Solution manual intermediate accounting IFRS volume 1 kiesoch20

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 20 Accounting for Pensions and Postretirement Benefits ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Basic definitions and 1, 2, 3, 4, 5, concepts related to pension 6, 7, 8, 12, plans 13, 23 Worksheet preparation Income statement recognition, computation of pension expense Brief Exercises Exercises Problems 16 Concepts for Analysis 1, 2, 3, 4, 5, 3, 4, 7, 10, 14 1, 2, 7, 8, 1, 1, 2, 3, 6, 11, 12, 13, 14, 15, 16, 17, 18, 19 1, 2, 3, 4, 5, 6, Financial statement 15, 21, 22 recognition, computation of pension expense 3, 9, 11, 12, 1, 2, 3, 4, 5, 2, 5, 13, 14, 6, 7, 8, 16, 17 Corridor calculation 18 8, 13, 18, 19 2, 3, 5, 6, 7, 8, Reconciliation schedule 24 3, 9, 10, 13, 14, 17 1, 2, 3, 6, 8, Past service cost 12, 13 5, 1, 2, 3, 5, 9, 1, 2, 3, 4, 5, 1, 11, 12, 13, 6, 7, 8, 14, 17, 19 Unrecognized net gain or loss 14, 17, 19, 20 7, 8, 9, 13, 14, 1, 2, 3, 5, 17, 18, 19 6, 7, 8, 4, 5, Disclosure issues 24 9, 11, 12 3, Special Issues 25, 26 27, 28, 29, 30 10 Copyright © 2011 John Wiley & Sons, Inc 9, 10, 11, 13, 16 10, 11, 12, 13 20, 21, 22 4, 3, 4, 5, 10 Kieso Intermediate: IFRS Edition, Solutions Manual 20-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Brief Exercises Learning Objectives Exercises Problems Distinguish between accounting for the employer’s pension plan and accounting for the pension fund Identify types of pension plans and their characteristics Explain alternative measures for valuing the pension obligation List the components of pension expense 1, 2, 1, 2, 6, 11, 12, 13, 15, 16 Use a worksheet for employer’s pension plan entries 3, 4, 7, 10, 11, 14 1, 2, 4, 7, 8, Describe the amortization of past service costs 5, 1, 2, 5, 7, 12, 13, 16, 17 1, 2, 3, 4, 6, 7, 8, Explain the accounting for unexpected gains and losses 12, 13, 17 1, 2, 3, 4, 5, 6, 7, 8, Explain the corridor approach to amortizing gains and losses 7, 8, 12, 13, 17, 18, 19 3, 4, 5, 6, 7, Describe the requirements for reporting pension plans in financial statements 9, 10, 11, 12, 13, 15, 16, 17 1, 2, 3, 4, 8, Explain special issues related to postretirement benefit plans 10, 11, 12, 13 20, 21, 22 10 10 20-2 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ASSIGNMENT CHARACTERISTICS TABLE Item E20-1 E20-2 E20-3 E20-4 E20-5 E20-6 E20-7 E20-8 E20-9 E20-10 E20-11 E20-12 E20-13 E20-14 E20-15 E20-16 E20-17 E20-18 E20-19 E20-20 E20-21 E20-22 P20-1 P20-2 P20-3 P20-4 P20-5 P20-6 P20-7 Level of Difficulty Time (minutes) Pension expense, journal entries Computation of pension expense Preparation of pension worksheet with reconciliation Basic pension worksheet Past service costs Computation of actual return Basic pension worksheet Application of the corridor approach Disclosures: Pension expense and reconciliation schedule Pension worksheet with reconciliation schedule Pension expense, journal entry, statement presentation Pension expense, journal entry, statement presentation Computation of actual return, gains and losses, corridor test, past service cost, pension expense, and reconciliation Worksheet for E20-13 Pension expense, journal entry Pension expense, statement presentation Reconciliation schedule and unrecognized loss Amortization of unrecognized net gain or loss (corridor approach), pension expense computation Amortization of unrecognized net gain or loss (corridor approach) Other postretirement benefit expense computation Other postretirement benefit worksheet Other postretirement benefit reconciliation schedule Simple Simple Moderate Simple Moderate Simple Moderate Moderate Moderate Moderate Moderate Moderate Complex 5–10 5–10 15–25 10–15 5–10 10–15 15–25 20–25 25–35 20–25 20–30 20–30 35–45 Complex Moderate Moderate Moderate Moderate 40–50 15–20 30–45 20–25 25–35 Moderate Simple Moderate Simple 30–40 10–12 15–20 10–15 Two-year worksheet and reconciliation schedule Three-year worksheet, journal entries, and reconciliation schedules Pension expense, journal entry, amortization of unrecognized loss, reconciliation schedule Pension expense, journal entries for two years Computation of pension expense, amortization of unrecognized net gain or loss (corridor approach), journal entries for three years Computation of unrecognized past service cost amortization, pension expense, journal entries, net gain or loss, and reconciliation schedule Pension worksheet Moderate Complex 40–50 45–55 Complex 40–50 Moderate Complex 30–40 45–55 Complex 45–60 Moderate 35–45 Description Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 20-3 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ASSIGNMENT CHARACTERISTICS TABLE (Continued) Description Level of Difficulty Time (minutes) P20-8 P20-9 P20-10 Comprehensive 2-year worksheet Comprehensive 2-year worksheet Postretirement benefit worksheet with reconciliation Complex Moderate Moderate 45–60 40–45 30–35 CA20-1 CA20-2 CA20-3 CA20-4 CA20-5 CA20-6 CA20-7 Pension terminology and theory Pension terminology Basic terminology Major pension concepts Implications of International Accounting Standard (IAS) 19 Unrecognized gains and losses, corridor amortization Non-vested employees—an ethical dilemma Moderate Moderate Simple Moderate Complex Moderate Moderate 30–35 25–30 20–25 30–35 50–60 30–40 20–30 Item 20-4 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO QUESTIONS **1 A private pension plan is an arrangement whereby a company undertakes to provide its retired employees with benefits that can be determined or estimated in advance from the provisions of a document or from the company’s practices In a contributory pension plan the employees bear part of the cost of the stated benefits whereas in a noncontributory plan the employer bears the entire cost **2 A defined contribution plan specifies the employer’s contribution to the plan usually based on a formula, which may consider such factors as age, length of service, employer’s profit, or compensation levels A defined benefit plan specifies a determinable pension benefit that the