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Flashcards in Present Value Pensions Deck (51):
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

  1. Accumulated benefit obligation.
  2. Projected benefit obligation.
  3. Unfunded accumulated benefit obligation.
  4. Unfunded projected benefit obligation.

Unfunded projected benefit obligation.

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

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

The ending pension liability balance is

  1. $40mn
  2. $10mn
  3. $50mn
  4. $200mn

$50mn

The beginning pension liability balance was $40mn ($200mn PBO - $160mn assets). With pension expense of $60mn and funding of $50mn, the pension liability increased an additional $10mn, yielding an ending pension-liability balance of $50mn ($40mn + $10mn). There is no information about amortization of PSC or net gain or loss, or difference between expected and actual return, or gain, loss or PSC during the period.

3

At December 31, 2005, the following information was provided by the Kerr Corp. pension plan administrator:

  • Fair value of plan assets $3.45mn
  • Accumulated benefit obligation $4.3mn
  • Projected benefit obligation $5.7mn

What is the amount of the pension liability that should be shown on Kerr's December 31, 2005 balance sheet?

  1. $5.7mn
  2. $2.25mn
  3. $1.4mn
  4. $850,000

$2.25mn

This answer is the underfunded projected benefit obligation - the plan's funded status and most critical number for the pension plan. This is the amount shown in the balance sheet. It can also be an asset, if plan assets exceed projected benefit obligation.

4

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.

  1. $3mn pension asset.
  2. $3mn pension liability.
  3. A pension asset of $23mn, and a $20mn pension liability.
  4. no pension-related value is reported in the balance sheet; all relevant amounts are reported in the footnotes.

$3mn pension asset.

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).

5

How should plan investments be reported in a defined benefit plan's financial statements?

  1. At actuarial present value.
  2. At cost.
  3. At net realizable value.
  4. At fair value.

 

At fair value.

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.

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?

  1. Service cost.
  2. Interest cost.
  3. Projected benefit obligation.
  4. Accumulated benefit obligation.

Accumulated benefit obligation.

The only difference between projected benefit obligation and accumulated benefit obligation is that the former uses estimated future salaries if the formula incorporates them, and the latter uses only current salaries, regardless of the levels used in the formula.

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

The funded status of a defined benefit pension plan for a company should be reported in

  1. The income statement.
  2. The statement of cash flows.
  3. The statement of financial position.
  4. The notes to the financial statements only.

The statement of financial position.

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.

8

The following information pertains to the 2004 activity of Ral Corp.'s defined benefit pension plan:

  • Service cost $300,000
  • Return on plan assets $80,000
  • Interest cost on pension benefit obligation $164,000
  • Amortization of actuarial loss $30,000
  • Amortization of unrecognized net obligation $70,000

Ral's 2004 pension cost was

  1. $316,000
  2. $484,000
  3. $574,000
  4. $644,000

$484,000

  • Service cost $300,000
  • Return on plan assets ($80,000)
  • Interest cost on pension benefit obligation $164,000
  • Amortization of actuarial loss $30,000
  • Amortization of unrecognized net obligation $70,000
  • Pension cost (or expense) $484,000

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 $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.

  1. The increase in PBO is gradually recorded over ten years.
  2. Pension liability is gradually increased over ten years.
  3. Pension expense for the current period is not affected.
  4. Other comprehensive income is immediately decreased by $5mn on January 1.

Other comprehensive income is immediately decreased by $5mn on January 1.

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.

10

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?

  1. 1
  2. 2
  3. 3
  4. 4

4

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.

11

Which of the following would not cause a change in the net gain or loss at the beginning of a period?

  1. Actual return on assets different from expected return.
  2. Amortization of the beginning-of-year net gain or loss.
  3. Increase in estimated employee turnover.
  4. Retroactive increase in benefits for employee service already performed.

Retroactive increase in benefits for employee service already performed.

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

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

  1. $36mn
  2. $46mn
  3. $32mn
  4. $50mn

$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).

13

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

  1. The net change in fair value of each significant class of investments.
  2. The net change in the actuarial present value of accumulated plan benefits.
  3. Contributions from the employer and participants.
  4. Benefits paid to participants.

