A company has a defined benefit pension plan that has been in operation for a number of years. On January 1, Year One, the company amends the plan and the projected benefit obligation increases by $280,000. On the same day, the actuary changes one of the actuarial assumptions and, as a result, the projected benefit obligation increases by another $420,000. On that day, the company has five employees who are each expected to work for an average of another seven years. At the end of Year One, what balance is shown in the company's accumulated other comprehensive income as reported within the stockholders' equity section of the balance sheet?
A: $660,000
I don't get why the second change of $420,000 isn't amortized this year and why the answer is talking about if it's large or not will determine if it is amortized. The first I'm hearing of this…maybe I missed it. Is this correct? I don't understand why…because it's not by the company making this change?
Full explanation:
The $280,000 is a prior service cost because it resulted from an amendment (or the creation) of a defined benefit pension plan. This amount is recorded initially in accumulated other comprehensive income and then reclassified each year into pension expense by amortizing the balance over the expected work expectancy of the employees who benefitted from the amendment. In this case, the amortization is $40,000 per year ($280,000 divided by seven years) so that it is reduced to $240,000 at the end of Year One. The $420,000 is a net (deferred) loss because it resulted from a change in an actuarial assumption. This amount also is placed into the accumulated other comprehensive income. It is also amortized but only if it is of a significantly large size and only starting in the year after its creation. Thus, whether it is large or not, no amortization is recorded in Year One and it remains at $420,000. The total amount in accumulated other comprehensive income is $660,000 ($240,000 plus $420,000).
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