employee will receive at a time in the future The employer must determine the amount that should be contributed now to provide for the future promised benefits In a defined contribution plan, the employer’s obligation is simply to make a contribution to the plan each year based on the plan formula The benefit of gain or risk of loss from assets contributed to the plan is borne by the employee In a defined benefit plan, the employer’s obligation is to make sufficient contributions each year to provide for the promised future benefits Therefore, the employer is at risk to the extent that contributions will not be adequate to meet the promised benefits **3 The employer is the organization sponsoring the pension plan The employer incurs the costs and makes contributions to the pension fund Accounting for the employer involves: (1) allocating the cost of the pension plan to the proper accounting periods, (2) measuring the amount of pension obligation resulting from the plan, and (3) disclosing the status and effects of the plan in the financial statements The pension fund or plan is the entity which receives the contributions from the employer, administers the pension assets, and makes the benefit payments to the pension recipients Accounting for the fund involves identifying receipts as contributions from the employer sponsor, income from fund investments, and computing the amounts due to individual pension recipients Accounting for the pension costs and obligations of the employer is the topic of this chapter; accounting for the pension fund is not **4 When the term ―fund‖ is used as a noun, it refers to assets accumulated in the hands of a funding agency for the purpose of meeting pension benefits when they become due When the term ―fund‖ is used as a verb, it means to pay over to a funding agency (as to fund future pension benefits or to fund pension cost) **5 An actuary’s role is to ensure that the company has established an appropriate funding pattern to meet its pension obligations, to make predictions and assumptions about future events and conditions that affect pension costs, and to assist the accountant in measuring facets of the pension plan that must be reported (costs, liabilities and assets) In order to determine the company’s pension obligation, the actuary must first determine the expected benefits that will be paid in the future To accomplish this requires the actuary to make actuarial assumptions, which are estimates of the occurrence of future events affecting pension costs, such as mortality, withdrawals, disablement and retirement, changes in compensation, and changes in discount rates to reflect the time value of money **6 In measuring the amount of pension benefits under a defined benefit pension plan, an actuary must consider such factors as mortality rates, employee turnover, interest and earnings rates, early retirement frequency, and future salaries Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 20-5 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 20 (Continued) **7 One measure of the pension obligation is the vested benefit obligation This measure uses only current salary levels and includes only vested benefits; that is, benefits the employee is already entitled to receive even if the employee renders no additional services under the plan A company’s accumulated benefit obligation is the actuarial present value of benefits attributed by the pension benefit formula to service before a specified date and is based on employee service and compensation prior to that date The accumulated benefit obligation differs from the projected benefit obligation in that it includes no assumption about future compensation levels The defined benefit obligation is based on vested and nonvested services using future salaries **8 Cash-basis accounting recognizes pension cost as being equal to the amount of cash paid by the employer to the pension fund in any period; pension funding serves as the basis for expense recognition under the cash basis Accrual-basis accounting recognizes pension cost as it is incurred and attempts to recognize pension cost in the same period in which the company receives benefits from the services of its employees Not infrequently, the amount which an employer must fund for pension purposes during a particular period is unrelated to the economic benefits derived from the pension plan in that period Cashbasis accounting recognizes the amount funded as periodic pension cost and the amount funded may be discretionary and vary widely from year to year Funding is a matter of financial management, based on working capital availability, tax considerations, and other matters unrelated to accounting considerations * The five components of pension expense are: (1) Service cost component—the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period (2) Interest cost component—the increase in the defined benefit obligation as a result of the passage of time (3) Actual return on plan assets component—the reduction in pension cost for actual investment income from plan assets and the change in the fair value of plan assets (4) Amortization of past service cost—the cost of retroactive benefits granted in a plan amendment (including initiation of a plan) (5) Gains and losses—a change in the value of either the defined benefit obligation or the plan assets resulting from experience different from that assumed or expected or from a change in an actuarial assumption Note to instructor: Regarding return on plan assets, the final component is expected rate of return We are assuming above that an adjustment is made to the actual return to determine expected return *10 The service cost component of pension expense is determined as the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period The plan’s benefit formula provides a measure of how much benefit is earned and, therefore, how much cost is incurred in each individual period The IASB concluded that future compensation levels had to be considered in measuring the present obligation and periodic