CFA 2018 Question bank 04 Employee Compensation Post Employment and Share Based

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Employee Compensation: Post-Employment and Share-Based

Question #1 of 54

Question ID: 462243

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Question #2 of 54

Question ID: 462266

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Question #3 of 54

Question ID: 462275

Test ID: 7440434

When considering themajordifferences betweenadefined contributionandadefined benefitpensionplan, whichofthe

following statementsismostaccurate?

A company with a defined contribution plan will report on its balance sheet the net difference between the value of the pension fund assets and the value of

the pension liability.

Accounting foradefined contributionpensionplanisthemost complicated becauseof themanyinvestmentoptionsavailabletotheemployees.

Among thedifferenttypesofpensionplans, accounting forapay-relateddefined

benefitplanisthemost complicated becauseoftherequiredactuarialassumptions.

Explanation

Threeactuarialassumptions (discountrate, expectedincreaseinemployee compensationandtheexpectedreturnonplan assets)must beestimatedtoprojectthevalueofthe corporation'spensionliabilitytoday.Subtle changestoanyofthethree

assumptions candrastically changetheestimatedliability.

Whichofthefollowing statementsregarding totalperiodic pension costisleastaccurate?

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

Itisequaltothesumofallthe changesinprojected benefitobligation (PBO)forthe

period (exceptfor benefitspaid)minustheactualreturnonassets.

Itisamorevolatilemeasureofpensionexpensethanreportedpensionexpense.

Explanation

Totalperiodic pension cost (thetrueoreconomic pensionexpense)isequaltothe changeinthefundedstatusfortheperiod

excludingthefirm's contributions.

Totalperiodic pension costis calculated byeliminating thesmoothedamountsfromreportedpensionexpenseandincluding

theactualreturnonassets.Theresultisamorevolatilemeasureofpensionexpense.

Peak Productionsisapubliclytraded companythatmanufactures consumerelectronicsproductsinthe U.S.The companyhas

beeninoperationnearlyfiftyyears, andhasa considerablepensionplanliabilityonitsfinancialstatements.Peak hasa w

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Question #4 of 54

Question ID: 462268

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Question #5 of 54

Question ID: 462267

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A high discount rate.

Ahigh calculatedprojected benefitobligation (PBO).

Ahigh compensation growthrate.

Explanation

Theassumptionofahighdiscountrate willresultinalowerpensionliabilityandalmostalwaysalowerpensionexpense.The moreaggressivetheactuarialassumptionsforapensionplanare, thelowerthe qualityofearningsforthefirm.

Fly-By-NightAirlinesisa U.S. companyplanning to changeitspensionplansothatit canreduceits costs. Itis considering

reducing itsdefined benefitpercentagefrom10% to5% ofending salary, retroactivefor10years. Inaddition, sincethefirmis anticipating substantiallyreducedsalaryincreasesinthefuture, itisplanning toreduceits compensation growthrate

assumption. Fromapensionaccounting perspective, the changeinthe:

Benefit percentage is a past service cost that will be amortized into and thus increase pension expense over the remaining service lives of its employees.

Compensation growthrateassumptionisa changeinactuarialassumptionthat will reducethedefined benefitobligationandfuturepensionexpense.

Benefitpercentageisa changeinactuarialassumptionthat will berecognizedinfullin

currentperiodpensionexpense.

Explanation

The changeinthe compensation growthrateassumptionisa changeinactuarialassumptionthat willreducethedefined

benefitobligationandfuturepensionexpense, astheeffectisamortizedintopensionexpenseovertime. Inthis question, the

changeisareductionin boththedefined benefitobligationandpensionexpense.

The changeinthe contributionpercentageisnota changeinactuarialassumption butaplanamendment (which would be reflectedasnegativepastservice costandeitheramortizedunder US GAAPorrecognizedinfullunder IFRS).

Amortizationofnegativepastservice cost (applicableonlyunder US GAAP) woulddecrease, notincrease, pensionexpense overtheremaining servicelivesofitsemployees. (LOS 20.d)

A companyreporting under U.S. GAAPreducedthediscountrateforitspensionobligationfrom10% to 8%, reducedthe expectedlong-termrateofreturnontheassetsinitspensionplanfrom 8% to 6%, and changedits compensation growthrate assumptionfrom4% to5%. Whatisthemostlikelyimpactofthese changesonthe currentyearending defined benefit obligationandpensionexpense?

The reduction in the discount rate will decrease the defined benefit obligation and will increase reported pension expense.

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Question ID: 462291

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Question ID: 454934

Thedecreaseinthelong-termrateofreturn willhavenoimpactonthedefined benefit obligationand willincreasereportedpensionexpense.

Explanation

Thedecreaseintheexpectedlong-termrateofreturnonplanassetsfrom 8% to 6% willhavenoeffectonthedefined benefit obligation (afterall, itisanobligationandnotanasset).Thereduction will, however, increasereportedpensionexpensefor

currentandfutureperiods becausetheexpectedreturnissubtracted while computing pensionexpense.

