Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 17 Pensions and Other Postretirement Benefits AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment To aid faculty in this endeavor, we have labeled each question, exercise and problem in Intermediate Accounting, 7e, with the following AACSB learning skills: Questions AACSB Tags Brief Exercises (cont.) AACSB Tags 17–1 17–2 17–3 17–4 17–5 17–6 17–7 17–8 17–9 17–10 17–11 17–12 17–13 17–14 17–15 17–16 17–17 17–18 17–19 17–20 17–21 17–22 17–23 17–24 17–25 17–26 Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Analytic Diversity, Reflective thinking Diversity, Reflective thinking 17–13 17–14 17–15 Analytic Analytic Analytic Exercises 17–1 17–2 17–3 17–4 17–5 17–6 17–7 17–8 17–9 Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic 17–1 17–2 17–3 17–4 17–5 17–6 17–7 17–8 17–9 17–10 17–11 17–12 17–13 17–14 17–15 17–16 17–17 17–18 17–19 17–20 17–21 17–22 17–23 17–24 17–25 17–26 17–27 17–28 17–29 17–30 17–31 17–32 17–10 Analytic 17–33 17–11 17–12 Analytic Analytic Brief Exercises Reflective thinking Analytic Reflective thinking Analytic Analytic Analytic Analytic Analytic Diversity, Analytic Analytic Analytic Analytic Analytic Analytic, Communications Analytic Analytic Reflective thinking Diversity, Analytic Analytic Analytic Analytic Diversity, Analytic Reflective thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking, Communications Reflective thinking, Communications © The McGraw-Hill Companies, Inc., 2013 17–1 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com CPA/CMA AACSB Tags Problems AACSB Tags Analytic Reflective thinking Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking Diversity, Reflective thinking Diversity, Reflective thinking Reflective thinking Analytic 17–1 17–2 17–3 17–4 17–5 17–6 17–7 17–8 17–9 17–11 17–12 17–13 17–14 17–15 17–16 17–17 17–18 17–19 17–20 17–21 Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Diversity, Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–2 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com QUESTIONS FOR REVIEW OF KEY TOPICS Question 17–1 Pension plans are arrangements designed to provide income to individuals during their retirement years Funds are set aside during an employee’s working years so that the accumulated funds plus earnings from investing those funds are available to replace wages at retirement An individual has a pension fund when she or he periodically invests in stocks, bonds, CDs, or other securities for the purpose of saving for retirement When an employer establishes a pension plan, the employer provides some or all of the periodic contributions to the retirement fund The motivation for corporations to establish pension plans comes from several sources Pension plans provide employees with a degree of retirement security They may fulfill a moral obligation many employers feel toward employees Pension plans often enhance productivity, reduce turnover, satisfy union demands, and allow employers to compete in the labor market Question 17–2 A qualified pension plan gains important tax advantages The employer is permitted an immediate tax deduction for amounts paid into the pension fund Conversely, the benefits to employees are not taxed until retirement benefits are received Also, earnings on the funds set aside by the employer accumulate tax-free For a pension plan to be qualified for special tax treatment, these general requirements must be met: It must cover at least 70% of employees It cannot discriminate in favor of highly compensated employees It must be funded in advance of retirement through contributions to an irrevocable trust fund Benefits must “vest” after a specified period of service, commonly five years It complies with specific restrictions on the timing and amount of contributions and benefits Question 17–3 This is a noncontributory plan because the corporation makes all contributions When employees make contributions to the plan in addition to employer contributions, it’s called a “contributory” plan This is a defined contribution plan because it promises fixed annual contributions to a pension fund, without further commitment regarding benefit amounts at retirement Question 17–4 The vested benefit obligation is the pension benefit obligation that is not contingent upon an employee's continuing service Question 17–5 The accumulated benefit obligation is the discounted present value of retirement benefits calculated by applying the pension formula with no attempt to forecast what salaries will be when the formula actually is applied The projected benefit obligation is the present value of those benefits when the actuary includes projected salaries in the pension formula © The McGraw-Hill Companies, Inc., 2013 17–3 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 17–6 The projected benefit obligation can change due to periodic service cost, accrued interest, revised estimates, plan amendments, and the payment of benefits Question 17–7 The balance of the plan assets can change due to investment returns, employer contributions, and the payment of benefits Question 17–8 The pension expense reported on the income statement is a composite