pension expense if the plan benefit formula incorporated them 11 The interest component is the interest for the period on the defined benefit obligation outstanding during the period The assumed discount rate should reflect the rates at which pension benefits could be effectively settled (settlement rates) Other rates of return on high-quality fixedincome investments might also be employed 20-6 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 20 (Continued) 12 Service cost is the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period Actuaries compute service cost at the present value of the new benefits earned by employees during the year Past service cost is the cost of retroactive benefits granted in a plan amendment or initiation of a pension plan The cost of the retroactive benefits is the increase in the defined benefit obligation at the date of the amendment *13 When a defined benefit plan is either initiated or amended, credit is often given to employees for years of service provided before the date of initiation or amendment The cost of these retroactive benefits are referred to as past service costs Employers grant retroactive benefits because they expect to receive benefits in the future As a result, past service cost should not be recognized as pension expense entirely in the year of amendment or initiation, but should be recognized during the service periods of those employees who are expected to receive benefits under the plan Consequently, unrecognized past service cost is amortized over the remaining average period to vesting of employees who will receive benefits and is a component of net periodic pension expense each period *14 Liability gains and losses are unexpected gains or losses from changes in the defined benefit obligation Liability gains (resulting from unexpected decreases) and liability losses (resulting from unexpected increases) are deferred and combined in the Unrecognized Net Gain or Loss account They are accumulated from year to year in a memo record account *15 If pension expense recognized in a period exceeds the current amount funded, a liability account referred to as Pension Liability arises; the account would be reported either as a current or noncurrent liability, depending on the ultimate date of payment If the current amount funded exceeds the amount recognized as pension expense, an asset account referred to as Pension Asset arises; the account would be reported as a current asset if it is current in nature; if non-current, it would be reported in the other assets section Often, one general account is used referred to as Pension Asset/Liability If it has a credit balance, it is identified as a liability; if a debit balance, it is an asset *16 Computation of actual return on plan assets Fair value of plan assets at end of period Deduct: Fair value of plan assets at beginning of period Increase in fair value of assets Deduct: Contributions to plan during the period Less benefits paid during the period Actual return on plan assets $10,150,000 9,200,000 950,000 $1,000,000 1,400,000 (400,000) $ 1,350,000 *17 An asset gain occurs when the actual return on the plan assets is greater than the expected return on plan assets while an asset loss occurs when the actual return is less than the expected return on the plan assets A liability gain results from unexpected decreases in the pension obligation and a liability loss results from unexpected increases in the pension obligation *18 Corridor amortization occurs when the accumulated unrecognized net gain or loss balance gets too large The gain or loss is too large when it exceeds the arbitrarily selected IASB criterion of 10% of the larger of the beginning balances of the defined benefit obligation or the fair value of the plan assets The excess unrecognized gain or loss balance may be amortized using any systematic method but the amortization cannot be less than the amount computed using the straight-line method over the average remaining service-life of active employees expected to receive benefits Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 20-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 20 (Continued) **19 The IASB allows companies to immediately recognize actuarial gains and losses If a company chooses immediate recognition, the actuarial gain or loss can either adjust net income or other comprehensive income *20 No, Bill is not correct Companies may use the corridor approach or the immediate recognition approach to recognize actuarial gains and losses The amount of actuarial gains (losses) recognized under the two approaches will differ *21 Jacob Inc would report a pension liability of €27,000 (€125,000 – €98,000) *22 Joshua Co would report a pension liability of £74,300 (£335,000 – £245,000 – £24,000 + £8,300) *23 (a) (b) (c) A contributory plan is a pension plan under which employees contribute part of the cost In some contributory plans, employees wishing to be covered must contribute; in other contributory plans, employee contributions result in increased benefits Vested benefits are benefits for which the employee’s right to receive a present or future pension benefit is no longer contingent on remaining in the service of the employer Retroactive benefits are benefits granted in a plan amendment (or initiation) that are attributed by the pension benefit formula to employee services rendered in periods prior to the amendment *24 Compromises by the IASB to full capitalization or recognition in the financial statements of relevant pension data resulted in nonrecognition of the defined benefit obligation, plan assets, past service cost, and gains and losses These unrecognized items are disclosed in a separate schedule in such a way that the total obligation and funded status (either over- or underfunded) of the pension plan are reconciled to the pension asset/liability reported in the statement of financial position by acknowledging the unrecognized pension elements (plan assets, past service cost, and deferred gains and losses) 25 Postretirement