The net change in the actuarial present value of accumulated plan benefits.

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.

14

Which of the following is not subject to delayed recognition?

  1. PBO.
  2. Actual return less than expected return.
  3. Increase in life expectancy.
  4. PSC.

PBO.

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.

15

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

  • Actuarial estimate of projected benefit obligation at January 1, 2005 $72,000
  • Assumed discount rate10%
  • 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

  1. $64,200
  2. $75,000
  3. $79,200
  4. $82,200

 $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

16

An entity sponsors a defined-benefit pension plan that is underfunded by $800,000. A $500,000 increase in the fair value of plan assets would have which of the following effects on the financial statements of the entity?

  1. An increase in the assets of the entity.
  2. An increase in accumulated other comprehensive income of the entity for the full amount of the increase in the value of the assets.
  3. A decrease in accumulated other comprehensive income of the entity for the full amount of the increase in the value of the assets.
  4. A decrease in the liabilities of the entity.

A decrease in the liabilities of the entity.

The plan is currently underfunded and remains underfunded after the asset increase. Reported pension liability is the underfunded amount, the difference between PBO and plan assets. This firm's reported pension liability decreased from $800,000 to $300,000 ($800,000 - $500,000) owing to the asset increase.

17

Which of the following disclosures is not required of companies with a defined benefit pension plan?

  1. A description of the plan.
  2. The amount of pension expense by component.
  3. The weighted average discount rate.
  4. The estimates of future contributions.

The estimates of future contributions.

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.

18

In the financial statements of employee benefit pension plans and trusts, the plan investments are reported at

  1. Fair value.
  2. Historical cost.
  3. Net realizable value.
  4. Lower of historical cost or market.

Fair value.

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.

19

The journal entry to recognize the amortization of $50 of net gain causes what effect on

  • pension expense, and
  • pension liability?

  • pension expense - decrease
  • pension liability - no effect

The amortization decreases pension expense because the gain reduced the firm's pension costs. The amortization amount is the portion of the gain that is entered into pension expense (as a negative amount). The gain was recorded previously. At that time, pension liability was decreased, and other comprehensive income increased. The complete entry is: (dr.) Pension gain/loss-OCI $50, (cr.) Pension expense 50.

20

The journal entry to record a $5,000 actuarial gain at year-end includes:

  1. Credit pension liability.
  2. Debit PBO.
  3. Credit pension asset.
  4. Credit pension gain/loss-other comprehensive income.

Credit pension gain/loss-other comprehensive income.

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).

21

A firm is applying international accounting standards to its defined-benefit pension plan. Owing to an amendment to the plan at the end of the current year, prior service cost (PSC) of $1mn is recognized (60% of which is vested). The appropriate period for amortization is ten years. As a result of the amendment, by what amount is pension expense for the following year increased?

  1. $40,000
  2. $100,000
  3. $60,000
  4. $0

$40,000

The vested portion of PSC is recognized immediately. The remainder (40% or $400,000) is gradually amortized to pension expense over ten years, or $40,000 per year.

22

Under certain circumstances, a firm provides severance pay and tuition assistance to employees who are laid-off. The beginning balance in the associated liability for the current year is $112,000. During the year, employees earned $48,000 of additional benefits, 60% of which are expected to be used by terminated employees, based on past experience. During the year, the firm paid $38,000 to reimburse previous employees for benefits taken. Compute the ending balance of the benefit liability.

  1. $122,000
  2. $102,800
  3. $58,000
  4. $77,200

$102,800

Only 60% of the benefits earned are expected to be taken by the covered employees. The amount recognized as expense is limited to this amount, because the criteria for recognition require that payments be probable in order for accrual to take place. The following equation (or T-account) provides the solution: $112,000 + (.60)($48,000) - $38,000 = $102,800.

23

A firm provides nonretirement postemployment benefits for its employees for a limited time after employment. At the beginning of the current year, the balance of the liability for unpaid benefits was $67,000. During the year, the firm accrued an additional $34,000. At year-end, the ending liability balance was $56,000 after a year-end downward adjustment of $5,000 due to a change in estimate. What amount of benefits were paid during the year?

