pacmandefense

Straight Elements, Inc. (SE) is a discount manufacturer of parts and supplies for the railroad industry, and uses U.S. GAAP. The following information is from SE’s financial statements and accompanying notes:

(Figures in millions)
PBO	$435
Service Cost	39
ABO	370
Actual Return on Plan Assets	39
Benefits Paid	22
Unamortized Past Service Cost	39
FMV of Plan Assets	295

If SE reported under IFRS instead of US GAAP, the liability reported on the balance sheet would be:

A) higher.

B) lower.

C) the same.

---

Under IFRS the pension liability would be lower because of the $39 million in unamortized past service costs. Under IFRS, the balance sheet entry (funded status) excludes amounts that have not been recognized in the income statement (e.g., deferred gains and losses, and past service cost). Note that the question is asking for the liability vs. the examples in the Notes work with assets. Hence, the logic reverses.

pacmandefense

Which of the following statements regarding pension accounting under current U.S. GAAP standards and International Financial Reporting Standards (IFRS) is most accurate?

A) Under IFRS, the funded status (difference in the PBO and the plan assets) is now reported on the balance sheet.

B) Under U.S. GAAP, firms are required to provide a reconciliation of the funded status and the reported net pension asset or liability.

C) Under IFRS and U.S. GAAP, the calculation of pension expense is the same.

---

The calculation of pension expense is not affected by the new standard. Pension expense still includes the smoothing effects of the amortization of deferred gains and losses and the amortization of past (prior) service costs.

Under current U.S. GAAP, the net pension asset or liability reported on the balance sheet is equal to the funded status, without adjustment for unrecognized items. However, under IFRS, the net pension asset or liability reported on the balance sheet represents the funded status adjusted for unrecognized items.

Under current IFRS, firms are required to provide a reconciliation of the funded status and the reported net pension asset or liability. The reconciliation can be used to make an adjustment to the new standard for comparison purposes

pacmandefense

Which of the following statements regarding the projected benefit obligation (PBO) and the value of the pension plan assets is most accurate?

A) Plan amendments during the year generally result in a decrease of the PBO at the end of the year.

B) The fair value of plan assets is increased by the amount of the expected return on assets.

C) If the PBO and the plan assets are the same, then nothing needs to be reported on the balance sheet.

---

Neither the PBO nor the plan assets are separately reported on the balance sheet. The funded status is the difference in the PBO and the plan assets. If the PBO exceeds the plan assets, the difference is reported as a liability. If the plan assets exceed the PBO, the difference is reported as an asset. If the amounts are the same, then neither a liability nor asset needs to be reported.

Plan amendments (i.e. additional benefits provided that increase the amount of the employer’s obligation to plan participants) generally result in an increase of the PBO.

The fair value of plan assets at the beginning of the period is increased by the actual return on plan assets as well as any employer contributions. It is reduced by the amount of benefits paid.

pacmandefense

Which of the following statements regarding pension accounting under U.S. GAAP standards is most accurate?

A) Changes in actuarial assumptions and past service costs fully and immediately affect the income statement.

B) A reconciliation between the funded status and the net pension asset (liability) reported on the balance is required.

C) Changes in the projected benefit obligation (PBO) and plan assets fully and immediately affect the balance sheet.

---

Changes in the projected benefit obligation (PBO) and plan assets immediately affect the funded status (difference in PBO and plan assets) and the full amount of the changes is reflected on the balance sheet when the change occurs.

Changes in actuarial assumptions and past service costs are recognized in the income statement over time thereby smoothing pension expense.

Since the funded status is equal to the net pension asset (liability) reported on the balance sheet under U.S. GAAP, then no reconciliation is required. Note: However, the reconciliation (as illustrated below) is required under current IFRS.

Funded status (Fair value of plan assets – PBO)
Unrecognized deferred (gains) and losses
+ Unrecognized past service cost
Unrecognized transition (asset) or liability
=Net pension asset (liability) reported on the balance sheet

---

pacmandefense

Under current U.S. GAAP, the assets and liabilities of a defined benefit pension plan are:

A) reported in the appropriate section of the balance sheet, with pension obligations shown under liabilities and plan assets shown under assets.