benefits other than pensions include healthcare and other welfare benefits provided to retirees, their spouses, dependents, and beneficiaries The other welfare benefits include life insurance offered outside a pension plan, dental care as well as medical care, eye care, legal and tax services, tuition assistance, day care, and housing activities 26 The major differences between pension benefits and postretirement benefits are listed below: Differences between Postretirement Healthcare Benefits and Pensions Item Pensions Healthcare Benefits Funding Benefit Generally funded Well-defined and level dollar amount Beneficiary Retiree (maybe some benefit to surviving spouse) Monthly Variables are reasonably predictable Generally NOT funded Generally uncapped and great variability Retiree, spouse, and other dependents As needed and used Utilization difficult to predict Level of cost varies geographically and fluctuates over time Benefit Payable Predictability Additionally, although healthcare benefits are generally covered by the fiduciary and reporting standards for employee benefit funds, in many jurisdictions the stringent minimum vesting, participation, and funding standards that apply to pensions not apply to healthcare benefits 20-8 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 20 (Continued) 27 A pension plan curtailment occurs when a company commits itself to substantially reduce the number of employees in a plan or to substantially reduce the benefits of an existing plan Curtailments often have a significant effect on the financial statements and often occur from an isolated event, such as the closing of a plant, discontinuance of an operation, or termination or suspension of a plan Curtailments are often linked with a restructuring of operations A settlement occurs when a company enters into a transaction that eliminates all further obligations for part or all of the benefits provided under a defined benefit plan For example, by making a lump-sum cash payment to participants in a defined pension plan in exchange for their rights to receive specified benefits in the future, a settlement has occurred 28 Companies recognize gains or losses on the curtailment or settlement of a defined benefit plan when the curtailment or settlement occurs The gain or loss on a curtailment or settlement is comprised of the following: (1) any resulting change in the present value of the defined benefit obligation, (2) any resulting change in the fair value of the plan assets, and (3) any related actuarial gains and losses and past service cost that had not been previously recognized Where a curtailment relates to only some of the employees covered by a plan, or where only part of an obligation is settled: The gain or loss includes a proportionate share of the previously unrecognized past service cost and actuarial gains and losses The proportionate share is determined on the basis of the present value of the obligations before and after the curtailment or settlement If a cash payment is made to employees affected by the curtailment, such that it eliminates all further obligations for benefits provided under the plan, a gain or loss may be recorded This is referred to as a settlement 29 The underlying concepts for the accounting for postretirement benefits are similar between U.S GAAP and IFRS—both U.S GAAP and IFRS view pensions and other postretirement benefits as forms of deferred compensation Other similarities include: (1) IFRS and U.S GAAP separate pension plans into defined contribution plans and defined benefit plans The accounting for defined contribution plans is similar (2) Both IFRS and U.S GAAP compute unrecognized past service costs (PSC) in the same manner (3) Both use corridor amortization for recognition on pension gains and losses Differences include: (1) IFRS recognizes any vested PSC amounts immediately and spreads unvested amounts over the average remaining period to vesting U.S GAAP amortizes PSC over the remaining service lives of employees (2) Under IFRS, companies have the choice of recognizing actuarial gains and losses in income immediately (either net income or other comprehensive income) or amortizing them over the expected remaining working lives of employees U.S GAAP does not permit choice—using corridor amortization, actuarial gains and losses are recognized in ―Accumulated other comprehensive income‖ and amortized to income over remaining service lives (3) For defined benefit plans, U.S GAAP recognizes a pension asset or liability as the funded status of the plan (i.e., defined benefit obligation minus the fair value of plan assets) IFRS recognizes the funded status, net of unrecognized past service cost and unrecognized gain or loss (4) The accounting for pensions and other postretirement benefit plans is the same under IFRS U.S GAAP has separate standards for these types of benefits, and significant differences exist in the accounting Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 20-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 20 (Continued) 30 20-10 The IASB and the FASB are working collaboratively on a postretirement benefits project The FASB has issued GAAP rules addressing the recognition of the funded status of benefit plans in financial statements The FASB has begun work on the second phase of the project, which will reexamine expense measurement of postretirement benefit plans The IASB also has added a project in this area but on a different schedule The IASB has already issued an exposure draft on expense measurement in pension plans It is unclear whether the Boards’ differences in schedule will lead to a converged standard Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 20-4 (Continued) (b) In order to discharge the pension liability, an employer contributes to a pension fund The return on the fund assets serves to reduce the interest element of the pension expense Specifically, the expected return reduces pension expense Expected return is the expected rate of return times the fair value of pension assets When a