 2005 .............. 120,000

Reagan expects a 10 percent return on its pension fund assets. Compute the difference between
the actual return and the expected return and explain how this amount affects net periodic pension
cost for 2005.

ANS:

Increase in fair value of plan assets $320,000

($3,720,000 - $3,400,000) .............................
Benefits paid during 2005 .............................. 168,000
Contributions made during 2005 ......................... (120,000)
Actual return on plan assets ........................... $368,000
Less expected return on plan assets ($2,760,000  10%) . 276,000
Difference between actual and expected return .......... $ 92,000

The $92,000 represents a deferred gain that is added to the other components in computing net
periodic pension cost for 2005. In effect the addition of this amount adjusts the actual return to
the expected return.

OBJ: LO 4

421
10. Using the information below, compute the gain or loss component of net periodic pension cost
and indicate whether the amount is added or deducted in determining pension cost for the period.

Actual return on plan assets ........................... $450,000

Expected return on plan assets ......................... 570,000
Unrecognized gain from prior years ..................... 240,000
Corridor amount ........................................ 150,000
Average service life for amortization purposes ......... 8

ANS:

Deferred loss for current year ($450,000 - $570,000) ... $120,000

Amortization of unrecognized gain from prior years .....
[($240,000 - $150,000)/8 years] ...................... 11,250
Gain or loss component ................................. $131,250

Both the deferred loss ($120,000) and the gain amortization ($11,250) have the effect of reducing
pension cost. Thus these amounts are combined and deducted (offset against other components)
in computing pension cost for the current period.

OBJ: LO 4

11. Based on the following data, determine the net periodic pension cost:

Service cost ........................................... $900,000

Amortization of prior service cost ..................... 120,000
Funding of prior service cost .......................... 180,000
Expected return on plan assets ......................... 400,000
Excess of actual return over expected return ........... 30,000
Amortization of deferred loss from prior years ......... 20,000
Interest cost .......................................... 360,000

ANS:

Service cost ................................ $900,000

Interest cost ............................... 360,000
Actual return on plan assets
($400,000 + $30,000) ....................... (430,000)
Amortization of prior service cost .......... 120,000
Gain or loss:
Deferred gain for current year ............ $30,000
Amortization of deferred loss ............. 20,000 50,000
Net periodic pension cost ................... $1,000,000

OBJ: LO 4

12. The following balances relate to the defined benefit pension plan of Todd Industries.

Dec. 31, 2005 Dec. 31, 2006

Fair value of plan assets ........... $414,000 $517,500
Market-related value of plan assets . 370,800 471,000
Projected benefit obligation ........ 487,500 611,400
Accumulated benefit obligation ...... 442,500 555,000
Prepaid/(accrued) pension cost ...... (18,300) 11,100

422
 Unrecognized prior service cost ..... 34,500 27,900

(1) Determine the minimum pension liability, if any, at December 31, 2005 and
December 31, 2006.
(2) Prepare journal entries for the minimum liability adjustment, if any, at December
31, 2005, and December 31, 2006. Assume that the company had no previously
recognized additional pension liability under FASB Statement No. 87.

ANS:

(1)
Minimum Liability Computations:
(ABO - Fair Value = Minimum pension liability)
Dec. 31, 2005: $442,500 - $414,000 = $28,500
Dec. 31, 2006: $555,000 - $517,500 = $37,500

(2)
Minimum Liability Adjustment:
2005 Deferred Pension Cost
($28,500 - $18,300) ................. 10,200
Additional Pension Liability ....... 10,200

2006 Deferred Pension Cost ................ 17,700

Excess of Additional Pension Liability
Over Unrecognized Prior
Service Cost ......................... 20,700
Additional Pension Liability ....... 38,400

Computations:
Minimum liability, Dec. 31, 2006 ..................... $37,500
Prepaid pension cost ................................. 11,100
Additional liability, Dec. 31, 2006 .................... $48,600
Balance before adjustment .............................. 10,200
Adjustment (credit) to additional liability ............ $38,400

Maximum deferred pension cost, Dec. 31, 2006 ........... $27,900

Balance before adjustment .............................. 10,200
Adjustment (debit) to deferred pension cost ............ $17,700