B) off balance sheet items which are shown only in the footnotes.

C) netted against each other, and only the net asset or liability amount is reported on the company’s balance sheet.

---

Under current U.S. GAAP, companies are required to report only the net asset or liability amount. They cannot show assets and liabilities separately. Although some smoothing details are still disclosed in the footnotes, all major components of pension assets and liabilities are now required to be shown on the balance sheet.

pacmandefense

Tim Gresham, CFO of Alpha Logistics is concerned about changes in the business environment which could lead to Alpha violating some of the covenants of their outstanding debentures. Specifically Gresham is concerned about leverage and profitability ratios. Gresham reviews Alpha’s most recent financial statements and decides that changing the assumptions for the company’s defined benefit pension plan may provide some relief in the short-run. Alpha reports under U.S. GAAP.
Which of the following changes in the pension plan’s assumptions would most likely lead to lower reported leverage and higher reported profitability?

A) Increasing expected return on plan assets.

B) Increasing the discount rate.

C) Increasing the growth rate in compensation expense.

---

Increasing discount rate leads to lower present values and reduces reported pension liability in the balance sheet and also reduces pension expense by reducing the service cost component. Increasing expected return on plan assets does reduce pension expense but does not affect reported assets or liabilities. Increasing the growth rate in compensation expense increases service cost as well as reported pension liability.

dirk01

The Board of Directors of Prime Bank has asked management to make changes in the accounting of its pension plan obligations in order to decrease the reported service cost. Management determines that there are two changes in actuarial assumptions that will result in a lower service cost. Which of the following pairs of changes in actuarial assumptions will best achieve the desired effect? Prime Bank can either:

A) increase the discount rate or decrease the rate of compensation growth.

B) decrease the rate of compensation growth or increase the expected rate of return.

C) decrease the discount rate or increase the expected rate of return.

---

An increase in the discount rate will result in lower service cost. Using a lower rate of compensation growth will yield lower future pension benefits owed, and thus a lower service cost. The expected return has no impact on service cost

dirk01

Roberto Perez, CFA, is the Chief Financial Officer for Home Stores, Inc., a large home improvement retailer with stores located across the United States. Home Stores is preparing for a secondary stock offering to secure the necessary capital to pursue an aggressive expansion campaign. Perez has received a directive from his boss to make every legitimate effort to present Home Stores’ upcoming financial statements in the best possible light. Perez determines that certain assumptions in the pension plan can be changed to fulfill this request. Which of the following pension plan assumptions can be changed by a firm to manipulate its reported results?

Change

Result

A) increased expected rate of return decreased service cost

B) decreased discount rate increased expected return

C) decreased rate of compensation growth decreased service cost

---

The rate of compensation growth is the expected average annual increase in employee compensation. If the rate of growth is lowered, reported results will be improved due to a decrease in service cost. A decrease in service cost will result in lower pension expense.

dirk01

Peak Productions is a publicly traded company that manufactures consumer electronics products in the U.S. The company has been in operation nearly fifty years, and has a considerable pension plan liability on its financial statements. Peak has a well-deserved reputation among analysts of utilizing aggressive accounting practices with regard to its pension plan. Which of the treatments of the following actuarial assumptions is the best example of aggressive accounting for a pension plan?

A) A high calculated projected benefit obligation (PBO).

B) A high compensation growth rate.

C) A high discount rate.

---

The assumption of a high discount rate will result in a lower pension liability and almost always a lower pension expense. The more aggressive the actuarial assumptions for a pension plan are, the lower the quality of earnings for the firm.

dirk01

Wes Livingston is the founder and CEO of Bigwell Corporation. Livingston is interested in Bigwell being acquired by a larger competitor and wants to have his company’s financial statements appear as attractive as possible to a potential suitor. In order to decrease the accumulated benefit obligation (ABO) of the company’s pension plan, which of the following changes in actuarial assumptions could be made?

A) Decrease the rate of compensation growth.

B) Decrease the discount rate.

C) Increase the discount rate.

---

Increasing the assumed discount rate of a pension plan will result in lower pension liabilities, thus decreasing both the ABO and the projected benefit obligation (PBO).