pension plan is adopted or amended, credit is often given for employee service rendered in prior years This retroactive credit, or past service cost, is not recognized as pension expense entirely in the year the plan is adopted or amended, but should be recognized as pension expense over the time that the employees who benefited from this credit worked The gains and losses component arises from a change in the amount of either the defined benefit obligation or the plan assets This component is amortized via corridor amortization The major similarity between the vested benefit obligation and the defined benefit obligation is that they both represent the present value of the benefit attributed by the pension benefit formula to employee service rendered prior to a specific date All things being equal, when an employee is about to retire, the vested benefit obligation will be equal to the defined benefit obligation The major difference between the vested benefit obligation and the defined benefit obligation is that the former is based on current salary levels and the latter is based on estimated future salary levels Assuming salary increases over time, the defined benefit obligation should be higher than the vested benefit obligation (c) Pension gains and losses, sometimes called actuarial gains and losses, result from changes in the value of the defined benefit obligation or the fair value of the plan assets These changes arise from the deviations between the estimated conditions and the actual experience, and from changes in assumptions The volatility of these gains and losses may reflect an unavoidable inability to predict compensation levels, length of employee service, mortality, retirement ages, and other relevant events accurately for a period, or several periods Therefore, fully recognizing the gains or losses on the income statement may result in volatility that does not reflect actual changes in the funded status of the plan in that period In order to decrease the volatility of the reporting of the pension gains or losses, the IASB had adopted what is referred to as the ―corridor approach.‖ This approach achieves the objective by amortization of the cumulative, unrecognized pension gains and losses, in excess of 10% of the greater of the defined benefit obligation or the fair value of the plan assets CA 20-5 This situation can exist because companies vary as to whether they are using an implicit or explicit set of assumptions when interest rates are disclosed In the implicit approach, two or more assumptions not individually represent the best estimate of the plan’s future experience with respect to these assumptions, but the aggregate effect of their combined use is presumed to be approximately the same as that of an explicit approach In the explicit approach, each significant assumption reflecting the best estimate of the plan’s future experience solely with respect to that assumption must be stated As a result, some companies are presently using an implicit approach, others an explicit approach IAS 19 requires the use of explicit assumptions As a result, this large variance in interest rates will probably disappear to some extent However, it should be noted that companies will have some leeway in establishing discount rates In addition, the expected return on assets will also be different among companies Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 20-57 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 20-5 (Continued) This situation will occur because of the pension liability required to be reported That is, companies are required to report as a liability the excess of their defined benefit obligation over the fair value of plan assets and adjusted for unrecognized PSC and unexpected gains and losses In the past, the basic liability companies reported was the excess of the amount expensed over the amount funded This statement is questionable If a financial measure purports to represent a phenomenon that is volatile, the measure must show that volatility or it will not be representationally faithful Nevertheless, many argue that volatility is inappropriate when dealing with such long-term measures as pensions A good example of where dampening might be useful is the recognition of gains and losses If assumptions prove to be accurate estimates of experience over a number of years, gains or losses in one year will be offset by losses or gains in subsequent periods, and amortization of unrecognized gains and losses would be unnecessary The main point is that volatility per se should not be considered undesirable when establishing accounting principles Although some managements may consider volatility bad, this belief should not influence standard-setting However, it is clear from some of the compromises made in IAS 19 that certain procedures were provided to dampen the volatility effect These pension plan assets in excess of the defined benefit obligation are not reported on the employer’s books However, the fair value of plan assets are required to be reported in the footnote, so that a reader of the financial statements can determine the funded status of the plan (a) In a defined contribution plan, the amount contributed is the amount expensed No significant reporting problems exist here On the other hand, defined benefit plans involve many difficult reporting issues which may lead to additional expense and liability recognition Significant amendments will generally increase past service cost which may lead to significant adjustments to pension expense in the future (b) Plan participants are of importance, because the expected future years of service computation can have an impact on the amortization of the past service cost and gains and losses (c) If the plan is underfunded, pension expense will generally increase (all other factors constant) If the plan is overfunded, pension expense will generally decrease (all other factors constant) The reason is that the expected return on plan assets will be less if the plan is underfunded and vice versa (d) If the company is using an actuarial funding method different than the one prescribed in IAS 19 (straight-line approach), some changes in the computation of pension expense will occur for the company The corridor method is an approach which requires that only gains and losses in excess of 10% of the greater of the defined benefit obligation or fair value of pension assets be allocated This excess is then amortized over the average remaining service period of current employees expected to participate in the plan The corridor’s purpose is to only recognize gains and losses above a certain amount, on the theory that gains and losses within the corridor will offset one another over time CA 20-6 (a) 20-58 To: Rachel Avery, Accounting Clerk From: Good Student, Manager of Accounting Date: January 3, 2012 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 20-6 (Continued) Subject: Amortization of unrecognized gains and losses in pension expense Pension expense includes several components; one occasionally included is the amortization of unrecognized gains/losses These gains/losses occur for two reasons First, the plan assets may provide a return that is either greater or less than what was expected Second, changes in actuarial assumptions may create increases or decreases in the pension liability If these gains/losses are small in relation to the defined benefit obligation (DBO) or the fair value of the plan assets (PA), then not include them in annual pension expense If, in any given year, the gains or losses become too great, then at least a portion must be included in pension expense so as not to understate or overstate the annual obligation This is done through a process called amortization To decide whether or not you should include gains/losses in annual pension expense, calculate 10 percent of either the DBO or the PA (whichever is greater) as a ―corridor.‖ Amortize the amount of any gain or loss falling outside the corridor over the average remaining service life of the active employees Note: these gains/losses must exist at the beginning of the year for which amortization takes place [see (a) on schedule below] Thus, in the attached schedule, no amortization of the $280,000 loss in 2008 was required because the balance in the unrecognized gain/loss account at the beginning of that year was zero However, at the beginning of 2009, the balance in that account was $280,000 The 10 percent corridor is $260,000, so the loss exceeds this corridor by $20,000 Since the remaining service life of employees is 10 years, you derive the amortized portion by dividing 10 into $20,000: $2,000 [see (b) on schedule below] Note that the unamortized portion of the gain/loss from the previous year is combined with the current gain/loss Check this new sum against a newly calculated 10 percent corridor If the sum exceeds this corridor, then amortize the excess In the attached schedule, the unamortized loss from 2009 ($278,000) was added to the 2009 loss of $90,000, resulting in a cumulative unrecognized loss of $368,000 (see (c) below) This amount exceeds the new corridor ($290,000) by $78,000 However, the remaining service life has been changed to 12 years, resulting in annual amortization of only $6,500 [see (d) below] Finally, if the losses from 2010 are added to the unamortized portion of the unrecognized loss from prior years, the sum falls within the 2011 corridor and does not need to be amortized at all Corridor and Minimum Loss Amortization Schedule Year 2008 2009 2010 2011 Defined Benefit Obligation (a) $2,200,000 2,400,000 2,900,000 3,900,000 Copyright © 2011 John Wiley & Sons, Inc Plan Asset Value (a) $1,900,000 2,600,000 2,600,000 3,000,000 10% Corridor $220,000 260,000 290,000 390,000 Cumulative Unrecognized Net Loss (a) $ 280,000 368,000 (c) 373,500 (e) Kieso Intermediate: IFRS Edition, Solutions Manual Minimum Amortization of Loss $ 2,000 (b) 6,500 (d) 20-59 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 20-6 (Continued) (1) (2) (3) (4) (5) (b) As of the beginning of the year ($280,000 – $260,000) ÷ 10 years = $2,000 $280,000 – $2,000 + $90,000 = $368,000 ($368,000 – $290,000) ÷ 12 years = $6,500 $368,000 – $6,500 + $12,000 = $373,500 Companies may choose to immediately recognize actuarial gains and losses in the period they arise Immediate recognition of actuarial gains and losses will decrease or increase pension expense with a corresponding decrease (increase) in the pension asset/liability The immediate recognition of a loss will cause both pension expense and the pension liability to be greater CA 20-7 While Selma may be correct in assuming that the termination of nonvested employees would decrease its pension-related liabilities and associated expenses, she is callous to suggest that firing employees is a reasonable approach to correcting the underfunding of College Electronix’s pension plan Arbitrarily dismissing productive employees on the basis of being vested or not vested in the pension plan in order to avoid capitalizing a liability and recognizing expenses is a capricious and unsound business decision Richard Nye should discuss the ethical, legal, and financial implications of the alternatives available as well as the accounting requirements relating to this situation This obligation and its effect on the financial statements should have been known to Cardinal Technology when it performed its due diligence audit of CE at the time of merger negotiations Cardinal Technology should capitalize the pension obligations of CE as required by IFRS 20-60 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com FINANCIAL REPORTING PROBLEM (a) M&S has funded pension plans (defined–benefit) for UK employees and the majority of employees oversees (b) 2008 2007 (c) Impact on 2008 financial statements: credit to pension expense increased net income by £50.8; actuarial gain of £605.4 on consolidated statement of recognized income and expense; net retirement benefit asset of £483.5; current liability of £50 for Partnership liability to the Marks & Spencer UK Pension Scheme; and long-term liability of £673.2 for Partnership liability to the Marks & Spencer UK Pension Scheme (d) M&S‘s Analysis of assets and expected rates of return portion of its pension footnote details the major categories of assets, which are property partnership interest; UK equities; overseas equities; government bonds; corporate bonds; and cash and other In general, the expected long-term rate of return on these assets increases with an increase in risk for the asset M&S‘s overall expected rate of return is 6.7% Pension expense Pension expense Copyright © 2011 John Wiley & Sons, Inc £50,800,000 £91,100,000 Kieso Intermediate: IFRS Edition, Solutions Manual 20-61 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com COMPARATIVE ANALYSIS CASE (a) Cadbury has defined-benefit plans for its UK employees and both defined-benefit and defined-contribution plans for overseas employees Nestlé has both defined-benefit plans and defined-contribution plans (b) Cadbury reported ―post-retirement cost‖ of £73 million in 2008 Nestlé reported ―defined-benefit expense‖ of CHF305 million in 2008 (c) 2008 Funded Status (millions) Cadbury Nestlé (£258) (CHF5,404) (d) Relevant rates used to compute pension information: Cadbury Discount rate—UK Discount rate—overseas Inflation rate—UK Overseas Salary increase—UK Overseas 6.1% 3.50 – 6.75% 2.65% 1.75 – 2.50% 3.65% 2.75 – 3.50% Nestlé Discount rate—Europe —Americas Expected long-term rate of return—Europe —Americas Expected rate of salary increase—Europe —Americas 5.0% 6.3% 5.7% 8.6% 3.2% 3.0% (e) Cadbury paid benefits of £116 million in 2008 and made contributions to the pension plan of £84 million Nestlé paid CHF1,368 million of benefits in 2008 and made contributions of CHF50 million to the pension plan 20-62 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com INTERNATIONAL REPORTING CASE (a) A key difference arises from recognition of Pension Asset/Liability at the funded status under U.S GAAP; IFRS generally does not recognize PSC and pension gains and losses In addition, under IFRS, PSC amortization periods are based on average period to vesting, which is usually shorter than service lives One other difference that students might note are the relatively high discount rate and expected return assumptions used by this U.S company For example, many U.S companies use rates up to three times as high as the rates used by international companies It should be noted that there are several similarities Under U.S GAAP, the pension obligation is measured based on the projected (defined) benefit obligation and the amount recognized is based on an amount net of the liability and plan assets There is smoothing of gains and losses Also, the components of pension expense are similar (b) Under IFRS, shorter amortization periods will result in higher pension expense with respect to prior (past) service costs Depending on whether the company has unrealized gains or losses, the shorter amortization period for the actuarial differences may result in either higher or lower reported income On the statement of financial position, under U.S GAAP there is less non-recognition of the prior (past) service costs and gains and losses So the net pension asset or liability will be measured at the net of the liability and fund assets The reported amounts on international companies‘ statement of financial positions will be more volatile, since the smoothing period is shorter (c) As indicated above, income and equity likely will be lower due to higher pension expense and lower net income If there are significant asset gains (which is possible given the low expected return assumptions), then income could be higher as the gains are amortized into income more quickly The lower discount rate used to measure the pension obligation will result in lower interest cost in income, but gives a higher measure of the projected (defined) benefit obligation Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 20-63 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ACCOUNTING, ANALYSIS, AND PRINCIPLES Balance in DBO at 12/31/2011 Balance at 1/1/2011 Interest cost: (€820.5 X 0.10) = Service cost Increase from actuarial assumptions Benefits paid €820.5 82.0 42.0 0.0 (40.0) €904.5 Amount of plan assets at 12/31/2011 Balance at 1/1/2011 Actual dollar return in 2011 Contributions in 2011 Benefits paid in 2011 €476.5 10.4 70.0 (40.0) €516.9 Corridor test and amortization of net gain/loss Corridor limit: 10% times greater of €820.5 and €476.5 = Excess of net G/L over corridor limit = €92.0 – €82.0 = Amortization = €10 ÷ 15 = Pension expense: Interest cost = (€820.5 X 0.10) = Service cost Amortization of unamortized past service cost = Amortization of unamortized net loss Expected return on plan assets: (€476.5 X 0.12) = Balance in pension liability Pension liability at 1/1/2011 Pension expense in 2011 Contributions in 2011 Copyright © 2011 John Wiley & Sons, Inc €82.0 42.0 15.0 0.7 (57.2) €82.5 (€102.0) (82.5) 70.0 (€114.5) Balance in Unamortized Past Service Cost at 12/31/2011 Balance at 1/1/2011 Amortization in 2011 20-64 €82.0 9.9 0.7 (€150.0) 15.0 (€135.0) Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) Balance in Unamortized Net Gain or Loss at 12/31/2011 Balance at 1/1/2011 Gain (loss) due to actual return on plan assets below expected return Amortization (€92.0) (46.8) 0.7 (138.1) Journal entry: Pension Expense Cash Pension Asset/Liability 82.5 70.0 12.5 PENCOMP, INC Income Statement for the year ended Dec 31, 2011 Revenues: Sales Expenses: Cost of goods sold Salary expense Pension expense Depreciation expense Interest expense Total expenses and losses Net income Copyright © 2011 John Wiley & Sons, Inc €3,000.0 €2,000.0 700.0 82.5 80.0 100.0 Kieso Intermediate: IFRS Edition, Solutions Manual 2,962.5 € 37.5 20-65 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) PENCOMP, INC Statement of Financial Position at Dec 31, 2011 Assets: Plant, and equip Accumulated dep € 2,000 (320) € 1,680 Inventory Cash 1,800 368 2,168 € 2,848 Total Assets Equity: Share capital