Pensions
Hard Practice Test
Intermediate Accounting 2
Hard Practice Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. Pension expense is decreased by
a. estimated losses on plan assets
b. prior year cash contributions
c. benefits paid to employees
d. prior service cost amortized in the current year
Answer
B. Contributions increase plan assets, which increase the estimated return on plan assets, which reduces pension expense. A company does not estimated losses on plan assets. Benefits paid and prior service cost are not part of the components of pension expense. Prior service cost amortized increases pension expense.
2. Pension expense is affected by
a. changes that occur in the pension benefit obligation
b. changes that occur in the fair market value of plan assets
c. the estimated change in the fair market value of plan assets
d. both a. and b.
Answer
D. Interest cost and service cost are included in both pension expense and pension benefit obligation. The fair market value of plan assets is used to determine pension expense. Less assets leads to more expense. Pension expense reflects a change in what is owed netted with the expected return on plan assets.
3. Which of the following terms is not a measure of the obligation of the employer after employees retire?
a. pension benefit obligation
b. accumulated benefit obligation
c. vested benefit obligation
d. cumulative benefit obligation
Answer
D. The PBO is the employer obligation at expected salary levels. The ABO is the employer obligation at current salary levels. Vested benefit obligation is part of the ABO and the PBO and reflects what is earned to date. Cumulative benefit obligation is not a term that is used when accounting for pensions.
4. Which of the following is a description of the pension benefit obligation?
a. present value of vested benefits at current pay levels
b. present value of vested benefits at projected pay levels
c. total present value of the benefits expected to be paid to employees at projected pay levels
d. cumulative prior service costs
Answer
B. The pension benefit obligation to employees is always a present value amount for both currently vested and non vested amounts that are expected to be paid for the total time employees are expected to work. The PBO is based on employees projected salaries at retirement.
5. A common cause of under funding is
a. the actual return on plan assets is less than estimated return
b. the actual return on plan assets is more than estimated return
c. an increase in the discount rate used by the actuary
d. annual service cost is less than expected
Answer
A. Required contributions take into account the expected earnings of plan assets. Plan assets that do not appreciate as expected tend to lead to underfunded plans. Service cost less than expected will cause the pension benefit obligation to be lower which will contribution to overfunding. A higher discount rate decreases the present value of the pension benefit obligation and leads to overfunding.
6. Delayed recognition of gains and losses causes
a. representational faithfulness
b. higher fair market value of plan assets
c. income optimization
d. income smoothing
Answer
D. FASB allows delayed recognition to keep volatility off the income statement, which is also called income smoothing.
7. Which of the following gives the best representation of the amount the employer is most likely to pay to retirees?
a. accumulated benefit obligation at the current year end
b. fair market value of plan assets at the current year end
c. pension benefit obligation at the current year end
d. pension liability recorded on the balance sheet
Answer
C. The pension benefit obligation is the present value of the amount that is expected to be paid to retirees upon retirement using expected salary and total years expected to work. Accumulated benefit obligation uses current salaries which will most likely not be what the payout is based on (a.). The pension liability represents the amount underfunded, which is not the total obligation to employees (d.). The fair market value of plan assets is expected to grow to the amount required after retirement (b.).
8. Other comprehensive income increases when
a. present value of plan assets is more than present value of pension benefit obligation
b. present value of plan assets is less than present value of pension benefit obligation
c. the actuary changes factors and it generates a gain
d. a gain in OCI is amortized into pension expense
Answer
C. Other comprehensive income increases with a credit. A credit to OCI occurs when the pension liability is decreases or pension expense decreases. A gain from changing plan factors will decrease the benefit obligation and increase other comprehensive income. Amortizing a gain will decrease pension expense and decrease the balance in OCI (d.). Both a. and b. change the pension asset or liability and do not directly change OCI.
9. Current year service cost is equal to the change in the total
a. present value of plan assets during the current year
b. total pension benefit obligation during the current year
c. present value of the net cost of employees working one more year
d. of the difference in the present value of plan assets and the present value of pension benefit obligation
Answer
C. The service cost that is included in pension expense is the present value of the cost of employees working one additional year. Service cost has no impact on the fair market value of assets. The pension benefit obligation is changed by more factors than just service cost.
