FAR 32 - Deferred Comp Arrangements 1 - Pension Exp/Reporting/Delayed Recognition Flashcards Preview

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Flashcards in FAR 32 - Deferred Comp Arrangements 1 - Pension Exp/Reporting/Delayed Recognition Deck (32):
1

Barrett Co. maintains a defined benefit pension plan for its employees. At each balance sheet date, Barrett should report pension liability equal to the
A. Accumulated benefit obligation.
B. Projected benefit obligation.
C. Unfunded accumulated benefit obligation.
D. Unfunded projected benefit obligation.

D. The reported liability for defined benefit pension plans is the unfunded projected benefit obligation. This is the projected benefit obligation, less pension plan assets at fair value. Projected benefit obligation is the fundamental measure of a firm's pension liability, but is reported only in the footnotes.

2

The funded status of a defined benefit pension plan for a company should be reported in
A. The income statement.
B. The statement of cash flows.
C. The statement of financial position.
D. The notes to the financial statements only.

C. Funded status is the difference between projected benefit obligation and plan assets at fair value. Neither of these amounts is reported in the balance sheet (they appear in the notes only), but their difference is reported in the balance sheet as the reported pension liability for defined benefit plans. It is the amount the plan is "behind" in terms of having assets available for payment of benefits.

3



A defined benefit plan's projected benefit obligation totaled $20mn at the end of the current year. Plan assets at market value totaled $23mn. Choose the correct statement concerning balance sheet reporting for this plan.
A. $3mn pension asset.
B. $3mn pension liability.
C. A pension asset of $23mn, and a $20mn pension liability.
D. no pension-related value is reported in the balance sheet; all relevant amounts are reported in the footnotes.

A. PBO and assets are netted for balance sheet reporting purposes. The firm has an overfunded plan and reports a $3mn asset ($23mn assets - $20mn PBO).

4

How should plan investments be reported in a defined benefit plan's financial statements?
A. At actuarial present value.
B. At cost.
C. At net realizable value.
D. At fair value.

D. Fair value represents the most representationally faithful amount to be applied to pension obligation. Fair value is the current amount available for payment of pension benefits.

5

A company has a defined benefit pension plan for its employees. On December 31, year one, the accumulated benefit obligation is $45,900, the projected benefit obligation is $68,100, and the fair value of the plan assets is $62,000. What amount, if any, related to the defined benefit plan should be recognized in the balance sheet at December 31, year one?
A. An asset of $16,100.
B. A liability of $6,100.
C. Nothing, as the fair value of the plan assets exceeds the accumulated benefit obligation.
D. An unrealized loss of $6,100.

B. The reported pension liability for a defined benefit pension plan is the difference between projected benefit obligation ($68,100) and the fair value of plan assets ($62,000), or $6,100. The two underlying amounts are reported in the footnotes, but are not recognized in the balance sheet. Only their difference, which is also the underfunded amount, is reported in the balance sheet as a liability.

6

What is the present value of all future retirement payments attributed by the pension benefit formula to employee services rendered prior to that date only?
A. Service cost.
B. Interest cost.
C. Projected benefit obligation.
D. Accumulated benefit obligation.

D. Accumulated benefit obligation is the present value of all unpaid future retirement benefits as of the balance sheet date based on (1) service rendered to that date, and (2) current salary levels.

Even if the pension benefit formula incorporates future salaries, accumulated benefit obligation uses current salary levels only to provide a more current measure of the pension liability.

7

T/F: Pension liability (or pension asset) and funded status are one and the same.

True

8

T/F: A pension asset is reported when PBO is less than plan assets at fair value.

True

9

On January 1 of the current year, a firm's defined benefit pension plan is amended to increase the benefits for service already provided by employees through that date. The resulting immediate increase in projected benefit obligation (PBO) is $500 at January 1. The average remaining service period of employees covered by the amendment is ten years. Service cost for the year is $1,500. Actual and expected return on plan assets is $178. The discount rate is 10%. PBO at January 1, including the effect of the prior service grant, is $2,800. The funding contribution for the current year is $1,800. Compute pension expense for the current year.

Pension expense = $1,500 service cost + $280 interest cost (= $2,800 x .10) - $178 expected return + $50 amortization of PSC (= $500/10) = $1,652. When PSC is initially recorded, another comprehensive income account is debited for $500. The amortization of $50 credits that account and debits pension expense for $50.