Retained earnings Total Equity €2,000.0 733.5 €2,733.5 Liabilities: Note payable Pension liability Total Liabilities Total Equity & Liabilities 1,000.0 114.5 1,114.5 €3,848.0 Plant and equip = no change from previous statement of financial position Accumulated depreciation = €(240) + €(2,000 ÷ 25) = €320 Determination of non-pension balances: Inventory = €1,800 given Cash = €438 – €700 + €3,000 – €2,000 – €100 – €200 – €70 = €368 Note payable = no change from previous statement of financial position Share capital = no change from previous statement of financial position Retained earnings = €896.0 + €37.5 – €200 = €733.5 20-66 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) ANALYSIS ROE = €37.5 ÷ €2,733.5 = 0.0173 or 1.37% In this example, only the unexpected return on plan assets ‗skipped‘ the income statement and went to other comprehensive income Had this item been included in income, ROE would have been = (€42.5 – €46.8) ÷ €2,460.4 = –0.0017 or –0.17 percent Whether this ‗should‘ be included in a return on equity calculation is debatable The rationale for excluding this from current period income (and therefore from ROE) is that a defined benefit pension plan is a long-term contract and so it is the long term expected return on the plan‘s assets that is relevant to measuring the cost of sponsoring the plan Some people believe that a particularly high or low return in a given year is not indicative of the long-term return Others argue that all returns, high or low, accrue to the plan sponsor and so pension expense should reflect all returns PRINCIPLES The effects of plan amendments and actuarial gains and losses in a given year can be thought of as fairly transitory items with respect to income In other words, these are items that are not likely to repeat at the same dollar amount year in and year out Including these items in income arguably makes identifying the company‘s ‗permanent‘ income more difficult Therefore, the IASB have (so far!) decided to keep those items out of the income statement Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 20-67 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL RESEARCH (a) According to IAS 19, paragraph 105, ―The expected return on plan assets is one component of the expense recognised in profit or loss The difference between the expected return on plan assets and the actual return on plan assets is an actuarial gain or loss; it is included with the actuarial gains and losses on the defined benefit obligation in determining the net amount that is compared with the limits of the 10% ‗corridor‘ specified in paragraph 92.‖ (b) Paragraph 95 states ―In the long term, actuarial gains and losses may offset one another Therefore, estimates of post-employment benefit obligations may be viewed as a range (or ‗corridor‘) around the best estimate An entity is permitted, but not required, to recognise actuarial gains and losses that fall within that range This Standard requires an entity to recognise, as a minimum, a specified portion of the actuarial gains and losses that fall outside a ‗corridor‘ of plus or minus 10% [Appendix A illustrates the treatment of actuarial gains and losses, among other things.] The Standard also permits systematic methods of faster recognition, provided that those methods satisfy the conditions set out in paragraph 93 Such permitted methods include, for example, immediate recognition of all actuarial gains and losses, both within and outside the ‗corridor‘ Paragraph 155(b)(iii) explains the need to consider any unrecognised part of the transitional liability in accounting for subsequent actuarial gains.‖ (c) According to paragraph 54, ―The amount recognised as a defined benefit liability shall be the net total of the following amounts: (1) the present value of the defined benefit obligation at the end of the reporting period (see paragraph 64); (2) plus any actuarial gains (less any actuarial losses) not recognised because of the treatment set out in paragraphs 92 and 93; (3) minus any past service cost not yet recognised (see paragraph 96); (4) minus the fair value at the end of the reporting period of plan assets (if any) out of which the obligations are to be settled directly (see paragraphs 102–104).‖ 20-68 Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL RESEARCH (Continued) Further, as stated in paragraph 58, ―The amount determined under paragraph 54 may be negative (an asset) An entity shall measure the resulting asset at the lower of: (1) the amount determined under paragraph 54; and (2) the total of: (i) any cumulative unrecognised net actuarial losses and past service cost (see paragraphs 92, 93 and 96); and (ii) the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan The present value of these economic benefits shall be determined using the discount rate specified in paragraph 78.‖ Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 20-69 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL SIMULATION Measurement (a) (b) Simply change the formula in cell B11 to multiply by 07; change the formula in cell B12 to multiply 10 times (G-9 * –1) Journal Entry Pension Expense Pension Asset/Liability Cash 113,250 14,250 99,000 Disclosure Defined Benefit Obligation Plan Assets at Fair Value Funded Status Unrecognized Past Service Cost Unrecognized Gain or Loss Pension Asset/Liability 20-70 Copyright © 2011 John Wiley & Sons, Inc $(762,250) 551,000 (211,250) 81,000 71,000 $ (59,250) Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ... 15 4* 15 4 € (1, 320) ( 1, 500 – 18 0) 1, 350 30 40 [€50 X (1 – 20)] 64 [€80 X (1 – 20)] € 13 4 *( 18 0 – 10 – 16 ) 20 -14 Copyright © 2 011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions... expense 1, 2, 1, 2, 6, 11 , 12 , 13 , 15 , 16 Use a worksheet for employer’s pension plan entries 3, 4, 7, 10 , 11 , 14 1, 2, 4, 7, 8, Describe the amortization of past service costs 5, 1, 2, 5, 7, 12 , 13 ,... postretirement benefit plans 10 , 11 , 12 , 13 20, 21, 22 10 10 20-2 Copyright © 2 011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test