Compensation and Benefits

Question 1

What 4 conditions must be met for an employer to accrue a liability for compensated absences?

Answer 1

1. the employer’s obligation relating to employees’ rights to receive compensation for future absences is attributable to employees’ services already rendered
2. the obligation relates to rights that vest or accumulate
3. payment of the compensation is probable
4. the amount can be reasonable estimated

Question 2

When do employee rights vest?

Answer 2

The rights vest if the ER is obligated to make payment, even if the EE terminates. The right to compensated absences is not contingent on the EE’s future service

Question 3

When do employee rights accumulate?

Answer 3

The rights accumulate if earned, but unused rights to compensated absences may be carried forward to one or more periods subsequent to that in which they are earned

Question 4

FASB ASC 710-10-25-2 does not require an ER to accrue a liability for non-vesting accumulating rights to receive sick pay benefits. However, it notes what about sick pay?

Answer 4

In substance, sick pay benefits are not sick pay benefits even though they may be called sick pay benefits should not be treated as sick pay benefits for accounting purposes.

Question 5

What is the most common type of deferred compensation?

Answer 5

rabbi trust

Question 6

What is a rabbi trust?

Answer 6

This term is in reference to a tax arrangement allowed by a private letter ruling involving a rabbi

Question 7

Explain a grantor trust.

Answer 7

A grantor trust is set up to fund compensation for a group of managers or executives. The goal is to provide a benefit that is not taxable to the recipients until some later date when they actually receive compensation. To qualify for no current taxation, the trust agreement must explicitly state that the assets of the trust are available to satisfy the claims of general creditors in the event of bankruptcy of the ER.

Question 8

Postemployment benefits that meet the conditions for recognition of compensation absences are required to be recognized as expense and related liability if what 4 criteria are met?

Answer 8

1. the ER’s obligation related to EE benefits that are attributed to services already rendered
2. the obligation relates to rights that vest or accumulate
3. payment of the compensation is probable
4. the amount can be reasonable estimated

Question 9

If the 4 criteria for postemployment benefits are not met, how are the postemployment benefits recorded?

Answer 9

As a loss contingency

Question 10

If an obligation for postemployment benefits is not recognized in accordance with FASB because the amount cannot be reasonable estimate, what should be done?

Answer 10

The entity must disclose the fact in the FS

Question 11

What is a pension plan?

Answer 11

It is an arrangement whereby a company provides benefits that can be determined or estimated in advance to its retired EEs. It is best thought of as deferred compensation in which EEs receive a portion of their earned compensation after retirement

Question 12

Who are the 3 parties to a pension plan?

Answer 12

1. employer: the company establishing the plan for the benefit of its EE
2. employees: individuals who quality to receive benefits under the pension plan
3. trustee: a financial institute that accepts contributions from the ER, invests those funds and administers payments to EEs

Question 13

Under GAAP, how are pension plans accounted for?

Answer 13

by accrual accounting

Question 14

What are the 2 general types of pension plans?

Answer 14

1. defined contribution plans

2. defined benefits plan

Question 15

Explain defined contribution pension plans.

Answer 15

Payments to EEs are based on the amount contributed into the plan based on an agreed-upon formula between the ER and EEs. The EEs assume the investment risk on the plan and the ER’s obligation is satisfied on funding the specified amount of contribution

Question 16

Explain defied benefits pension plan.

Answer 16

Benefits to be received by EEs in the future are defined, rather than the contribution the ER must make. Benefits are to be paid as a result of many estimates and assumptions about salary levels, retirement ages, EE turnover, etc. The ER bears the risk of return on the plan assets because the ERs obligation is to provide funds sufficient to pay a defined level of benefits rather than to contribute a specified amount into the pension fund.

Question 17

What is actuarial assumptions in benefit pension plans?

Answer 17

estimates of future events affecting pension costs such as mortality, withdrawal from workforce, disablement and retirement, changes in compensation and discount (interest) rates to reflect the time value of money

Question 18

What is projected benefit obligation in benefit pension plans?

Answer 18

The actuarial present value as of a date of all benefits attributed by the pension benefit formula to EE services rendered to that date. The PBO is measure using assumptions as to future compensation levels if the pension benefit formula is based on those future compensation levels.

Question 19

What is accumulated benefit obligation in benefit pension plans?

Answer 19

The actuarial present value as of a specified date of the benefits attributed by the pension benefit formula to EE services rendered before that date and based on compensation prior to that date. The ABO differs from the PBO in that it includes no assumption concerning future compensation levels.

Question 20

What is Fair value of plan assets in benefit pension plans?