10

On January 1 of the current year, a firm's defined benefit pension plan is amended to increase the benefits for service already provided by employees through that date. The resulting immediate increase in projected benefit obligation (PBO) is $5mn at January 1. The average remaining service period of employees covered by the amendment is ten years. Select the correct statement about the effects of this prior service grant.
A. The increase in PBO is gradually recorded over ten years.
B. Pension liability is gradually increased over ten years.
C. Pension expense for the current period is not affected.
D. Other comprehensive income is immediately decreased by $5mn on January 1.

D. The immediate increase of $5mn in PBO is recorded as a decrease in other comprehensive income. Therefore, comprehensive income (the sum of other comprehensive income and net income) is immediately decreased by the present value of the increase in the cost of the pension plan. The journal entry at January 1 debits other comprehensive income and credits pension liability.

11

Which of the following would not cause a change in the net gain or loss at the beginning of a period?
A. Actual return on assets different from expected return.
B. Amortization of the beginning-of-year net gain or loss.
C. Increase in estimated employee turnover.
D. Retroactive increase in benefits for employee service already performed.

D. This answer describes prior service cost (PSC). This increase in PBO is not merged with net gain or loss, but is rather treated separately, for purposes of computing pension expense. Amortization of PSC yields component 4; amortization of net gain or loss yields component 5.

12

Which of the following is not subject to delayed recognition?
A. PBO.
B. Actual return less than expected return.
C. Increase in life expectancy.
D. PSC.

A. Changes to PBO are recognized immediately. SC and interest cost are recognized as increases in pension expense and pension liability in the pension-expense entry. PSC, and PBO gains and losses are recognized immediately in the pension liability and other comprehensive income. PBO, however, is not recorded directly in one account; rather, it is reported in the notes to the financial statements.

13

The following information pertains to Seda Co.'s pension plan:

Actuarial estimate of projected benefit obligation at January 1, 2005 $72,000
Assumed discount rate 10%
Service costs for 2005 $18,000
Pension benefits paid during 2005 $15,000

If no change in actuarial estimates occurred during 2005, Seda's projected benefit obligation at December 31, 2005 was

$82,200
Projected benefit obligation (PBO), January 1, 2005 $72,000
Plus interest cost (growth in PBO), .10($72,000) $7,200
Plus service cost $18,000
Less benefits paid in 2005 ($15,000)
PBO, December 31, 2005 $82,200

14

In the financial statements of employee benefit pension plans and trusts, the plan investments are reported at
A. Fair value.
B. Historical cost.
C. Net realizable value.
D. Lower of historical cost or market.

A. Pension plan assets are accumulated for the purpose of paying retiree benefits under the plan. In assessing the ability of the plan to pay benefit payments, fair value is the most relevant reporting attribute. The bulk of pension plan assets are invested in financial instruments whose value varies over time. Measurement of these investments is most appropriate at fair value and is consistent with reporting projected benefit obligation at present value—both are current values as of the reporting date.

15

Which of the following disclosures is not required of companies with a defined benefit pension plan?
A. A description of the plan.
B. The amount of pension expense by component.
C. The weighted average discount rate.
D. The estimates of future contributions.

D. Firms are required to make extensive disclosures about employer-sponsored pension plans.

Those disclosures include (a) a description of the plan, (b) the amount of pension expense by component (current service cost, interest cost, return on plan assets, etc.), and (c) the weighted average discount rate used in pension calculations.
There is no requirement to provide estimates of future contributions.

16

The journal entry to record a $5,000 actuarial gain at year-end includes:
A. Credit pension liability.
B. Debit PBO.
C. Credit pension asset.
D. Credit pension gain/loss-other comprehensive income.

D. When the actuarial gain is recognized, pension liability is debited, because PBO is reduced by the gain, and pension liability is the difference between PBO and assets. Pension gain/loss-OCI is credited, because the firm's pension costs have decreased. The pension gain/loss-OCI account causes other comprehensive income to be credited (increased).

