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Chapter 17 Flashcards

1
Q

Pension plans often enhance productivity, reduce turnover, satisfy union demands, and allow employers to compete in the labor market. true or false?

A

true. This is accomplished by setting aside funds during an employee’s working years so that at retirement the accumulated funds plus earnings from investing those funds are available to replace wages

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2
Q

A pension formula typically defines retirement pay based on the employees’ years of service, annual compensation, and sometimes age. True or False?

A

True

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3
Q

Define an Actuary

A

A professional trained in a particular branch of statistics and mathematics, to assess the various uncertainties (employee turnover, salary levels, mortality, etc.) and to estimate the company’s obligation to employees in connection with its pension plan.

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4
Q

Unions typically oppose pension plans. true or false?

A

False - Motivation to sponsor a plan sometimes comes from union demands and often relates to being competitive in the labor market. Other factors include providing employees with a degree of retirement security. This security also can induce a degree of job satisfaction and perhaps loyalty that might enhance productivity and reduce turnover

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5
Q

Difference between Defined Contribution and Defined Benefit plans

A

Defined Contribution: promise fixed annual contributions to a pension fund (say, 5% of the employees’ pay). Employees choose (from designated options) where funds are invested—usually stocks or fixed-income securities. Retirement pay depends on the size of the fund at retirement. Defined Benefit: promise fixed retirement benefits defined by a designated formula. Typically, the pension formula bases retirement pay on the employees’ (a) years of service, (b) annual compensation (often final pay or an average for the last few years), and sometimes (c) age. Employers are responsible for ensuring that sufficient funds are available to provide promised benefits.

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6
Q

Today, approximately three-fourths of workers covered by pension plans are covered by defined benefit plans. True or False?

A

False: Today, approximately three-fourths of workers covered by pension plans are covered by defined contribution plans, roughly one-fourth by defined benefit plans.

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7
Q

Uncertainties complicate determining how much to set aside each year to ensure that sufficient funds are available to provide promised benefits. in defined contribution plans.

A

False - this is a characteristic of Defined Benefit Plans. This is particularly true when pension benefits are defined by a pension formula, as usually is the case. A typical formula might specify that a retiree will receive annual retirement benefits based on the employee’s years of service and annual pay at retirement (say, pay level in the final year, highest pay achieved, or average pay in the last two or more years).

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8
Q

For defined contribution plans, the employee would bear the risk of uncertain investment returns. True or False?

A

True. The employee would bear the risk of uncertain investment returns and, potentially, settle for far less at retirement than at first expected. Risk is reversed in a defined benefit plan. Because specific benefits are promised at retirement, the employer would be responsible for making up the difference when investment performance is less than expected.

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9
Q

Defined contribution plans promise defined periodic contributions to a pension fund, without further commitment regarding benefit amounts at retirement. True or false?

A

True

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10
Q

Since actuarial estimates are inherently subjective, estimates invariably deviate from the actual outcome to one degree or another For instance, the return on assets can turn out to be more or less than expected. These deviations are referred to as gains and losses. True or False?

A

True. Pension gains and losses occur when the pension obligation is LOWER (gain) or HIGHER (loss) than expected. Pension gains and losses occur when the return on plan assets is higher or lower than expected.

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11
Q

The key elements of a defined benefit pension plan are:

A
  1. The employer’s obligation to pay retirement benefits in the future. 2. The plan assets set aside by the employer from which to pay the retirement benefits in the future. 3. The periodic expense of having a pension plan. The first two of these elements are not reported individually in the employer’s financial statements. This may seem confusing at first because it is inconsistent with the way you’re accustomed to treating assets and liabilities. Even though they are not separately reported, it’s critical that you understand the composition of both the pension obligation and the plan assets because (a) they are reported as a net amount in the balance sheet, and (b) their balances are reported in disclosure notes.
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12
Q

Why are virtually all new pension plans are defined contribution plans.

A

1.Government regulations make defined benefit plans cumbersome and costly to administer. 2.Employers are increasingly unwilling to bear the risk of defined benefit plans; with defined contribution plans, the company’s obligation ends when contributions are made. 3.There has been a shift among many employers from trying to “buy long-term loyalty” (with defined benefit plans) to trying to attract new talent (with more mobile defined contribution plans).

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13
Q

True or False - the ABO is the portion of the accumulated benefit obligation that plan participants are entitled to receive regardless of their continued employment.

A

False. That is the Vested Benefit Obligation (VBO). ABO is The actuary’s estimate of the total retirement benefits (at their discounted present value) earned so far by employees, applying the pension formula using existing compensation levels.

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14
Q

True or False? If the pension formula does not include future compensation levels, the PBO and the ABO are the same

A

true

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15
Q

What is the Projected Benefit Obligation?

A

Projected benefit obligation (PBO) The actuary’s estimate of the total retirement benefit (at their discounted present value) earned so far by employees, applying the pension formula using estimated future compensation levels. (If the pension formula does not include future compensation levels, the PBO and the ABO are the same.)

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16
Q

Difference between the PBO and ABO?

A

Accumulated benefit obligation (ABO) - The actuary’s estimate of the total retirement benefits (at their discounted present value) earned so far by employees, applying the pension formula using existing compensation levels. Projected benefit obligation (PBO) The actuary’s estimate of the total retirement benefit (at their discounted present value) earned so far by employees, applying the pension formula using estimated future compensation levels. (If the pension formula does not include future compensation levels, the PBO and the ABO are the same.)

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17
Q

. The amount can be calculated directly as the assumed discount rate multiplied by the projected benefit obligation at the beginning of the year.

A

Interest Cost. Even though the projected benefit obligation is not formally recognized as a liability in the company’s balance sheet, it is a liability nevertheless. And, as with other liabilities, interest accrues on its balance as time passe

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18
Q

This represents the increase in the projected benefit obligation attributable to employee service performed during the period.

A

Service Cost

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19
Q

When the ABO is estimated, the most recent salary is included in the pension formula to estimate future benefits. True or false?

A

True. When the ABO is estimated, the most recent salary is included in the pension formula to estimate future benefits, even if the pension formula specifies the final year’s salary. No attempt is made to forecast what that salary would be the year before retirement.

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20
Q

True or False - A prior service cost arises when the pension plan itself is amended to revise the way benefits are determined

A

True - When a pension plan is amended, credit often is given for employee service rendered in prior years. The cost of doing so is called prior service cost. Applied retroactively so employees won’t get upset.

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21
Q

Most VBO’s are vested in five years. True or false?

A

True - Today, benefits must vest (a) fully within five years or (b) 20% within three years with another 20% vesting each subsequent year until fully vested after seven years. Five-year vesting is most common.

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22
Q

Define a Gain or Loss on PBO

A

Decreases and increases in estimates of the PBO because of periodic re-evaluation of uncertainties are called gains and losses. When one or more of these estimates requires revision, the estimate of the PBO also will require revision. The resulting decrease or increase in the PBO is referred to as a gain or loss, respectively.

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23
Q

Pension Plan Assets must be recorded in the disclosure notes as well

A

Its separate balance, too, must be reported in the disclosure notes to the financial statements (as does the separate PBO balance

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24
Q

Define Pension Plan Assets

A

employer contributions and accumulated earnings on the investment of those contributions to be used to pay retirement benefits to retired employees. . Like the PBO, the pension plan assets are not reported separately in the employer’s balance sheet but are netted together with the PBO to report either a net pension asset (debit balance) or a net pension liability (credit balance).

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25
Payment of retirement benefits increases the PBO. True or false?
False - Reduces PBO
26
A trustee accepts employer contributions, invests the contributions, accumulates the earnings on the investments, and pays benefits from the plan assets. True or False?
True
27
BO at the end of 2013 is $450 million. Because the plan assets are only $340 million, the pension plan is said to be underfunded/overfunded?
Underfunded. An underfunded pension plan means the PBO exceeds plan assets. It is not unusual for pension plans today to be underfunded. An overfunded pension plan means plan assets exceed the PBO.
28
Estimated long-term return on invested assets. are also known as:
Expected return on plan assets. When an employer estimates how much it must set aside each year to accumulate sufficient funds to pay retirement benefits as they come due, it's necessary to estimate the return those investments will produce. The higher the return, the less the employer must actually contribute. On the other hand, a relatively low return means the difference must be made up by higher contributions.
29
The assets of a pension fund must be held by a trustee. True or false?
True. A trustee accepts employer contributions, invests the contributions, accumulates the earnings on the investments, and pays benefits from the plan assets to retired employees or their beneficiaries. The trustee can be an individual, a bank, or a trust company. Plan assets are invested in stocks, bonds, and other income-producing assets.
30
Example of Pension Expense
Figure 17-12
31
Like wages, salaries, commissions, and other forms of pay, pension expense is part of a company's compensation for employee services each year. But what is different about Pension Expense?
the fact that this form of compensation actually is paid to employees many years after the service is performed means that other elements in addition to the annual service cost will affect the ultimate pension cost. See slide 27
32
Overfunding and Underfunding are examples of Funded Status. Define the Funded Status
Though firms don't report PBO or Plan assets seperately on the balance sheet, they do report the difference betweed these two amounts. this is the "Funded Status". PBO - Fair Value of Plan Assets (if pbo larger) = Underfunded Status. Fair Value of Plan Assets - PBO = Overfunded Status
33
Low interest rates hurt plans' funded status. True or false?
True. . Low interest rates hurt plans' funded status because the pension obligation is a present value calculation that increases with a lower discount rate. Even small interest rate changes have big effects on funded status.
34
Is the Expected or Actual return included in the calculation of Pension Expense?
Expected! FASB concluded that the actual return should first be adjusted by any difference between that return and what the return had been expected to be. So, it's actually the expected return that is included in the calculation of pension expense. difference between the actual and expected return is considered a loss or gain on plan assets. Any loss or gain is not included in pension expense right away
35
Interest cost is the discount rate times the PBO balance at the beginning of the year for Pension Expense. True or False?
True.
36
When Calculating Pension Expense, an Amortization of Prior Service Cost may be a component. Why is Prior Service Cost amortized?
Prior service cost is recognized as pension expense over the future service period of the employees whose benefits are recalculated. Amending a pension plan, and especially choosing to make that amendment retroactive, typically is done with the idea that future operations will benefit from those choices. For that reason, the cost is not recognized as pension expense in the year the plan is amended. Instead, it 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..
37
True or False - Service Cost each year is the first component of Pension Expense
True
38
Prior Service Costs are beneficial in retaining employees. Are they considered assets/liabilities/AOCI?
AOCI. This is a result of the FASB's disinclination to treat the cost as an expense as it is incurred. The Board, instead, prefers to ascribe it the off-the-income-statement designation as other comprehensive income (OCI) in the same manner as the handful of losses and gains also categorized the same way and not reported among the gains and losses in the traditional income statement.
39
True or False - Prior service cost is expensed as it is incurred.
False - Prior service cost is not expensed as it is incurred. Instead, it is reported as a component of AOCI to be amortized over time.