10. A payment to retirees may change
a. other comprehensive income
b. prepaid pension
c. pension expense
d. the unrecognized gain/loss
Answer
B. The entry to record a payment to retirees decreases both the total plan assets and the total pension benefit obligation. The difference in the plan assets and the pension benefit obligation is reported as a prepaid pension or the pension liability.
11. The following information relates to the second and third year of a pension plan
| Prior Year | Current Year | |
| Fair market value of plan assets, 12/31 | 986,211 | ? |
| Accumulated benefit obligation, 12/31 | 752,700 | ? |
| Pension benefit obligation,12/31 | 817,925 | ? |
| Unrecognized gain/(loss) on assets, 12/31 | 118,260 | ? |
| Prior service cost | 96,000 | 168,000 |
| Service Cost | 74,265 | 82,450 |
| Discount Rate | 4.5% | 5 % |
| Actual return on plan assets | 4% | (6%) |
| Estimated return on plan assets | 8% | 8% |
| Contributions | 132,000 | 116,000 |
| Payments to Retirees | 61,000 | 57,000 |
| Plan amendment loss on 1/2/CY | 0 | 88,000 |
A. Determine the fair market value of plan assets at the end of the current year.
B. Determine the pension benefit obligation at the end of the current year
C. Compute pension expense for the current year.
D. Record all journal entries related to the pension plan for the current year.
E. Prepare the pension spreadsheet for the current year.
Answer
A.
| Beginning FMV of plan assets | 986,211 |
| Actual return 986,211 x (6%) | (59,173) |
| Contributions | 116,000 |
| Payments to retirees | (57,000) |
| Ending FMV of plan assets | 986,038 |
B.
| Beginning PBO | 817,925 |
| Service cost | 82,450 |
| Interest Cost 817,925 x 5% | 40,896 |
| Prior service cost in CY | 88,000 |
| (Gain)/loss on PBO (no CY) | 0 |
| Payments to retirees | (57,000) |
| Ending PBO | 972,271 |
C.
| Service Cost | 82,450 |
| Interest Cost 817,925 x 5% | 40,896 |
| Prior Service Cost Amortized (below) | 16,000 |
| Estimated Return 986,211 x 8% | (78,897) |
| Gain on Assets Amortized: see below | ( 1,708) |
| Pension Expense | 58,741 |
| Beginning PSC | 96,000 |
| Current year added PSC | 88,000 |
| Less Ending PSC | (168,000) |
| Difference is amount amortized | 16,000 |
| Larger of PBO or FMV | 986,211 |
| x 10% | 10% |
| Amount must be larger than: | 98,621 |
| Unrecognized gain/loss on assets | 118,260 |
| Difference to amortize | 19,639 |
| Service life of employees | 11.5 |
| Recognize gain in pension expense | 1,708 |
| Total prior service cost (96+88) 184,000 = 11.5 years Amount amortized 16,000 |
D. Journal entries for the current year
Record pension expense:
| Pension Expense 58,741 Plan Assets 78,897 OCI – Gain on assets 1,708 OCI – PSC 16,000 PBO 123,346 |
Record the company contribution:
| Plan Assets 116,000 Cash 116,000 |
Benefit Payments
| PBO 57,000 Plan Assets 57,000 |
Record the Plan Amendment:
| OCI – PSC 88,000 PBO 88,000 |
Record the difference in actual and estimated return on assets:
| OCI – Loss on Assets 138,070 Plan Assets 138,070 |
Actual (59,173) – 78,897 estimated = 138,070 less than estimated
E. Pension Spreadsheet for the CY
| Pension Expense |
Pension B. Oblig. |
Plan Assets |
OCI |
|
| Beginning Balance | 817,925 | 986,211 | 22,260 | |
| Service Cost | 82,450 | 82,450 | ||
| Interest Cost | 40,896 | 40,896 | ||
| Amortization of | ||||
| PSC | 16,000 | 16,000 | ||
| Estimated Return on Assets | (78,897) | 78,897 | ||
| Amort of G/L on assets | (1,708) | (1,708) | ||
| Contributions | 116,000 | |||
| Payments to Retirees | (57,000) | (57,000) | ||
| CY G/L PBO actuary changes | 88,000 | (88,000) | ||
| Diff in Actual/Est. Return | (138,070) | (138,070) | ||
| _________ | _________ | __________ | __________ | |
| Ending Balance | 58,741 | 972,271 | 986,038 | (189,518) |
Beginning OCI = 118,260 gain – 96,000 PSC loss
| End of year BPO 972,271 End of year FMV 986,038 Over funded Asset 13,767 |
Report on Balance Sheet:
|
Prepaid Pension Asset 13,767 OCI (189,518) |
A. Calculate pension expense for the current year.
B. Determine the pension benefit obligation at the end of the current year.
C. Determine the FMV of plan assets at the end of the current year.
D. Prepare the required journal entries related to the defined pension plan for the current year.
E. Prepare a pension spreadsheet for the current year.
Answer
A.
| Service Cost | 350,000 |
| Interest Cost 1,700,000 x 7% | 119,000 |
| Prior Service Cost Amortized | 60,000 |
| Estimated Return 1,520,000 x 12% | (182,400) |
| Gain on Assets Amortized (see below) | ( 8,000) |
| Pension Expense | 338,600 |
| Larger of PBO or FMV | 1,700,000 |
| x 10% | 10% |
| Amount must be larger than: | 170,000 |
| Unrecognized gain on assets | 250,000 |
| Difference to amortize | 80,000 |
| Service life of employees | 10 |
| Recognize gain in pension expense | 8,000 |
B.
| Beginning PBO | 1,700,000 |
| Service cost | 350,000 |
| Interest Cost 1,700,000 x 7% | 119,000 |
| Prior service cost CY | 0 |
| (Gain)/loss on PBO in CY | (100,000) |
| Payments to retirees | (76,050) |
| Ending PBO | 1,992,950 |
C.
| Beginning FMV of Plan Assets | 1,520,000 |
| Actual Return on Assets | 151,600 |
| Contributions | 375,000 |
| Payments to Retirees | (76,050) |
| Ending FMV of Plan Assets | 1,970,550 |
1,520,000 + 375,000 = 1,895,000 beginning x 8% = 151,600
D. Record all journal entries
Record Pension Expense
| Pension Expense 338,600 Plan Assets 182,400 OCI – Gain on Assets 8,000 OCI- PSC 60,000 PBO 469,000 |
Record the company contribution:
| Plan Assets 375,000 Cash 375,000 |
Record change in current year actuary estimates:
| PBO 100,000 OCI – Gain 100,000 |
Record the difference in actual and estimated return on assets:
| OCI – Loss on Assets 30,800 Plan Assets 30,800 |
1,520,000 + 375,000 = 1,895,000 beginning FMV x 8% = 151,600 actual
Actual 151,600 – 182,400 estimated = 30,800 less than estimated
Benefit Payments to Retirees
| PBO 76,050 Plan Assets 76,050 |
E. Pension Spreadsheet for the Current Year
| Pension Expense |
Pension B. Oblig. |
Plan Assets |
OCI |
|
| Beginning Balance | 1,700,000 | 1,520,000 | (350,000) | |
| Service Cost | 350,000 | 350,000 | ||
| Interest Cost | 119,000 | 119,000 | ||
| Amortization of | ||||
| PSC | 60,000 | 60,000 | ||
| Estimated Return on Assets | (182,400) | 182,400 | ||
| Amort of G/L on assets | (8,000) | (8,000) | ||
| Contributions | 375,000 | |||
| Payments to Retirees | (76,050) | (76,050) | ||
| CY G/L PBO actuary changes | (100,000) | 100,000 | ||
| Diff in Actual/Est. Return | (30,800) | (30,800) | ||
| ________ | __________ | __________ | _________ | |
| Ending Balance | 338,600 | 1,992,950 | 1,970,550 | (228,800) |
Beginning OCI = 250,000 gain – 600,000 PSC loss
| End of year BPO | 1,992,950 |
| End of year FMV | 1,970,550 |
| Underfunded Liability | 22,400 |
Report on the Balance Sheet:
| Pension Liability 22,400 OCI Loss (228,800) |
13. Following is information related to the company’s pension plan for the current year:
| 12/31 Prior Year | 12/31 Current Year | |
| Unrecognized gain/(loss) on assets | ( 74,000) | ( 90,480) |
| Unrecognized prior service costs | 240,000 | 210,000 |
| Fair Value of pension plan assets | 1,464,000 | 1,761,000 |
| PBO | 2,060,000 | ?? |
| ABO | 1,860,000 | 1,956,000 |
| Contribution to plan | 100,000 | 300,000 |
| Payments to Retirees | 85,000 | 89,000 |
| Discount rate | 5% | 5% |
A. Determine service cost and the estimated return on plan assets for the current year given current year pension expense is $365,000.