Thereductioninthediscountratefrom10% to 8% willincrease (notdecrease)thedefined benefitobligationand willalso

increasereportedpensionexpense becauseit willincreasethe currentservice cost.Additionally, theactuarial gainsand lossesresulting fromthis change (thedifference betweenthedefined benefitobligationaftertheincreaseandthedefined

benefitobligation beforetheincrease) will beamortizedintopensionexpenseovertimeusing the corridorapproach. Amortization willstartintheperiodafterthe changeismade.

Thedecreaseintheexpectedlong-termrateofreturnonitsplanassetsfrom 8% to 6% willincrease, notdecrease, reported pensionexpense.Expectedreturnreducespensionexpense. (LOS 20.d)

Whichofthefollowing statementsaboutstock appreciationrights, performancestock, andphantomstock ismostaccurate?

Phantom stock payoffs are based on the performance of the firm's actual shares.

Stock appreciationrightsneverhaveanydilutioneffectontheexisting shareholders.

Performancestock cannot besold bytheemployeeuntilvesting hasoccurred.

Explanation

Stock appreciationrightsdonot causedilutiontotheexisting shareholderssincenosharesareactuallyissued.

Performancestock isatypeofstock grant. Itis contingentonmeeting performance goalssuchasaccounting earningsor otherfinancialreporting metricslikereturnonassetsorreturnonequity. Unfortunately, tying performancetoaccounting

earningsandothermetricsmayresultinmanipulation bytheemployee. Withrestrictedstock, thetransferredstock cannot be sold bytheemployeeuntilvesting hasoccurred.

Phantomstock issimilartostock appreciationrightsexceptthepayoffis basedontheperformanceofhypotheticalstock

insteadofthefirm'sactualshares.

Whichofthefollowing statementsabout cashflow is (are)CORRECT?

Statement #1: The casheffectsofdecreasing accountspayableturnoverareunlimited.

Statement #2: Thetax benefitsfromemployeestock options canresultinasignificantsourceofinvesting cash flow.

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Question ID: 462285

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Question ID: 462263

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Incorrect Incorrect

Correct Incorrect

Incorrect Correct

Explanation

Statement#1isanincorrectstatement.The casheffectsofdecreasing accountspayableturnoverarelimited.Suppliers will eventuallystopextending credit becauseofdelayedpayments.Statement#2 isanincorrectstatement.Thetax benefitsfrom employeestock options canresultinasignificantsourceofoperating andfinancing cashflows.Tax benefitsdonotaffect investing cashflows.

Considerasituationatafirm wherethedifferencesinits cashflow andeconomic pensionexpenseare consideredmaterialto thefinancialstatements.Therelevanttax rateis 30%.Theexpectedreturnonplanassetsis $120,000, interest costis

$85,000, employer's contributionis $215,000, service costis $450,000, andtheactualreturnonplanassetsis $50,000.Based ontheinformationprovidedandforanalyticalpurposesonly, whichofthefollowing statementsismostappropriate?

There is a reclassification of $270,000 from operatingcash flow to financing cash flow.

Thereisareclassificationof $189,000fromoperating cashflow tofinancing cashflow.

Thereisareclassificationof $140,000fromoperating cashflow tofinancing cashflow.

Explanation

Thetotalperiodic pension cost = service cost + interest cost − actualreturnonplanassets = $450,000 + $85,000 − $50,000 = $485,000.

Sincethedifferencesin cashflow andeconomic pensionexpenseare consideredmaterial, foranalysispurposes weshould

considerreclassifying thedifferencefromoperating activitiestofinancing activitiesinthe cashflow statement.

Theemployer's contribution wasonly $215,000.Sincethetotalperiodic pension costexceedsthe cashflow, thedifference,

netoftax, istreatedasa borrowing inthe cashflow statementforanalyticalpurposes. Givenatax rateof 30%, $189,000is reclassifiedfromoperating cashflow tofinancing cashflow [($485,000totalperiodic pension cost − $215,000employer

contribution) ((1 − 30% tax rate)].

Wonderful Manufacturing hasimplementeda changeinitspensionplan, that willincreasethefuture benefitsforallofits

currentemployees. Whichofthefollowing isthemostlikelyeffectonthe company'sfinancialstatementsofthis changein promised benefitsunder current U.S. GAAPstandards?

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Question #10 of 54

Question ID: 462274

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Question #11 of 54

Question ID: 462287

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Question #1

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Question ID: 462265

Thenetpensionliability willincreaseimmediately bytheprojectedincreaseinpension

benefitsduetoemployees.

Thefirm'spriorfinancialstatements will beadjustedtoreflecttheincreasein benefits.

Explanation

Aplanamendment willresultinanimmediateincreaseinthePBO. Under current U.S.accounting standards, anincreasein PBO willresultinanincreaseinthenetpensionliability (decreaseinfundedstatus).

Whichofthefollowing measuresisleastsensitiveto changesinpensionplanactuarialassumptions?

Projected benefit obligation (PBO).

Totalperiodic pension cost.

Balancesheetassetorliability.

Explanation

Totalperiodic pension costisanet (smaller)amountandtherefore, is generally quitesensitivetorelativelyminor changesin actuarialassumptions.

