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a312 > Exam 3 > Flashcards

Exam 3 Flashcards

1
Q

Plan sponsor

A

-Employer, makes payments into the fund

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2
Q

Plan participants

A

-Current or former employees, beneficiaries of the plan, receive retirement benefits from fund as “additional compensation” for work performed prior to retirement

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3
Q

Why do employers establish pension plans?

A
  • Increase employee motivation and productivity
  • Reduce current demand for pay increases
  • Reduce turnover
  • Comply with union contracts
  • Remain competitive in the labor market
  • Generate tax benefits
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4
Q

Qualified pension plans

A

Qualified receive beneficial tax treatment

  • Employees: not taxed on contributions made to plan, not taxed on earnings, taxed when withdrawing pension amounts (deferred)
  • Employers: receive a tax deduction for contributions to the plan, exclude pension fund earnings from taxable income
  • Non-qualified receive no tax benefits
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5
Q

Defined Contribution Plan

A
  • Contribution that employer makes is specified based on a formula that considers years of service, salary, etc
  • Employee’s retirement depends on how much the contributions earn between now and retirement
  • Employee bears the risk
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6
Q

Contributory vs. Non-contributory

A

Contributory: employee bears part of the cost of contributions or can make additional payments
Non: employer bears the full cost

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7
Q

Defined benefit plan

A
  • Employer bears the risk
  • Commits employer to pay specified retirement benefits to employees after retirement
  • Benefits are established by a pension benefit formula but periodic contributions not specified
  • Most pension plans to arise from collective bargaining are defined benefit
  • Annual payments to receive during reitrement are usually (percent)(years of service)(avg highest salary)
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8
Q

ERISA

A

Employee Retirement Security Act, minimum contribution a company must make to ensure plan heath

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9
Q

PBGC

A

Government entity, guarantees minimum benefits

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10
Q

Pension Liability

A
  • By initiating a pension plan, company entails a liability (future obligation attributable to current or past benefits received)
  • Theoretically, should reflect the PV of retirement payments to be made in the future due to cumulative service performed to date
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11
Q

Pension Asset

A

-Plans are the sum of all the contributions a company makes to the pension fund plus earnings

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12
Q

PBO

A

Plan Benefit Obligation

  • Actuarial PV of the benefits attributed to employee services rendered to date
  • PV of all benefits earned as of right now
  • Based on expected final salarY
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13
Q

ABO

A

Accumulated Benefit Obligation

  • Obligation for benefits the employee is expected to receive using current salary levels
  • Represents potential obligation faced by tteh firm if the plan is discontinued
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14
Q

Vesting

A
  • Employers often require work for a certain amount of years before they can receive full benefits
  • Either 100% vesting after 5 years or vesting schedule
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15
Q

VBO

A

Vesting Benefit Obligation

  • VBO is the present value of all vested benefits employees have earned to date based on current salaries
  • PBO>=ABO>=VBO
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16
Q

Plan assets

A
  • Investments (bonds, stocks, etc) and operational assets used in administering pension fund
  • Funds are restricted to payment and administration of pension plan benefits
  • Assets sit off employers books and can be accessed by employer only upon plan termination
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17
Q

Underfunded

A

PBO > Plan Assets

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18
Q

Overfunded

A

PBO < Plan Assets

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19
Q

Change in PBO

A 
Beginning PBO balance
\+Service Cost
\+Interest Cost
\+/-Actuarial gains/losses
\+/-Prior Service Cost
-Benefits paid
=Ending PBO balance
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20
Q

Change in Plan Assets

A 
Beginning Plan Assets Balance
\+Employer Contributions
\+Return on Assets
-Benefits Paid
=Ending Plan Assets Balance
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21
Q

Attribution

A
  • Pension expense measured according to attribution

- Allocate PV of future benefit to periods of employee service

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22
Q

Pension expense

A

Periodic pension expense is the net cost of 6 components:

