Question

Nerwin, Inc. is a furniture manufacturing company with 50 employees. Recently, after a long negotiation with the local labor union, the company decided to initiate a pension plan as a part of its compensation plan. The plan will start on January 1, 2014. Each employee covered by the plan is entitled to a pension payment each year after retirement. As required by accounting standards, the controller of the company needs to report the pension obligation (liability).

On the basis of a discussion with the supervisor of the Personnel Department and an actuary from an insurance company, the controller develops the following information related to the pension plan.

Average length of time to retirement 15 years
Expected life duration after retirement 17 years
Total pension payment expected each year after retirement for all employees.
Payment made at the end of the year. $351,150 per year
The interest rate to be used is 7%.

Required: Calculate the present value of this deferred annuity (at January 1, 2014).

Answer 1

$1,242,616 (approx)

Step-by-step explanation:

The Present value of annual pension payment at the end of 17th year:-

= $351,150 × (1 - (1 + 0.07) - 17) ÷ 0.07

= $351,150 × (1 - (1.07) - 17) ÷ 0.07

= $351,150 × (1 - 0.31657) ÷ 0.07

= $351,150 × 0.68343 ÷ 0.07

= $239,986.4445 ÷ 0.07

= $3,428,377.78 (approx)

Computation of Present value of deferred annuity at the starting of pension plan on January 1, 2014

= $3,428,377.78 ÷ (1.07)^15

= $3,428,377.78 ÷ 2.7590

= $1,242,616 (approx)