FRA - Pension Flashcards
DB
China
Employer pay after retirement
firm bears the risk
DC
US
Employee contributes and bears the risk
PBO/PVDBO (IFRS)
actuarial pv as a date of al benefits attributed by the pension benefit formula to employee service rendered prior to that date
(LIABILITY)
assumptions:
expected futures salary increases
going concern
employee’s continued service
Accumulated benefit obligation
actuarial pv of benefits attributed to employee service rendered prior to that date and based on current and past compensation levels
current compensation levels
liquidation of pension obligation
Vested Benefit obligation
the amount of ABO to which the employee is entitled
vesting schedule
Fund Status
report on B/S under IFRS and US GAAP
= FV OF PA - FV of PBO
if < 0 , underfunded as net pension liability
>0, overfunded, net pension asset
report the surplus in min(surplus, asset ceiling)
subject to a ceiling defined as the pv of future economic benefits, such as refunds from the plan or reductions of future contribution
Plan Asset
BB FV PA
+Employer contribution
+Actual return
-benefit paid to employee
PBO
BB PBO \+Current service cost \+past service cost (plan amendments during the year) \+interest costs \+actuarial losses -actuarial gains during the year -benefit paid to employee
Assumptions of PBO
- Discount rate: based on current rates of return on high quality corporate bonds with durations consistent with the durations of the benefit
- assumed rate of increase in compensation
- vesting
disclose the discount rate, the expected return on plan assets, and the rate of compensation growth in footnote
Pension expense - IFRS
Service cost (current &past) recognized as an expense in P&L
Net interest expense
=dr * bb fund status
remeasurement gains/losses
-actuarial gains/losses affecting PVDBO
&
diff. in actual and expected returns
Expected return on PA
has no effect on pension obligation, but reduces pension expenses
Pension Expense - US GAAP
Recognized in P&L:
Current service cost
+Interest cost = bb PBO* discount rate
-Expected return on PA = discount rate * BB PA
+Amortization of gain/loss
+amortization of prior service cost (oci)
Recognized in OCI:
the amortization of past service costs
Actuarial gains/losses
= diff. b/w expected return on PA - actual return on PA
unamortized Past Service Cost, subsequent period are amortized to P&L over the average service lives of the affected employees
Amortization
corridor approach
if the cumulative amount of the Unrecognized actuarial gains and losses > 10% of max(DBO or fv of PA)
unrecognized actuarial gains and losses - 10% of max(PBO or fv of PA)
over working life of the plan
THEN the EXCESS is amortized over the expected average remaining working lives of the employees participating in the plan, report on P&L
Amortization of past service cost: under GAAP, it’s reported as a part of OCI and amortized over the remaining service life of the affected employees
Period Pension Expense - US GAAP
recognized in P&L = current service cost \+ interest cost - EXPECTED return on PA \+Amortization of past service cost -amortization of actuarial gains \+amortization of actuarial losses
Period Pension Expense - IFRS
recognized in P&L
=Current service cost
+ net interest cost = discount rate * bb FS
+ past service cost
diff. between actual return and expected returns recognized in OCI
Recognized in OCI:
actuarial gains/losses on PB + net return on PA (ACTUA RETURN - PA * interest)
Health care inflation rate
inflation will decrease gradually and become constant to ultimate healthcare trend rate
assumption that result in HIGHER PBO and higher periodic cost
- higher assumed near-term health care trend rate
- higher assumed ultimate health care trend rate
- a LATER year in which the ultimate health care trend rate is assumed to be reached
assumption that result in LOWER PBO and higher periodic cost
- lower assumed near-term increase in health care trend rate
- lower assumed ultimate health care trend rate
- an EARLIER year in which the ultimate health care trend rate is assumed to be reached
IFRS VS. US GAAP PENSION EXPENSE
US GAAP not include:
past service cost
include amortization of past service cost and subtract expected return on PA
Adjustment on operating income
replace reported pension expense with service cost as operating expense
add interest cost to interest expense, non operating
add actual return on pa to non operating
ignore amortization cost
Operating profit = current service + interest -expected return on PA - current service
Interest expense = interest exp + interest cost
other income = other income + actual return on asset
= adjusted operating profit
cash flow impact
contribution + benefit paid
period contribution > total pension cost
from an economic perspective as a REDUCTION of pension obligation
Period contribution < total pension cost
view as a source of financing
over contribution
contribution > total period pension cost
CFO + (Contribution - TPPC) * (1-T)
CFF - (Contribution -TPPC) *(1-T) repayment
under contribution
contribution < total period pension cost
CFO - (Contribution - TPPC) ( 1-T)
CFF + (Contribution - TPPC)(1-T), borrowing
Stock compensation forms
stock options
stock grants
stock appreciation rights
phantom shares
Disadvantage of share-based compensation
Do not provide desired incentives as the managers may have limited influence over the market value
Lead managers to be risk averse or excessive risk-taking as they cares about the market value
May dilute the shareholders’ interest
Stock Option - call option
vesting date is the first exercise of the stock options at fv at grant date
share-based compensation sensitivity factor
INCREASE of the following, DECREASE the value of the call option Vega - volatility Rho - rf Theta - Time to expiration dividend
exercise options effect
no impact on total equity
company recognize compensation expense when exercise the option, reducing taxes paid and increase CFO
Stock grants
contingent on performance goals, may result in manipulation
Equity settle ( stock option & grants)
fv at grant date
fv is amortized over vesting period in accordance with vesting schedule
is recorded on I/S as an expense
increase APIC in equity
Cash settle (phantom shares)
value at fv and compensation expense is allocated over service period of the employee
An increase in the assumed stock price volatility would
increase the value of the option grants, increase the compensation expense and lower the reported net income.
Inputs of share-based compensation
the following DECREASE would DECREASE the fv/ compensation expense
- exercice price
- stock price at grant date
yes3. expected term/life
yes4. expected volatility - expected dividends
yes6. rf
changes in pension assumption (such as discount rate) will impact ______
the actuarial loss/gain (as a plug)
total periodic pension cost
current service + interest + past service + actuarial losses- actual returns
= contribution - change in funded status
same under IFRS and US GAAP
the split b/w i/s and oci differs
= change in PBO + Benefit paid - actual return
= i/s expense + change in OCI
interest cost
(bb pbo + past service cost)*discount rate
final year’s salary
current salary * (1+ growth )^(year to retirement -1)
Annual payment on retirement
final salary * benefit formula * (years of service + past service years)
value of benefits at retirement date
N=years to live, I/Y = Dr, pmt=annual payment on retirement
cpt pv
annual unit credit = pv/ (years of service + past service years)