  1. 40,000
  2. 45,000
  3. 34,000
  4. 29,000

40,000

This question requires you to work backwards to solve for the amount paid during the year. Solving the following equation (or using a T account), the amount paid is $40,000. Equation: $67,000 + $34,000 - $5,000 – pmts = $56,000.

24

Which of the following is not a criterion that must be met in order for nonretirement postemployment benefits to be accrued, rather than be treated as a cash expense upon payment.

  1. The benefits are attributable to services rendered
  2. The benefits accumulate or vest
  3. The benefits are contingent on continued employment
  4. The benefits are estimable

The benefits are contingent on continued employment

This answer is a description of vested benefits. Benefits need not vest for accrual to be mandatory.

25

Which of the following is not covered by the accounting standard applicable to non-retirement post-employment benefits?

A.  Severance-pay benefits.

B.  Post-retirement healthcare benefits.

C.  Salary-continuation benefits.

D.  Job-training benefits.

Post-retirement healthcare benefits.

Accounting for post-retirement healthcare benefits is covered by a different standard, and involves a much different type of accounting, similar to accounting for defined-benefit pension plans. Such benefits include coverage for all or a portion of a retiree's healthcare costs for the rest of the retiree's life.

26

Accounting for non-retirement post-employment benefits is an example of :

  1. Accrual accounting.
  2. Cash-basis accounting.
  3. Fair-value accounting.
  4. Historical-cost accounting.

Accrual accounting.

Until the specific accounting standard was adopted, firms often used the pay-as-you-go basis (cash basis) for the accounting, but now, firms must record the relevant expense in the period in which the benefits are earned by the employee, provided that the appropriate criteria are met.

27

Rice Corp. adopted a defined benefit pension plan on January 1, year 1.  The plan does not provide any retroactive benefits for existing employees.  The pension funding payment is made to the trustee on December 31 each year.  The following information is available for year 1 and year 2:

  • Year 1 / Year 2
  • Service cost $150,000 / $165,000
  • Funding payment1 70,000 / 185,000
  • Interest on projected benefit--15,000
  • obligation  
  • Actual return on plan assets--18,000
  • Experience gains or losses----

In its December 31, year 2 balance sheet, Rice should report pension asset/liability of

  1. $20,000
  2. $25,000
  3. $40,000
  4. $43,000

$43,000

Pension asset/liability is the cumulative excess of the amount funded over the amount recorded as pension expense. In year 1, funding was $170,000 and the only element of pension expense which applied was service cost ($150,000), so pension asset/liability was $20,000 at 12/31/Y1.  In year 2, pension expense was $162,000 as computed below.

  • Service cost $165,000
  • Interest on P.B.O. 15,000
  • Actual return on plan assets (18,000)
  • Pension expense $162,000

Therefore, the year 2 funding ($185,000) exceeded pension expense ($162,000) by $23,000, increasing pension asset/liability to $43,000 ($20,000 + $23,000).

28

The present value of pension benefits accrued to date using assumptions as to future compensation levels is the

  1. Prior service cost.
  2. Accumulated benefit obligation.
  3. Projected benefit obligation.
  4. Accrued pension cost.

Projected benefit obligation.

The projected benefit obligation is the present value of pension benefits accrued to date using assumptions as to future compensation levels.

The actuarial present value of the obligation determined under the accumulated benefits method is referred to as the accumulated benefit obligation (ABO). If the defined benefit formula is not dependent on the amount of a future salary (say a retiree receives a fixed amount for each month worked), there would be no difference between the two approaches. If the defined benefit formula is pay-related and salaries are assumed to increase over time, the projected benefit obligation will be a greater amount than the accumulated benefit obligation.

29

A necessary condition for the recording of a pension liability is present when

  1. Projected benefit obligation exceeds accumulated benefit obligation.
  2. The market-related asset value exceeds accumulated benefit obligation.
  3. Accumulated benefit obligation exceeds the fair value of plan assets.
  4. Projected benefit obligation exceeds pension plan assets.

Projected benefit obligation exceeds pension plan assets.

