Solution manual intermediate accounting 7th by nelson spiceland ch17

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 17–15

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

17–4 Reflective thinking Exercises

17–5 Reflective thinking 17–1 Reflective thinking

17–7 Reflective thinking 17–3 Reflective thinking

17–13 Reflective thinking 17–9 Diversity, Analytic

17–18 Reflective thinking 17–14 Analytic, Communications

17–21 Reflective thinking 17–17 Reflective thinking

17–22 Reflective thinking 17–18 Diversity, Analytic

17–25 Diversity, Reflective thinking 17–21 Analytic

17–26 Diversity, Reflective thinking 17–22 Diversity, Analytic

CPA/CMA AACSB Tags Problems AACSB Tags

6 Diversity, Reflective thinking 17–6 Analytic

7 Diversity, Reflective thinking 17–7 Analytic

8 Diversity, Reflective thinking 17–8 Analytic

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:

1 It must cover at least 70% of employees

2 It cannot discriminate in favor of highly compensated employees

3 It must be funded in advance of retirement through contributions to an irrevocable trust fund

4 Benefits must “vest” after a specified period of service, commonly five years

5 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

Answers to Questions (continued)

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

“service years” worked in each of these years

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

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

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

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 high- grade 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

Less: Retiree benefits (6)

Less: Retiree benefits (6)

Service cost = $85 – 80 – 4 + 6 = $7 million

Less: Retiree benefits (?)

Retiree benefits = $85 – 80 – 4 – 10 = $9 million

Less: Retiree benefits (6)

Retiree benefits = $83 – 80 – 4 – 7 = $8 million

Return on assets = $104 – 100 – 7 + 6 = $3 million

Rate of return on assets = $3 million ÷ $100 million = 3%

Brief Exercise 17–8

The difference between an employer’s obligation (PBO) and the resources available to satisfy that obligation (plan assets) is the funded status of the pension plan The employer 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 liability if the PBO exceeds the plan assets or a net pension asset if the plan assets exceed the PBO In the situation described, JDS would report a net pension liability of $15 million:

($ in millions)

If the plan assets are $45 million, JDS would report a net pension asset of $5 million:

Brief Exercise 17–9

Expected return on the plan assets ($5 actual, less $1 gain) (4)

Brief Exercise 17–10

Expected return on the plan assets ($4 actual, plus $2 loss) (6)

* $20 ÷ 10 years = $2

Brief Exercise 17–11

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 larger 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 Pension expense in this instance is decreased by a $2 million amortization of the net gain:

Brief Exercise 17–12

The net pension liability, which is the difference between the PBO and plan assets, increases by the combination of the service cost, interest cost, and the expected return ($70 + 50 – 55 million) as is reflected in the following entry

Pension expense (total) 67

the prior service cost (an accumulated other comprehensive income account) is

reduced by $2 million This reduction is reported as other comprehensive income in

the statement of comprehensive income

Brief Exercise 17–13

Pension gains and losses (either from changing assumptions regarding the PBO or the return on assets being higher or lower than expected) are deferred and not

immediately included in pension expense and net income They are, however,

reported as other comprehensive income in the period they occur Accordingly, these

gains and losses are reported in Andrews’s statement of comprehensive income as a gain of $4 million and a loss of $1 million Here are the entries:

Loss—OCI(loss from actual return falling short of expected) 1

Plan assets 1

PBO 4

Gain—OCI(gain from change in assumption) 4

The net pension liability in the balance sheet declines by the $3 million net effect

of the loss and the gain:

($ in millions)

The Net loss—AOCI in the balance sheet increases by the current $1 million

Loss—OCI and deceases by the current $4 million Gain—OCI, a net reduction of $3 million

