Reading 10: Employee Compensation (Post-employment and Share Based)

Question 1

Projected benefit obligation (PBO)

Answer 1

• Also called the PV of defined benefit obligation

- Is actuarial PV of all future pension benefits earned to date, based on future salary increases.

Question 2

Annual unit credit

Answer 2

Value at retirement/number of years of service

Question 3

Current Service Cost

Answer 3

-PV of benefits earned by employees during the current period.

Question 4

Interest Cost

Answer 4

• increase in obligation due to passage in time
• GAAP: (beginning PBO + prior service cost) x discount rate
• IFRS: (beginning funded status - prior service cost) x discount rate

Question 5

Past (prior) service cost

Answer 5

-Retroactive benefits awarded to employees when a plan is initiated or amended.

Question 6

Change in actuarial assumptions

Answer 6

• gains and losses that results from changes in variables such as mortality, employee turnover, retirement age and the discount rate.
• **actuarial loss will increase benefit obligation

Question 7

Funded Status

Answer 7

Plan Assets | Fair value (+) contributions (+) actual return (-) benefits paid = Fair value at the end of the year
PBO | PBO at beg of year (+) service cost (+) interest cost (+) past service cost (plan amendments during year) (+/-)
actuarial losses/gains during the year (-) benefits paid = PBO at the end of the year

Plan assets - PBO = FUNDED STATUS
***reported as an A or L on the balance sheet (there is a ceiling on the A). Overfunded leads to either lower future contributions or future refunds.

Question 8

Total Periodic Pension Cost

Answer 8

TPPC = employer contribution - (ending funded status - beginning funded status)
or
TPPC = current service cost + interest cost - actual return on plan assets +/- actuarial losses/gains due to changes in assumptions affecting PBO + prior service cost

Question 9

Difference b/w recognition of components of pension cost under GAAP and IFRS

Answer 9

• GAAP: current service cost (Income Statement), Past service cost (OCI, amortized over service life), Interest cost (Income Statement), Expected Return (Income Statement), Actuarial G/L (Amortized portion in Income Statement. Unamortized in OCI)
• IFRS: current service cost (Income Statement), Past service cost (Income Statement), Interest cost (Income Statement), Expected Return (Income Statement*), Actuarial G/L (All in OCI - not amortized called Remeasurements)

**Under IFRS, the expected rate of return on plan assets is implicitly assumed to be the same as the discount rate used for computation of PBO and a net interest expense/income is reported).

Question 10

Presentation

Answer 10

• GAAP: Aggregated and presented as a single line item

- IFRS: Separately

Question 11

Difference b/w Reported Pension Expense and TPPC

Answer 11

1) Reported Pension Expense (Periodic pension cost in the income statement)
- reported in income statement
- uses EXPECTED return on plan assets.
- is computed differently depending on whether we’re using IFRS or GAAP
2) TPPS (Total periodic pension cost)
- true (economic) cost of pension plan
- does not change based on accounting system chosen
- uses ACTUAL return on plan assets

Question 12

Increasing the discount rate

Answer 12

• Reduce PVs, hence PBO is lower. Lower PBO improved funding status.
• Results in lower periodic pension cost b/c of lower current service cost.
• Usually* reduces interest cost (beginning PBO x the discount rate) unless the plan is mature.

Question 13

Increasing expected return on plan assets (under GAAP)

Answer 13

• reduce periodic pension cost reported in P&L (TPPC is unchanged)
• Will not affect the benefit obligation or funded status

Question 14

Cash Flow Considerations

Answer 14

-If firm contributions exceed its total periodic pension cost, the difference can be viewed as a reduction in the overall pension obligation….similar to an excess principal payment on a loan.
-If TPPC > contributions, difference can be seen as borrowing.
^consider moving from operating to financing activities in cash flows

Question 15

Share Based Compensation

Answer 15

• Recorded as compensation is earned
• If shares are not issued publicly, estimate must be used for stock grants.
• Unless market price of option is available, value of stock options must be estimated using an options valuation model

Question 16

Stock Options

Answer 16

• Compensation expense is based on the FV of options on the grant date based on options expected to vest
• Vesting date is the first date the options can be exercised
• Comp expense is allocated in the income statement over the service period, which is time between grant date and vesting date.
• Recognition of comp expense will decrease net income and retained earnings, but will increase paid-in-capital by same amount.
• NO CHANGE IN TOTAL EQUITY

Question 17

Decreases to Option Price

Answer 17

-lower volatility, shorter term, lower risk free rate, higher expected dividend yield

Question 18

Stock Grants

Answer 18

• Compensation expense based on FV of stock on grant date
• allocated over employees service period
• can involve an outright transfer of stock w/o conditions, restricted stock and performance stock.

Question 19

Stock Appreciation Rights

Answer 19

• difference between SAR and option is the form of payment
• Gives the employee the right to receive compensation based on the increase in the price of the firm’s stock over a predetermined amount.
• No shares actually issued

Question 20

Phantom Stock

Answer 20

• similar to SAR except the payoff is based on performance of hypothetical stock instead of firm’s actual shares.
• Used in privately held firms and firms with highly illiquid stock.