Reading 20 - Employee Compensation Flashcards
In regards to a defined benefits plan, what does the funded status of the plan refer to ?
The difference between the benefit obligation and the plan assets
What is the projected benefit obligation (PBO) aka present value of defined benefit obligation (PVDBO) under IFRS?
The actuarial present value of all future pensions benefits earned to date, based on expected future salary increases.
What is the** service cost**?
Is the present value of benefits earned by the employees during the current period
**Is immediately recognized in the income statement**
What is the interest cost?
Is the increase in the obligation due to the passage of time
= Beg. of period PBO * Discount Rate
**Is immediately recognized as a component of pesion expense**
What are past (prior) service costs?
Retroactive benefits awarded to employees when a plan is initiated or amended
IFRS: costs are expensed immediately
GAAP: costs are amortized over the average service life of the employee
What are Changes in actuarial assumptions?
The gains and losses that result from changes in variables such as mortality , employee turnover, retirement age, and the discount rate
What is the formula to calculate the Fair Value of Plan Assets?
What is the formula to calculate the value of the Projected Benefit Obligation (PBO) for a given yr?
What are the 3 assumptions a firm discloses about its pension calculations?
- The discount rate : is based on interest rates for high quality dixed income investments with a maturity profile simialr to the future obligation
- The rate of compensation growth : the avg annual rate by which employee compensation is expected to increase over time
- The expected return on plan assets : the assummed long-term rate of return on the plan’s investments
What will increasing the discount rate do to a defined benefit obligation?
- Reduce present values, hence a lower PBO. Lower PBO improves the funding status
- Usually results in lower pension expense b/c of lower current service cost.
- Reduce interest cost
What will decreasing the compensation growth rate do to a defined benefit obligation?
- Reduce future pension payments
- Reduce current service costs and lower interest cost
How is the amount of Pension expense on the income statement calculated?
Net Periodic Benefit Costs
+ Service Cost
+ Interest Cost
- Expected return on plan assets
+/- Amort of actuarial (gains) loss
+ Amortization of prior service costs
= Pension expense on income statement
What will increasing the expected return on plan assets do to a defined benefit obligation?
- Reduce pension expense
- Not affect the benefit obligation or the funded status of the plan
What are some things analysts may want to consider when comparing firms who use different accounting treatments for pensions?
- Gross vs. net pension assets/liabilities
- Differences in assumptions used (ie…different discount rates, investment returns)
- Differences between IFRS and GAAP in recognizing pension expense
- Diffferences due to classification in the income statement
What are 2 reasons for netting pension assets and liabilities?
- The employer largely controls the plan assets and the obligation, therefore bears the risks and potential rewards
- Company’s decisions regarding funding and accounting for the pension plan are more likely to be affected by the net pension obligation
***netting the assets/liabilties reduces the firm’s total assets which results in higher ROA
How are stock options accounted for the financial statements?
The compensation expense is allocated in the income statement over the service period, which is the time between the grant date and the vesting date.
Option pricing models typically incorporate the following 6 inputs….
- Exercise price
- Stock price at the grant date
- Expected return
- Expected volatility
- Expected dividends
- Risk-free rate
What are stock appreciation rights?
An award that gives the employee the right to receive compensation based on the increase in the price of the firm’s stock over a predetermined amount
How do GAAP and IFRS differ in how they treat the recognition of the different pension components?
Current serivce cost, Interest cost and Expected return are treated the same for both. They are recognized on the Income Statement
**Past Service **cost: **
GAAP -> OCI, amortized over service life
IFRS -> Income Statement
Actuarial Gains/Losses:
GAAP -> Amortized portion on the income statment, unamortized in OCI
IFRS -> All in OCI, not amortized
How can an analyst reclassify pension expense for analytical purposes?
Background:
Under GAAP, net pension expense (including interest) is shown as an operating expense.
Action:
- Add back the pension expense and subtract only service cost in determining operating income
- Interest should be added to the firm’s interest expense
- Actual return on plan assets should be added to nonoperating income
What is the formula to calculate the total periodic pension cost?
Total periodic pension cost
= service cost + interest cost – actual return on plan assets + plan ammendments
or
= ending PBO - beginning PBO + benefits paid - actual return on plan assets
What is the Corridor Approach?
- Refers to actuarial gains/losses
- Only allowed in US GAAP
- Gains & losses outside a “corridor” are amortized
- The corridor is a 10% threshold, gains >10% and losses > -10% are presumed to be permanent and are amortized.
- Amortization of an acturial gain reduces pension expense and the opposite is true for losses
