A Pension Question, please discuss note, statements, following, describes

bleach

This is a question on schweser note:

All else equal, which of the following statements best describes the impact of an increase in the expected return on plan assets?

A. Increase in plan assets and decrease in pension expense ( my choice)
B. Decrease in PBO and increase in service cost ( obviously not relevent)
C. Increase in net income. (correct answer)

My logic for choosing A is following: Expected return on assets (up) ---> expense (down)
----> ending plan assets (lower). I do not see error in that.

Note answer: lower expense leads to higher net income. (I do not know where they derived that!)

please discuss.

chaojimali

expected return on plan assets does not do anything for the Plan assets Balance sheet account. Only Actual return on Plan Assets affects Plan assets on the Balance sheet.

Reported Pension Expense = Service Cost + Interest Cost - Expected Return on Plan assets.

And Reported Pension Expense is deducted from Revenues while arriving at Net Income.

When Exp. Return on Plan assets goes up -> Reported Pension expense Reduces -> which increases Net Income....

so that is the right answer.

CP

tobeornottobe

+1 with CP. One this to realize withe pension is that..anything that goes on the balance sheet is only actual numbers, actual returns, past service cost etc. On the income statement however, remember that we dont like too much variability, so to smooth things there we use expected numbers and recognized portions of past service cost and actual gain and losses. Thats why when we are evaluating a firm with pension, we should look at the true economic expense where the actual numbers are used.

brainsX

^I don't know what you're referring to with "expense" in your FV of plan assets formula, but as far as I know, that's wrong.

C is clearly correct because an increase in expected return has no effect on plan assets. As you can see in your formula, actual return is there. The 2nd part of choice A is correct. If expected return inreases, this drives down pension expense. If pension expense is lower, net income is higher.

yospaghetti

Oh ok Never mind,

i mixed up management expense with pension expense.

random_walker47

Expected return on assets has nothing to do with the FV of the assets. Increase in expected return on assets will lower pension expense which will lead to higher NI