Pensions
Medium Practice Test
Intermediate Accounting 2
Medium Practice Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. Which of the following describes a defined contribution pension plan?
a. the employee has a liability for payments made at retirement
b. the employer has a liability for payments made at retirement
c. all employer contributions are made after the employee retires
d. payments made to employees at retirement does not depend on assets available after retirement
Answer
A. With a defined contribution pension plan, the employer makes contributions to the employee’s account each year and financing retirement is the responsibility of the employee. The company only makes payments while the employee is working.
2. Which of the following is not considered when recording and reporting pension liability?
a. Benefit payments
b. Accumulated benefit obligation
c. Fair market value of plan assets
d. The pension benefit obligation
Answer
B. Accumulated benefit obligation is not used for anything except footnote disclosure. It is not considered a true representation of what is owed because it is based on current salary levels rather than projected salary levels which are more realistic. Benefit payments reduce both the fair market value of assets and the pension benefit obligation.
3. A gain on plan assets occurs when the
a. estimated return is greater than actual return
b. actual return is greater than estimated return
c. pension benefit obligation is greater than plan assets
d. pension benefit obligation is less than plan assets
Answer
B. A gain means that the actual return was higher than the estimated return. This amount is not recognized until it becomes larger than 10% of the larger of the plan assets or the pension benefit obligation.
4. Which of the following is correct relative to how pensions are reported on the balance sheet?
a. the ending fair market value of plan assets is reported
b. the ending pension benefit obligation is reported
c. the difference in fair market value of assets and pension benefit obligation is reported
d. both a. and b.
Answer
C. Pension plan assets and the pension benefit obligation are not reported on a company’s balance sheet. The difference in the two is reported because the company can use the plan assets to pay the liability. The company cannot report the pension plan assets on their balance sheet because they do not own and control the plan assets.
5. When comparing the accumulated benefit obligation (ABO) to the pension benefit obligation (PBO),
a. the ABO is normally greater than the PBO
b. the PBO is normally greater than the ABO
c. which one is greater depends on how many employees the company has
d. which one is greater depends on the discount rate that is used
Answer
B. The ABO is based on current salary levels and the PBO is based on projected salary levels. Expected wage inflation typically results in higher projected salary levels than current salary levels.
6. Interest cost associated with the pension benefit obligation will
a. decrease pension expense and increase pension benefit obligation
b. decrease plan assets and increase pension expense
c. increase pension expense and increase pension benefit obligation
d. increase plan assets and increase pension benefit obligation
Answer
C. Interest cost is added to service cost when computing pension expense and added to beginning pension benefit obligation when computing the ending pension benefit obligation. Interest expense is an adjustment to the present value of the PBO because one year has passed. Interest cost does not impact the fair market value of plan assets.
7. A plan that is over funded
a. has recorded more pension expense than cash contributions
b. has an accumulated benefit obligation less than fair market value of assets
c. has a pension benefit obligation less than fair market value of assets
d. has earned much less than expected on plan assets
Answer
C. Over or under funded is determined by comparing the ending fair market value of plan assets to the ending pension benefit obligation. Over funded means assets are greater than the obligation. When plan assets earn less than expected it typically leads to an under funded situation (d.). A higher pension expense than cash contributed will normally lead to an underfunded situation over time when assets appreciate as expected (a).
8. Costs related to pension plan benefits are accounted for
a. using the accrual basis
b. using the cash basis
c. after employees work to earn the benefits and actually retire
d. when the company pays the benefits
Answer
A. An expense is recorded in the period of time the employees work to earn the benefit. This is the accrual basis accounting.
9. A portion of the unrecognized gain or loss on plan assets is included in the fair market value of plan assets if
a. the cumulative to date unrecognized gain/loss is greater than 10% of the greater of plan assets or pension benefit obligation
b. the prior year unrecognized gain/loss is greater than 10% of the greater of plan assets or pension benefit obligation
c. the pension benefit obligation is 10% greater than the fair market value of plan assets
d. none of the above
Answer
D. The gain or loss on plan assets is included in pension expense, not the fair market value of assets. The actual return only changes the fair market value of plan assets.
10. Amortizing a net gain on plan assets will
a. increase plan assets
b. decrease pension benefit obligation
c. decrease pension expense
d. increase pension benefit obligation
Answer
C. Amortizing a net gain will reduce pension expense and move the gain out of OCI. The pension obligation does not change for gains and losses on plan assets. The amount in the plan assets does not impact the amount owed to employees.
11. A company has a defined benefit plan with the following disclosed in the footnotes
| Current Year | |
| Fair market value of plan assets on 1/1 | 1,200,000 |
| Actual return on plan assets | 72,000 |
| Contributions to the plan | 145,000 |
| Payments to Retirees | ( 62,000) |
| Fair market value of plan assets on 12/31 | 1,355,000 |
| Projected Benefit Obligation on 1/1 | 1,400,000 |
| Service Cost | 98,000 |
| Interest Cost | 84,000 |
| Payments to Retirees | (62,000) |
| Change in actuary assumptions | (35,000) |
| Projected Benefit Obligation on 12/31 | 1,485,000 |
The estimated return on plan assets was higher than the actual return by 19,000.
