EXAMPLE TEST QUESTIONS

Chapter 14

Multiple Choice

1. APB Opinion No. 8 set minimum and maximum limits on the annual provision for pension cost. An amount that was always included in the calculation of both the minimum and the maximum limit isa. Normal costb. Amortization of past service costc. Interest on unfunded past and prior service costsd. Retirement benefits paid

Answer a

2. In accounting for a pension plan, any difference between the pension cost charged to expense and the payments into the fund should be reported as a. An offset to the liability for prior service costb. Accrued or prepaid pension costc. An operating expense in this periodd. An accrued actuarial liability

Answer b

3. Benefits under a pension plan that are not contingent upon an employee’s continuing service area. Granted under a plan of defined contributionb. Based upon terminal fundingc. Actuarially unsoundd. Vested

Answer d

4. According to SFAS No. 87, “Employer’s Accounting for Pensions,” gains and losses should bea. Fully allocated to current and future periodsb. Offset against pension expense in the year of occurrence c. Allocated if any unrecognized gain or loss at the beginning of the year is in excess of 10

percent of the greater of the projected benefit obligation or the market value of the plan assetsd. Disclosed in a note to the financial statements only

Answer c

5. According to SFAS No. 87, prior service costs should bea. Charged to retained earnings as a cost relating to the pastb. Amortized over the service period of each employee expected to receive benefitsc. Taken into consideration only by expensing interest on the unfunded amountd. Recorded in full as a liability at their discounted present value

Answer b

6. According to SFAS No. 87, which of the following is never recorded as a component of annual pension cost?a. Amortization of the intangible asset recorded as the offset to the minimum pension liabilityb. Amortization of prior service costc. Amortization of gains and lossesd. Amortization of the transition amount

Answer a

7. In determining whether to accrue employee’s compensation for future absences, among the conditions that must be met are that the obligation relates to rights that

Accumulate Vesta. No Nob. No Yesc. Yes Nod. Yes Yes

Answer a

8. The funded status of a defined benefit pension plan is equal to thea. Vested benefit obligation minus the fair value of the pension plan assets.b. Accumulated benefit obligation minus the fair value of the pension plan assets.c. Projected benefit obligation minus the fair value of the pension plan assets.d. Projected benefits plus the fair value of the pension plan assets minus employer

contributions to the pension plan.

Answer c

9. If the projected benefit obligation of a defined benefit pension plan exceeds the fair value of the pension plan assets, the employer must report

a. The difference as a liability in the balance sheet and a corresponding adjustment to the amount of pension expense reported in earnings.

b. The difference as a liability in the balance sheet and a corresponding adjustment to other comprehensive income, net of deferred income taxes .

c. The difference as an asset in the balance sheet and a corresponding adjustment to the amount of pension expense reported in earnings.

d. The difference as an asset in the balance sheet and a corresponding adjustment to other comprehensive income, net of deferred income taxes.

Answer b

10. The funded status of a defined benefit pension plan is reported in the balance sheet. a. As an asset, if the pension plan is underfunded.b. As a liability, if the pension plan is underfunded.c. Because it measures the minimum pension plan liability.d. When it exceeds the projected benefit obligation.

Answer b

11. Some theorists argue that the best measure of the employer’s defined benefit pension plan obligation is the accumulated benefit obligation.a. Since the accumulated benefit obligation is measured using current salaries, it represents the

conservative floor for a company’s pension obligation to its employees.b. It is consistent with the measurement of pension expense.c. Since the accumulated benefit obligation is measured using future salaries, it represents the

conservative floor for a company’s pension obligation to its employees.d. The accumulated benefit obligation measures the present value of the amounts that

employees will receive from the pension plan once they retire.

Answer a

12. benefits that are not contingent on the employee continuing in the service of the company are a. Accumulated benefits.b. Projected benefits.c. Benefits earned to date.d. Vested benefits.

Answer d

13. The corridor approacha. Is used to determine how much interest to add to the service cost and amortization of prior

service in order to calculate pension expense for the period.

b. Is used to determine the minimum amount of accumulated unamortized net gains or losses that must be amortized during the accounting period.

c. Is used to determine the amount of prior service cost to expense each accounting period.d. Is use to determine the pension plan’s funded status.

Answer b

14. What effect did the requirement to replace the minimum liability requirement with the funded status of a pension plan have for underfunded pension plans?a. Return on assets decreased.b. There was no effect on return on assets.c. The debt-to-Equity ratios increased.d. Working capital increased.

Answer c

15. What effect did the requirement to replace the minimum liability requirement with the funded status of a pension plan have for overfunded pension plans?. a. Return on assets decreased.b. There was no effect on return on assets.c. The debt-to-Equity ratios increased.a. Return on common stockholders’ equity increased.

Answer a

16. Which of the following is not a difference between defined benefit pension plans and other postretirement benefits (ORBS)a. Unlike defined benefit pension plan payments, there is no cap on the amount of OORB

benefit to be paid to participants .b. Unlike defined benefit pension plans, management promises OORB payments in exchange

for current services.c. Unlike defined benefit pension plans, employees do not accumulate additional OORB

benefits with each year of service.d. Unlike defined benefit pension plans, OORBs do not vest.

Answer b

17. The expected postretirement benefit obligation (EPBO) isa. Similar to the defined benefit pension plan’s projected benefit obligation because it is the

obligation attributable to employee service rendered to date.b. Used to calculate the interest component of OORB expense before full eligibility is achieved.c. Recognized over the life expectancy of the employees when most participants are fully

eligible to receive benefits.

d. The actuarial present value of the total benefits expected to be paid assuming full eligibility is achieved.

