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CASE 13: RETIRMENT OBLIGATIONS
68 A.
a. The defined contribution plan is where the employer agrees to contribute to a pension trust a certain sum each period, based on a formula. This is often a 401(k) plan.
The defined benefit plan differs from the defined contribution plan in that it does not contribute a certain sum each period but instead guarantees the benefit the employee receives upon retirement. Thus, the two plans differ in timing in how the companies pay employee benefit.
Johnson & Johnson actually sponsor various retirement and pension plans, including defined benefit, defined contribution and termination indemnity plans. Overall, the Company generally uses the defined contribution plan, stating that they have the right to modify these plans in the future, as opposed to being obligated to award the employee each period a defined plan amount.
b. Retirement plan obligations are liabilities because they represent the obligation of payment that the company owes.
c. Actuaries must make many predictions, or actuarial assumptions, of mortality rates, employee turnover, interest and earnings rates, and many other factors necessary to operate a pension plan.
B.
a. The companies pension obligations are influenced each year by four main types of activities: service cost; interest cost; actuarial gains or losses; and benefits paid to retirees. Service cost is the actuarial present value of benefits attributed by the pension
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benefit formula to employee service during a period. This service cost is what an employer must pay’s present value to obtain the employee’s guaranteed future benefit.
Interest cost is the interest for the period of the projected benefit obligation outstanding during the period.
Actuarial gains or losses are the actual return on the plan assets and the increase in pension funds from interest, dividends, and realized and unrealized changes in the fair value of the plan assets. If the actual return is positive, then the company subtracts it when computing pension expense. If negative, the company adds it when computing pension expense.
Benefits paid to retirees are the payout that the employer makes to its retirees. It decreases plan assets.
C.
a. The companies’ pension assets are influenced each year by three main types of activities including actual return on pension investments, company contributions to the plan, and benefits paid to retirees. Actual return on pension investments are different from expected return on pension investments because they are not solely an estimate but instead that which was actually recorded.
D. In general, companies’ pension expense and pension plan assets both have a return on plan assets component; however, they differ in that the return for the pension expense is the expected return and the return for the plan assets is the actual return.
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The rationale for this difference is that because plan asset’s actual return are reported at fair value and the net of the beginning and ending balances of fair values because it is important to take fair market value into the plan asset total.
E. The primary difference between the company’s other-benefits plan and its retirement plan is that the retiree health benefits are not funded in advance while the retirement plan is funded with compensation from the years prior.
F.
a. Johnson & Johnson incurred 646,000,000 in 2007.
b.
Service Cost 597
Liability 587
Interest Expense 656
Liability 656
G.
a. At December 31, 2007, the company’s retirement plan obligation is $12,002,000,000.
This value represents the obligation that they owe to pay their employees at retirement.
b. The pension related interest cost for the year 656,000,000 and the average interest rate the company used to calculate interest cost during 2007 is 5.63 percent. This interest rate seems to be a little higher than the average in that year, which was around 4.9 percent or 5.0 percent. The interest rate that the company uses is adapted and compared to interest rates on great investments; therefore, the resemblance is adequate.
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c. $481,000,000 was paid out in pension benefits to retirees during the 2007 fiscal year.
Johnson and Johnson did pay cash for the benefits since it was out of their plan assets.
The benefits paid out are a deduction from the plan assets and decreases the obligation plan assets.
H.
a. The value at December 31, 2007, of the retirement plan assets held by Johnson &
Johnson’s retirement plan is $10,469,000,000. This value is the fair value of the company’s investments.
b. In 2007, the expected return on plan assets in is 809,000,000 while the actual was 743,000,000. In 2006, the expected return on plan assets was 701,000,000 and the actual return was greater at 966,000,000. These differences are significant. The 2006 return better reflects the economics of Johnson & Johnson’s pension expense because not only did they meet their expected return but they exceeded it, favorably increases the company’s plan assets.
c. Johnson & Johnson and their employees contributed to the retirement plan, during 2007, 317,000,000, while in 2006 they contributed 259,000,000. This reflects the difference in the company’s contributions.
d. Johnson & Johnson’s retirement plan assets are comprised of investments including equity securities, debt securities, and even a small portion in real estate. Largely equity securities are hold the biggest proportion of investments in 2007 at 79 percent domestically and 67 percent internationally.
I. We know that a company is in overfunded or underfunded status by measuring the difference between fair value of the plan assets and the projected benefit obligation. At