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Mountain View Inc.’s latest financial statements show the projected benefit obligation (PBO) of their pension plan to be $250 million, while the fair market value of the plan assets is $210 million. The company’s balance sheet reflects a net pension liability of $25 million. In light of this information, which of the following actions is Mountain View required to take in accordance with current U.S. accounting standards? Ignoring income taxes, the company is required to:

A) record a $15 million “additional pension liability” on its balance sheet.

B) record a $40 million “additional pension liability” on its balance sheet.

C) disclose a $15 million “additional pension liability” in the footnotes to its financial statements.

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If the PBO exceeds the fair market value of plan assets, GAAP requires that companies disclose the difference on the balance sheet as a liability. The total difference between the PBO and the fair market value of plan assets is $40 million (= $250 million − 210 million). Since $25 million of net pension liability is already reflected in the financial statements, Mountain View needs to book $15 million in additional pension liability.

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When analyzing the disclosures made with regard to pension plan accounting released by a company, which of the following measures most accurately reflects the true economic position of the plan?

A) The accumulated benefit obligation (ABO).

B) The fair value of plan assets.

C) The funded status of the plan.

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The funded status of a pension plan is simply the fair market value of the plan assets minus the PBO.

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Darla Whitney, CFA, is an investment advisor for a small money management firm in New York. She is considering the purchase of shares in Best Corp., a German company. Whitney is aware that there are differences in the accounting treatment of pension benefits for U.S. companies under GAAP and those companies operating under the International Financial Reporting Standards (IFRS). Which of the following statements most accurately describes the most significant difference between the GAAP and the IFRS rules for the accounting for pension plans?

A) GAAP requires that actuarial gains and losses be amortized over the employee’s service life, while IFRS requires that they be amortized over a period not to exceed 15 years.

B) GAAP recognizes the funded status on the balance sheet, while IFRS reflects the funded status adjusted for unrecognized items.

C) GAAP requires that prior service costs for currently vested employees be expensed in the period incurred, while IFRS requires them to be deferred and amortized.

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The major difference between GAAP rules and IFRS rules is the treatment of the funded status. GAAP requires the recognition of the funded status on the balance sheet, while IFRS treatment reflects the funded status adjusted for unrecognized items.

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Which of the following measures is least sensitive to changes in pension plan actuarial assumptions?

A) Reported pension expense.

B) Projected benefit obligation (PBO).

C) Funded status.

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Reported pension expense is a net (smaller) amount and therefore, is generally quite sensitive to relatively minor changes in actuarial assumptions.

Changing an assumption may have a small effect on the projected benefit obligation (PBO) but may have a much larger effect on the funded status (which is a net pension amount).

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Financial analysts can use select data from a company’s financial statements to derive an economic pension expense in order to better reflect the company’s true economic pension cost. Which of the following formulas will most accurately calculate a company’s economic pension expense?

A) Beginning fair value of plan assets + service cost + interest cost – ending fair value of plan assets.

B) Service cost + interest cost + plan amendments – actual return on plan assets.

C) Service cost + interest cost – actual return on plan assets – benefits paid.

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An economic pension expense is calculated without reflecting the amortization of unrecognized items and other smoothing mechanisms included in reported pension expense, and in addition uses the plan’s actual return on assets, rather than the plan’s expected return.

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An economic pension expense can be calculated to better reflect a firm’s true economic pension cost than the reported pension expense. Which of the following adjustments to reported pension cost should be made?

A) The inclusion of amortization of unrecognized items.

B) The inclusion of actual benefits paid to employees.

C) The use of actual instead of expected return on assets.

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Reported pension cost can be adjusted by the removal of both the amortization of unrecognized items and other smoothing mechanisms, plus the use of actual return on assets rather the expected return. The resulting economic pension expense is a more accurate portrayal of the firm’s true pension cost

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Federal Companies reported the following information in the footnotes to its most recent financial statements:

Beginning Projected Benefit Obligation (PBO)	$65,000,000
Ending PBO	90,000,000
Service Cost	27,000,000
Interest Cost	3,000,000
Benefits Paid	5,000,000
Actual Return on Plan Assets	7,500,000
Expected Return on Plan Assets	8,500,000

Given the information above, calculate Federal’s economic pension expense for the year.