Answer 20

The amount that a pension plan could reasonable expect to receive for an investment in a current sale between a willing buyer and a willing seller.

Question 21

What is prior service cost in benefit pension plans?

Answer 21

The cost of granting the benefits of a plan amendment retroactively to EE who provided services before the plan amendment.

Question 22

Define a settlement of a pension plan.

Answer 22

It is an irrevocable action that relieves the ER (or the plan) of primary responsibility for an obligation and eliminates significant risks related to the obligation and the assets used to effect the settlement.

Question 23

Define a curtailment of a pension plan.

Answer 23

It is defined as a significant reduction in, or elimination of, defined benefit accruals for present EEs’ future services.

Question 24

Amounts resulting from settlement or curtailment of defined benefit pension plans are generally required to be recognized when?

Answer 24

immediately rather than delayed

Question 25

FASB ASC 715-20-45-2 requires an entity to recognize on its BS the full overfunded or underfunded status of its defined benefit pension plans. How do you know if the fund is overfunded/underfunded?

Answer 25

The status is the difference between the FV of the plan assets and the projected benefit obligation. Thus from a BS standpoint, the requirements of FASB are a significant step in the direction of requiring an entity to recognize defined benefit pension plans on a FV basis.

Question 26

Pension expense represents the amount of pension expense during a period under current GAAP. What 5 components either increase or decrease the amount of pension expense?

Answer 26

1. service cost - the portion of pension expense that represents an estimate of the increase in pension benefits payable (specifically, the increase in the projected benefit obligation) as a result of EE services rendered during the current period
2. interest cost - the portion of pension expense that represents the increase in the projected benefit obligation as a result of the passage of time. The fact that at the end of the year the payment of the pension benefits is closer in time than it was at the beginning of the year causes the present value of the pension benefit obligation to increase. The interest cost component causes an increase in pension expense
3. return on plan assets - an increase in the plan assets (ex: dividends received and increases in the FV of investments held by the plan) causes the net cost of the pension plan to the ER to be less than it otherwise would be. The amount recognized in the current period as a reduction of pension expense is the estimated return on plan assets, not the actual return. The estimated return on plan assets that is credited to pension expense during the period is calculated by multiplying the expected rate of return times the FV of the pan assets at the beginning of the year. The actual return is recognized as a component of other comprehensive income
4. gain or loss recognition - The unrealized gains/losses association with changes in the FV of the plan assets and with changes in the projected benefit obligation are recognized as components of other comprehensive income. In certain cases, GAAP may require the recognition of a portion of these gains/losses as a component of pension expense. The recognition of a gain would decrease pension expense whereas the recognition of a loss would increase pension expense. The gain/loss included in pension expense would be reflected as a reduction of the remaining unrecognized gain/loss included in accumulated other comprehensive income
5. prior service cost amortization - when plan amendments are made, additional benefits are sometimes applied retroactively to EE for service rendered in prior years. This increase represents a cost to the ER. GAAP requires that this cost be recognized as a component of pension expense over the remaining service years of the affected EEs. FASB requires that the unrecognized prior service cost be recognized as a component of other comprehensive income. The amortization of the unrecognized prior service cost is recognized as increase in pension expense and as a reduction of the unrecognized amount remaining in accumulated other comprehensive income.

Question 27

In addition to the five components of pension expense, a component representing the amortization of a transition asset or obligation may be encountered. What is the transition asset or obligation?

Answer 27

The transition asset or obligation is the unrecognized asset or obligation stemming from the initial application of FASB which notes that any remaining unrecognized transition asset or obligation be recognized as an adjustment of accumulated other comprehensive income.

Question 28

To prevent the accumulated other comprehensive income related to unrealized gains and losses from getting too large, current GAAP utilizes a corridor approach. What is this approach?

Answer 28

Under this approach, the accumulated other comprehensive income related to unrealized gains/losses does not have to be amortized (included in the determination of pension expense) as long as the balance in that particular accum other compreh income does not exceed 10% of the larger of the beginning of year balances in the projected benefit obligation or the market-related value of the plan assets. The market related value can be either fair market value or a calculated value that recognizes changes in FV in a systematic and rational manner over not more than 5 years. The market related value is assumed to be the same as FV. If it does exceed this limit, the excess must be amortized over the average remaining service period of active EEs who are expected to receive benefits under the plan.

Question 29

What 3 categories do changes in plan assets and or projected benefit obligations fall into excluding contributions and benefits paid?

Answer 29

1. changes due to unrecognized gains/losses
2. changes due to prior service cost
3. changes associated with a transition asset or obligation.

