F6 - Pensions and Income Tax Accounting

Question 1

Define two types of pension plans.

Answer 1

Defined Contribution Plan:
Amount of contributions is specified.

Defined Benefit Plan:
Amount of benefit to be received is specified or estimated.

Question 2

What is the difference between projected benefit obligation (PBO) and accumulated benefit obligation (ABO)?

What is the name for the pension plan liability under IFRS?

Answer 2

ABO:
Actuarial PV of benefits attributed by the pension benefit formula to employee service rendered before a specified date based on employee service and current and past compensation levels.

PBO:
Actuarial PV of all benefits attributed by the pension benefit formula formula to employee service rendered before a specified date based on assumptions as to future compensation levels.

Under IFRS, the pension plan liability is the defined benefit obligation (DBO).

Question 3

What is the formula used to calculate the ending projected benefit obligation (PBO)?

Answer 3

Beginning PBO
+ Service Cost
+ Interest Cost
+ Prior Service Cost from current period admendments
+ Actuarial losses incurred in the current period
- Actuarial gains incurred in the current period
- Benefits paid to retires
= Ending PBO

(only S, I, A, G) and P

Question 4

What is the formula used to calculate the ending fair value of plan assets?

Answer 4

Beginning fair value of plan assets
\+ Contributions
\+ Actual return on plan assets
- Benefit payment
= Ending fair value of plan assets

Question 5

Name the components of net periodic pension cost (net pension expense) under U.S. GAAP.
(SIR AGE)

Answer 5

Service Cost
Interest Cost
Return on plan assets
Amortization of prior service cost
Amortization of Gains and Losses
Amortization of Existing unrecognized net obligation or unrecognized net asset at implementation

Question 6

How are unrecognized gains and losses amortized to pension expense under U.S. GAAP?

Answer 6

Using the corridor approach. The formula is:
Unrecognized gain or loss
= Excess
/ Average remaining service life = Amortization of unrecognized gain or loss

Question 7

How is funded status calculated and reported under U.S. GAAP?

Answer 7

Companies with defined benefit pension plans must report funded status on the balance sheet.

Fair Value of Plan Assets

= Funded Status

Under U.S. GAAP:
Overfunded: (Fair value of plan assets > PBO). Report as a noncurrent asset.
Underfunded: (Fair value of plan assets < PBO). Report as a current liability (to the extent that benefits payable in the next 12 months exceed the fair value of the plan’s assets), a noncurrent liability, or both.

Question 8

How is funded status calculated and reported under IFRS?

Answer 8

Defined Benefit Obligation

= Funded Status

Under IFRS:
Overfunded: (DBO < Fair value of plan assets). Report as a net defined benefit asset.
Underfunded: (DBO > Fair value of plan assets). Report as a net defined benefit liability.

IFRS does not specify whether the asset/liability should be reported as current or noncurrent.

Question 9

How are changes in the funded status from pension gains and losses and prior service costs reported on the financial statements under U.S. GAAP and IFRS?

Answer 9

U.S. GAAP:
Both are recognized as components of OCI in the period incurred, with the related tax effects. Then reclassified to net periodic pension cost as amortized.

IFRS:
Prior (past) service cost is reported as a component of service cost on the income statement in the period incurred. Pension gains and losses are reported in OCI in the period incurred and are not reclassified (amortized) to the income statement.

Question 10

Define pension settlements and pension curtailments.

Answer 10

Settlements:
A transaction that (a) is an irrevocable action, (b) relieves the employer of primary resonsibility for a pension benefit obligation, and (c) eliminates significant risks related to the obligation and the assets used to effect the settlement.

Curtailments:
An event that significantly reduces the expected years of future service of present employees or eliminates for a significant number of employees the accrual of defined benefits for some or all of their future services.

Question 11

What are some of the requied disclosures for a defined benefit plan?

I dread having to disclose this stuff!

Answer 11

Description: A description of funding policies and types of assets held.

Reconciling items: A schedule reconciling funded status of the plan including all reconciling items (FVPA, PBO, etc.).

Expense and OCI components: Components of net periodic pension cost (pension expense) and accumulated OCI.

Actuarial assumptions.

Discount rate: The weighted-average discount rate.

Question 12

What are the components of net periodic postretirement benefit cost (postretirement expense) under U.S. GAAP?

Answer 12

Service Cost
Interest Cost
Return on plan assets
Amortization of prior service cost
Amortization of Gains and losses
Expense/Amortization of transition obligation

Question 13

How do we account for postretirement benefits on the balance sheet under U.S. GAAP?