EXERCISES

Exercise 17–1

Events

I 1 Interest cost

N 2 Amortization of prior service cost

D 3 A decrease in the average life expectancy of employees

I 4 An increase in the average life expectancy of employees

I 5 A plan amendment that increases benefits is made retroactive to

prior years

D 6 An increase in the actuary’s assumed discount rate

N 7 Cash contributions to the pension fund by the employer

D 8 Benefits are paid to retired employees

I 9 Service cost

N 10 Return on plan assets during the year lower than expected

N 11 Return on plan assets during the year higher than expected

Less: Retiree benefits (4)

Exercise 17–3

Events

I 1 Interest cost

I 2 Amortization of prior service cost—AOCI

N 3 Excess of the expected return on plan assets over the actual return

D 4 Expected return on plan assets

N 5 A plan amendment that increases benefits is made retroactive to

prior years

N 6 Actuary’s estimate of the PBO is increased

N 7 Cash contributions to the pension fund by the employer

N 8 Benefits are paid to retired employees

I 9 Service cost

N 10 Excess of the actual return on plan assets over the expected return

I 11 Amortization of net loss—AOCI

D 12 Amortization of net gain—AOCI

Exercise 17–4

Requirement 1

($ in millions) Pension expense (total) 14

Plan assets (expected return on assets) 4

Requirement 2

($ in millions) Pension expense (total) 10

Plan assets (expected return on assets) 4

Requirement 3

($ in millions) Pension expense (total) 17

Plan assets (expected return on assets) 4

The amortization amounts are reported as other comprehensive income in the

statement of comprehensive income

Less: Retiree benefits (11)

Service cost = $465 – 360 – 36 + 54 = $123 million

Less: Retiree benefits (66)

Cash contributions = $750 – 700 – 77 + 66 = $39 million

Exercise 17–8

Expected return on the plan assets ($99 actual, less $9 gain*) (90)

* (11% x $900) – (10% x $900)

Exercise 17–9

Under IFRS the various components of pension expense are not reported

as a single net amount Instead, Sterling Properties would separately report service cost (including past service cost), net interest cost/income, and remeasurement gains and losses:

Income statement:

Statement of comprehensive income:

* Because plan assets exceed the DBO, we have net interest income rather than net interest cost

** This solution assumes that the 6% interest rate is also the interest rate for high-quality corporate bonds, which is the rate prescribed for determining the net interest cost/income Note: Using IFRS, there would be no prior service cost in AOCI and no amortization of the net loss

The following entry also would be required although it does not affect the pension expense or the plan asset funding:

Expected return on the plan assets ($216 actual, plus $24 loss*) (240)

* (10% x $2,400) – (9% x $2,400)

Requirement 2

Loss—OCI ($216 actual return on assets – $240 expected return) 24

The amortization amounts are reported as other comprehensive income in

the statement of comprehensive income

* Present value of an ordinary annuity of $1: n = 15, i = 7% (from Table 4)

** Present value of $1: n = 25, i = 7% (from Table 2)

Requirement 5

* Present value of an ordinary annuity of $1: n = 15, i = 7% (from Table 4)

** Present value of $1: n = 24 , i = 7% (from Table 2)

Exercise 17–12 (concluded)

Requirement 6

* Present value of an ordinary annuity of $1: n = 15, i = 7% (from Table 4)

** Present value of $1: n = 24, i = 7% (from Table 2)

Exercise 17–13

Requirement 1

Note: The balance in this account is recognized as part of accumulated other

comprehensive income in the balance sheet

Exercise 17–14

In the balance sheet,

Liabilities increase by $274 million:

¾ The PBO increases by $374 (service cost and interest cost); plan

assets increase by $100 (expected return on assets plus the gain due to

the actual return exceeding expectations) When those two accounts

are reported in the balance sheet by netting the two together (PBO less

plan assets), the net pension liability (underfunded plan) will increase

Accumulated other comprehensive income:

¾ The prior service cost—AOCI (a negative shareholders’ equity

account) decreases by the $8 million amortization

¾ The net loss—AOCI (a negative shareholders’ equity account)

decreases by the $2 million amortization and by the $10 million

PBO ($224 service cost + $150 interest cost) 374

To record gain on assets

Plan assets 10

Net Loss—AOCI Expense Cash Pension

Net Pension (Liability ) / Asset

Exercise 17–16

Requirement 1

($ in millions)