Credit to additional liability ......................... $38,400

Debit to deferred pension cost ......................... 17,700
Debit to contra equity account ......................... $20,700

OBJ: LO 4

13. The following information relates to the defined benefit pension plan of Orchard Company as of
December 31, 2005:

Unrecognized net loss from prior years ................. 43,000

Market-related value of pension plan assets ............ 2,343,000
Accumulated benefit obligation ......................... 2,500,000
Unrecognized prior service cost ........................ 400,000
Fair value of pension plan assets ...................... 2,557,000
Projected benefit obligation ........................... 2,800,000

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 What amount should be shown on Orchard's December 31, 2005 balance sheet as
"Prepaid/Accrued Pension Cost?" Clearly indicate whether the amount should be shown as a
liability or an asset.
ANS:

Projected benefit obligation ........................... $(2,800,000)

Fair value of pension plan assets ...................... 2,557,000
Excess of obligation over funding (underfunding) ....... $ (243,000)
Unrecognized net loss from prior years ................. 43,000
Unrecognized prior service cost ........................ 400,000
Prepaid pension cost (an asset) ........................ $ 200,000

OBJ: LO 4

14. Thomas, Inc., provides a noncontributory defined benefit plan for its 200 employees. Information
from the company's pension footnote for the year ended December 31, 2004, and partial
information for the year ended December 31, 2005, are given below:

12/31/04 12/31/05
Fair value of plan assets ............. $1,347,500 $1,225,000
Projected benefit obligation .......... (1,587,500) (1,475,000)
Unrecognized prior service cost ....... 113,095
Unrecognized loss ..................... 163,750
Prepaid pension cost .................. 36,845
Additional pension liability .......... (64,345)
Prepaid/(accrued) pension cost ........ (27,500)

The company's actuary indicated that the settlement rate and expected rate of return on plan
assets were both 8% for 2004 and 2005. The company contributed $221,250 to the plan at the end
of 2005. Service cost for 2005 was $125,000. The actuary also disclosed that the accumulated
benefit obligation was $1,375,000 on December 31, 2004, and $1,200,000 on December 31,
2005.

On January 1, 2004, the company amended its plan to grant retroactive credit for prior service
rendered by employees prior to the amendment. This amendment increased unrecognized prior
service cost by $125,000 at that date. The prior service cost is being amortized over the average
remaining service life of the employees affected by the amendment. The average remaining
service life of the workforce in each year has been constant at 10.5 years.

(1) Prepare a schedule computing pension cost for 2005.

(2) Prepare the journal entries to record pension expense and the pension contribution,
and to recognize the correct minimum liability, if any.
(3) Prepare the reconciliation between the beginning and ending balances of the
projected benefit obligation as required by GAAP for the disclosures related to
pension plans.

ANS:

(1)
Service cost .................................. $ 125,000
Interest cost ($1,587,500 x .08) .............. 127,000
Actual loss on plan assets ($1,347,500 + 343,750
$221,250 - $1,225,000) ........................
Deferral of loss on plan assets [$343,750 + (451,550)
($1,347,500 x .08)] ...........................
Amortization of prior service cost ($125,000 _ 11,905

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 10.5) .........................................
Recognition of deferred loss [(($163,750 - 476
($1,587,500 x .1))) _ 10.5] ...................
Total pension expense ......................... $ 156,581
(2)
Pension Expense ............................... 156,581
Prepaid/Accrued Pension Cost .................. 64,669
Cash ........................................ 221,250

Additional Pension Liability .................. 64,345

Deferred Pension Cost ....................... 64,345

Computation:
Accumulated benefit obligation at Dec. 31, 2005 1,200,000
Fair value of plan assets at Dec. 31, 2005 .... 1,225,000

Since the fair value of plan assets at 12/31/05 exceeds the ABO at that date, no minimum liability
is needed and the account should be reduced to zero.

(3)
Projected benefit obligation at Dec. 31, 2004 .......... $1,587,500
Service cost ........................................... 125,000
Interest cost .......................................... 127,000
Benefits paid (364,500)
($1,587,500 + $125,000 + $127,000 - $1225,000) ........
Projected benefit obligation at Dec. 31, 2005 .......... $1,475,000

OBJ: LO 4, LO 5

15. The projected benefit obligation is the actuarial present value of the benefits attributed to
employee service rendered to date. The projected benefit obligation is based on the present value
of vested and nonvested benefits accrued to date using employees' future salary levels.