  1. Service cost (+)
  2. interest cost (+)
  3. expected return on plan assets (+)
  4. amortization of prior service cost
  5. recognized portion of cumulative gains or losses
  6. amortization of transition asset or liability
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23
Q

Service Cost

A
  • Actuarial present value of the pension benefits earned by employees in a given period
  • Based on employees estimated future salaries and projected years of service
  • PV of benefits employee earned during that year (from one more year of service)
24
Q

Interest Cost

A

-Accrues on total outstanding pension liability during a reporting period at discount rate to reflect time value of money
-Updates present value of previously earned benefit payments to new reporting period
-Cost of the obligation being one year closer to having to be paid
=PBO beginning * Discount rate

25
Q

ERPA

A

-Expected investment return on plan assets during the period, offsets other periodic pension expenses
-Based on ERR assets will generate
-Instead of using actual return each period, smoothes the volatility of asset returns
=ERR * Plan Assets Beginning

26
Q

ARPA

A

-Increase in pension funds from int, dividends, and realized and unrealized changes in FMV of plan assets
-Used in calculating fund balance
Beginning Fund Balance
+ ARPA
+ Employer Contributions
- Benefit Payments
= Ending Balance

27
Q

Expected vs. Actual

A
  • ERPA used for pension expense calculation only
  • ARPA used in calculating new plan asset balance
  • Difference becomes a pension G/L which is D/C to OCI and pension expense
28
Q

PSC

A
  • Credit for work performed before pension plan went into effect
  • Total PSC = pension benefit costs associated with time worked before the plan began
29
Q

PSC Amortization

A

-Amortized over the remaining service period

1 / Avg. remaining service period

30
Q

SFAS 158

A

Requires firms to report funded status on the balance sheet

31
Q

PBO Gain/Loss

A
  • Increase in PBO is loss
  • Decrease in PBO is gain
  • Change in assumptions (change in death date, retirement date, salary, growth rate, disc.)
32
Q

Asset Gains/Losses

A
  • Asset loss is actual return is lower than expected return
  • Asset gain is actual return exceeds expected return
  • Change in plan itself
33
Q

Pension Gains and Losses

A
  • Pension expense should ultimately reflect the new assumptions and actual returns
  • Not immediately recognized in pension expense, but subject to delayed recognition (amortized gradually)
  • Effects of future losses may offset previous gains and vice versa
  • Offsetting and amortization help minimize overall impact of gains and losses on pension expense (control volatility)
34
Q

Changes in rates

A
  • Service cost and interest cost are always computed using the discount rate assumed at the BEGINNING of the year (if rate changes during the year)
  • PBO is computed using most RECENT compensation and discount rates
35
Q

Amortization of Pension G/L

A
  • Not amortized as soon as they occur, accrue in unrecognized gains and losses account which is not amortized until it gets large enough
  • Delay allows offsets and minimizes volatility of pension expense
36
Q

Corridor Amortization

A
  • Minimum g/l amortization that must be recognized in the current year
  • Not required unless UGL balance and the BEGINNING of the year exceeds 10% of PBO or PA (whichever is larger)
  • Amount above 10% must be amortized over the average remaining service period of the active employees covered by plan
37
Q

Transition Asset/Liability

A
  • If plan’s funded status is worse than previously reported, transition liability generated
  • Amortized on SL basis over average remaining service period
  • If avg service is less than 15, then you can amortize over 15 years
  • Most firms have completed or are at the end of the amortization
38
Q

Changes in assumptions (Financial Statements)

A
  • Look for changes in disc rate, estimated compensation increase and ERPA
  • Effect of Increase on NI –> Disc rate (+), Decrease service cost (+), Increase int cost (-), ERPA (+). Compensation rate (-)
39
Q

Issuing stock

A
  • Authorized: how many approved by the state
  • Issues: have been sold to shareholders
  • Outstanding: still held by shareholders
  • Record the value for what you received, credit common stock for par value and APIC for the rest
40
Q

Treasury Stock

A
  • Shares of stock reacquired by the firm
  • Does not have voting rights, dividends, or distributions upon liquidation
  • Not considered outstanding
41
Q

Why repurchase stock?