40
What two possible components of Pension Expense are amortized?
Prior Service Costs and Amortization of Net Loss or Gains. We report both components as OCI
41
For 2013, the actual return on plan assets exceeded the expected return by $3 million. In addition, there was a $23 million loss from changes made by the actuary when it revised its estimate of future salary levels causing its PBO estimate to increase. Global would make the following journal entry to record the gain and loss:
Loss-OCI - 23 PBO 23 Plan Assets 3 Gain - OCI 3 If the change in assumption had caused the PBO to be reduced instead, we would debit the PBO here and credit a gain–OCI. Of course, if the actual return had been less than expected, we would debit a loss–OCI and credit plan assets here.
42
If a net gain were being amortized, the amount would be added to pension expense. True or False?
False - If a net gain were being amortized, the amount would be deducted from pension expense because a gain would indicate that the net cost of providing the pension plan had decreased. Amortization of a net gain would decrease pension expense. Amortization of a net loss increases pension expense.
43
A net gain or a net loss affects pension expense only if it exceeds an amount equal to 10% of the PBO, or 10% of plan assets, whichever is higher. True or False?
True, this is known as the corridor amount. When the corridor is exceeded, the excess is not charged to pension expense all at once. Instead, as a further concession to income smoothing, only a portion of the excess is included in pension expense.
44
Whilst Recording Pension Expense, PBO is credited and made up of these two components:
Service Cost and Interest Cost
45
Define Comprehensive Income
Comprehensive income, as you may recall from Chapter 4, is a more expansive view of income than traditional net income. In fact, it encompasses all changes in equity other than from transactions with owners.24 So, in addition to net income, comprehensive income includes up to four other changes in equity. Other comprehensive income (OCI) items are reported both (a) as they occur and then (b) as an accumulated balance within shareholder's equity in the balance shee
46
When an entity adds its annual cash investment to its plan assets, these are known as
Cash Contributions
47
Whilst computing and recording Pension Expense, which two components are credited and amortized?
Prior Service Cost - AOCI Net Loss - AOCI. If we were amortizing a net gain, we would debit the account because a net gain has a credit balance (these are contra-accounts)
48
Difference between Defined Contribution Plans and Defined Benefit Plans?
See slide 4
49
Journal Entry for a Defined Contribution Pension Plan
Let’s assume that the annual contribution is to be 3% of an employee’s salary. If an employee earned $110,000 during the year, the company would make the following entry: (slide 6)
50
One of the requirements for a pension plan to qualify for special tax treatment is that it must Cover at least 60% of employees. True or False?
False - -Cover at least 70% of employees. -Cannot discriminate in favor of highly compensated employees. -Must be funded in advance of retirement through an irrevocable trust fund. -Benefits must vest after a specified period of service. -Complies with timing and amount of contributions.
51
that at retirement the accumulated funds plus earnings from investing those funds are available to replace wages. True or False?
True. Pension plans are designed to provide income to individuals during their retirement years. This is accomplished by setting aside funds during an employee’s working years so that at retirement the accumulated funds plus earnings from investing those funds are available to replace wages.
52
Three key elements of a Defined Benefit Pension Plan
See Slide 9
53
Example of a Defined Benefit Pension Plan
See Slide 8
54
The employee’s retirement benefits are totally dependent upon how well investments perform for defined contribution pension plans. True or False?
True.
55
Differences between three types of Pension Obligations?
See slide 11
56
Another way of seeing Pension Obligations -
See slide 12
57
The annual pension expense reflects changes in both the pension obligation and the plan assets. True or False?
True.
58
Example of PBO - Jessica Farrow was hired by Global Communications in 2002. Farrow is expected to retire in 2041 after 40 years of service. Her retirement period is expected to be 20 years. At the end of 2011, 10 years after being hired, her salary is $100,000. The interest rate is 6%. The company’s actuary projects Farrow’s salary to be $400,000 at retirement.