ASC Topic 715 requires that if the projected benefit obligation exceeds the fair value of plan assets, a liability must be recognized in the balance sheet.

30

Which of the following components should be included in the calculation of net pension cost recognized for a period by an employer sponsoring a defined benefit pension plan?

  • Interest cost
  • Actual return on plan assets

  • Interest cost - YES
  • Actual return on plan assets - YES

Per ASC Topic 715, both the interest cost and the actual return on plan assets (if any) should be included in the calculation of net pension cost recognized for a period by an employer sponsoring a defined benefit pension plan.

Pension Expense is a net amount calculated by adding together five factors. These factors are:

  1. service cost,
  2. interest on the projected benefit obligation,
  3. expected return on plan assets,
  4. amortization of unrecognized prior service cost, and
  5. the effect of gains and losses.

31

Which of the following methods is used in IFRS to account for defined benefit pension plans?

  1. Projected-unit-credit method.
  2. Benefit-years-of-service method.
  3. Accumulated benefits method.
  4. Vested years of service method.

Projected-unit-credit method.

IFRS requires the use of the projected-unit-credit method to calculate the present value of the defined benefit obligation (PV-DBO).

32

Visor Co. maintains a defined benefit pension plan for its employees. The service cost component of Visor’s net periodic pension cost is measured using the

  1. Unfunded accumulated benefit obligation.
  2. Unfunded vested benefit obligation.
  3. Projected benefit obligation.
  4. Expected return on plan assets.

Projected benefit obligation.

Per ASC Topic 715, the service cost component recognized shall be determined as the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period, which is known as the projected benefit obligation.

33

Kent, Inc., a calendar-year company, established a defined benefit pension plan in December year 1. The following data relate to this plan at December 31, year 3:

  • Projected benefit obligation $4,700,000
  • Accumulated benefit obligation $4,000,000
  • Total fair value of plan assets $3,000,000

In its December 31, year 3 balance sheet, Kent should report a liability relating to the pension plan of

  1. $4,000,000
  2. $1,700,000
  3. $1,000,000
  4. $0

$1,700,000

ASC Topic 715 requires that a liability is recognized on the balance sheet if the projected benefit obligation exceeds the fair value of plan assets. Therefore, a liability of $1,700,000 ($4,700,000 − $3,000,000) must be recognized on the balance sheet.

34

Jerry Corp., a company whose stock is publicly traded, provides a noncontributory defined benefit pension plan for its employees. The company’s actuary has provided the following information for the year ended December 31, year 5:

  • Projected benefit obligation $400,000
  • Accumulated benefit obligation $350,000
  • Plan assets (fair value) $410,000
  • Service cost $120,000
  • Interest on projected benefit obligation $12,000
  • Amortization of unrecognized prior service cost $30,000
  • Expected and actual return on plan assets $41,000

The market-related asset value equals the fair value of plan assets. Prior contributions to the defined benefit pension plan equaled the amount of net periodic pension cost accrued for the previous year-end.  No contributions have been made for year 5 pension cost.  In its December 31, year 5 balance sheet, Jerry should report a pension asset of

  1. $203,000
  2. $121,000
  3. $ 10,000
  4. $0

$10,000

Since prior contributions equaled the amount of net pension cost previously accrued, there is no pension asset/liability at 1/1/Y5. Year 5 pension expense is $121,000, as computed below.

  • Service cost $120,000
  • Interest on PBO $12,000
  • Amort. of unrec. PSC $30,000
  • Return on plan assets ($41,000)
  • Pension cost $121,000

Although no year 5 contributions have been made, there is no liability at 12/31/Y5 because the plan assets exceed the PBO.  Therefore, a pension plan asset of $10,000 is recognized.

35

Under IFRS, how is the discount rate for pensions determined?

  1. It is determined by the market yield at the end of the reporting period for high-quality corporate bonds having a similar term or maturity.
  2. It is equal to the settlement rate.
  3. It is equal to the return on assets rate.
  4. It is determined by the firm’s weighted-average interest rate.

It is determined by the market yield at the end of the reporting period for high-quality corporate bonds having a similar term or maturity.