Answer d

Essay

1. Discuss the difference between defined benefit and defined contribution pension plans.

A defined contribution plan sets forth a certain amount that the employer is to contribute to the plan each period. For example, the plan may require the employer to contribute 8 percent of the employee's salary each year. However, the plan makes no promises concerning the ultimate benefits to be paid. The retirement benefits actually received by the recipients are determined by the return earned on the invested pension funds during the investment period.

The terms of a defined benefit plan specify the amount of pension benefits to be paid out to plan recipients in the future. For example, the retirement plan of a company may promise that an employee retiring at age 65 will receive 2 percent of the average of the highest five years' salary for every year of service. An employee working for this company for thirty years will receive a pension for life equal to 60 percent of the average of his or her highest five salary years. Companies that provide defined benefit pension plans must make sufficient contributions to the funding agency in order to meet benefit requirements when they come due. Although no specific amount is required to be funded each period, the Employee Retirement Income Security Act (ERISA) does impose minimum funding requirements on these plans.

2. Discuss the cost approach and benefits approach actuarial funding methods.

The employer's actuarial funding method may be either a cost approach or a benefit approach. A cost approach estimates the total retirement benefits to be paid in the future and then determines the equal annual payment that will be necessary to fund those benefits. The annual payment necessary is adjusted for the amount of interest assumed to be earned by funds contributed to the plan.

A benefit approach determines the amount of pension benefits earned by employee service to date and then estimates the present value of those benefits. Two benefit approaches may be used: (1) the accumulated benefits approach and (2) the benefits/years of service approach. The major difference between these two methods is that under the accumulated benefits approach, the annual pension cost and liability are based on existing salary levels, whereas under the benefits/years of service approach (also called the projected unit credit method), the annual pension cost and liability are based on the estimated final pay at retirement. The liability for pension benefits under the accumulated benefits approach is termed the accumulated benefits obligation. The liability computed under the benefits/years of service approach is termed the projected benefit obligation.

3. Define the following components of pension cost: under SFAS No. 87 (FASB ASC 715):a. Service cost

The service cost component of pension cost is the actuarial present value of the benefits attributed by the pension formula to employee service for that period.

b. Interest cost

The interest cost component is the increase in the projected benefit obligation due to the passage of time. Recall that the pension liability is calculated on a discounted basis and accrues interest each year. The interest cost component is determined by accruing interest on the previous year's pension liability at the settlement-basis discount rate.

c. Return on plan assets

The return on plan assets component is the difference between the fair value of these assets from the beginning to the end of the period, adjusted for contributions, benefits, and payments. That is, the interest and dividends earned on the funds actually contributed to the pension fund, combined with changes in the market value of invested assets, will reduce the amount of net pension cost for the period. SFAS No. 87 allows the use of either the actual return or the expected return on plan assets when calculating this component of pension expense.

d. Amortization of unrecognized prior service cost

Prior service cost is the total cost of retroactive benefits at the date the pension plan is initiated or amended. Prior service cost is amortized over the expected remaining service period of each employee expected to receive benefits.

e. Amortization of gains and losses

Gains and losses include actuarial gains and losses or experience gains and losses. At a minimum, the amount of gain or loss to be amortized in a given period is the amount by which the cumulative unamortized gains and losses exceed what the pronouncement termed the

corridor. The corridor is defined as 10 percent of the greater of the projected benefit obligation or market value of the plan assets. The excess, if any, is divided by the average remaining service period of employees expected to receive benefits.

4. What four categories of information are required to be disclosed under the provisions of SFAS No. 35 (FASB ASC 960)?

The FASB ASC 960 guidelines require that pension plan financial statements include four basic categories of information:

1. Net assets available for benefits

2. Changes in net assets during the reporting period

3. The actuarial present value of accumulated plan benefits

4. The significant effects of factors such as plan amendments and changes in actuarial assumptions on the year-to-year change in the actuarial present value of accumulated plan benefits

5. Discuss the characteristics that make accounting for other postretirement benefits more difficult than accounting for pensions.

These characteristics are:

1. Defined benefit pension payments are determined by formula, whereas the future cash outlays for OORBs depend on the amount of services, such as medical care, that the employees will eventually receive. Unlike pension plan payments, there is no “cap” on the amount of benefits to be paid to participants. Hence, the future cash flows associated with OORBs are much more difficult to predict.

2. Unlike defined pension benefits, employees do not accumulate additional OORB benefits with each year of service.

3. OORBs do not vest. That is, employees who leave have no further claim to future benefits. Employees have no statutory right to vested health care benefits. Defined benefits are covered by stringent minimum vesting, participation, and funding standards, and are insured by the Pension Benefit Guaranty Corporation under ERISA. Health and other OORBs are explicitly excluded from ERISA.

6. What changes in accounting for pensions were required by SFAS No. 158 (FASB ASC 715)?

The FASB ASC 715 guidelines require recognition of the overfunded or underfunded status of a DBPP or OPBP as an asset or liability in a company's statement of financial position and to

recognize changes in that funded status in the year in which the changes occur through comprehensive income. That is, a company is required to:

1. Recognize the funded status of a benefit plan in its statement of financial position. This amount is to be measured as the difference between plan assets at fair value and the projected benefit obligation.

2. Recognize as a component of other comprehensive income, net of tax, the gains or losses, and prior service costs or credits that arise during the period but were not recognized as components of net periodic benefit cost.

3. Measure DBPP and OPBP assets and obligations as of the date of the benefit provider's fiscal year-end.

4. Disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation.