Reading 15: Employer Contribution

Question 1

Defined Benefit Accounting

Answer 1

Employer

bears the investment risk

Needs to estimate future benefit amount.

Diffcult accounting / analysis issues

Two Types:

Pay Related - related to salary level

Non Pay Related - Unrelated to Salary level.

Question 2

Projected Benefit Obligations

Answer 2

PV of all future pension payments earned to date based on expected salary increases over time. Assumes employee works till retirement

Estimates Liability on a Going concern basis

Under IFRS PBO = Present Value of Defined Benefit Obligation (PVDBO)

Question 3

PBO Components

Answer 3

Service Cost - Attributed to employees efforts during the year. The Acuturial PV of pension benefits earned in a year.

Interest Cost - from passage of time = Beginning PBO x Discount Rate

Actuarial Gains and Losses - due to changes in Acturial Assumptions

Past Service Costs - Retroactive impact on past benefits resulting from plan amendments

Benefits Paid - Payments made.

Question 4

PBO Equation

Answer 4

PBO = Begning PBO + Servcie Cost + Interest Cost +/- Acturial Gains and Losses +/- Past Service Costs - Benefits Paid

Question 5

Answer 5

Question 6

Fair Value of Plan Assets

Answer 6

Employer Contributions - Funding policy is a function of Income tax, ERISA rules (US), CF Considerations

Actual Return on Assets - Actal Capital Gain / Dividends / Interest (will fluctutate with Market)

Benefits Paid - Payments made.

Question 7

Funded Status

Answer 7

Funded Status = Fair Value of Plan Assets - PBO

If FV> PBO = Overfunded , If FV<pbo></pbo>

<p>Funded Status = Economic Position of the Plan. = Balance Sheet Asset / Liab</p>

</pbo>

Question 8

Periodic Pension Cost

Answer 8

Total Periodic Pension Costs = Contributions - Change in Funded Status

TPPC = I/S Expense + OCI Expense

TPPC is the same under IFRS or USGAAP but differ in where the pension cost is reflected.

Question 9

Income Statement - USGAAP

Answer 9

Periodic Pension Cost (I/S) = Service Cost + Interest Cost - Expected Return on Plan Assets +/- Amortization of Actuarial Gains / Losses +/- Amort of Past Service Costs

Expected Return on Plan Assets, Amort of Acturial Gains/ Losses and Amort of Past Service Costs are smoothed events

Unamortized Past service cost and acturial gains and losses in OCI.

Question 10

Income Statement - IFRS

Answer 10

Periodic Pension Cost (I/S) = Service Cost +/- Net Interest Expense +/- Past Service Costs

Remeasurements are reflected in OCI and not amortized.

Net Interest Expense = Beg Funded Status x Discount Rate

Question 11

IFRS Vs USGAAP - Discount Rate and Expected Return Issue

Answer 11

IFRS

Interest Expense = Opening funded Status x Discount Rate

USGAAP

Expected Return Opening Plan Assets x %Expected Return

Interest Expense = Opening PBO x Discount Rate

Question 12

Actuarial Pension Plan Assumptions

Answer 12

All plans must make and disclose three assumptions

Discount Rate

Rate of compensation increase

Expected return on plan assets (USGAAP)

Question 13

Impact of Actuarial Assumptions

Answer 13

Question 14

Delayed Recognition of Pension Costs

Answer 14

Terminology

IFRS : Remeasurement gains and Losses = Acturial Gains and Losses + (Acutal - Expected) ROA

USGAAP: Acturial Gains and Losses = Acturial Gains and Losses + (Actual-Expected) ROA

Two Main Delayed EventsRemeasurement (IFRS and USGAAP)

Arising from changes in Acturial Assumptions affecting the PBO

From Differences in the acutal and expected return on plan assets (IFRS = Expected Return = Discount Rate)

Past Service Costs

Changes in PBO due to plan amendments Amortized over service life of Plan Participants

Expenses Immediately under IFRS.

Question 15

Acturial Gains and Losses Corridor Approach

Answer 15

If Beginning Actuarail Gains and Losses exceed 10% of Opening PBO / Opening Plan Assets then it should be AMORTIZED

Question 16

IFRS Vs USGAAP

Answer 16

Expected Return vs Discount Rate:

USGAAP: Expected Return and Discount Rates may differ

IFRS: Expected Return = Discount Rate

Interest and $Expected Return:

USGAAPL Interest and $Expected Return may differ

IFRS: Netted

Opening OCI Balances

USGAAP: 10% Corridor Approach Amortization

IFRS: No Amortization

Past Service Costs

USGAAP: Past Service Cost taken to OCI and then Amortized

IFRS: Immediately Expensed.

Question 17

Analyst Adjustments (I/S)

Answer 17

Most Balancesheet would use Full Pension expenses is taken through operating expenses. This is not correct

Service Cost: Only Service Cost is Operating

Pension Expense: Remove Pension Expense from operating expenses

Interest Cost: Add Interest Cost to Interest Expense

Actual Return on Plan Assets: Add actual return on plan assets to non operating income

Amortization; Ignore amortization

Hence Total I/S effect is Service + Interest - Actual Return.

Question 18

Answer 18

Question 19

Analyst Adjustment - Cash Flow Statement

Answer 19

Adjust CFO and CFF to represent after tax difference in economic Pension expense and cash contributions.

Contributions > TPPC = Principal PMT [ Contributions-TPPC[((1-T) - Decrease CFF Increase CFO

Contribution < TPPC = Borrowing Contributions = TPPC - Increase CFF Decrease CFO

Question 20

Answer 20

Question 21

Answer 21

Question 22

Share Based Compensation

Answer 22

Disclosures Required

Nature and Extent of share based compensation

How Fair Value is determined

Impact on Income for the period

Accounting

Allocate fair value over service period (the period benefitted by the employees service)

Question 23

Stock Grants

Answer 23

Compensation Expense equals market value at grant date

Restricted Stock : Ownership returned to Company if conditions are not met. (length of service or performance goals)

Performance Shares : Granted on meeting performance goals

Question 24

Stock Options

Answer 24

Fair value at grant date = estimated option premium

Service period equals time between grant date and vesting date

Vesting date = first date the option may be exercised

Fair value is expensed over vesting date (i.e RE declines, Paid in Capital Increases - No net change in total equity)

Question 25

Option Valuation Methods

Answer 25

Fair Value measured “based on observable market price (premium) of an option with the same or similar terms and conditions, if one Is available”

In the absence of a market based instrument, fair value is determined by

Black Scholes Model

Binomial Model

Monte Carlo Simulation

Question 26

Model Assumptions

Answer 26

Six Assumptions

Exercise Price

Stock Price at grant date

Volatility

Risk Free Rate

Expected Term to expiry

Dividend Yield