Unrecognized losses on plan assets totaled 168,000 at the beginning of the year.
The average service life is 14 years.
A. Determine pension expense for the current year.
B. Determine the discount rate for the current year.
C. Determine the actual return on plan assets (%) for the current year.
D. Record all required entries related to the pension plan for the current year.
E. Determine the line items and amounts the company will report on the current year- end balance sheet.
Answer
A. Pension Expense
| Service Cost | 98,000 |
| Interest Cost | 84,000 |
| Prior Service Cost Amortized | 0 |
| Estimated Return | (91,000) |
| (Gain)/Loss on Assets (see below) | 2,000 |
| Pension Expense | 93,000 |
no prior service cost
19,000 + 72,000 actual
| Larger of PBO or FMV 1/1 | 1,400,000 |
| x 10% | 10% |
| Amount must be larger than: | 140,000 |
| Unrecognized loss on assets | 168,000 |
| Difference to amortize | 28,000 |
| Service Life | 14 |
| Include in pension expense: loss | 2,000 |
B. Determine the Discount Rate
Beginning PBO x discount rate = interest expense
Interest expense is given.
Divided interest expense by the beginning PBO:
84,000 / 1,400,000 = 6%
C. Determine the actual rate of return
The actual return on plan assets is equal to actual return divided by beginning FMV
of plan assets:
72,000 / 1,200,000 = 6%
D. All Journal Entries
Pension expense:
| Pension Expense 93,000 Plan Assets 91,000 PBO 182,000 OCI – G/L plan assets 2,000 |
Company Contribution:
| Plan Assets 145,000 Cash 145,000 |
Benefit Payments:
| PBO 62,000 Plan Assets 62,000 |
Record the difference in actual and estimated return on assets:
| OCI – Loss on Assets 19,000 Plan Assets 19,000 |
(Actual 72,000 – 91,000 estimated = 19,000 less than estimated)
Record the change in actuary assumptions, reduction to the obligation
| PBO 35,000 OCI – Gain 35,000 |
E. Amounts / Line Items on the Balance Sheet
| End of year BPO | 1,485,000 |
| End of year FMV | 1,355,000 |
| Pension Liability | 130,000 |
| Beginning OCI | |
| Unrecognized Loss on assets | (168,000) |
| CY change in Actuary Factors | 35,000 |
| Amortize unrecognized loss | 2,000 |
| CY Loss on Assets | (19,000) |
| Ending OCI | (150,000) |
12. The following information relates to the second and third year of a pension plan:
| End of 2nd Year |
End of 3rd Year |
|
| Fair market value of plan assets | 1,222,100 | 1,675,340 |
| Accumulated benefit obligation | 986,250 | 1,024,365 |
| Pension benefit obligation | 1,153,236 | 1,206,664 |
| Unrecognized gain/(loss) on assets | 46,250 | ? |
| Unrecognized prior service cost | 110,000 | 100,000 |
| Contributions to the pension trust fund | 125,000 | 400,000 |
| Payments to Retirees | (77,000) | (112,000) |
| Discount Rate | 5% | 5.5% |
| Estimated Return on plan assets | 7% | 7% |
| Service life of employees | 15 | 15 |
| Pension Asset | 68,864 | ? |
A. Determine the amount of gain/loss on assets that should be included in the pension expense for year 3.
B. Determine the actual return on plan assets in $ and % for year 3
C. Record the entry to record pension expense for year 3. Service cost is $102,000.
D. Determine the unrecognized gain/(loss) on plans assets at the end of year 3
E. Record all other entries related to the pension plan for the 3rd year.
Answer
A.
| Larger of PBO or FMV 1/1 | 1,222,100 |
| x 10% | 10% |
| Amount must be larger than: | 122,210 |
| Unrecognized gain on assets | 46,250 |
| Difference (lower than 10%) | 75,960 |
| Service Life | 14 |
| Include in pension expense | 0 |
The difference does not meet the 10% threshold;
nothing is included in pension expense in the CY.
B.
| Beginning FMV of plan assets | 1,222,100 |
| Actual return (plug) | 165,240 |
| Contributions | 400,000 |
| Payments to retirees | (112,000) |
| Ending FMV of plan assets | 1,675,340 |
All amounts are given except for actual return; plug to find the actual return
Actual return divided by beginning FMV of assets = % return
165,240 / 1,222,100 = 13.52% actual return on assets
C.
| Service Cost | 102,000 |
| Interest Cost 1,153,236 x 5.5% | 63,428 |
| Prior Service Cost Amortized | 10,000 |
| Estimated Return 1,222,100 x 7% | (85,547) |
| (Gain)/Loss on Assets (see A.) | 0 |
| Pension Expense | 89,881 |
PSC Amortized is the difference in CY and PY
Record Pension expense:
| Pension Expense 89,881 Plan Assets 85,547 PBO 165,428 OCI – PSC 10,000 |
D.
| Beginning gain unrecognized 1/1 | 46,250 |
| Estimated return (see C. above) | (85,547) |
| Actual return (see B. above) | 165,240 |
| Recognized in the current year (see A.) | 0 |
| Ending gain unrecognized 12/31 | 125,943 |
E.