Changing anassumptionmayhaveasmalleffectontheprojected benefitobligation (PBO) butmayhaveamuchlargereffect onthefundedstatus (whichisanetpensionamount) whichisthe balancesheetassetorliability.

Whichofthefollowing is NOTanadvantageofshare based compensationover cash compensation?

In a share based compensation plan, expense is not recognized, unless the exercise price is set below the market price.

Share based compensationdoesnotrequirea cashoutlay.

Share based compensationservestoalignemployeeinterest withtheinterestsof stockholders.

Explanation

Share based compensationneedsto berecognizedatfairvalueunder both U.S. GAAPand IFRS. Intrinsic valuedoesnot matter. However, theexpenseisdoesnotrequirea cashoutlayandservestoaligntheinterestsofemployeesand stockholders.

FederalCompaniesreportedthefollowing informationinthefootnotestoitsmostrecentfinancialstatements:

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Question ID: 462270

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Ending PBO 90,000,000

ServiceCost 27,000,000

InterestCost 3,000,000

BenefitsPaid 5,000,000

Actual ReturnonPlanAssets 7,500,000

Expected ReturnonPlanAssets 8,500,000

Giventheinformationabove, calculate Federal'stotalperiodic pension costfortheyear.

$41,000,000.

$27,500,000.

$22,500,000.

Explanation

Totalperiodic pension cost = service cost + interest cost-actualreturnonplanassets + planammendments

Therefore, $27,000,000 + 3,000,000- 7,500,000 = $22,500,000

Therearenootheractuarialassumptionsaffecting PBO asevidenced byreconciliationofPBO:

Beginning

PBO 65

(+)Service

cost 27

(+) Interest

cost 3

(-)Benefits paid (5)

(=)Ending

PBO 90

Tim Gresham, CFO ofAlpha Logisticsis concernedabout changesinthe businessenvironment which couldleadtoAlpha violating someofthe covenantsoftheiroutstanding debentures.Specifically Greshamis concernedaboutleverageand profitabilityratios. GreshamreviewsAlpha'smostrecentfinancialstatementsanddecidesthat changing theassumptionsfor the company'sdefined benefitpensionplanmayprovidesomereliefintheshort-run.Alphareportsunder U.S. GAAP.

Whichofthefollowing changesinthepensionplan'sassumptions wouldmostlikelyleadtolowerreportedleverageandhigher reportedprofitability?

Increasing expected return on plan assets.

Increasing thediscountrate.

Increasing the growthratein compensationexpense.

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Question #14 of 54

Question ID: 462290

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Increasing discountrateleadstolowerpresentvaluesandreducesreportedpensionliabilityinthe balancesheetandalso reducespensionexpense byreducing theservice cost component. Increasing expectedreturnonplanassetsdoesreduce pensionexpense butdoesnotaffectreportedassetsorliabilities. Increasing the growthratein compensationexpense

increasesservice costas wellasreportedpensionliability.

Whichofthefollowing statementsaboutthemethodsofvaluing employeestock optionsisleastaccurate?

With either method, the offset to compensation expense recognized is an increase in paid-in capital.

Withthefairvaluemethod, compensationexpenseisallocatedintheincome statementfortheperiod betweenthe grantdateandthevesting date.

Withtheintrinsic valuemethod, oncetheoptionsarein-the-money, compensation expenseisrecognizedontheincomestatement.

Explanation

Withtheintrinsic valuemethod, compensationexpenseisrecognizedintheincomestatementonlyifthemarketpriceofthe stock exceedstheexercisepriceoftheoptiononthedatetheoptionwasgranted(grantdate).

Compensationexpenseisnow basedonthefairvalueoftheoptiononthe grantdate basedonthenumberofoptionsthatare expectedtovest.Thevesting dateisthefirstdatetheemployee canactuallyexercisetheoption.The compensationis allocatedintheincomestatementovertheserviceperiod (whichisthetime betweenthe grantdateandthevesting date).

Forany compensationexpenserecognized, theoffsetisanexpenseinpaid-in capital, whichisastockholders' equityaccount.

Jason Moore, CFA, isa creditanalystforEverestBank in New York inthefirm'sinvestment banking division.Anexisting customerofEverest, LonghornPartners, whichis basedinTexas, hasapproachedthe bank fora $45millionloanto beused toacquireasmaller competitor. Moorehas beenappointedheadofthe creditteamthat willreview Longhorn's current

business withEverestas wellas Longhorn's currentoperations, inordertoassess Longhorn'srequest.

Overall, Longhornhasachieved consistentprofitabilityoverthelastdecade.The companyisappropriatelyleveragedand appearsto be well-run byitsseniormanagementteam. However, therearea coupleofitemsinthe company'sfinancial statementsthat Moore believesmay warrantfurtheranalysis. Hespecifically wantstoadjust Longhorn'sreportedoperating

profitfor comparativeanalysis withother companies whomaynotreporttheirentirepensionexpenseasanoperating

expense.