Answer 13

The funded status of the postretirement benefit plan must be shown as a noncurrent asset (if overfunded) or a current liability, a noncurrent liability, or both (if underfunded). Changes in funded status due to net gains or losses, prior service costs, or net transition assets or obligations should be shown in AOCI until amortized to net periodic postretirement benefit cost.

Question 14

What are some of the required disclosures for postretirement benefit plans?

I dread having to disclose this stuff!

Answer 14

Description: A description of the plan.

Reconciling items: A schedule reconciling funded status of the plan, including all reconciling items (FVPA, APBO, EPBO, etc.).

Expense and OCI components: Components of net periodic postretirement benefit cost, including all components, and accumulated OCI.

Actuarial assumptions: Assumptions and rates used in computing APBO and EPBO, including assumed health care cost trend rate, effect of 1% increase/decrease in assumed health care cost trend rates.

Discount rate: The weighted-average discount rate.

Question 15

List the four criteria for recognizing postemployment benefits and compensation for future absences.

Answer 15

~Employee’s services already rendered
~Rights vest or accumulate
~Payment of the compensation is probable
~Amount can be reasonably estimated

Question 16

Define permanent differences and list some examples.

Answer 16

Permanent differences are transations that affect either taxable income or financial income, but not both, and only in the period in which they occur. They do not affect future financial or taxable income.
~Premium on key officer life insurance policy when entity is owner and beneficiary
~Proceeds from key officer life insurance
~Tax-exempt interest on state and muncipal bonds
~Nondeductible portion of meals and entertainment
~Fines and expenses in violation of law
~Dividends received deduction

Question 17

Define temporary differences and list some examples.

Answer 17

Temporary differences are differences between taxable income and financial income that result in taxable or deductible amounts in future years and necessitate the recognition of deferred tax assets and liabilities.
~Depreciation (financial vs. MACRS)
~Gross profit on long-term construction contracts (percentage completion vs. completed contract)
~Estimated warranty costs
~Litigation accruals
~Gross profit on installment sales (accrual vs. cash)
~Bad debt expense using the allowance method vs. actual bad debt expense

Question 18

Define deferred tax liability.

Answer 18

Anticipated future tax liabilities derived from situations in which future taxable income will be greater than future financial income due to temporary differences.

A deferred tax liability is measured by applying the applicable enacted tax rate and provisions of the enacted tax law to temporary differences in the periods in which they are expected to reverse.

F/S Income > Taxable Income
(opposite is Future Taxable Income > Future F/S Income)

Question 19

Define deferred tax asset.

Answer 19

Anticipated future taxable income will be less than future financial income due to temporary differences.

A deferred tax asset is recognized for all deductible temporary differences, operating losses, and tax credit carryforwards by applying the applicable enacted tax rate and provisions of the enacted tax law to temporary differences in the period in which they are expected to reverse. Deferred assets are also subject to recording a valuation allowance to reduce the asset to its net realizable value if it is more likely than not that its full value will not be recognized.

F/S Income < Taxable Income
(opposite is Future Taxable Income < Future F/S Income)

Question 20

What is the valuation allowance?

Answer 20

If it is more likely than not (> 50%) that some portion or all of the deferred tax asset will not be realized, a valuation allowance needs to be created to recognize the reduction in the carrying amount of the deferred tax asset.

Note: IFRS prohibits the use of a valuation allowance. Under IFRS, a DTA is recognized only when it is probable (more likely than not) that sufficient taxable profit will be available against which the temporary difference can be utilized.

Question 21

Identify the tax rate used to measure deferred tax assets and liabilities under U.S. GAAP and IFRS.

Answer 21

U.S. GAAP:
The enacted tax rate expected to apply to taxable items (temporary differences) in the periods the taxable item is expected to be paid (liability) or realized (asset).

Do not allow the examiners to trick you into using the anticipated, proposed, or unsigned tax rate.

IFRS:
IFRS permits the use of enacted or substantively enacted tax rates.

Question 22

How are deferred tax assets and liabilities classified on the balance sheet under U.S. GAAP and IFRS?

Answer 22

U.S. GAAP:
Classification between current and noncurrent is based on the classification of the related asset/liability. If there is no related asset or liability, then the timing of the reversal is used.

Current deferred tax assets and liabilities should be netted against each other. Noncurrent deferred tax assets and liabilities should be netted against each other.

IFRS:
Under IFRS, deferred tax assets and deferred tax liabilities are reported as noncurrent on the balance sheet. Deferred tax assets and deferred tax liabilities may be netted if the entity has a legally enforeable right to offset current tax assets against current tax liabilities and the deferred tax assets and deferred tax liabilities relate to income taxes levied by the same tax authorities.