CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingHard
A company has a defined benefit pension plan. At the end of the year, the company's actuary provides the following information: Projected Benefit Obligation (PBO) of $10,000,000, Plan Assets (fair value) of $8,500,000, and an unrecognized prior service cost of $300,000. What is the funded status of the pension plan that should be reported on the company's balance sheet?
- ANet asset of $1,500,000
- BNet liability of $1,500,000
- CNet liability of $1,800,000
- DNet asset of $1,200,000
Show answer & explanationAnswer & explanation
Correct answer: B. Net liability of $1,500,000
The funded status of a defined benefit pension plan is the difference between the Projected Benefit Obligation (PBO) and the fair value of Plan Assets. A PBO exceeding plan assets results in a net liability. Unrecognized prior service costs are part of Accumulated Other Comprehensive Income (AOCI) and do not directly affect the funded status reported on the balance sheet.
Why the other options are wrong
- A. This incorrectly calculates a net asset instead of a net liability.
- C. This incorrectly includes the unrecognized prior service cost in the calculation of funded status.
- D. This incorrectly includes the unrecognized prior service cost and miscalculates the funded status.
Defined Benefit Pension Funded Status
The funded status of a defined benefit pension plan is the difference between the Projected Benefit Obligation (PBO) and the fair value of the plan assets. This amount is reported as a net asset or net liability on the balance sheet.
- Funded status = Fair Value of Plan Assets - Projected Benefit Obligation (PBO).
- A PBO greater than plan assets results in a net liability.
- AOCI components (like prior service costs) are not part of the funded status calculation, but affect equity.
Memory trick: PBO vs. ASSETS: The difference is the funded STATUS.