The discount rate to be used for pension accounting is determined by the market yield at the end of the reporting period for high-quality corporate bonds having a similar term or maturity.

36

An employer sponsoring a defined benefit pension plan should disclose the

  • Amount of unrecognized prior service cost
  • Fair value of plan assets

  • Amount of unrecognized prior service cost - YES
  • Fair value of plan assets - YES

The required disclosures for pensions and other postretirement benefits are as follows:

  1. A reconciliation schedule of the benefit obligation showing the components separately
  2. A reconciliation schedule of the fair value of plan assets with the components shown sepa­rately
  3. The funded status of the plans, and the amounts recognized in the balance sheet showing separately the noncurrent assets, current liabilities, and noncurrent liabilities recognized
  4. Information about plan assets including equity securities and debt securities, a narrative de­scription of investment policies and strategies, a narrative description of the basis used to de­termine overall expected rate-of-return on assets, disclosure of classes of plan assets, and information about assets if information is expected to be useful
  5. For defined benefit pension plans, the accumulated benefit obligation
  6. The benefits expected to be paid in each of the next five fiscal years and in the aggregate for the five fiscal years thereafter
  7. The employer’s best estimate of contributions expected to be paid to the plan during the rest of the fiscal year
  8. The net periodic benefit cost recognized with the components shown separately
  9. The net gain or loss and net prior service cost or credit recognized in other comprehensive income (OCI) for the period, and any reclassification adjustments of OCI (amortization of items) that are recognized in pension cost
  10. The amounts in accumulated OCI that have not yet been recognized as pension costs, showing separately the net gain or loss, the net prior service cost or credit, and net transi­tion asset or obligation
  11. On a weighted-average basis, the rates used for the assumed discount rate, rate of compensa­tion increase, and expected long-term rate of return on plan assets, and the assumptions used to determine benefit obligations and net benefit cost
  12. The assumed health care cost trend rate, a description of the pattern of change
  13. The effect a 1-percentage-point increase or decrease would have on the aggregated service and interest cost components and the accumulated postretirement benefit obligation for health-care benefits
  14. The amounts and types of securities of the employer and related parties included in plan as­sets, the approximate amount of future annual benefits of plan participants covered by insur­ance contracts issued by employer or related parties, and any significant transactions between the employer or related parties and the plan during the year
  15. Any alternative method used to amortize prior service amounts or unrecognized net gains and losses
  16. Any substantive commitments, such as past practice or history of regular benefit increases used to account for benefit obligation
  17. The cost of providing special or contractual termination benefits recognized during the period and a description of the nature of the event
  18. An explanation of any significant changes in the plan assets or the benefit obligation
  19. The amounts in accumulated OCI expected to be recognized as components of pension cost over the fiscal year-end that follows the most recent balance sheet presented, showing separately net gain or loss, net prior service cost or credit, and net transition asset or obligation
  20. The amount and timing of any plan assets expected to be returned to the employer during the next 12-month period (or operating cycle, if longer) after the most recent balance sheet

37

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

  • Actuarial estimate of projected benefit obligation at 1/1/Y2 $72,000
  • Assumed discount rate 10%
  • Service costs for 2010 $18,000
  • Pension benefits paid during year $215,000

If no change in actuarial estimates occurred during year 2, Seda’s projected benefit obligation at December 31, year 2, was

  1. $64,200
  2. $75,000
  3. $79,200
  4. $82,200

$82,200

The projected benefit obligation is the actuarial present value of the pension obligation at the end of the period.  Since there were no changes in actuarial estimates during the year, the end of period projected benefit obligation is computed as follows:

  • Projected benefit obligation, 1/1/Y2 $72,000
  • Service cost $18,000
  • Interest on projected benefit obligation (10% × $72,000) $7,200
  • Benefit payments ($15,000)
  • Pension benefit obligation, 12/31/Y2 $82,200

Service cost and interest on the projected benefit obligation increase the projected benefit obligation; benefit payments decrease the projected benefit obligation.

