On January 1, 2014, Magee Corporation started doing business by hiring R. Walker as an employee at an annual salary of $50,000, with an annual salary increment of $10,000. Based on his current age and the company’s retirement program, Walker is required to retire at the end of the year in 2017. However, at his option, he could retire any time after completing one full year of service. Regardless of when he retires, the company will pay a lump-sum pension at the end of 2018. The lump-sum payment is calculated to be 25% of the cumulative lifetime salary Walker earned. Magee’s annual discount rate is 10%. Assume that Walker retires at the end of 2017.
1. Assuming that Magee Corporation does not fund its pension expense, calculate this expense for 2014–2017. Clearly identify the service and interest cost components. Based on your calculations, provide journal entries to record the effects of pensions during 2011–2018.
2. Assume that Magee fully funds its pension cost as soon as it vests and that the contributions to the pension fund earn exactly a 10% rate of return annually. Based on these revised assumptions, redo requirement 1.
3. Explain why the total pension expense in requirement 1 and in requirement 2 differ.
4. Assume that Magee does not fund its pension expense. Discuss how different assumptions regarding the discount rate affect the pension expense. Compare the pension expense with discount rates of 5%, 10%, and 15%.