Formanyyears, Longhornhasofferedtoitsfulltimeemployeesatraditionaldefined-benefitpensionplan:eligibleemployees arepromisedanannualpensionpaymentof 3% peryearofservicetimestheirannualsalaryatretirement.Selected

informationregarding thepensionplanfrom Longhorn'smostrecentfinancialstatementisasfollows:

PensionBenefit Obligation (PBO)

(ending) $85,475,000

AccumulatedBenefit Obligation (ABO)

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Question #1

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Question ID:462259

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Question #1

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Question ID:462260

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Question ID:462261

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unchanged.

Explanation

Anincreaseintheassumedstock pricevolatility wouldincreasethevalueoftheoption grants, increasethe compensation expenseandlowerthereportednetincome. (StudySession 6, LOS 20.h)

Comparedtothereported compensationexpense, if Longhornhadusedalowerestimatedlifeassumptioninvaluing stock

option grantstoitsseniorexecutives, Longhorn's compensationexpense wouldhavemostlikely been:

unchanged.

lower.

higher.

Explanation

Lowerestimatedlifeoftheoptionsleadtolowervaluesoftheoptionandlower compensationexpense. (StudySession 6, LOS

20.h)

Longhorn'sadjustedoperating profitisclosestto:

$15,843,000

$18,527,000

$14,110,000

Explanation

Adjustedoperating profitis computedasreportedoperating profit + reportedpensionexpense − service cost.

=17,185,000 + 5,456,000 − 4,114,000 = $18,527,000

(StudySession 6, LOS 20.f)

Assumeforthis questiononlythattheactualreturnonplanassets was $981,200higherthantheexpectedreturnof

$5,308,800.Theamountof benefitspaidtoplanparticipants wasclosestto:

$8,485,000.

$5,192,000.

$1,285,000.

Explanation

Actualreturnonplanassets = 5,308,800 + 981,200 = $6,290,000

Beginning Planassets (given) 66,360,000

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Question ID:462262

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Question ID:462289

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Question ID:462242

(+)Actualreturnonplanassets

(computed)

6,290,000

(−)Benefitspaid (plug) 8,485,000

(=)EndPlanAssets (given) 71,365,000

(StudySession 6, LOS 20.b)

Wes LivingstonisthefounderandCEO ofBigwellCorporation. LivingstonisinterestedinBigwell being acquired byalarger

competitorand wantstohavehis company'sfinancialstatementsappearasattractiveaspossibletoapotentialsuitor. Inorder todecreasetheprojected benefitobligation (PBO)ofthe company'spensionplan, whichofthefollowing changesinactuarial assumptions could bemade?

Increase the rate of compensation growth.

Increasethediscountrate.

Decreasethediscountrate.

Explanation

Increasing theassumeddiscountrateofapensionplan willresultinlowerprojected benefitobligation (PBO). Increasing rate of compensation growthanddecreasing discountrate wouldincreasethePBO.

Indetermining thefairvalueofemployeestock options, whichofthefollowing statementsismostappropriate?

A lower risk-free rate will usually increase the estimated fair value.

Ahigherthanexpecteddividendyield willdecreasetheestimatedfairvalue.

Absentamarket-basedinstrument, U.S. GAAPand IFRSpreferfirmstousethe Black-Scholesoption-pricing model.

Explanation

Dividendspaidoutreducethevalueoftheunderlying sharesandtherefore, reducethevalueoftheoption.

Thereisnopreferenceofaspecific option-pricing modelineither IFRSor U.S. GAAP.AcceptablemodelsincludetheBlack -Scholesmodelorthe binomialmodel.

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Question ID:462288

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2 5 of 54

Question ID:462244

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ThefinancialstatementsofPace Industriesissuedoverthepastfiveyearsshow aprogressivelyincreasing netdifference

betweenthevalueofitspensionfundandtheprojectedfuturepensionliabilityonthe balancesheet.Pacemostlikelyoffers

whichofthefollowing typesofpensionplanstoitsemployees?

A defined contribution plan.

Adefined benefitplan.

A401(k)plan.

Explanation

A company withadefined benefitplan willfundaportfoliostructuredtofulfillfuturepensionobligations.Thedifference

betweenthe currentvalueoftheassetsandtheprojectedfutureliabilityisshownasanetamountonthe balancesheet.

Whichofthefollowing statementsaboutstock-based compensationare correctorincorrect?

Statement#1: The grantdateofaservice-basedawardisthedate whentheemployees' benefitsarefullyvested.

Statement#2: Whentwoormoreperformance conditionsmust besatisfied, therequisite serviceperiodends whenthefirst conditionismet.

Only one is correct.

Bothareincorrect.

Bothare correct.

Explanation

The grantdateisthedateanawardisapproved bythe boardofdirectorsor compensation committee. Whentwoormore performance conditionsmust besatisfied, therequisiteserviceperioddoesnotenduntilall conditionsaremet.

Theprojected benefitobligation (PBO)isdefinedasthe:

actuarial future value of all post-retirement healthcare benefits earned to date.

actuarialpresentvalueofallfuturepension benefitsearnedtodate basedon expectedfuturesalaryincreases.

actuarialpresentvalueofallfuturepension benefitsearnedtodateand basedon

currentsalarylevels.