38

ASC Topic 715 requires disclosure of assumed health care cost trend rates for defined benefit postretirement plans. Assumed health care cost trend rates should be disclosed for the

  • Following year
  • Years beyond the following year

  • Following year - YES
  • Years beyond the following year - YES

Assumed health care cost trend rates should be disclosed for defined benefit postretirement plans for both the following year and for years beyond the following year.

39

Note section disclosures in the financial statements for pensions do not require inclusion of which of the following?

  1. The components of period pension costs.
  2. The amount of unrecognized prior service cost.
  3. The differences in executive and nonexecutive plans.
  4. A detailed description of the plan including employee groups covered.

The differences in executive and nonexecutive plans.

 

40

An employer’s obligation for postretirement health benefits that are expected to be fully provided to or for an employee must be fully accrued by the date the

  1. Benefits are paid.
  2. Benefits are utilized.
  3. Employee retires.
  4. Employee is fully eligible for benefits.

Employee is fully eligible for benefits.

ASC Topic 715 requires that the employer’s obligation for postretirement health benefits that are expected to be fully provided to or for an employee must be fully accrued by the date that the employee is fully eligible for benefits.

41

The following information relates to the year 3 activity of the defined benefit pension plan of Lindy Corp., a company whose stock is publicly traded:

  • Service cost $150,000
  • Return on plan assets $40,000
  • Interest cost on pension benefit obligation $82,000
  • Amortization of actuarial loss $15,000
  • Amortization of unrecognized net obligation $35,000

Lindy’s year 3 pension cost is

  1. $322,000
  2. $287,000
  3. $242,000
  4. $158,000

$242,000

Pension cost is a net amount calculated by adding or subtracting the factors as follows:

  • Service cost $150,000
  • Return on plan assets ($40,000)
  • Interest cost on pension benefit obligation $82,000
  • Amortization of actuarial loss $15,000
  • Amortization of unrecognized net obligation $35,000
  • Pension cost $242,000

Service cost and interest on the projected benefit obligation always increase pension expense; return on plan assets almost always decreases pension expense.  Amortization of actuarial loss and amortization of a net obligation both increase pension expense.

42

In which of the following pension instances would the pension asset/liability adjustment (net of tax), be reported on the balance sheet for a particular year?

  1. Only when there is an amendment to a defined benefit pension plan.
  2. Only when the projected benefit obligation exceeds plan assets.
  3. When the unrecognized prior service cost exceeds the additional pension liability required to be recognized.
  4. When the additional pension liability required to be recognized exceeds the unrecognized prior service cost.

Only when the projected benefit obligation exceeds plan assets.

ASC Topic 715 requires a pension liability to be recognized if the fair value of plan assets is less than the projected benefit obligation. 

Funded Status of Pension Plan 

ASC 715 requires that the funded status of the plan be reported in the balance sheet.  The funded status is the difference between the projected benefit obligation and the fair value of the plan assets at the measurement date.  If the plan is overfunded, a noncurrent asset is recorded on the balance sheet. If the plan is underfunded, either a current liability, a noncurrent liability, or both are reported on the balance sheet. Any gains and losses not already recognized as pension expense are recognized in other comprehensive income (net of tax).  ASC Topic 715 also requires that if a plan is amended and either increases or decreases the projected benefit obligation, this amount should be recognized as either a prior service cost or credit.  Prior service costs or credits should be amortized over the future periods of service of the employees expected to receive benefits.

ASC Topic 715 further requires that all overfunded plans are aggregated and disclosed as a noncurrent asset. All underfunded plans are aggregated and disclosed as a current liability, noncurrent liability, or both. In other words, the funding status of plans may NOT be netted (overfunded plans may not be netted with underfunded plans).  The measurement date for plans is the fiscal year-end, (i.e., balance sheet date) of the entity.

This completes the overview of the accounting required by employers for pension plans.  In the next section, the determination of Pension Cost is thoroughly reviewed.  The general term pension cost is preferred over pension expense because pension cost is included in overhead in the determination of product costs and therefore may be part of inventory in the balance sheet. When permissible the term “Pension Expense” is used instead because it is simpler and clearer.  The disclosure of the elements included in pension expense is one of the most significant disclosures required by ASC Topic 715 and should be carefully studied.

