[carpeCPA]

Becker Question –

Why is there a deferred tax asset effect for current period service cost? Isn’t the tax effect recognized immediately because there’s no deferral of the expense recognition?

AmeriGene Inc. reported net periodic pension cost of $400,000 in the current year, calculated as follows:

Service cost $ 300,000

Interest cost 175,000

Expected return on plan assets (100,000)

Amortization of prior service cost 40,000

Amortization of net gain (15,000)

= Net periodic pension cost 400,000

AmeriGene has an overfunded pension plan. The company’s effective tax rate is 30%. How will the service cost component of the current year net periodic pension cost affect the current year balance sheet?

a. $300,000 decrease in retained earnings.

b. $90,000 increase in accumulated other comprehensive income.

c. $300,000 increase in noncurrent pension benefit asset.

d. $90,000 increase in deferred tax asset.

Explanation

Choice “d” is correct. Deferred taxes must be considered when recording net periodic pension cost and changes in pension plan funded status due to prior service cost, net gains and losses, and net transition assets and obligations. Therefore, the service cost component of AmeriGene’s net periodic pension cost would be recorded with the following JE:

Debit (Dr) Credit (Cr)

Net periodic pension cost $ 300,000

Pension benefit asset $ 300,000

Deferred tax asset 90,000

Deferred tax benefit – income statement 90,000

Choice “c” is incorrect. As demonstrated in the journal entry above, service cost decreases the pension benefit asset.

Choice “a” is incorrect. Net periodic pension cost affects retained earnings on an after-tax basis. Therefore, the service component will decrease retained earnings by $210,000 [$300,000 × (1 − 30%)].

Choice “b” is incorrect. Service cost does not affect accumulated other comprehensive income. The pension component of accumulated other comprehensive income reflects changes in the funded status of a pension plan due to prior service cost, net gains and losses, and net transition assets or obligations.

REG - 93 (Jul'13)
FAR - 97 (Dec '13)
AUD - 99 (May '14)
BEC - Jul '14

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[NYCaccountant]

I would think it would create a deferred tax asset. You are recognizing the expense related to the service cost in your book income, but probably not recognizing the expense on your tax return. Service cost is the future pension benefits to be paid sometime in the future based on what was earned in the current year. I would think that the service cost does not factor into income taxes until it is paid in the future, so as a result it would not be deducted in the current year on your tax return. Because of this, you'll have a temporary difference of 90k, which would reverse sometime in the future. That's just how I look at it, but I def can be wrong.

FAR - 93
REG - 87
BEC - 84!!!!
AUD - 99!!!!!! CPA exam complete.

[Author]

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