Identify arguments that can be advanced for and against the use of the projected benefit
obligation concept in accounting for pensions.

ANS:
Opponents of the projected benefit obligation concept argue that based upon the definition of a
liability, pension benefits dependent on future increases in compensation cannot be a present
obligation. The liability measurement, therefore, should be based only on actual compensation
experience to date. The opponents also note that if the pension plan were terminated or if an
employee with vested benefits did not render future services, the employer's obligation would be
limited to amounts based on compensation to date.

Proponents of the projected benefit obligation concept argue that estimated future compensation
levels should be considered if a pension plan's formula incorporates them. These proponents
argue that a promise to pay benefits based on a percentage of the employee's future salary is far
different from a promise to pay a percentage of the employee's current salary. The projected
benefit obligation is an estimate of a present obligation to make future cash payments as a result
of past events. The going-concern assumption supports the use of future compensation levels in
calculating the projected benefit obligation.

OBJ: LO 3

425
16. Employers use a discount rate to compute the actuarial present value of benefits, pension
expense, and the obligation of the employer under the pension plan. The choice of the discount
rate can have a great effect on measures of pension cost and benefit obligations. Assumptions
regarding discount rates must be made carefully in order to ensure that differences in pension
plans are properly reflected in the annual reports of companies sponsoring such plans.

Identify factors employers should consider when choosing the discount rate to be used in
accounting for pension plans of the enterprise.

ANS:
Assumed discount rates are used in measurements of the projected, accumulated and vested
benefit obligations and the service and interest cost components of net periodic pension cost. The
assumed discount rate should reflect the rate at which pension obligations could be settled if
sufficient funds were invested at that rate. Actuarial present value considers not only the time
value of money, but also factors that affect the probability of payment, such as life expectancy,
turnover, and disability. An estimate of the discount rate should include consideration of the rates
implicit in the current prices of annuity contracts that could be used to effect settlement of the
obligation. Information on available annuity rates currently published by the Pension Benefit
Guaranty Corporation represents one source of rates on annuity contracts. Employers also should
look at rates of return on high-quality fixed-income investments currently available and expected
to be available during the period to maturity of the pension benefits. Consideration also should be
given to the average age of employees. The discount rate for a plan covering mainly retirees
might reflect a portfolio of investments with shorter maturities than those of a plan covering a
younger workforce. In this regard, it should be noted that a relatively small change in the
discount rate can have a rather dramatic effect on pension liabilities.

OBJ: LO 3

17. The areas of pension plans and other post retirement benefits (such as health care benefits) appear
on the surface to be quite similar. Nonetheless, the Financial Accounting Standards Board issued
its pronouncement on other postretirement benefits some five years after the issuance of the
pronouncement on pensions.

Explain why the FASB did not consider the areas of pensions and other post retirement benefits
concurrently.

ANS:
FASB did not consider pensions and other postretirement benefits concurrently due to the
differing nature of the two obligations. Pension plans typically are funded while health care
benefits are not. The benefits provided under pension plans typically are quite clearly defined
whereas benefits for health care and other postretirement benefits are not. Indeed, many
postretirement plans do not limit health care benefits and provide coverage regardless of the
seriousness or length of an illness. The beneficiaries under a pension plan usually are limited to
the retiree and his or her surviving spouse. Benefits for other postretirement benefits include the
retiree, his or her spouse, and other dependents. Predicting the amount and timing of benefits paid
under a pension plan is somewhat easier since benefits typically are paid monthly and tend to be
well defined and somewhat fixed. Other postretirement benefits must be paid as required and may
be highly unpredictable both as to timing and amount. The level of utilization of health care
benefits is dependent on such things as life span, changes in technology, changes in the body of
medical knowledge, and the incidence of previously unknown diseases. Each of these factors also
may affect the price of health care. Furthermore, the price of health services may vary according
to the geographic location of the recipients.

OBJ: LO 3, LO 7

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