The formula is given by the company. See Slide 14. Pay close attention to amount of years taken up at each step.
59
Components of Pension Expense
See Slide 10
60
Three key elements of a Defined Contribution Pension Plan
1. Contributions are defined by agreement. 2. Employer deposits an agreed-upon amount into an employee-directed investment fund. 3. Employee bears all risk of pension fund performance.
61
Five events that chagne PBO?
see Slide 16
62
Prior service cost is the increase in the PBO due to a plan change that provides credit for employee service rendered in prior years.. True or false?
True.
63
If the actuary’s estimate of the final salary has not changed, the PBO a year later at the end of 2012 would be lower. True or false?
False. Would be higher - 1. One more service year is included in the pension formula calculation (service cost). 2.The employee is one year closer to retirement, causing the present value of benefits to increase due to the time value of future benefits (interest cost).
64
EG of PBO calculation
See slide 22
65
Interest Cost is calculated as Discount rate multiplied by
PBO Beg Balance
66
For Pension Expense - Is acutal or expected return used?
Expected
67
Eg of Plan AssetsCalculation
See slide 24
68
In 2012, Global Communications amended the pension plan, increasing the PBO at that time. For all plan participants, the prior service cost was $60 million at 1/1/12. The average remaining service life of the active employee group is 15 years. Amortization of Prior Service Cost
$60 million PSC ÷ 15 = $4 million per year
69
See Gains and Losses summary
See slide 32
70
What is journal entry of funding of plan assets When Global adds its annual cash investment of $48 million to its plan assets?
See slikde 39
71
Eg of Pension Expense
See slikde 36
72
See journal of Pension Expense (slide 38)
slikde 38
73
When Global pays $38 million in retirement pension benefits, what does the entry look like?
slikde 40
74
For 2013, the actual return on plan assets exceeded the expected return by $3 million. In addition, there was a $23 million loss from changes made by the actuary when it revised its estimate of future salary levels causing its PBO estimate to increase. Global would make the following journal entry to record the gain and loss:
See Slide 37. Of course, know opppsite effects as well
75
EG of Comprehensive Income with effects
Comprehensive income is a more expansive view of income than traditional net income.
76
Where would the comprehensive income affects be on the balance sheet?
See slide 44
77
Pension plan assets were $300 million at the beginning of the year. The return on plan assets was 5%. At the end of the year, retiree benefits paid by the trustee were $13 million and cash invested in the pension fund was $17 million. Is that return on plan assets included?
Yes, even tho it doesn't say "actual"
78
The projected benefit obligation was $460 million at the beginning of the year. Service cost for the year was $25 million. At the end of the year, pension benefits paid by the trustee were $21 million and there were no pension-related other comprehensive income accounts requiring amortization. The actuary’s discount rate was 5%.Does this have any relevance?
Yes, take .05 of the PBO to get 23, which is added to PBO.
79
The pension plan was amended last year, creating a prior service cost of $90 million. Service cost and interest cost for the year were $28 million and $13 million, respectively. At the end of the year, there was a negligible balance in the net gain–pensions account. The actual return on plan assets was $13 million although it was expected to be $14 million. On average, employees’ remaining service life with the company is 15 years. How is amrotization of Prior Service Cost found?
Amortization of prior service cost is the Prior Service Cost divided by employee's remaining service life
80
The projected benefit obligation was $60 million at the beginning of the year. Service cost for the year was $12 million. At the end of the year, pension benefits paid by the trustee were $7 million and there were no pension-related other comprehensive income accounts requiring amortization. The actuary’s discount rate was 5%. The actual return on plan assets was $6 million although it was expected to be only $5 million.
Service + Interest + Expected Return. DO NOT use PBO as Beg. Balance like you did initially.
81
JDS Foods’ projected benefit obligation, accumulated benefit obligation, and plan assets were $65 million, $55 million, and $37 million, respectively, at the end of the year. What, if any, pension liability must be reported in the balance sheet?