of periodic changes that occur in both the pension obligation and the plan assets These include service cost, interest cost, return on the plan assets, and the amortization of prior service cost and of net gains or losses Question 17–9 The service cost in connection with a pension plan is the present value of benefits attributed by the pension formula to employee service during the period, projecting future salary levels (i.e., the projected benefits approach) Question 17–10 The interest cost is the projected benefit obligation outstanding at the beginning of the period multiplied by the actuary's interest (discount) rate This is the “interest expense” that accrues on the PBO and is included as a component of pension expense rather than being separately reported Question 17–11 GAAP specifies that the actual return be included in the determination of pension expense However, the actual return is adjusted for any difference between actual and expected return, meaning that the expected return is really the amount reflected in the calculation of pension expense This “investment revenue” is deducted as a component of pension expense rather than being separately reported The difference between actual and expected return on plan assets is combined with gains and losses from other sources for possible future amortization to pension expense Question 17–12 Prior service cost is the obligation (present value of benefits) due to giving credit to employees for years of service provided before either the date of an amendment to (or initiation of) a pension plan Prior service cost is recognized as other comprehensive income as incurred and then as a component of accumulated other comprehensive income in the company’s balance sheet The account is allocated (amortized) to pension expense over the service period of affected employees The straight-line method allocates an equal amount of the prior service cost to each year The service method recognizes the cost each year in proportion to the fraction of the total remaining “service years” worked in each of these years Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–4 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 17–13 Gains or losses related to pension plan assets represent the difference between the return on investments and what the return had been expected to be They are recognized as other comprehensive income as incurred and then as a component of accumulated other comprehensive income in the company’s balance sheet: either a net loss–AOCI or a net asset–AOCI depending on whether cumulative losses have exceeded gains, or vice versa The account is amortized to pension expense only if the net loss–AOCI or net asset–AOCI exceeds a defined threshold Specifically, a portion of the excess is included in pension expense only if it exceeds an amount equal to 10% of the PBO, or 10% of plan assets, whichever is higher The amount that should be included is the excess divided by the average remaining service period of active employees expected to receive benefits under the plan Gains or losses related to the pension obligation are treated the same way In fact, gains and losses from both sources are combined to determine the net gains or net losses referred to above Question 17–14 A company’s PBO is not reported among liabilities in the balance sheet Similarly, the plan assets a company sets aside to pay those benefits are not reported among assets in the balance sheet However, firms report the net difference between those two amounts, referred to as the “funded status” of the plan, as either a net pension liability (if underfunded) or a net pension asset (if overfunded) Question 17–15 The two components of pension expense that may reduce pension expense are the return on plan assets (always) and the amortization of a net gain–AOCI (amortizing a net loss–AOCI increases the expense) Question 17–16 The components of pension expense that involve delayed recognition are the prior service cost and gains and losses Question 17–17 The excess of the actual return on plan assets over the expected return is considered a gain It does, in fact, decrease the employer’s pension cost, but not immediately the pension expense It is reported as other comprehensive income as it occurs, grouped with other gains and losses to create a net gain–AOCI or net loss–AOCI account, and then amortized as a component of pension expense only if the net gain–AOCI or net loss–AOCI exceeds an amount equal to 10% of the PBO, or 10% of plan assets, whichever is higher Question 17–18 The cash contribution is debited to the pension asset It adds to plan assets, thereby reducing an underfunded status (PBO > assets) or increasing an overfunded status (assets > PBO) So, if the plan is underfunded so that a net pension liability exists, the liability is reduced Otherwise, if the plan is overfunded so that a net pension asset exists, the asset is increased © The McGraw-Hill Companies, Inc., 2013 17–5 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 17–19 TFC Inc revises its estimate of future salary levels causing its PBO estimate to increase by the $3 million The $3 million is considered a loss