F6: Pensions and Income Tax Accounting

Question 1

What are the main things that pension plans are concerned about?

Answer 1

The pension expense that is on the sponsor company’s income statement
Any related pension accounts that appear on the balance sheet for the sponsor company.

Question 2

If something is overfunded what is it? Underfunded? How do you tell?

Answer 2

Its an asset if it is overfunded and you can tell if the fair value of the plan assets at the beginning of the year > PBO at the beginning of the year. = always non current
If its underfunded its a liability and the fair value of the plan assets and can be both current or non current

Question 3

Whats the difference between a ABO and a PBO?

Answer 3

The accumulated benefit obligation uses the current salaries in the formula for the benefits. No assumptions. 
The PBO( projected benefit obligation) uses the future salary or future assumptions when coming up with the benefit. Affects I/S and is more conservative thats why it is used more.

Question 4

What are the factors that are included in determining the PBO?

Answer 4

Service cost (+)
Interest cost (+)
Prior service cost (+)
Actuarial losses (+)
Actuarial gains (-)
Benefits paid (-)

Question 5

What are the components of plan asset?

Answer 5

Starting fair value of plan assets
Contributions (+)
Actual returns on plan assets (+)
Benefits paid to retirees (-)
= ending fair value of plan assets.

Question 6

What are the components of pension expense?

Answer 6

This is the increase in the PBO, and can be remembered by SIR AGE.
S - Current service cost (+)
I - Interest Cost (+)
R - Return on Plan assets (-)
A - Amortization of prior service cost (+)
G - gains (-) losses (+)
E - Amortization of existing net obligation or asset (+)

The SIR affects the income statement right away.
The AGE goes into OCI which gets closed out to AOCI, and is income smoothing and is amortized.

Question 7

What is the journal entry for funding the plan?

Answer 7

DR: Pension Liability
CR: Cash
This reduces the liability

Question 8

How do you calculate interest cost in SIR AGE?

Answer 8

Beginning of period PBO x Discount Rate (or settlement rate) = interest cost

Question 9

How do you calculate the expected return on plan asset?

Answer 9

First of all you can use either the actual returns on plan assets or the expected return on plan assets.
Expected return on plan assets = Beg FV of plan assets x expected rate of return on plan assets.
If you are using the expected return on plan assets you must report the difference between that and the actual and put it into OCI, and then amortized to pension expense over time. And they would fall under the G/L section of the SIR AGE.

Question 10

What are the two types of gains and losses that are included in SIR AGE?

Answer 10

1. Difference between the expected and actual returns when the expected return method is used.
   Actual returns > Expected returns = Gain
   Actual returns
2. Actuarial gains and losses, either way in order for them to get recognized they must meet the 10% test.

Question 11

What is the corridor approach for accounting for gains and losses?

Answer 11

You take the greater of the overfunded statues = asset, or the underfunded status the liability, and then times it by 10%. Then you take the actual gain or loss and subtract out the 10% there will be an excess which would be divided by the average remaining service life which will be the gain or the loss.

Question 12

What is the amortization of the existing net obligation or net asset for the E in SIR AGE? Formula.

Answer 12

PBO - fair value of plan assets = Initial unfunded obligation / (15 years or avg life of employee whichever is greater) = minimum amortization.

Question 13

What is the formula for the changes in the funded status?

Answer 13

Beg funded status
contributions (+)
service cost (-)
interest cost (-)
expected return on plan assets (+)
prior service cost incurred in the current period (-)
net gains (+)
net losses (-)
Ending funded status.

Question 14

What are the journal entires to record a DTA due to an increase in the service costs? If the account was underfunded?

Answer 14

1. First of all if the benefits are increased that means you will have a bigger liability and it should be expensed but it is not yet ready to hit the I/S so… treat OCI like an expense.
   DR: OCI
   CR: Pension liability/Asset
   Since you are increasing the liability you will be allowed to get a benefit as a result. Since you will be having to put in more money to the account at a later date.
   DR: Deferred tax asset
   Cr: Deferred tax benefit - OCI
2. Then you will be taking it out of AOCI and expensing or amortizing it by
   DR: Net periodic pension cost
   CR: OCI

Then you will also use some of your tax benefit. You will recognize the benefit on your income statement
Dr: DTA - OCI
CR: Deferred tax benefit - income statement

Question 15

How do you deal with pension gains and what are the journal entries?

Answer 15

Pension gains increase the funded status.
DR: Pension benefit asset/liability
CR: OCI
Since you will not have to put in as much contributions this will result in a future expense not benefit, as pose to having to put in more money in the future.
DR: Deferred tax expense2 - OCI
CR: Deferred tax liability

2. Amortization of expense.
   DR: OCI -
   CR: Net periodic pension cost

Dr: Deferred tax expense - I/S
CR: Deferred tax expense - OCI

Question 16

When it comes to the accrual requirement for post retirement benefits what causes a liability and what causes a contingency?