28. Since PBO is higher than Plan Assets, makes a Net Pension Liability. Say Plan assets were higher, like 89 Million - Would be a net pension asset of 24.
82
When are corridor amounts utilized?
When analyzing net gains or losses. Take the Net amount, subtract is from the corridor amount if it exceeds it (10% of PBO or Plan Assets), then amortize that excess amount (if any).
83
Whilst recording Pension Expense, the Plan Assets are debited the expected return. True or false?
True
84
Data indicates that Expected return on plan assets is 10% Actual return on plan assets is 11% Are these multipled by the PBO or Plan Assets?
Plan Assets
85
Data indicates that Interest rate is 6%. Is this multiplied by PBO or Plan Assets?
PBO
86
Record benefit payments.. You keep forgetting the debit.
PBO 18 Plan Assets 18
87
Sachs Brands' defined benefit pension plan specifies annual retirement benefits equal to: 1.6% × service years × final year's salary, payable at the end of each year. Angela Davenport was hired by Sachs at the beginning of 1999 and is expected to retire at the end of 2033 after 35 years' service. Her retirement is expected to span 18 years. Davenport's salary is $90,000 at the end of 2013 and the company's actuary projects her salary to be $240,000 at retirement. The actuary's discount rate is 7%. What is service years?
15 service years AS OF date. (1999-2013)
88
Sachs Brands' defined benefit pension plan specifies annual retirement benefits equal to: 1.6% × service years × final year's salary, payable at the end of each year. Angela Davenport was hired by Sachs at the beginning of 1999 and is expected to retire at the end of 2033 after 35 years' service. Her retirement is expected to span 18 years. Davenport's salary is $90,000 at the end of 2013 and the company's actuary projects her salary to be $240,000 at retirement. The actuary's discount rate is 7%. What is the company's projected benefit obligation at the end of 2013 with respect to Davenport?
First, need to find present value of the retirement annuity as of the retirement date (end of 2033): $57,600 × 10.05909\* = $579,404 The PBO is the present value of the retirement benefits at the end of 2013: $579,404 × 0.25842\* = $149,730
89
When is a corridor amount necessary?
When calculating AMORTIZATION of net loss or gain
90
Sachs Brands' defined benefit pension plan specifies annual retirement benefits equal to: 1.6% × service years × final year's salary, payable at the end of each year. Angela Davenport was hired by Sachs at the beginning of 1999 and is expected to retire at the end of 2033 after 35 years' service. Her retirement is expected to span 18 years. Davenport's salary is $90,000 at the end of 2013 and the company's actuary projects her salary to be $240,000 at retirement. The actuary's discount rate is 7%. If no estimates are changed in the meantime, what will be the company's projected benefit obligation at the end of 2016 (three years later) with respect to Davenport?
Same as prior approach, just add 3 to service years 1.6% × 18 × $240,000 = $69,120 $69,120 × 10.05909\* = $695,284 $695,284 × 0.31657\*\* = $220,106
91
How to find a prior service cost that arose as a result of an amendment change?
Find PBO with and without amendment, difference is PSC
92
How to amortize prior service cost?
Take the PSC (difference of PBOs before and after amendment), divide by service years remaining
93
To find service cost for one year in regards to a person
Do PBO formula but for just 1 year. 1.75% × 1 × $240,000 = $4,200 $4,200 × 10.05909\* = $42,248 $42,248 × 0.27651\*\* = $11,682
94
Interest cost with respect to an indivudal is the
discount rate multiplied by PBO (new PBO if amendment)
95
Record the prior service cost
Debit: Prior Service Cost - OCI Credit: PBO
96
Record any Gain or Loss in PBO
Could be a gain or loss from change in plan. IF GAIN: DR PBO and CR Gain - OCI IF LOSS: DR Loss-OCI and CR PBO
97
Record any gain or loss in Plan Assets.
if Gain: DR Plan Assets and Credit Gain-OCI IF LOSS: DR Loss - OCI and CR Plan Assets
98
If says "report CHANGE in PBO or Plan Assets", what does change mean?
NOT gain or loss. If PBO, change represents benefits paid. If Plan Assets, means cash contributions added
99
If asked for current balance of Prior Service Cost:
take amount subtracted by the amount from amortized years (1 year's worth if first year)
100
If need the Net Gain in OCI -
101
T-Account for a Gains or Losses (include the difference between actual and expected return)

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