and is reported in the statement of comprehensive income rather than being reported as part of traditional net income as would occur if included as part of pension expense It then becomes part of accumulated other comprehensive income in the balance sheet as part of the net loss–AOCI or net gain–AOCI A portion of that balance might possibly be amortized to pension expense if the net loss–AOCI or net gain–AOCI exceeds an amount equal to 10% of the PBO, or 10% of plan assets, whichever is higher Question 17–20 The difference between the employer’s obligation (PBO) and the resources available to satisfy that obligation (plan assets) is the funded status of the pension plan Firms must report the net difference between those two amounts, referred to as the “funded status” of the plan, in the balance sheet It’s reported as a net pension asset if the plan assets exceed the PBO or as a net pension liability if the PBO exceeds the plan assets Question 17–21 The expected postretirement benefit obligation (EPBO) is the actuary's estimate of the total postretirement benefits (at their discounted present value) expected to be received by plan participants When a plan is pay-related, future compensation levels are implicitly assumed The accumulated postretirement benefit obligation (APBO) measures the obligation existing at a particular date, rather than the total amount expected to be earned by plan participants The APBO is conceptually similar to a pension plan’s projected benefit obligation The EPBO has no counterpart in pension accounting Question 17–22 The cost of benefits is “attributed” to the years during which those benefits are assumed to be earned by employees The attribution period spans each year of service from the employee’s date of hire to the employee’s “full eligibility date,” which is the date the employee has performed all the service necessary to have earned all the retiree benefits estimated to be received by that employee The approach assigns an equal fraction of the EPBO to each of those years The attribution period does not include any years of service beyond the full eligibility date, even if the employee is expected to work after that date Question 17–23 The service cost for pensions reflects additional benefits employees earn from an additional year’s service, whereas the service cost for retiree health care plans is simply an allocation to the current year of a portion of a fixed total cost Question 17–24 The attribution period spans each year of service from the employee’s date of hire to the employee’s “full eligibility date,” 30 years in this case The APBO is $10,000, which represents the portion of the EPBO earned after 15 years of the 30-year attribution period: $20,000 x 15/30 = $10,000 Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–6 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (concluded) Question 17–25 Mid-South Logistics prepares its financial statements according to U.S GAAP Under U.S GAAP, prior service cost is included among OCI items in the statement of comprehensive income and thus subsequently becomes part of AOCI where it is amortized over the average remaining service period On the other hand, under IAS No 19, prior service cost (called past service cost under IFRS) is combined with service cost and reported within the income statement, in the period in which it arises, rather than as a component of other comprehensive income as it is under U.S GAAP, so it never is amortized to expense Since Mid-South Logistics is amortizing a portion of the amount, U.S GAAP is indicated Question 17–26 Under both U.S GAAP and IFRS we report gains and losses among OCI items in the statement of comprehensive income; thus, they subsequently become part of AOCI But, under IFRS the gains and losses are not subsequently amortized to expense and recycled or reclassified from other comprehensive income as is required under U.S GAAP (when the accumulated net gain or net loss exceeds the 10% threshold) A second difference pertains to the make-up of the gain or loss on plan assets This amount under U.S GAAP is the difference in the actual and expected returns, where the expected return is different from company to company and usually different from the interest rate used to determine the interest cost Under IFRS, though, we use the same rate (the rate for highgrade corporate bonds) for both the interest cost on the defined benefit obligation and the interest income on the plan assets In fact, under IFRS, we multiply that rate times the net difference between the defined benefit obligation and plan assets and report the net interest cost/income © The McGraw-Hill Companies, Inc., 2013 17–7 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com BRIEF EXERCISES Brief Exercise 17–1 ($ in millions) Beginning of the year PBO Service cost Interest cost Loss (gain) on PBO Less: Retiree benefits End of the year PBO $80 10 (6) $88 x (5% x $80) Brief Exercise 17–2 ($ in millions) Beginning of the year PBO Service cost Interest cost Loss (gain) on PBO Less: Retiree benefits End of the year PBO $80 ? (6) $85 x (5% x $80) Service cost = $85 – 80 – + = $7 million Brief Exercise 17–3 ($ in millions) Beginning of the year PBO Service cost Interest cost Loss (gain) on PBO Less: Retiree benefits End of the year PBO $80 10 (?) $85 x (5% x $80) Retiree benefits = $85 – 80 – – 10 = $9 million Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–8 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 17–4 ($ in millions) Beginning of the year PBO Service cost Interest cost Loss (gain) on PBO Less: Retiree benefits End of the year PBO $80 10 x (5% x $80) ? (6) $85 Gain = $85 – 80 – 10 – + = $3 million Brief Exercise 17–5 ($ in millions) Plan assets Beginning of the year Actual return Cash contributions Less: Retiree benefits End of the year $80 x (5% x $80) (6) $85 Brief Exercise 17–6 ($ in millions) Plan assets Beginning of the year Actual return Cash contributions Less: Retiree benefits End of the year $80 (?) $83 x (5% x $80) Retiree benefits = $83 – 80 – – = $8 million © The McGraw-Hill Companies, Inc., 2013 17–9 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 17–7 ($ in millions) Plan assets Beginning of the year Actual return Cash contributions Less: Retiree benefits End of the year $100 ? x (? % x $100) (6) $104 Return on assets = $104 – 100 – + = $3 million Rate of return on assets = $3 million ÷ $100 million = 3% Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–10 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 17–5 (concluded) Requirement Dell’s plan is a 401(k) plan—named after the Tax Code section that specifies the conditions for the favorable tax treatment of these plans 401(k) plans allow voluntary contributions by employees, which in Dell’s case is matched up to 5% of salary per year Dell simply records pension expense equal to the cash contribution Summarized for the year, Dell recorded the following: ($ in millions) Pension expense Cash Solutions Manual, Vol.2, Chapter 17 132 132 © The McGraw-Hill Companies, Inc., 2013 17–102 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Ethics Case 17–6 Mr Maxwell’s apparent motivation for the change in the way contributions are handled is to have the company benefit from the earning power of the contributed funds for up to three months, prior to the funds being deposited for the benefit of the employees Temporarily diverting 401(k) funds this way benefits the company at the expense of the employee There is some question as to whether the practice described is illegal In practice, such cases are rarely prosecuted Regardless of the legality, though, there is the ethical question of whether the employer should earn dividends, interest, and so forth on funds deducted from employees’ paychecks, prior to the funds being deposited to the employees’ accounts © The McGraw-Hill Companies, Inc., 2013 17–103 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Research Case 17–7 Results will vary depending on companies chosen Walmart provided the following disclosures in its annual report for the year ending January 31, 2011: Note 14 Retirement-Related Benefits (in part) The Company maintains separate Profit Sharing and 401(k) Plans for associates in the United States and Puerto Rico, under which associates generally become participants following one year of employment Through fiscal 2011, the Profit Sharing component of the plan was entirely funded by the Company, and the Company made an additional contribution to the associates' 401(k) component of the plan In addition to the Company's contributions, associates could elect to contribute a percentage of their earnings to the 401(k) component of the plan Beginning in fiscal 2012, the Company will offer a safe harbor 401(k) plan to all eligible United States associates The Company will match 100% of participant contributions up to 6% of annual eligible earnings The Company will offer the same matching contribution to all eligible Puerto Rico associates The matching contributions will immediately vest at 100% for each associate Participants can contribute up to 50% of their pretax earnings, but not more than the statutory limits Participants age 50 or older may defer additional earnings in catch-up contributions up to the maximum statutory limits Annual contributions made by the Company to the United States and Puerto Rico Profit Sharing and 401(k) Plans are made at the sole discretion of the Company Contribution expense associated with these plans was $1.1 billion in fiscal 2011 and 2010 and $1.0 billion in fiscal 2009 Employees in international countries who are not U.S citizens are covered by various post-employment benefit arrangements These plans are administered based upon the legislative and tax requirements in the countries in which they are established Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–104 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 17–7 (continued) Annual contributions to international retirement savings and profit sharing plans are made at the discretion of the Company, and were $221 million, $218 million and $210 million in fiscal 2011, 2010 and 2009, respectively The Company's subsidiaries in the United Kingdom and Japan have defined benefit pension plans The plan in the United Kingdom was underfunded by $494 million and $339 million at January 31, 2011 and 2010, respectively The plan in Japan was underfunded by $309 million and $249 million at January 31, 2011 and 2010, respectively These underfunded amounts have been recorded in "Deferred income taxes and other" in our Consolidated Balance Sheets at January 31, 2011 and 2010 Certain other international operations have defined benefit arrangements that are not significant In February 2011, ASDA and the trustees of ASDA's defined benefit plan agreed to remove future benefit accruals from the plan and, with the consent of a majority of the plan participants, also removed the link between past accrual and future pay increases In return, ASDA will pay £43 million (approximately $70 million) in compensation costs to the plan participants This curtailment charge will be recorded in expense in the first quarter of fiscal 2012 Older, more mature, companies are more likely to have defined benefit plans Macy’s, Inc., has a defined benefit plan described in Note 11 Among the many facts disclosed is the following: The following weighted average assumptions were used to determine benefit obligations for the supplementary retirement plan at January 29, 2011 and January 30, 2010: 2010 2009 Discount rate 5.40% 5.65% Rate of compensation increases 4.50% 4.50% © The McGraw-Hill Companies, Inc., 2013 17–105 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 17–7 (concluded) The Codification reference for the requirement to disclose the discount rate used to estimate the PBO is: FASB ASC 715–20–50–1k: Compensation-Retirement Benefits–Defined Benefit Plans-General–Disclosure–Disclosures by Public Entities Specifically, section k states: x k On a weighted-average basis, all of the following assumptions used in the accounting for the plans, specifying in a tabular format, the assumptions used to determine the benefit obligation and the assumptions used to determine net benefit cost: o Assumed discount rates (refer to paragraph 715-30-35-45 for a discussion of representationally faithful disclosure) o Rates of compensation increase (for pay-related plans) o Expected long-term rates of return on plan assets Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–106 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Real World Case 17–8 Answers will vary depending on the year of the financial statements used The following answers are based on FedEx’s fiscal 2011 financial statements Requirement FedEx sponsors both defined benefit and defined contribution pension plans as well as a postretirement healthcare plan These are described in disclosure note 12: PENSION PLANS Our largest pension plan covers certain U.S employees age 21 and over, with at least one year of service Pension benefits for most employees are accrued under a cash balance formula we call the Portable Pension Account Under the Portable Pension Account, the retirement benefit is expressed as a dollar amount in a notional account that grows with annual credits based on pay, age and years of credited service, and interest on the notional account balance The Portable Pension Account benefit is payable as a lump sum or an annuity at retirement at the election of the employee The plan interest credit rate varies from year to year based on a U.S Treasury index Prior to 2009, certain employees earned benefits using a traditional pension formula (based on average earnings and years of service); however, benefits under this formula were capped on May 31, 2008 We also sponsor or participate in nonqualified benefit plans covering certain of our U.S employee groups and other pension plans covering certain of our international employees The international defined benefit pension plans provide benefits primarily based on final earnings and years of service and are funded in compliance with local laws and practices POSTRETIREMENT HEALTHCARE PLANS Certain of our subsidiaries offer medical, dental and vision coverage to eligible U.S retirees and their eligible dependents U.S employees covered by the principal plan become eligible for these benefits at age 55 and older, if they have permanent, continuous service of at least 10 years after attainment of age 45 if hired prior to January 1, 1988, or at least 20 years after attainment of age 35 if hired on or after January 1, 1988 Postretirement healthcare benefits are capped at 150% of the 1993 per capita projected employer cost, which has been reached and, therefore, these benefits are not subject to additional future inflation © The McGraw-Hill Companies, Inc., 2013 17–107 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 17–8 (continued) Requirement A pension plan is underfunded when the obligation (PBO) exceeds the resources available to satisfy that obligation (plan assets) and overfunded when the opposite is the case The PBO exceeds plan assets in both years reported Thus, a net pension liability is reported in the balance sheet both years, as FedEx’s defined benefit plans are underfunded The amounts of each are reported in the disclosure note as reproduced below The postretirement healthcare plan is not just underfunded; it is unfunded The funded status reported as a liability, then, is equal to the postretirement benefit obligation each year Accumulated Benefit Obligation ("ABO") Pension Plans 2011 2010 $16,806 $14,041 Postretirement Healthcare Plans 2011 2010 Changes in Projected Benefit Obligation ("PBO") and Accumulated Postretirement Benefit Obligation ("APBO") PBO/APBO at the beginning of year $14,484 $11,050 $565 $433 Service cost 521 417 31 24 Interest cost 900 823 34 30 Actuarial loss 1,875 2,607 44 102 Benefits paid (468) (391) (48) (45) Other 60 (22) 22 21 PBO/APBO at the end of year $17,372 Change in Plan Assets Fair value of plan assets at the beginning of year Actual return on plan assets Company contributions Benefits paid Other $648 $565 $13,295 $10,812 2,425 1,994 557 900 (468) (391) 32 (20) $— — 26 (48) 22 $— — 24 (45) 21 Fair value of plan assets at the end of year $15,841 $13,295 $— $— Funded Status of the Plans $(1,531) $(1,189) Solutions Manual, Vol.2, Chapter 17 $14,484 $(648) $(565) © The McGraw-Hill Companies, Inc., 2013 17–108 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 17–8 (concluded) Requirement FedEx reports three actuarial assumptions used to determine projected benefit obligations: Pension Plans Discount rate Rate of increase in future compensation levels Expected long-term rate of return on assets 2011 2010 5.76% 6.37% 4.58% 4.63% 8.0% 8.0% x The reported decrease in the discount rate from 2010 to 2011 increased FedEx’s projected benefit obligation The lower the discount rate in a present value calculation, the higher the present value x FedEx reported a decrease in the rate of increase in future compensation levels This decreased FedEx’s PBO Lower compensation estimates in the pension formula result in lower estimates of retirement benefits and thus in the PV of those benefits x The expected long-term rate of return on assets will not directly affect FedEx’s projected benefit obligation It affects instead the plan assets and pension expense © The McGraw-Hill Companies, Inc., 2013 17–109 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Real World Case 17–9 Requirement The increase in a company’s PBO attributable to making a plan amendment retroactive is referred to as the prior service cost Prior service cost adds to the cost of having a pension plan Amending a pension plan typically is done with the idea that future operations will benefit from having done so Thus, the cost is not recognized as pension expense entirely in the year the plan is amended, but is recognized as pension expense over the time that the employees who benefited from the retroactive amendment will work for the company in the future In GM’s case, that may be a relatively short time Apparently, a motive for GM’s amendment was the expectation that employees would retire early and take advantage of the limited time offer Requirement The amendment increased GM’s pension obligation GM’s pension expense will be higher each year for as long as the prior service cost is amortized Presumably, in this instance, GM expects the bulk, if not all, of the cost to be expensed in the first year Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–110 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Analysis Case 17–10 Requirement Normally, a company’s net periodic pension cost represents an expense and therefore decreases earnings Often, though, circumstances cause this element of the income statement to actually increase reported earnings This occurs when the “expected return on assets,” a negative component of pension expense, is higher than the combined total of the other components Consider the following disclosure adapted from a pension footnote in a previous annual report of Qwest Communications that indicated that “the pension plan contributed” $87 million to reported earnings during the year: ($ in millions) Service cost Interest cost Expected return on plan assets Net (credit) cost $ 170 601 (858) $ (87) The major contributor to this effect is the expected return on plan assets of over $858 million © The McGraw-Hill Companies, Inc., 2013 17–111 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 17–10 (concluded) Requirement Companies must report the actuarial assumptions used to make estimates concerning pension plans, namely the discount rate, the average rate of compensation increase, and the expected long-term rate of return on plan assets x The expected long-term rate of return on assets directly affects the net pension expense The higher the rate, the higher the “expected return on assets,” a negative component of the net pension cost The more aggressive a company is in estimating this return, the lower will be the expense and the higher reported profits will be x The discount rate can affect profits, too The higher the discount rate in a present value calculation, the lower the present value A lower present value will decrease the service cost and interest cost components of the net pension cost and increase earnings x The lower the rate of increase in future compensation levels, the lower will be the PBO, the service cost, and interest cost So, the lower the rate of increase in future compensation levels, the higher earnings will be Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–112 