Answer 16

1. Obligation is for services already rendered
2. Rights accumulate or vest
3. Payment is probable
4. The amount of benefits is reasonably estimated.
   1&2 give forth to a liability, 3&4 give forth to a contingency.

Question 17

How can you do the amortization of expense of the transition obligation?

Answer 17

You can either expense the full amount or do this formula.
Accumulated post retirement benefit obligation - FV of plan assets = initial unfunded / 20 years or remaining service life whichever is greater = minimum amortization.

Question 18

What is intraperiod tax allocation?

Answer 18

this involves apportioning the total tax provision for financial accounting purposes in a period between income and loss from
IDA PUFER, where the DA PUFER is reported net of tax.

Question 19

What is interperiod tax allocation?

Answer 19

This is where the permanent difference and temporary differences from the IRS tax code and U.S GAAP is taken into account.
Permanent affect current and not deferred tax computation.

Question 20

What are permanent differences?

Answer 20

They only affect the current period and not deferred taxes or anything in the future period. They do not reverse.
They either enter into pretax GAAP financial income, but never enter into taxable income (interest income)
Or enter into Tax income, but never enter into GAAP income (dividends received deduction)
EX. Tax exempt interest (muni, state), life insurance proceeds, life insurance premiums, certain penalties fines bribes, nondeductible portion of meal and entertainment expense, dividends received deduction for corporations,

Question 21

What are temporary differences?

Answer 21

They affect the deferred tax computation. As well as the current tax computation. They can also reverse in the future.
They can enter into GAAP before they do taxable income, or vice versa.

Question 22

How do you get the deferred income tax and the current income tax?

Answer 22

Current income tax = the income tax payable or refundable for the current year as determined on the corporate tax return.
Deferred income tax - change in deferred tax liability or asset account on the balance sheet from the beginning of the current year to the end of the current year.

Question 23

When it comes to temporary differences what results in a DTA? Give examples.

Answer 23

1. Tax return income first and financial statement income later. (Prepaid rent, prepaid interest, prepaid royalties)
2. Financial statement expense first and tax return expense later. (bad debt expense, start-up expense, warranty expense)

Just know that if it is revenue that hits the F/S first then you will have to pay for the good thing later with a DTL, and if you have an expense that hits the F/S first you will have a DTA in the future. And the opposite of these situations will happen if it hits the income tax first.

Question 24

When it comes to temporary differences what results in a DTL? give examples.

Answer 24

1. Financial statement revenue first and tax return income later. (installment sales, equity method - div)
2. Tax return expense first, and financial statement expense later (depreciation expense, amortization of franchise, prepaid expense).
   Just know that if it is revenue that hits the F/S first then you will have to pay for the good thing later with a DTL, and if you have an expense that hits the F/S first you will have a DTA in the future. And the opposite of these situations will happen if it hits the income tax first.

Question 25

What is another way that you can determine if there is going to be a DTL or a DTA by comparing the future tax income to the future F/S income?

Answer 25

• If the Future tax income is > future financial accounting income = DTL, this means that the current year is the opposite.
• If the future tax income is

Question 26

Changes in Tax laws are recognized as how?

Answer 26

They are recognized in the current period and forward just like a change in accounting estimate. And will go into income tax expense for that period as income from continuing operations.
Only deals with enacted rates only!!

Question 27

What is the formula for computing deferred taxes adjustment when there are changes?

Answer 27

Ending balance (What we want)
- Current balance (What we got)
= required adjustment.

Question 28

What are the two rules for classifying a DTA or a DTL?

Answer 28

1. Deferred items should be classified based on the related asset or liability for financial reporting. EX. if a DTA relates to a warranty then its a current, if DTL is related to fixed asset depreciation then its non current.
   They must also be presented as one amount, netted.
2. If they are not related to an asset or liability we will look at the reversal dates.
   All the DTAs and DTLs that are current must be offset and presented as one amount. Net asset or Net liability.
   All the DTAs and DTls that are non current must also be netted into one account.

Question 29

If you have a future reduction in taxable income what will this become?

Answer 29

This will lead to being a DTA.

Question 30

How do you calculate the effective interest rate?

Answer 30

This is the income tax expense / pretax income

Question 31

What will an increase in the allowance account for a DTA do? Why would you do this?

Answer 31

You would increase the allowance account for a DTA if when the DTA is going to reverse there is not expected to be any taxable income.
Another reason why you would increase the allowance account is if the DTA is deemed more likely than not to be realized.
The increase in the allowance account will increase the income statement expense, decrease the asset and create an allowance account.