Record the company contribution:
| Plan Assets 400,000 Cash 400,000 |
Record the difference in actual and estimated return on assets:
| Plan Assets 79,693 OCI – Gain on Assets 79,693 |
(Actual 165,240 – 85,547 estimated = 79,693 more than estimated)
Prepaid Pension Asset:
| End of year BPO | 1,206,664 |
| End of year FMV | 1,675,340 |
| Over funded | 468,676 |
13. A company had the following related to its pension plan:
For the current year:
| Discount Rate | 6% |
| Expected return on plan assets | 8% |
| Actual return on plan assets | 12% |
| Service cost | 310,000 |
| Service life | 8 years |
Beginning of current year
| PBO | 2,300,000 |
| Plan assets market value | 2,500,000 |
| Unrecognized prior service cost | 52,000 |
| Unrecognized net loss on assets | 450,000 |
End of current year:
| Cash contribution to pension trust | 275,000 |
| Benefit payments to retirees | 220,000 |
The expected life of employees increases, which resulted in a loss of $172,000 in the current year.
A. Calculate pension expense for the current year
B. Determine the fair market value of assets at the end of the current year
C. Determine pension benefit obligation at the end of the current year
D. Record all necessary journal entries for the current year.
E. Prepare a pension spreadsheet and determine the amounts to be reported on the balance sheet at the end of the current year.
Answer
A. Pension Expense
| Service Cost | 310,000 |
| Interest Cost 2,300,000 x 6% | 138,000 |
| Prior Service Cost Amortized | 6,500 |
| Estimated Return 2,500,000 x 8% | (200,000) |
| Loss on Assets (see below) | 25,000 |
| Pension Expense | 279,500 |
52,000 / 8 years = 6,500 PSC Amortized
| Larger of PBO or FMV 1/1 | 2,500,000 |
| x 10% | 10% |
| Amount must be larger than: | 250,000 |
| Unrecognized gain/loss on assets | 450,000 |
| Difference to amortize | 200,000 |
| Service life of employees | 8 |
| Loss recognize in pension expense | 25,000 |
B.
| Beginning FMV of plan assets | 2,500,000 |
| Actual return 2,500,000 x 12% | 300,000 |
| Contributions | 275,000 |
| Payments to retirees | (220,000) |
| Ending FMV of plan assets | 2,855,000 |
C.
| Beginning PBO | 2,300,000 |
| Service Cost | 310,000 |
| Interest Cost 2,300,000 x 6% | 138,000 |
| Prior service cost this year | 0 |
| (Gain)/loss on PBO | 172,000 |
| Payments to retirees | (220,000) |
| Ending PBO | 2,700,000 |
No PSC, no CY amendments
The loss on PBO happened in CY, so include it
D.
Record pension expense:
| Pension Expense 279,500 Plan Assets 200,000 PBO 448,000 OCI – Loss on assets 25,000 OCI – PSC 6,500 |
Record the company contribution:
| Plan Assets 275,000 Cash 275,000 |
Record the difference in actual and estimated return on assets:
| Plan Assets 100,000 OCI – Gain on Assets 100,000 |
(Actual 300,000 – 200,000 estimated = 100,000 more than estimated)
Record the current year actuary change:
| OCI – Loss on actuary change 172,000 PBO 172,000 |
Record Benefit Payments
| PBO 220,000 Plan Assets 220,000 |
E. Pension Spreadsheet and Amounts on the Balance Sheet
| Pension Expense |
Pension B. Oblig. |
Plan Assets |
OCI |
|
| Beginning Balance | 2,300,000 | 2,500,000 | (502,000) | |
| Service Cost | 310,000 | 310,000 | ||
| Interest Cost | 138,000 | 138,000 | ||
| Amortization of | ||||
| PSC | 6,500 | 6,500 | ||
| Estimated Return on Assets | (200,000) | 200,000 | ||
| Amort of G/L on assets | 25,000 | 25,000 | ||
| Contributions | 275,000 | |||
| Payments to Retirees | (220,000) | (220,000) | ||
| CY G/L PBO actuary changes | 172,000 | (172,000) | ||
| CY PSC | ||||
| Diff in Actual/Est. Return | 100,000 | 100,000 | ||
| ________ | __________ | __________ | _________ | |
| Ending Balance | 279,500 | 2,700,000 | 2,855,000 | (542,500) |
| End of year BPO | 2,700,000 |
| End of year FMV | 2,855,000 |
| Over funded | 155,000 |
Report on the Balance Sheet:
|
Prepaid Pension Asset 155,000 OCI Loss (542,500) |