43

The following information pertains to Gali Co.’s defined benefit pension plan for year 2:

  • Fair value of plan assets, beginning of year $350,000
  • Fair value of plan assets, end of year $525,000
  • Employer contributions $110,000
  • Benefits paid $85,000

In computing pension expense, what amount should Gali use as actual return on plan assets?

  1. $65,000
  2. $150,000
  3. $175,000
  4. $260,000

$150,000

The actual return on plan assets represents the return earned on accumulated pension fund assets. It is calculated as the difference in the fair value of plan assets at the beginning and the end of the period adjusted for contributions made to the plan and benefit payments made by the plan during the period.  This calculation separates out the change in the FV of plan assets that is due to interest and dividends earned.  The formula for determining the actual return is as follows:

  • Actual Return = Ending plan assets − Beginning plan assets + Benefits − Contributions
  • $150,000 = ($525,000 − $350,000) + $85,000 − $110,000    

44

Kemp Company provides a defined benefit postretirement plan for its employees. Kemp adopted the plan on January 1, year 1, in accordance with the provisions of ASC Topic 715.  Data relating to the pension plan for year 1 are as follows:

  • Service cost for year $128,000
  • Interest on the accumulated postretirement benefit obligation $5,000
  • Amortization of the unrecognized transition obligation $8,000

At the end of year 1, Kemp makes a benefit payment of $10,000 to employees. In its December 31, year 1 balance sheet, Kemp should record accrued postretirement benefit cost of

  1. $35,000
  2. $31,000
  3. $51,000
  4. $15,000

$31,000

 

To determine the accrued postretirement benefit cost, the net periodic
postretirement benefit cost must first be calculated as follows:

  • Service cost $28,000
  • Interest on the accumulated postretirement benefit obligation $5,000
  • Amortization of the unrecognized transition obligation $8,000
  • = Net periodic postretirement benefit cost $41,000

An adjusting entry is required at year-end to record net periodic postretirement benefit cost and the cash benefit payments made to employees. An accrued postretirement benefit cost will be recorded if the net postretirement benefit cost exceeds the cash payments to employees.  The journal entry would be

  • Postretirement benefit cost $41,000 
    • Cash $10,000
    • Accrued postretirement benefit cost $31,000

45

Interest cost included in the net pension cost recognized for a period by an employer sponsoring a defined benefit pension plan represents the

  1. Shortage between the expected and actual returns on plan assets.
  2. Increase in the projected benefit obligation due to the passage of time.
  3. Increase in the fair value of plan assets due to the passage of time.
  4. Amortization of the discount on unrecognized prior service costs.

Increase in the projected benefit obligation due to the passage of time.

The interest expense on the projected benefit obligation is defined as the increase in the amount of the projected benefit obligation due to the passage of time.

46

An employer offered for a short period of time special termination benefits to some employees. The employees accepted the offer, which provided for immediate lump-sum payments and future payments at the end of the next 2 years. The amounts can be reasonably estimated. The amount of expense recognized this year should include

  1. One-third of the lump-sum payments and one-third of the present value of the future payments.
  2. Only the lump-sum payments.
  3. The lump-sum payments and the total of the future payments.
  4. The lump-sum payments and the present value of the future payments.

The lump-sum payments and the present value of the future payments.

Per ASC Topic 712 (SFAS 88), an employer that offers for a short period of time special termination benefits to employees shall recognize a liability and an expense when the employees accept the offer and the amount can be reasonably estimated. The amount recognized shall include any lump-sum payments and the present value of any expected future payments. This answer is correct because the employees accepted the offer and the amount can be reasonably estimated.

47

On June 1, year 1, Ward Corp. established a defined benefit pension plan for its employees. The following information was available at May 31, year 3:

  • Projected benefit obligation $14,500,000
  • Accumulated benefit obligation $12,000,000
  • Pension asset/liability ($200,000)
  • Plan assets at fair market value $7,000,000
  • Unrecognized prior service cost $2,550,000

To report the proper pension liability in Ward’s May 31, year 3 balance sheet, what is the amount of the adjustment required?