A
  • Take company private
  • Stock for potential takeover
  • Manipulate EPS
  • Increase market value of stock
  • Exercise of employee stock options
42
Q

Treasury stock journal entries

A
  • Par value method (record treasury stock at par value)
  • Cost method (record at purchase price)
  • Treasury stock NOT recorded as an asset!!
  • APIC amount above purchase price, if lower debit retained earnings for the rest
43
Q

Retirement of stock

A
  • Company buys the stock and cancels the stock certificate
  • # issued decreases
  • Stock cannot be resold
  • Company must remove the capital account and all accounts related to the stock
44
Q

Preferred Stock

A
  • Preferences (special rights) from common stock, in exchange may sacrifice voting rights
  • Preferences might include: priority with dividends, priority if liquidation, convertability into common stock,a optional redemption
45
Q

Cumulative preferred stock

A
  • Shareholders have the right to all unpaid dividends
  • If dividends are passed over in a year, then the benefits accumulate
  • The total accumulated amount (dividends in arrears) must be paid before common shareholders can be paid any dividends
46
Q

Noncumulative preferred stock

A
  • Shareholders have no claim on passed over dividends
  • Firm may pay dividends to common shareholders once it has paid the current year’s preferred dividend
  • Few preferred stock issues are noncumulative
47
Q

Participating Dividends

A
  • Nonparticipating: preferred only entitled to the preferred stock’s stated dividend
  • Partially Participating: Participate proportionately with common shareholders in any dividend distribution beyond preferred rate up to specified level
  • Fully Participating: preferred participate proportionately with common shareholders in any dividend distribution beyond the preferred rate
48
Q

Stock dividend

A
  • Dividend distributed by issuing more stock
  • Shareholders receive additional shares of stock in proportion to existing holdings
  • Really just reclassifying earned capital to contributed capital
  • Small stock dividend (less than 25% of total outstanding shares) –> use Market-Value method
  • Large stock dividend (more than 25% of total outstanding shares)–> use Par-Value method
49
Q

Market Value Method

A
  • Record transaction at fair market value of stock

- Stock dividend distributable credit at declaration, debit at issuance

50
Q

Par Value Method

A
  • Record transaction that par value

- Retained earnings and stock dividend distributable

51
Q

Stock Split

A
  • Company might declare a stock split in order to reduce the market value of its stock to make it more affordable for investors
  • Increases # of shares outstanding and decreases par value of the stock
  • No journal entry made, just memo noting the change
  • No difference between 2 for 1 split and 100% stock dividend, but dividend has entry and split does not
52
Q

Dilutive securities

A
  • Contain and option for the holder to obtain a specified # of shares through purchase or conversion
  • Convertible bonds
  • Convertible preferred stock
  • Stock warrants
  • Stock options
53
Q

Accounting for convertible debt

A

2 options:

  • Book value method: issuance price for the stock equals book value of bonds (used most often)
  • Market value method: issuance price for stock equals current market price of stock (gain or loss reported)
54
Q

Convertible preferred stock

A

-Similar to book value approach (not market value because never recognize income from trading its own equity)

55
Q

Mandatorily redeemable preferred stock

A
  • Firm promises to pay back the preferred stock at a stated price in the future
  • Characteristics of both debt and equity
  • SEC said not equity, so companies created the mezzanine (between liabilities and equity)
  • Many of these companies no longer use these securities
56
Q

Convertible bonds

A
  • Recorded like regular bonds, proceeds are recorded in bonds payable
  • Recorded as if entire value derives from the bond and no value derives from convertability feature
  • Effects: calling it debt could be misleading, misrepresented interest expense

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