Explanation

Theprojected benefitobligation (PBO)isdefinedastheactuarialpresentvalueofallfuturepension benefitsearnedtodate

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Question ID:462286

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Question ID:462276

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Thefollowing informationrelatesto Nazarali Inc. (Nazarali)anditsdefined-benefitpensionplanfortheyear: Contributions $3.0million

Reportedpensionexpense $2.8 million

Totalperiodic pension cost $3.1million

Basedontheinformationabove, whichofthefollowing statementsismostaccurate?

There is a reduction in the overall pension obligation of $100,000.

Thereisasourceof borrowing of $100,000.

Thereisareductionintheoverallpensionobligationof $200,000.

Explanation

Thetotalperiodic pension costrepresentsthetrue costofthepension.Thereportedpensionexpenseisirrelevantinthis

case.

Sincethetruepensionexpense ($3.1million)exceedsthe contributions ($3.0million), the $100,000difference can beviewed asasourceof borrowing.Alternatively, ifthefirm's contributionsexceedthetruepensionexpense, thedifference can be viewedasareductionintheoverallpensionobligation, similartoanexcessprincipalpaymentonaloan.

Whichofthefollowing statementsregarding pensionaccounting under U.S. GAAPstandardsand/orunder International

Financial Reporting Standards (IFRS)ismostaccurate?

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

Under IFRSand U.S. GAAP, the calculationofpensionexpenseisthesame.

Under U.S. GAAP, firmsarerequiredtoprovideareconciliationofthefundedstatus andthereportednetpensionassetorliability.

Explanation

The calculationofreportedpensionexpensediffers between U.S. GAAPand IFRS. Under U.S. GAAPandunder IFRS, thenet pensionassetorliabilityreportedonthe balancesheetisequaltothefundedstatus, withoutadjustmentforunrecognized items.

Since balancesheetasset/liabilityunder U.S. GAAPand IFRSreflectsfundedstatus, noreconciliationisnecessaryinthe footnotes.

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Question #

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Question ID:462249

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Question #

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Question ID:462250

residentialand commercialmarketin whichSpringtownsellsits windows. Hortonisheadoftheduediligenceteamthat will fullyevaluatePrime Doors' financialstatementspriortotheproposedacquisition.p>

Prime Doorshas beeninoperationforthirtyyears, and currentlyhasapproximately 800employeesattwooperating facilities.

HortonobservesinthenotestothefinancialstatementsthatPrime Doorshasadefined benefitpensionplan, for whichall employeesareeligible.Employeesarevestedattherateof 20% peryearofemployment, andarefullyvestedupon

completionoffiveyearsofemployment.Springtowndoesnotofferapensionplantoitsemployees, butencourages employeesto contributeto Individual RetirementAccounts (IRAs)andoffersa401(k)program.

Horton wantstofullyevaluatethefinancialimplicationsofSpringtown'sassumptionofPrime Doors' pensionassetsandthe associatedfutureliabilitiesandexpenses. Likemost companies, thepensionplanforSpringtown'semployeesisnotfully funded, but Horton wantstoreview allassumptionsused bySpringtown'saccountantsinthevaluationoftheplan's current liabilities.Themost currentinformationregarding thepensionplansisasfollows:

Select Pension Plan Information for Prime Doors (as of 12/31/05)

Projected benefitobligation (PBO) $15,500,000

Accumulated benefitobligation (ABO) $13,750,000

Marketvalueofplanassets $11,875,000

Hortonnoticesaparagraphinthepensionplanfootnotesthattheoriginalpensionplan wasamendedlastyear, effectively increasing thelevelof benefitsto bepaidtoemployees withmorethantenyearsofservice. However, heisnotabletodetect

whateffect, ifany, this changeinprojected benefitshashadonPrime Doors' financialstatementsorisexpectedtohaveinthe future.

Hortonisawarethata commonlyusedmethod can beusedtoadjusttheincomestatementandprovidea bettermeasureof Prime Doors' economic pension costthanreportedpensionexpense. Heisnot quitesure which componentsofthefinancial statementsareutilizedtoderiveanadjustedpensionexpense, butintendstoinvestigate whatanalysishe canperformto gain moreinsightintothe company'sposition withregardstoitspensionplan.

Whenaccounting forpensionliabilitiesinthe U.S., a companymustmakefundamentalassumptionstoestimatethefuture liabilityandexpenseforeachemployee. How arethefollowing assumptionsrequiredto betreatedinthepensionfootnotes?

Requireddisclosure Notrequiredto bedisclosed

Discount rate Rate of compensation

growth

Discountrate Expectedreturnonplanassets

Rateof compensation growth Expectedlengthofemployment

Explanation

A companymustdisclosethediscountrate, theexpectedreturnonplanassets, andtherateof compensation growth.The expectedlengthofemploymentisnotarequireddisclosure.

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an immediate increase in pension expense equal to the amount of the amendment.

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Question ID:462254

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Question ID:462246

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anunrecognizedpriorservice costthatisamortizedovertheexpectedremaining

servicelifeoftheaffectedemployees.