Question 30

What 4 things must be included in defined benefit pension plans financial statements?

Answer 30

1. the net assets available for benefits as of the end of the plan year
2. the changes in net assets during the plan year
3. the actuarial present value of accumulated plan benefits as of either the beginning or end of the plan year
4. the effects, if significant, of certain factors affecting the year to year change in the actuarial present value of accumulated plan benefits

Question 31

List 3 miscellaneous additional provisions of FASB ASC 960 (Plan accounting - defined benefit pension plans).

Answer 31

1. information regarding net assets is to be prepared on the accrual basis
2. plan investments (excluding contracts with insurance companies) are to be presented at FV. Contracts with insurance companies are to be presented in the same way as in the plan’s annual report to certain governmental agencies pursuant to the ERISA. Plans not subject to ERISA are to account for their contracts with insurance companies as if they also filed that annual report
3. participants’ accumulated plan benefits are those future benefit payments that are attributable under the plan’s provisions to EE services rendered to the benefit information date. The primary information regarding participants’ accumulated plan benefits reported in plan FS is their actuarial present value

Question 32

What does FASB require of a defined benefit pension plan to report an investment contract issued by either an insurance enterprise or other entity?

Answer 32

It must be reported at FV. It permits a defined benefit pension plan to report only contracts that incorporate mortality or morbidity risk at contract value.

Question 33

How are the various types of stock options and other equity plans accounted for their officers and key employees?

Answer 33

It requires the enterprise to use the fair value method.

Question 34

What is the intrinsic value method?

Answer 34

Under this method, the amount of compensation cost is the excess of the market price of the stock at the measurement date (usually the grant date) over the exercise price (the amount the EE must pay for the stock at the date of exercise). It is usually only available when FV cannot be estimated

Question 35

There are non-compensatory stock purchase plans that allow EE to buy shares of corp stock but are not treated as a compensation expense. What 3 things do these plans require?

Answer 35

1. substantially all FT EEs meeting limited employment qualifications may participate
2. the time permitted for plan enrollment of an option or purchase right is limited to a reasonable period, not exceeding 3 days
3. the discount from the market price of the stock is no greater than would be reasonable in an offer of stock to stockholders or others.

Question 36

FASB ASC 718-10-30-2 requires the FV method. It applies to all share-based payment plans except for what?

Answer 36

equity instruments held by an EE stock ownership plan (ESOP)

Question 37

What does fair value method recognize on share-based payment plans?

Answer 37

The cost of consideration received for EE services at FV of the equity instruments issued. The objective of the measurement process is to estimate the FV at the grant date of the stock options and other equity instruments to which EEs are entitled when they have rendered the required services and satisfied all other conditions necessary to earn the right to benefit from the instrument

Question 38

The FV of an equity share (ex stock option) should be based on the observable market price of a share with the same or similar terms and conditions, if one is available. If an observable market price is not available, what valuation technique should be used?

Answer 38

The FV should be estimated using an acceptable valuation technique. FASB specifies that the technique should be on that

1. is applied in a manner consistent with the FV measurement objective of FASB ASC 718-10-30-6
2. is based on established principles of financial economic theory and generally applied in that field and
3. reflects all substantive characteristics of the instruments

Question 39

What is the valuation technique known as a lattice model?

Answer 39

It is one that produces an estimated FV based on the assumed changes in prices of a financial instrument over successive periods of time. An example is the binomial model.

Question 40

What is the valuation technique known as a closed-form model?

Answer 40

It is one that uses an equation to produce an estimated FV. The Black-Scholes-Merton formula is an example of this technique

Question 41

For a share option or similar instrument, the valuation technique or model must meet and take into consideration what 6 criteria?

Answer 41

1. exercise price of the option
2. expected term of the option
3. current price of the underlying share
4. expected volatility of the price of the underlying share for the expected term of the option
5. expected dividends on the underlying share for the expected term of the option
6. risk-free interest rate for the expected term of the option

Question 42

Some awards of share-based compensation necessitate the recognition of a liability by the issuing entity because the EEs can require the entity to settle the award how?

Answer 42

by transferring assets (cash) to EEs rather than issuing equity instruments.

Question 43

Compensation cost for plans including share appreciation rights or other variable plan awards are measured how?

Answer 43

according to the terms the EE is mostly likely to choose based on the information available each period.

Question 44

How does the entity measure and recognize awards?

Answer 44

The amount of the liability each period is based on the current FV of the award at the end of the period. The effects of the changes in the liability during the service period are recognized as compensation cost over the service period. Changes in the liability due to changes in FV of the award after the service period are compensation costs of the period in which the changes occur