Expected return on the plan assets ($32 actual, plus $8 loss) (40)

Computation of net loss amortization:

Net loss—AOCI (previous losses exceeded previous gains) $ 80

10% of $600 PBO (greater than $400 plan assets) (60)

÷ 10 years

The amortization amounts are reported as other comprehensive income in

the statement of comprehensive income

Exercise 17–17

d_ 1 Future compensation levels estimated a Actual return exceeds expected f_ 2 All funding provided by the employer b Net gain—AOCI

a_ 3 Credit to OCI and debit to c Vested benefit obligation

l_ 4 Retirement benefits specified e Choice between PBO and ABO

e_ 5 Trade-off between relevance g Accumulated benefit obligation

b_ 6 Cumulative gains in excess of losses i Interest cost

g_ 7 Current pay levels implicitly assumed j Delayed recognition in earnings i_ 8 Created by the passage of time k Defined contribution plan

c_ 9 Not contingent on future employment l Defined benefit plan

h_ 11 Increased by employer contributions n Amortize net loss—AOCI

m_ 12 Caused by plan amendment

j_ 13 Loss on plan assets

n_ 14 Excess over 10% of plan assets or PBO

Exercise 17–18

Requirement 1

A decrease in the discount rate from 7% to 6% increases the projected benefit

obligation The lower the discount rate in a present value calculation, the higher the present value When the obligation increases, it is reported as a loss

Requirement 2

($ in millions)

U.S GAAP requires that actuarial gains and losses be included among OCI items

in the statement of comprehensive income, thus subsequently become part of AOCI

Requirement 3

Reporting actuarial gains and losses among OCI items in the statement of

comprehensive income also is required under IAS No 19, referred to as

remeasurement gains and losses Under IAS No 19 they are not subsequently

amortized to expense and recycled or reclassified from other comprehensive income

as is required under U.S GAAP (if the net gain or net loss exceeds the 10% corridor threshold) So, the entry might be identical to the one in Requirement 2 except we call

it a “remeasurement” loss and the projected benefit obligation is called the defined benefit obligation (DBO):

($ in millions)

Remeasurement loss—OCI (from change in discount rate) 13

Exercise 17–19

Requirement 1

($ in millions)

Expected return on the plan assets ($40 actual, plus $5 loss) (45)

Computation of net gain amortization:

Net gain—AOCI (previous gains exceeded previous losses) $ 80

Gain—OCI (from change in assumption regarding the PBO) 10

Loss—OCI ($40 actual return on assets – $45 expected return) 5

Exercise 17–19 (concluded)

SHAREHOLDERS’ EQUITY: A CCUMULATED

O THER C OMPREHENSIVE I NCOME

The pension plan is overfunded Beale will report a net pension asset of $34 million

in its 2013 balance sheet:

Plan assets – PBO = Net pension asset

2012 $500 – 480 = $20

2013 $570 – 536 = $34

– AOCI

Net Gain

– AOCI

Pension Expense Cash

Net Pension (Liability) / Asset

Expected return on the plan assets ($27 actual, less $3 gain) (24)

Gain—OCI ($27 actual return on assets – $24 expected return) 3

Exercise 17–22

Under U.S GAAP, prior service cost is included among other comprehensive income items in the statement of comprehensive income and thus subsequently becomes part of accumulated other comprehensive income where it is amortized over the average remaining service period

Under IAS No 19, past service cost (called prior service cost under U.S GAAP) is

expensed immediately as part of the service cost for the year

Other comprehensive income:

Exercise 17–22 (concluded)

Requirement 2

Lacy’s retired employees were paid benefits of $37 million in 2013 Paying those benefits, of course, reduces the obligation to pay benefits (the DBO), and since the payments are made from the plan assets, that balance is reduced as well:

To Record Payment of Benefits