A) $41,000,000.

B) $27,500,000.

C) $22,500,000.

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Economic pension expense = service cost + interest cost – actual return on plan assets + plan ammendments
Therefore, $27,000,000 + 3,000,000 – 7,500,000 = $22,500,000

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Which of the following statements regarding economic pension expense is least accurate?

A) It is equal to the sum of all the changes in projected benefit obligation (PBO) for the period (except for benefits paid) less the actual return on assets.

B) It is equal to the change in the funded status for the period.

C) It is a more volatile measure of pension expense than reported pension expense.

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Economic pension expense is equal to the change in the funded status for the period excluding the firm’s contributions.

Economic pension expense is calculated by eliminating the smoothed amounts from reported pension expense and including the actual return on assets. The result is a more volatile measure of pension expense.

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Which of the following statements about stock-based compensation are correct or incorrect?

Statement #1:	The grant date of a service-based award is the date when the employees’ benefits are fully vested.
Statement #2:	When two or more performance conditions must be satisfied, the requisite service period ends when the first condition is met.

A) Both are incorrect.

B) Only one is correct.

C) Both are correct.

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The grant date is the date an award is approved by the board of directors or compensation committee. When two or more performance conditions must be satisfied, the requisite service period does not end until all conditions are met.

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Jason Moore, CFA, is a credit analyst for Everest Bank in New York in their investment banking division. An existing customer of the bank, Longhorn Partners, which is based in Texas, has approached the bank for a $45 million loan to be used to acquire a smaller competitor. Moore has been appointed head of the credit team that will review Longhorn’s current business with the bank as well as their current operations in order to assess Longhorn’s request.
Overall, Longhorn has achieved consistent profitability over the last decade. The company is appropriately leveraged and appears to be well-run by its senior management team. However, there are a couple of items in the company’s financial statements that Moore believes may warrant further analysis.
For many years, Longhorn has also offered to its fulltime employees a traditional, pension plan. It is a pay-related defined benefit plan, in which upon retirement, eligible employees are promised an annual pension payment of 3% per year of service times their annual salary at retirement. Select information regarding the pension plan from Longhorn’s most recent financial statement is as follows:

Pension Benefit Obligation (PBO)	$85,475,000
Accumulated Benefit Obligation (ABO)	65,250,000
Fair value of plan assets	71,365,000
Net pension liability	5,450,000
Discount rate	6.25%

According to the information above, the funded status of Longhorn’s pension plan is closest to:

A) underfunded by $6,115,000.

B) underfunded by $14,110,000.

C) overfunded by $6,115,000.

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A plan is underfunded when the PBO exceeds the fair market value of the plan assets. In this case, the PBO exceeds the plan assets by $14,110,000 (= $85,475,000 − 71,365,000). (Study Session 6, LOS 24.e)

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Moore reads in the footnotes to Longhorn’s financial statements that the pension plan’s PBO balance increased by $5,000,000 last year. Of this amount, approximately 50% was attributed to benefits earned by its employees that year. The remaining 50% was attributed to a change in the pension plan’s actuarial assumptions. Which one of the following changes to actuarial assumptions would cause an increase in PBO?

A) A decrease in the discount rate.

B) A decrease in the rate of compensation growth.

C) A decrease in the expected rate of return.

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Decreasing the assumed discount rate used to calculate the present value of the pension obligations will increase the PBO. (Study Session 6, LOS 24.d)

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Ignoring taxes, what adjustment is necessary to Longhorn’s net pension liability and other comprehensive income in order to comply with current U.S. accounting standards?

Net pension liability

Other comprehensive income

A) Increase $8,660,000 Decrease $8,660,000

B) Decrease $8,660,000 Increase $8,660,000

C) Increase $14,110,000 Decrease $14,110,000

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According to current U.S. accounting standards, the funded status must be reported on the balance sheet. The plan is underfunded by $14,110,000 ($71,365,000 Plan assets – $85,475,000 PBO). Since Longhorn is reporting a liability of $5,450,000, an additional liability of $8,660,000 ($14,110,000 required liability – $5,450,000 reported liability) must be reported. The increase in net pension liability is offset by a decrease in other comprehensive income. (Study Session 6, LOS 24.e)