17

Data for a defined benefit pension plan for the current year are as follows:
PBO, January 1, $200mn
Assets, January 1, $160mn
Pension expense, $60mn
Funding contribution, $50mn
PBO gain (year-end), $14mn
Amortization of PSC for year, $4mn

The ending pension liability balance is

$32mn
The beginning pension-liability balance was $40mn ($200mn PBO - $160mn assets). Pension expense is $60mn, but includes $4mn of amortization of PSC, which increases pension expense without an increase in the pension liability (the previous recognition of PSC caused pension liability to increase). Therefore, pension liability increased by $56mn from recording pension expense. Funding reduced the pension liability by $50mn and the PBO gain reduced the pension liability by $14mn. The ending balance is therefore $32mn ($40mn + $56mn - $50mn - $14mn).

18

How many of the following four aspects of accounting for pension gains and losses contribute to the reduction in volatility of reported pension expense:
(1) use of corridor amortization as an acceptable method,
(2) gains and losses cancel,
(3) spreading the amount subject to amortization over the average remaining service period of plan participants,
(4) the use of expected return for component 3 of pension expense?

All four items are relevant. The corridor is a value that reduces the amount subject to amortization. The cancellation of gains and losses goes a long way to reducing the total amount amortized - in many cases, large gains are offset by large losses, resulting in considerable amounts never being amortized. Dividing the amount subject to amortization by average remaining service period spreads the amortization over many periods, rather than recognizing gains and losses immediately. The use of expected, rather than actual, return for component 3 smoothes the volatility from stock market returns.

19

Each of the following is a component of the changes in the net assets available for benefits of a defined benefit pension plan trust, except
A. The net change in fair value of each significant class of investments.
B. The net change in the actuarial present value of accumulated plan benefits.
C. Contributions from the employer and participants.
D. Benefits paid to participants.

B. The net change in the actuarial present value of accumulated plan benefits refers to the liability side of the pension plan, rather than to the plan assets. This amount is the change from the previous reporting period of the amount required to pay the present value of promised benefits. It is one measure of the change in the obligation of the plan. Changes in net assets refers to the asset side of the plan. Assets are typically held by a trust company that provides financial statements that report the amount of assets available to pay pension benefits, and changes in those assets.

20

T/F: When an actuarial gain is recognized, pension liability is reduced.

True

21

T/F: Amortization of prior service cost increases pension expense because that part of prior service cost is being recognized as a component of pension expense.

True

22

T/F: Delayed recognition of service cost is permitted.

False.
Service costs PV are amortized.

23

T/F: Amortization of prior service cost and net pension loss increase pension expense.

True

24

T/F: When a sponsoring firm uses a trustee, the sponsoring firm records a journal entry when retiree benefits are paid.

False.
The sponsoring firm makes periodic funding contributions to the trust company. Those contributions and earnings on them comprise the pension plan assets available for payment of retirement benefits.
There is no JE on sponsoring firms books when retirement benefits are paid - these amounts are paid by the trustee.

25

T/F: The recognition of prior service cost increases net pension liability because prior service cost is an immediate increase in PBO.

True

26

T/F: The recognition of the initial amount from a retroactive grant increasing pension benefits decreases other comprehensive income in the year recognized.`

True

27

T/F: Delayed recognition means that prior service cost and actuarial gains and losses are not recognized in any form until they are included in pension expense.

False.
A gradual recognition through amortization is used.

28

T/F: When actual and expected return are the same for a period, the return on asset component of pension expense reduces pension liability because assets are increased.

True

29

T/F: A firm has always funded its pension expense fully. This means the firm has no balance sheet liability account.

False.
The pension expense in any given year is made up of five components.
The pension expense for a period reflects changes in PBO and assets during the period, along with amortizations of changes in PBO and assets occurring in previous periods.

30

The pension benefits an EE is entitled to at retirement are explicitly stated in the pension plan. The benefit level is based on the benefit formula which includes such variables as:

1. years of service
2. age at retirement
3. Highest salary attained.

31

Accounting for defined benefit pension plan is characterized by the following special attributes:

1. Delayed recognition of certain items in pension expense.
2. Net cost reporting of pension expense.
3. Offsetting in the BS.

32

What are the five components of pension expense?

Component 1 = service cost
Component 2 = interest cost
Component 3 = expected return on plan assets
Component 4 = amortization of prior service cost
Component 5 = amortization of net G/L

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