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Research Case 17–11 The specification of postretirement benefit coverage in the Content Specification Outline will depend on the date the website is accessed The examination structure comprises four separately scored sections: x Auditing & Attestation x Business Environment & Concepts x Financial Accounting & Reporting (business enterprises, not-for-profit organizations, and governmental entities) x Regulation (professional responsibilities, business law, and taxation) Postretirement benefits are not specifically mentioned by name However, the content specification outline indicates testing of standards for presentation and disclosure in the balance sheet and of comprehensive income and, more specifically, employee benefits are tested in the Financial Accounting & Reporting section The education requirements to sit for the CPA exam vary somewhat from state to state In Tennessee, examination candidates must have a minimum of 150 semester (225 quarter) hours, which includes: x A baccalaureate or higher degree from a Board-recognized academic institution, x 24 semester hours in accounting, and x 24 semester hours in general business subjects Educational requirements must be met within 120 days following the examination or grades will be voided © The McGraw-Hill Companies, Inc., 2013 17–113 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Analysis Case 17–12 Requirement ($ in millions) Net loss, beginning of 2010 Gain on plan assets (actual: $329 – 218) 2010 amortization 2010 loss on PBO Net loss, end of 2010 $1,186 (112)* (61) 103 $1,116 * rounded to reflect the $9M net gain Macy’s reports in Note 11: $112 – $103 = $9 Requirement Gains or losses should not be part of pension expense unless and until total net gains or losses exceed a defined threshold Specifically, a portion of the excess is included in pension expense only if it exceeds an amount equal to 10% of the PBO, or 10% of plan assets, whichever is higher The amount that should be included is the excess divided by the average remaining service period of active employees expected to receive benefits under the plan Amortization of net gains is deducted from pension expense; amortization of a net loss is added to pension expense ($ in millions) Net loss Less: 10% corridor (threshold)* Excess Service period Amortization (given) $ 1,186 (288) $ 898 ? ÷ $ 61 Average service years = $ 898 ÷ $61 = 14.7 years * 10% times either the beginning-of-the-period PBO ($2,879) or plan assets ($1,865), whichever is larger Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–114 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 17–12 (concluded) Requirement ($ in millions) Net gain, beginning of 2010 Loss (gain) on plan assets (actual: – expected: 0) 2010 amortization 2010 loss on APBO Net gain, end of 2010 $38 (5) (8) $25 Requirement Note 12 states the effect on expense of a 1% decrease in the healthcare cost trend is $1M Using that, we can determine the effect on net income ($ in millions): $847 reported net income + $1 million (1 – 35) = $848 © The McGraw-Hill Companies, Inc., 2013 17–115 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Air France–KLM Case Requirement Under IAS No 19, prior service cost (called past service cost under IFRS) is combined with service cost and reported within the income statement Under U.S GAAP, prior service cost is not expensed immediately, but is included among OCI items in the statement of comprehensive income and thus subsequently becomes part of AOCI where it is amortized to earnings over the average remaining service period Requirement If AF used IFRS, it would report gains and losses among OCI items in the statement of comprehensive income, which subsequently become part of AOCI The gains and losses remain in AOCI; they are not subsequently amortized to expense and recycled or reclassified from other comprehensive income as is required under U.S GAAP (when the accumulated net gain or net loss exceeds the 10% threshold) Requirement Under IFRS the various components of pension expense are not reported as a single net amount AF would separately report service cost (including past service cost) net interest cost/income, and amortization of remeasurement gains and losses Service cost and net interest cost/income would be reported within the income statement Remeasurement gains and losses would be reported as other comprehensive income in the statement of comprehensive income Under U.S GAAP, all components of pension expense are reported as a single net amount in the operating profit (loss) section of the income statement Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–116 ... Inc., 2013 17–27 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Exercise 17–14 In the balance sheet, Liabilities increase by $274 million:... the pension formula © The McGraw-Hill Companies, Inc., 2013 17–3 Intermediate Accounting 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions... years” worked in each of these years Solutions Manual, Vol.2, Chapter 17 © The McGraw-Hill Companies, Inc., 2013 17–4 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com