Pensions
Self Test
Intermediate Accounting 2
Self Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. A defined benefit plan is one that
a. defines the amount of benefit that will be paid at retirement
b. defines the amount of contribution that will be made prior to retirement
c. defines the benefit that will be paid to the company by the pension trust fund
d. defines the contribution that must be made each period
Answer
A. A defined benefit plan defines the benefit that will be paid to employees after retirement. The company has the responsibility for payment at retirement. The present value of the obligation at retirement is funded as employees work.
2. A defined contribution plan is one that
a. defines the amount of benefit that will be paid at retirement
b. defines the amount of contribution that will be made prior to retirement
c. defines the benefit that will be paid to the company by the pension trust fund
d. defines the contribution made after retirement
Answer
B. A defined contribution plan defines the contribution that is made in the current year and the company has no obligation for payments after retirement. Employees receive a contribution each period that should grow to provide the employee funds after retirement.
3. The pension benefit obligation (PBO) is
a. the amount that is owed employees based on current salaries
b. the amount that is owed employees based on projected future salaries
c. the present value of the amount owed employees based on current salaries
d. the present value of the amount owed employees based on projected future salaries
Answer
D. The pension benefit obligation is the present value of the expected payments to employees after retirement based on projected future salary levels.
4. The accumulated benefit obligation (ABO) is
a. the amount that is owed employees based on current salaries
b. the amount that is owed employees based on future salaries
c. the present value of the amount owed employees based on current salaries
d. the present value of the amount owed employees based on future salaries
Answer
C. The accumulated benefit obligation is the present value of amounts expected to be paid to employees after retirement based on current salary levels.
5. GAAP requires pension expense to be
a. accrued in the period it is earned by the employee
b. accrued in the period cash is paid to retirees
c. always equal to the amount of cash that is contributed to the trust fund
d. re-estimated and adjusted for prior period differences between actual and estimated costs
Answer
A. Pension expense must be accrued as it is earned by employees. The expense is computed using several factors and is not the same amount as the cash contributed to the pension trust fund.
6. The minimum pension liability reported on the balance sheet should be equal to
a. the difference in pension expense and the contribution for the current period
b. the difference in the pension benefit obligation and cumulative cash contributed
c. the difference in the fair market value of assets in the pension trust fund and the present value of the amount owed to employees
d. the change in the pension liability during the current period
Answer
C. A company must report a minimum pension liability equal to the difference in fair market value of plan assets and the pension benefit obligation when the fair market value of plan assets is less than the pension benefit obligation. The pension benefit obligation is the present value of amounts owed to employees.
7. The computation of pension expense includes
a. the change in the pension benefit obligation for the period
b. interest expense on the fair market value of assets
c. the estimated return on fair market value of assets
d. the current period changes in actuarial factors
Answer
C. The computation of pension expense includes 5 common items: service cost, interest cost, prior service cost amortized, estimated return on plan assets, and amortization of the unrecognized gain/loss on plan assets. A company may also elect to include the actual return on assets instead of the estimated return on assets.
8. The computation of pension expense may include
a. the total difference in the estimated return and actual return on fair market value of plan assets for the current period
b. a portion of the difference in the estimated return and actual return on fair market value of plan assets when it exceeds a minimum amount
c. the total difference in the estimated return and actual return on the pension benefit obligation.
d. the change in interest that will be paid in the current period
Answer
B. Pension expense may include the estimated return on plan assets. If so, the deferred gain/loss (cumulative difference in actual and estimated return) that is larger than 10% of the greater of fair market value of plan assets or the pension benefit obligation is amortized over the service life of employees and also included in pension expense over time. The expense is reduced by the return because the company does not have to contribution amounts that the assets earn. The company may also elect to include the actual return on plan assets and not defer the difference in OCI. Interest is not paid separately. Interest is a part of pension expense because the service cost is stated at the present value (todays dollars) of the obligation and as time passes, interest must be added to adjust the current present value of the cost/obligation.
9. Pension expense and the change in pension benefit obligation for the current period both include
a. interest expense on the present value of pension benefit obligation
b. estimated return on plan assets
c. payments to retirees
d. prior service cost that occurred from plan amendments in the current year
Answer
A. Interest expense is included in both the pension expense and change in pension benefit obligation. Estimated return on plan assets is included only in pension expense. Payments to retirees does not change pension expense. Prior service cost impacts only the pension benefit obligation. Amortization of prior service cost is included only in pension expense. Please refer to the formulas for pension expense and pension benefit obligation.
10. The change in fair market value of plan assets includes
a. service cost
b. interest cost
c. contributions to plan assets
d. estimated return on plan assets
Answer
C. Contributions to plan assets increases the fair market value of plan assets. Estimated return does not change plan assets; actual return changes plan assets. Service and interest cost change the pension benefit obligation and do not change the value of plan assets.
11. “Underfunded” is defined as
a. fair market value of plan assets is greater than pension benefit obligation
b. fair market value of plan assets is less than pension benefit obligation
c. pension benefit obligation is less than accumulated benefit obligation
d. accumulated benefit obligation is less than pension benefit obligation
Answer
B. An under funded plan occurs when the fair market value of plan assets is less than the pension benefit obligation. Accumulated pension benefit is not used for financial statement reporting and is only a footnote disclosure.
12. An underfunded situation will be reported as a(n):
a. additional pension expense on the income statement
b. other comprehensive income on the balance sheet
c. intangible liability on the balance sheet
d. pension liability on the balance sheet
Answer
D. A company with a pension obligation greater than the plan assets will report a pension liability. The underfunded situation occurs because the cost of the pension plan is greater than the contributions and return on assets over time.
13. Prior service cost is incurred when the
a. actuary changes the expected life of employees
b. plan is amended to include prior years of service
c. plan is amended to include future years of service
d. discount rate increases
Answer
B. Prior service costs occur when the plan is amended to increase benefits and the increase is also based on prior years of service (past years that employees have worked).
14. Changes to actuary factors used to compute the pension benefit obligation for the current year are included in
a. the beginning of the year pension benefit obligation
b. the change in pension benefit obligation for the current year
c. the change in fair market value of pension plan assets in the current year
d. pension expense for the current year
Answer
B. Changes in the amount owed to employees caused by changes in the actuary factors (such as retirement age, life expectancy, wage inflation, the discount rate) are added to the pension benefit obligation the year the change in factors is implemented.
15. Benefit payments to a retiree will change
a. pension expense
b. fair market value of pension plan assets
c. pension benefit obligation
d. both b. and c.
Answer
D. Retirement benefits paid reduces the fair market value of pension plan assets and the pension benefit obligation. The plan assets pay the benefits and the company no longer owes for the amount paid.