Pensions
Easy Practice Test
Intermediate Accounting 2
Easy Practice Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. Which of the following is not included in pension expense?
a. estimated return on plan assets
b. contributions
c. service cost
d. prior service cost amortized
Answer
B. The components of pension expense are service cost, interest cost, amortization of prior service cost, estimated return on plan assets, and amortization of gain/loss on plan assets and actuary changes. Contributions are not included in the computation of pension expense.
2. Which of the following is not included when determining the ending fair market value of assets?
a. contributions
b. estimated return on plan assets
c. payments to retirees
d. actual return on plan assets
Answer
B. The fair market value of plan assets is determined just like any other investment account. Add contributions, subtract payments to retirees (withdrawals) and adjust for actual return (add a positive return or subtract a negative return). An estimate does not impact the actual plan asset value.
3. Which of the following is not included when determining the ending pension benefit obligation?
a. interest cost
b. gain or loss from changes to actuary factors
c. payments to retirees
d. actual return on plan assets
Answer
D. The beginning pension benefit obligation is adjusted for service cost, interest cost, prior service cost due to amendments during the current year only, gain/loss due to current year changes in actuary factors, and payments to retirees. The return on plan assets does not impact the present value of the total amount owed to employees.
4. Which of the following is used to determine the gain or loss on assets that is included in the current year pension expense?
a. contributions
b. interest cost
c. pension benefit obligation
d. accumulated benefit obligation
Answer
C. The amount of the unrecognized gain/loss that is recognized in the current year pension expense is determined by the amount that is greater than 10% of the larger of the PBO or FMV of plan assets. Only the greater of the PBO or fair market value of plan assets at the beginning of the year impact the gain or loss included in the current year pension expense.
5. The prepaid pension or pension liability that should be reported on the balance sheet is equal to the difference in
a. actual fair market value of assets and pension benefit obligation at the beginning of the current year
b. actual fair market value of assets and accumulated benefit obligation at the end of the current year
c. actual fair market value of assets and pension benefit obligation at the end of the current year
d. the pension benefit obligation and the accumulated benefit obligation at the end of the current year
Answer
C. The liability that must be reported is the amount that the obligation that exceeds plan assets available to pay the benefit obligation at the end of the year. The PBO is the present value of the pension obligation to employees.
6. The difference in the estimated return on plan assets and the actual return on plan assets for the current year is
a. included in pension expense
b. added to prior year cumulative unrecognized gain/loss on assets
c. included in ending fair market value of plan assets
d. ignored and never used
Answer
B. The difference for the current year is added to the cumulative unrecognized amount to be used next year to determine the amount to include in pension expense. The unrecognized gain/loss amount that is included in pension expense for the current year is based on the prior year ending cumulative difference. Ending FMV of plan assets considers actual return only (c.).
7. Prior service cost included in pension expense is
a. the change from amendments to the pension plan during the current year
b. the cumulative change from plan amendments
c. the cumulative change from amendments to the pension plan divided by the average service life of employees
d. prior service cost is not included in pension expense
Answer
C. The prior service cost included in pension expense is an amortized partial amount of the full gain or loss from changing the plan and “grandfathering” prior years of service. The total change is added to the pension benefit obligation (PBO) in the year the change occurs.
8. The gain/loss that is included when determining the ending pension benefit obligation is
a. the decrease in prior service cost from prior year to the current year
b. the change that occurs with actuary factor adjustments in the current year
c. a change in the actual rate of return on plan assets
d. a change in the estimated rate of return on plan assets
Answer
B. The current year gain or loss from changes in actuary factors is included in the PBO during the current year. Gains decrease the liability and losses increase the liability. (a.) is the amortized amount that is included in pension expense. The value of plan assets never impacts the benefit obligation (PBO).
9. The actual return on plan assets is determined by
a. beginning fair market value of plan assets multiplied by an estimated average rate of return
b. ending fair market value of plan assets multiplied by the current year actual rate of return
c. beginning fair market value of plan assets multiplied by current year actual rate of return
d. ending fair market value of plan assets multiplied by the current year average cumulative actual rate of return
Answer
C. The actual return is always equal to the beginning fair market value of plan assets multiplied by the actual rate of return. (Most plans use weighted average of plan assets multiplied by the weighted average actual rate of return [the actual return], which is not practical for homework problems)
10. A defined benefit plan is a
a. promise to make a minimum annual contribution to the plan
b. promise to make a predetermined payment to retirees for life after retirement
c. promise to earn the estimated rate of return on assets over time
d. does not give the company a liability to pay in the future
Answer
B. A defined benefit plan is a promise to pay a predetermined amount to employees at retirement by the employer. The employer has a liability to make the payments in the future after the employee retires.