  1. $2,250,000
  2. $4,750,000
  3. $4,800,000
  4. $7,300,000

$7,300,000

ASC Topic 715 requires the recognition of pension liability if the projected benefit obligation exceeds the fair value of the plan assets. The adjustment needed is the amount to bring the liability equal to $7,500,000 ($14,500,000 less $7,000,000). There is currently $200,000 in the unfunded pension asset (liability) account. Therefore, an adjusting entry is made for $7,300,000.

48

The following information pertains to Kane Co.’s defined benefit pension plan:

  • Pension asset (liability), January 1, year 5 $2,000
  • Service cost $19,000
  • Interest cost $38,000
  • Actual return on plan assets $22,000
  • Amortization of unrecognized prior service cost $52,000
  • Employer contributions $40,000

The fair value of plan assets exceeds the projected benefit obligation.  In its December 31, year 5 income statement, what amount should Kane report as pension cost?

  1. $45,000
  2. $49,000
  3. $67,000
  4. $87,000

$87,000

Year 5 pension expense, computed below, is recorded by debiting pension expense and crediting the pension asset/liability account.

  • Service cost $19,000
  • Interest cost $38,000
  • Actual return on plan assets ($22,000)
  • Amort. of unrecognized PSC $52,000
  • = Pension expense $87,000

49

An entity sponsors a defined benefit pension plan that is underfunded by $800,000.  A $500,000 increase in the fair value of plan assets would have which of the following effects on the financial statements of the entity?

  1. An increase in the assets of the entity.
  2. An increase in accumulated other comprehensive income of the entity for the full amount of the increase in the value of the assets.
  3. A decrease in accumulated other comprehensive income of the entity for the full amount of the increase in the value of the assets.
  4. A decrease in the liabilities of the entity.

A decrease in the liabilities of the entity.

For a defined benefit pension plan, the fair value of the plan assets is compared to the projected benefit obligation at the balance sheet date. If the fair value of plan assets is greater than the projected benefit obligation, a pension asset is recognized on the balance sheet. If the fair value of plan assets is less than the projected benefit obligation, a pension liability is recognized. If the defined benefit plan is underfunded by $800,000 (meaning the pension benefit obligation exceeds the fair value of plan assets), and the plan assets increase in value by $500,000, the pension liability will decrease.

50

In the calculation of pension expense recognized for a period by an employer sponsoring a defined benefit pension plan, which components will not be included?

  1. Interest cost on the projected benefit obligation.
  2. Actuarial present value of benefits attributed by the pension benefit formula to employee service during that period.
  3. Amortization of the unrecognized net obligation (and loss or cost) or unrecognized net asset (and gain) existing at the date of transition.
  4. Excess of accumulated benefit obligation over the fair value of the plan assets.

Excess of accumulated benefit obligation over the fair value of the plan assets.

Excess of accumulated benefit obligation over the fair value of the plan assets should not be included as a component of pension expense because it represents the unfunded accumulated benefit obligation which could require recognition of an additional minimum liability.

Pension Expense is a net amount calculated by adding together five factors. These factors are (1) service cost, (2) interest on the projected benefit obligation, (3) expected return on plan assets, (4) amortization of unrecognized prior service cost, and (5) the effect of gains and losses.

51

West Company adopted a defined benefit pension plan on January 1, year 4.  West amortizes the prior service cost over 16 years and funds prior service cost by making equal payments to the fund trustee at the end of each of the first 10 years.  The service (normal) cost is fully funded at the end of each year. The following data are available for year 4:

  • Service (normal) cost for year 4 $110,000
  • Prior service cost: 
    • Amortized $41,700
    • Funded $57,200

West’s pension asset/liability at December 31, year 4, is

  1. $0
  2. $15,500
  3. $41,700
  4. $57,200

$15,500

Pension asset (liability) is the excess of the amount funded over the amount recorded as pension expense. The amount funded is $167,200 ($110,000 service cost + $57,200 funding of prior service cost).  Pension expense is $151,700 ($110,000 service cost + $41,700 amortization of prior service cost). Therefore, pension asset/liability is $15,500 ($167,200 − $151,700).