B. Prepare a pension spreadsheet for the current year.
C. Record all required journal entries for the current year
Answer
A. Begin by recreating the pension expense journal entry. Put the pension expense at the bottom of pension expense calculation. You have to compute estimated return below before you can plug service cost.
| Service Cost (work up & plug) | 334,480 |
| Interest Cost 2,060,000 x 5% | 103,000 |
| PSC Amortized (240-210) | 30,000 |
| Estimated Return (see below) | (102,480) |
| (Gain)/Loss on Assets (see below) | 0 |
| Pension Expense (given) | 365,000 |
| Larger of PBO or FMV | 2,060,000 |
| x 10% | 10% |
| Amount must be larger than: | 206,000 |
| Unrecognized loss on assets | 74,000 |
| Difference to amortize (lower than 10%) | 0 |
| Beginning FMV of plan assets | 1,464,000 |
| Actual return (plug to find) | 86,000 |
| Contributions | 300,000 |
| Payments to retirees | (89,000) |
| Ending FMV of plan assets | 1,761,000 |
| Unrecognized loss at 1/1 | (74,000) |
| Actual Return on plan assets (above) | 86,000 |
| Estimated Return on plan asset (plug) | (102,480) |
| Unrecognized loss at 12/31 (given) | ( 90,480) |
B. Pension Spreadsheet
| Pension Expense |
Pension B. Oblig. |
Plan Assets |
OCI |
|
| Beginning Balance | 2,060,000 | 1,464,000 | (314,000) | |
| Service Cost | 334,480 | 334,480 | ||
| Interest Cost | 103,000 | 103,000 | ||
| Amortization of | ||||
| PSC | 30,000 | 30,000 | ||
| Estimated Return on Assets | (102,480) | 102,480 | ||
| Amort of G/L on assets | _ | _ | ||
| Contributions | 300,000 | |||
| Payments to Retirees | (89,000) | (89,000) | ||
| CY G/L PBO actuary changes | _ | _ | ||
| Diff in Actual/Est. Return | (16,480) | (16,480) | ||
| ________ | ________ | ________ | ________ | |
| Ending Balance | 365,000 | 2,408,480 | 1,761,000 | (300,480) |
C. Record all journal entries required:
Pension Expense
| Pension Expense 365,000 Plan Assets 102,480 OCI- PSC 30,000 PBO 437,480 |
Record the company contribution:
| Plan Assets 300,000 Cash 300,000 |
Record the difference in actual and estimated return on assets:
| OCI – Loss on Assets 16,480 Plan Assets 16,480 |
(Actual 86,000 – 102,480 estimated = 16,480 less than estimated)
Benefit Payments:
| PBO 89,000 Plan Assets 89,000 |
| End of year PBO | 2,408,480 |
| End of year FMV | 1,761,000 |
| Underfunded Liability | 647,480 |
Report on the Balance Sheet:
|
Pension Liability 647,480 OCI Loss (300,480) |
Report on the Income Statement:
| Pension Expense (365,000) |