Explanation

Theamendmentaffectsthefundedstatusonthe balancesheetimmediately. Intheincomestatement, theamendmentis amortizedasa componentofpensionexpenseovertheremaining servicelifeoftheaffectedemployees.

Pensionexpenseasreported byafirmisroutinelyadjusted byanalyststoderiveamoreaccuratemeasureofafirm'strue economic pension cost.Economic pensionexpenseis calculatedas:

reported pension cost - actual return on plan assets.

Contribution- ( Ending fundedstatus- beginning fundedstatus)

reportedpensionexpense-service cost + interest cost.

Explanation

Economic pensionexpenseis calculated withoutreflecting theamortizeditemsnormallyincludedinpensionexpenseand using "actual" insteadof "expected" returnonassets. It can bealso computedasChangeinfundedstatusexcluding contributions.

TheBoardof DirectorsofPrimeBank hasaskedmanagementtomake changesintheaccounting ofitspensionplan obligationsinordertodecreasethereportedservice cost. Managementdeterminesthattherearetwo changesinactuarial assumptionsthat willresultinalowerservice cost. Whichofthefollowing pairsof changesinactuarialassumptions willbest achievethedesiredeffect? PrimeBank caneither:

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

increasethediscountrateordecreasetherateof compensation growth.

decreasethediscountrateorincreasetheexpectedrateofreturn.

Explanation

Anincreaseinthediscountrate willresultinlowerservice cost. Using alowerrateof compensation growth willyieldlower futurepension benefitsowed, andthusalowerservice cost.Theexpectedreturnhasnoimpactonservice cost.

Whichofthefollowing statementsregarding theprojected benefitobligation (PBO)andthevalueofthepensionplanassetsis mostaccurate?

If the PBO and the plan assets are the same, then nothing needs to be reported

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Question #

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Question ID:462279

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Thefairvalueofplanassetsisincreased bytheamountoftheexpectedreturnon assets.

Planamendmentsduring theyear generallyresultinadecreaseofthePBO atthe endoftheyear.

Explanation

NeitherthePBO northeplanassetsareseparatelyreportedonthe balancesheet.Thefundedstatusisthedifferenceinthe PBO andtheplanassets. IfthePBO exceedstheplanassets, thedifferenceisreportedasaliability. Iftheplanassetsexceed thePBO, thedifferenceisreportedasanasset. Iftheamountsarethesame, thenneitheraliabilitynorassetneedsto be reported.

Planamendments (i.e.additional benefitsprovidedthatincreasetheamountoftheemployer'sobligationtoplanparticipants)

generallyresultinanincreaseofthePBO.

Thefairvalueofplanassetsatthe beginning oftheperiodisincreased bytheactualreturnonplanassetsas wellasany employer contributions. Itisreduced bytheamountof benefitspaid.

Paul Roberts, CPA, isapartnerin Roberts & Smith, anaccounting firmthatislocatedinChicago.Thefirmhasrecently been retained by Midwest Manufacturing, amajorproducerofheavymachineryandtractorpartsinthe U.S. Midwesthas beenin operationsince1965, and currentlyhasapproximately 700full-timeemployees.The companyhaditsinitialpublic offering in 1986.The companyhashired Roberts'sfirmtoensurethattheaccounting for Midwest'semployeepensionplanisfullyin

compliance U.S. GAAPstandards.

Selectedyear-endpensionplaninformationforMidwestManufacturing

2006 2007

PBO $21million $23 million

Discount Rate 6.0% 7.5%

RateofCompensation Increase 4.0% 4.0%

Benefitspaid $0.8m $1m

Interest cost $1.6m

Service cost $3m

Roberts willeducate Midwest'saccounting departmentonpensionplanaccounting that would berelevanttotheirsituation.

Inaccordance with U.S. GAAP, distinguish whichofthefollowing eventsare classifiedas "actual" eventsand whichonesare

"smoothed" events.

Actual Smoothed

service cost interest cost

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ᅚ C)

Question #37 of 54

Question ID:462280

ᅚ A)

ᅞ B)

ᅞ C)

Question #38 of 54

Question ID:462281

ᅞ A)

ᅚ B)

ᅞ C)

service cost expectedreturnonplan assets

Explanation

Service costandinterest costare consideredto beactualevents.Expectedreturnonplanassets, amortizationof unrecognizedpriorservice costs, andamortizationanddeferralofactuarial gainsandlossesare classifiedassmoothed events.Together, thesefive componentsareusedto calculateaplan'sreportedpensionexpenseorincomeontheincome statement.Totalperiodic pension costisactual cost (notsmoothed)oftheplan- butnotreflectedfullyinthereportedpension expense. (StudySession 6, LOS 20.c)

Basedontheinformationprovided, theimpactof changeindiscountratein 2007 (as comparedto 2006)isclosestto:

a decrease in PBO of $1.6 million.

adecreaseinPBO of $2 million.

adecreaseinPBO of $2.6 million.

Explanation

Ahigherdiscountrate willresultinlowerPBO. Reconciliationofopening and closing PBO shows:

Beginning PBO $21million Given

(+) Interest cost 1.6 Given

(+)Service cost 3.0 Given

(-)Benefitspaid (1.0) Given

(-)ActuarialChanges (1.6) PLUG (=)Ending PBO $23 million Given

Changesduetoactuarialassumptions = −$1.6m

(StudySession 6, LOS 20.b)

Asof January1 , 2007, thefairvalueofplanassets was $19 million. Whichthree componentsarenecessaryto calculatethe fairvalueoftheplanassetsattheendoftheyear?

expected return on plan assets, employer and participant contributions, and

benefits paid.

actualreturnonassets, employer contributions, and benefitspaid.

service cost, interest cost, and benefitspaid.

Explanation

Companiesarerequiredtodiscloseareconciliationofthe beginning andending balancesofthefairvalueofplanassets, which can be calculatedasfollows:

Fairvalueofplanassetsatthe beginning oftheyear

+ Actualreturnonassets

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Question #39 of 54

Question ID:462282 may increase or decrease as a result of applying the standard.

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Question #42 of 54

Question ID:462277

ᅞ A)

ᅞ B)

ᅚ C)

Question #43 of 54

Question ID:462264

ᅞ A)

ᅞ B)

ᅚ C)

Question #44 of 54

Question ID:462269

Becausedeferredandunrecognizeditemsarerequiredto bereportedonthe balancesheet butnottheincomestatement, the

balancesheet willreflectthetrueeconomic positionofthepensionplan, buttheincomestatement willnotnecessarilyreflecta truemeasureofeconomic pensionexpense. U.S. GAAPand IFRSstilldiffer withrespecttoreporting pensionexpense.

(StudySession 6, LOS 20.b, c)

Under current U.S. GAAP, theassetsandliabilitiesofadefined benefitpensionplanare:

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

reportedintheappropriatesectionofthe balancesheet, withpensionobligations shownunderliabilitiesandplanassetsshownunderassets.

nettedagainsteachother, andonlythenetassetorliabilityamountisreportedonthe

company's balancesheet.

Explanation

Under current U.S. GAAP, companiesarerequiredtoreportonlythenetassetorliabilityamount.They cannotshow assets andliabilitiesseparately.Althoughsomesmoothing detailsarestilldisclosedinthefootnotes, allmajor componentsofpension assetsandliabilitiesarenow requiredto beshownonthe balancesheet.

Financialanalysts canuseselectdatafroma company'sfinancialstatementstoderivetotalperiodic pension costinorderto

betterreflectthe company'strueeconomic pension cost. Whichofthefollowing formulas willmostaccurately calculatea

company'struepensionexpense?

Service cost + interest cost - actual return on plan assets - benefits paid.

Beginning fairvalueofplanassets + service cost + interest cost-ending fairvalueof planassets.

Service cost + interest cost + planamendments-actualreturnonplanassets.

Explanation

Thetotalperiodic pension cost, (absentanyinformationon changesinactuarialassumptions)is calculated withoutreflecting

theamortizationofunrecognizeditemsandothersmoothing mechanismsincludedinreportedpensionexpense, andin additionusestheplan'sactualreturnonassets, ratherthantheplan'sexpectedreturn.

Ananalystviewstheassumptionsmade bya companyreporting under U.S. GAAPregarding itspensionliabilitiesas unrealistic, andthinksthediscountrateandexpectedrateofreturnshould both beincreased.Themostlikelyeffectof increasing thediscountrateandexpectedrateofreturnonthepension benefitobligation (PBO)is:

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ᅞ A)

ᅞ B)

ᅚ C)

Question #45 of 54

Question ID:462247

ᅚ A)

ᅞ B)

ᅞ C)

Question #46 of 54

Question ID:462245

ᅞ A)

ᅚ B)

ᅞ C)

Increase Decrease

Noeffect Decrease

Decrease Noeffect

Explanation

ThePBO willdecrease becauseahigherdiscountrate will causethepresentvalueofthefutureobligationstodecline.There

will benoeffectfrom changing theexpectedrateofreturn becauseexpectedreturnrelatestothepensionexpense, nottothe sizeoftheobligation.

Whichofthefollowing statementsregarding pensionaccounting ismostaccurate?

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

Areconciliation betweenthefundedstatusandthenetpensionasset (liability) reportedonthe balanceisrequired.

Changesinactuarialassumptionsandpastservice costsfullyandimmediatelyaffect theincomestatement.

Explanation

Changesintheprojected benefitobligation (PBO)andplanassetsimmediatelyaffectthefundedstatus (differenceinPBO and planassets)andthefullamountofthe changesisreflectedonthe balancesheet whenthe changeoccurs.

Changesinactuarialassumptionsandpastservice costsarerecognizedintheincomestatementovertimetherebysmoothing

pensionexpense.

Sincethefundedstatusisequaltothenetpensionasset (liability)reportedonthe balancesheetundernoreconciliationis required.

Theactuarialpresentvalueofallfuturepension benefitsearnedtodate, basedonexpectedfuturesalaryincreases, is called the:

total projected pension cost.

projected benefitobligation (PBO).

pensionliability.