11. Pension related data included the following:
| Current Year | |
| Pension benefits paid to retirees | 28,960 |
| Actual return on plan assets | 3% |
| Contribution to the pension trust fund | 100,000 |
| Discount Rate | 6% |
| Expected return on plan assets | 8% |
| Fair market value of plan assets on 1/1 | 1,256,810 |
| Pension Benefit Obligation on 1/1 | 1,456,981 |
| Unrecognized gain on assets | 112,045 |
| Service Cost | 69,127 |
| Accumulated Benefit Obligation | 1,062,755 |
| Pension Liability | 200,171 |
A. Compute pension expense for the current year
B. Determine FMV of plan assets at 12/31
C. Record all required journal entries related to the pension plan for the current year.
D. Prepare a pension spreadsheet for the current year
Answer
A.
| Service Cost | 69,127 | always given |
| Interest Cost | 87,419 | 1,456,981 x 6% |
| Prior Service Cost Amortized | 0 | no PSC |
| Estimated Return | (100,545) | 1,256,810 x 8% |
| (Gain)/Loss on Assets | 0 | see below |
| Pension Expense | 56,001 |
| Larger of PBO or FMV on 1/1 | 1,456,981 |
| x 10% | 10% |
| Amount must be larger than: | 145,698 |
| Unrecognized gain/loss on assets | 112,045 |
| Difference to amortize | 0 |
The unrecognized amount is smaller than the 10% threshold;
nothing is included in the expense
B.
| Beginning FMV of plan assets | 1,256,810 |
| Actual return | 37,704 |
| Contributions | 100,000 |
| Payments to retirees | ( 28,960) |
| Ending FMV of plan assets | 1,365,554 |
1,256,810 x 3% = 37,704
C. Record all entries related to the pension plan:
Pension Expense
|
Pension Expense 56,001 Company Contribution: Pension Assets 100,000 Benefit Payments: PBO 28,960 |
Record the difference in actual and estimated return on assets:
| OCI – Loss on Assets 62,841 Plan Assets 62,841 |
(Actual 37,704 – 100,545 estimated = 62,841 less than estimated)
D. Pension Spreadsheet
| Easy 11 | Pension Expense |
Pension B. Oblig. |
Plan Assets |
OCI |
|
| Beginning Balance | 1,456,981 | 1,256,810 | 112,045 | ||
| Service Cost | 69,127 | 69,127 | |||
| Interest Cost | 87,419 | 87,419 | |||
| Amortization of | |||||
| PSC | _ | _ | |||
| Estimated Return on Assets | (100,545) | 100,545 | |||
| Amort of G/L on assets | _ | _ | |||
| Contributions | 100,000 | ||||
| Payments to Retirees | (220,000) | (28,960) | |||
| CY G/L PBO actuary changes | |||||
| CY PSC | |||||
| Diff in Actual/Est. Return | (62,841) | (62,841) | |||
| ___________ | ___________ | ___________ | _________ | ||
| Ending Balance | 56,001 | 1,393,527 | 1,365,554 | 49,204 |
| Pension Benefit Obligation | 1,393,527 |
| Fair Market Value of Plan Assets | 1,365,554 |
| Underfunded Liability | 27,973 |
12. Pension data related to the current year for the company include the following:
| Discount rate | 6% |
| Expected return on plan assets | 10% |
| Actual return on plan assets | 2 % |
| Service cost | $390,000 |
| Average service life | 15 years |
As of January 1, current year:
| PBO | $2,800,000 |
| ABO | $2,200,000 |
| FMV of Plan Assets | $2,100,000 |
| Unrecognized prior service cost | $ 325,000 |
| Unrecognized net asset gain | $ 330,000 |
| Pension Liability | $ 700,000 |
On December 31, current year:
| Cash contributions to pension fund | $325,000 |
| Benefit payments to retirees | $290,000 |
A. Determine pension expense for the current year.
B. Determine the fair market value of plan assets at the end of the current year.
C. Determine the pension benefit obligation at the end of the current year.
D. Make all required journal entries for the current year.
E. How should the company report the pension plan on the balance sheet at year end?
Answer
A. Pension Expense
| Service Cost | 390,000 | always given |
| Interest Cost | 168,000 | 2,800,000 x 6% |
| Prior Service Cost Amortized | 21,667 | 325,000 / 15 years |
| Estimated Return | (210,000) | 2,100,000 x 10% |
| (Gain)/Loss on Assets | (3,333) | see below |
| Pension Expense | 366,334 |
| Larger of PBO or FMV | 2,800,000 |
| x 10% | 10% |
| Amount must be larger than: | 280,000 |
| Unrecognized gain/loss on assets | 330,000 |
| Difference to amortize | 50,000 |
| Service life of employees | 15 |
| Recognize in pension expense | 3,333 |
B. Ending FMV of plan assets
| Beginning FMV of plan assets | 2,100,000 |
| Actual return | 42,000 |
| Contributions | 325,000 |
| Payments to retirees | (290,000) |
| Ending FMV of plan assets | 2,177,000 |
2,100,000 x 2% = 42,000 actual return
C. Ending PBO
| Beginning PBO | 2,800,000 | |
| Service cost | 390,000 | always given |
| Interest Cost | 168,000 | see A. |
| Prior service cost this year | 0 | no increase in CY |
| (Gain)/loss on PBO | 0 | no change in CY |
| Payments to retirees | (290,000) | given |
| Ending PBO | 3,068,000 |
D. Record Entries
Pension expense:
| Pension Expense 336,334 Plan Assets 210,000 OCI – G/L plan assets 3,333 PBO 558,000 OCI – PSC 21,667 |
Company Contribution:
|
Plan Assets 325,000 Benefit Payments: PBO 290,000 |
Record the difference in actual and estimated return on assets:
| OCI – Loss on Assets 168,000 Plan Assets 168,000 |
(Actual 42,000 – 210,000 estimated = 168,000 less than estimated)
E. On the Balance Sheet
| End of year PBO | 3,068,000 |
| End of year FMV of assets | 2,177,000 |
| Under funded amount (if +) | 891,000 |
| Beginning OCI | |
| PSC loss | (325,000) |
| Net Gain on Assets | 330,000 |
| Amortize the Gain | (3,333) |
| Amortize the PSC | 21,667 |
| CY Loss on Asset return | (168,000) |
| Ending OCI | (144,666) |
Report on the Balance Sheet:
| Pension Liability | 891,000 |
| Other Comprehensive Income | (144,666) |
13. The company has two defined benefit plans.
| Plan 1 | Plan 2 | |
| Unrecognized gain/(loss) on 1/1 | 143,000 | (302,000) |
| Accumulated Benefit Obligation on 1/1 | 1,400,000 | 1,650,000 |
| Pension Benefit Obligation on 1/1 | 1,625,000 | 1,812,000 |
| Actual return on plan assets | 6% | (12%) |
| Fair market value of plan assets on 1/1 | 1,150,000 | 2,156,000 |
| Service life of employees | 20 | 16 |
Both plans expect to earn 8% on plan assets
A. Determine the gain or loss on assets that should be included in pension expense for plan 1 and plan 2.
B. Determine the unrecognized gain/(loss) for plan 1 at the end of the year
Answer
A. Gain or loss that should be included in pension expense:
| Plan 1 | Plan 2 | |
| Larger of PBO or FMV | 1,625,000 | 2,156,000 |
| x 10% | 10% | 10% |
| Amount must be larger than: | 162,500 | 215,600 |
| Unrecognized gain/(loss) on assets | 143,000 gain | 302,000 loss |
| Difference | (19,500) | 86,400 |
| Service life of employees | 20 | 16 |
| Recognize in pension expense | 0 | 5,400 |
Plan 1 is less than the 10% threshold;
nothing is included in pension expense
Plan 2: The amortized loss will increase the pension expense
B. The unrecognized gain at the end of the year for plan 1 is:
| Beginning gain/(loss) unrecognized | 143,000 |
| Estimated return | (92,000) |
| Actual return | 69,000 |
| Recognized in the current year | 0 |
| Ending gain/(loss) unrecognized | 120,000 |
1,150,000 x 8% = 92,000
1,150,000 x 6% = 69,000
Unrecognized means the amount has not yet been included in pension expense.
The amount is reported as OCI until it is amortized to pension expense.
The unrecognized gain/(loss) on plan assets is the cumulative difference between estimated return and actual return for all prior years that has not been included in pension expense.
A gain occurs when the actual return is higher,
A loss occurs when the actual return is lower.
Each year, the difference is added to the unrecognized amount from prior year. Each year, the amount amortized and included in the pension expense is deducted from the unrecognized amount.