Explanation

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Question #47 of 54

Question ID:462273

ᅚ A)

ᅞ B)

ᅞ C)

Question #48 of 54

Question ID:462271

ᅞ A)

ᅞ B)

ᅚ C)

Questions #49-54 of 54

employees will continueto work forthefirmuntiltheyretire.Pension costisperiodic andnottotalprojected.Pensionliabilityis thenetamountofPBO andfairvalueofplanassets.

(StudySession 6, 20.b)

RobertoPerez, CFA, istheChief Financial Officerfor HomeStores, Inc., alargehomeimprovementretailer withstores locatedacrossthe UnitedStates. HomeStoresispreparing forasecondarystock offering tosecurethenecessary capitalto pursueanaggressiveexpansion campaign.Perez hasreceivedadirectivefromhis bosstomakeeverylegitimateeffortto present HomeStores' upcoming financialstatementsinthe bestpossiblelight.Perez determinesthat certainassumptionsin thepensionplan can be changedtofulfillthisrequest. Whichofthefollowing pensionplanassumptions can be changed bya firmtomanipulateitsreportedresults?

Change Result

decreased rate of

compensation growth decreased service cost

increasedexpectedrateof

return decreasedservice cost

decreaseddiscountrate increasedexpectedreturn

Explanation

Therateof compensation growthistheexpectedaverageannualincreaseinemployee compensation. Iftherateof growthis lowered, reportedresults will beimprovedduetoadecreaseinservice cost.Adecreaseinservice cost willresultinlower pensionexpense.

Inordertodecreasetheprojected benefitobligation (PBO)ofapensionplan, whichofthefollowing changesinpension assumptions can bemadetoyieldthedesiredresult?

Increase the expected rate of return.

Decreasethediscountrate.

Decreasetherateof compensation growth.

Explanation

Adecreaseintherateof compensation growth willlowerfuturepensionpaymentsandinturn, lowerthePBO.

Jason Johnson, CFA, isaprincipalofalargeprivateequityfirmin New York. Oneoftheassociatesinhisfirmhasidentifieda potentialinvestmentopportunityforthefirm: Gasline, Inc.isamajorproducerof carbonsteelpipeusedinthetransportationof

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Question #49 of 54

Question ID:462293

ᅞ A)

ᅞ B)

ᅚ C)

Question #50 of 54

Question ID:462294

ᅞ A)

ᅚ B)

ᅞ C)

Ofparticular concernto Johnsonis Gasline'snumerous, complicatedtransactionsrelatedtothe company'svariousstock

-based compensationplansanditsdefined benefitpensionplan.

Forexample, theCEO of Gasline wasawardedastock optionpackageatthe beginning of 2013, which couldultimatelyhavea significantimpactonthe company'sfutureearnings. DetailsoftheCEO'sstock option grantareoutlined below

CE

O

ptions

(

g

rant date

J

anuary 1

,

2

01

3 )

S

tri

k

e

p

ri

c

e

$37

.00

C

u

rrent

m

ar

k

et

p

ri

c

e

$3

5.00 N

um

b

er

o

f

o

p

tions

100 ,

000 O

p

tion

p

eriod

4 y

ears

V

estin

g

p

eriod

2

5 %

p

er

y

ear

ForthevaluationoftheCEO'sstock options grantedon January1, 2013, Gaslineestimatedafairvalueof $100,000 byusing MonteCarlosimulation. Inaccordance withSFAS No.123(R), whichofthefollowing statementsismostaccurate? Gasline's accounting treatmentoftheoptionsis:

not in compliance because the fair value must be established by using the Black-Scholes option pricing model.

in compliance becausethefirm canelecttouseeithertheintrinsic valuemodelorthe fairvaluemodelinthevaluationofstock optionplans.

in compliance becausea MonteCarlosimulationisanacceptablemethodofvaluing

optionsintheabsenceofamarket-basedinstrument.

Explanation

UnderSFAS No.123(R), firmsarerequiredtousethefairvaluemethodofvaluing stock optionplans. Intheabsenceofa market-basedinstrument, firmsmayselectanduseanoption-pricing modelsuchastheBlack-Scholes, the binomialmodelor

MonteCarlo. (LOS 20.h)

AssumethattheCEO of Gaslineexercises $25,000ofhisoptionson December 31, 2013, andthemarketpriceofthestock on thatdateis $39.50.Calculatethetotal compensationexpensefortheyearending 2013 that Gaslineshouldrecognizein association withtheCEO option grant.

$100,000.

$25,000.

$62,500.

Explanation

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Changesinactuarialassumptionsdonotaffectplanassets.Thefundedstatus would changeonlydueto changesinPBO due to changeinactuarialassumptions.Totalperiodic pension cost woulddecreaseduetoactuarial gains.Actuarial gains would

be consideredremeasurement gainsand would bereflected OCI (andnotincomestatement). Under US GAAPifthe gains meettherequirementsofamortizationunder corridorapproach, thefuturereportedpensionexpense would belower. (LOS