Pension Essay Questions and answers: (ignore the question #s) Questions asked most frequently in past exams:

1)Theoretically justify why actuarial g and l seldom create large adjustments to pension expense. How would you advise the funding manager of a defined benefit pension plan to tret these gains in his decision on how much to fund to a plan? We expect them to even out in the long run and if we are going radical in one direction they should be smoothed out of working years to match benefits with epenses. They however affect funding decision immmediatly as loss can cause cash shorteges and vice versa. So funding manager must realize that long term trends may reverse but must react to shortages quicker than accountants. 2) explain why a defined benefit pension plan may have a greater positive effect on loyalty of employees than a defined contribution plan. Indicate the administrative and tax differences that may affect a companys decision as to which to adopt in a business? 4) what is the primary theoretical issue in determining pension expense? Theoretically justify and indicate how the treatment of actuarial gains and losses reflects that principle? It is matching pension expense to benefits received since benefits coming from employees (loyalty, focus contentment) are smooth over time expenses should be smoothed over time. Actuarial gains and losses are expected to counteract one another over time so we do not over react in three ways:1) wait till next year to consider gand and loss 2) only gain and loss outside acceptable range or corridor 3) amortize the excess over time 6) Explain whether actual or expected return on assets are used to determine pension expenses and why this is so. Which # is used to determine the liability requirement and why is this so? Expected return is used to help create a smoothing pattern to pension expense which reflects the smooth benefit pattern received from employees and satisfies the matching principle. In Liability requirements the fair value of the plan assets is used to determine liability and the plan asset values reflect actual return on assets. This is because only actual assets could be sold to pay off pension benefits therefore they should be used t o measure remaining liabilities to be presented on the balance sheet, the reality is needed on balance sheet. 7) Explain how a large unfunded amendment to a pension plan can affect the liabilities reported under a pension plan if it is announced on 12/31 of a year. Briefly explain why this unfunded amendment doesnt affect the pension expense of that year in the same way. An unfunded amendement will increase the pbo immediately and therefore increase liabilities on the 12/31 balance sheet. Expenses will not be affected until the following year because

benefits of the amendment are not obtained until then and matching demands that expense occur when benefits do. 10) A) actuarial gains and losses get unique treatment on financial statements. Justify the treatment theoretically and how might this deceive a reader of an income statement. B) How might the balance sheet help the reader understand the situation surrounding large actuarial losses? How about gains? C) Explain how the footnotes of the financial statements might help the reader understand the situation regarding large actuarial losses? How about gains? A) the unique treatment is to spread them out or ignore them unless substantial because they will tend to cancel out in the long run, employee benefits do not reflect the actuarial gains and losses, matching the cost to benefit crucial B) Because the actuarial gain and loss imact the ABO and the ABO is a key factor in determining B/s results if they are necessary -> large actuarial losses may be required to be shown on B/S. However since we do not let ABO B/S due to gains appear on B/S gains are not shown on B/S. C) However since the comparison to PBO is made in footnote and gains and losses impact footnote disclosure they will both be apparent to the reader.

Questions asked less frequently: 3) Indicate and theoretically justify the 3 different viewpoints of the obligations a company has to its employees who are eligible for a defined benefit pension plan. Indicate what elements drive each viewpoint and where on the financial statement the viewpoint will appear? (was on prior to 2007 test) Viewpoint 1) balance of prepaid/ accrued pension cost account. This is result of matching cost to benefit periods and simply is based on the fact that if you paid more than exp then asset if paid less than exp then liability. Viewpoint 2) ABO- FV plan assets at the B/S date this is based on conservatism principle meaning that if the plan ends tomorrow and we are short funds to pay everyone off we must tell the reader of the shortage. Viewpoint 3) PBO- FV PA or funding status this is even more conservative but it show what funding goals are for the company based on actuary prediction and represent how close we are to goal and shows any shortage. 5) explain what alternative methods to straight line amortization exist for amortizing prior service cost in a defined benefit pension plan and theoretically justify its use. What does the fasb recommend?

There is a method that is similar to sum of years digits amortization that is recommended by the fasb it assigns more expense to the earlier periods and assigns cost to all periods that employees who are awarded prior service credit. This is best because the # of employees that remain with the company diminishes over time and therefore benefits diminish. The matching principle demands that costs are ecpensed in accordance with benefits. 8) (question not listed only answer) winter 2012 exam pension expense doesnt equal contribution because in gaap we must match the expense to the benefits received since the benefits from employees is smooth over time we must make an effort to spread these costs out and funding is not always spread out equally each year. It depends on the availability of cash. 9) How do you check the OCI account is correct? You check OCI by making sure it equals unrecognized prior service costs which equals components 4,5,6 and 7 that have not been expensed or recognized. 11)A) Explain the pros and cons of a defined benefit versus a defined contribution pension plan from the companies viewpoint B) from the employees viewpoint C) suppose the average annual rate of return on assets is 30%. Explain how this would affect your answer to item a) A) The companies viewpoint on defined Contribution pros : Know exactlyu what cost will be. Con has less long term impact on employee. Defined benefit pros: keeps employee focusing on today, could cost very little if dies early Cons: cost could be overly high if individual lives long or salaries increase, hard to account for. B) Employee Pros: assured of same standard of living during retirement Cons: If market triples you dont own funds until retire C) IF huge return company reaps benefit on defined benefit plan thus defined benefit plan may have been better (less costly) if this huge return continues 12) explain how the accounting treatment of other post retirement benefits satisfies the matching principle. Give several expamples. The factors that determine other post retirement expenses are smoothed out to reflect smooth benefits thus satisfying matching principle. Spread out actuarial gain and losses. Expected return rather than actual return for # 3, spread out prior service costs, service cost only this years work 13) Theoretically justify the accountants treatment of a large actuarial loss incurred early in a pension plans life. What basic principle of accounting may be broken by this treatment? Little to no expense this period, will offset in the future, benefits are smooth from employees, matching demands expenses be smoothed as well. It violates conservatism and full disclosure. It is unusual to not recognize losses as soon as possible.

14) (question missing on test) fall 2007 There is an Other comprehensive Income Account which is located in the stockholders equity section of the balance sheet and the current years adjustment shows up in the other comprehensive income statement. Its balance should be equal to unrecognized prior service cost that still exist in the plan ( components 4, 5 and 6) which have not been recognized to date. 15) Explain why accountants attempt to smooth out pension expense and why this may cause the need for a second journal entry related to defined benefit pension plans. Give 3 examples of how accountants execute the smoothing effect and where in a financial statement package ( besides I/S and B/S a reader can learn more about this smoothing effect and how it relates to the true funding needs of the plan. The benefits coming from a pension plan are relatively smooth and to match costs with benefits we must smooth or spread expenses according to benefits. Because we dont always receive those benefits as expected liability. May be owed sooner or more than predicted. A second calculation surrounding potential additional liability problems is necessary to satisfy B/S needs for conservatism 3 examples of smoothing are: 1) discount rate rarely changes 2) use expected rate of return 3) amortize PSC using S/L 4) amortize actuarial G/L using S/L 5) only amortize actuarial G/L in excess of corridor 6) take S/C at 1/30 of total costs 16) Explain what the funding status of a companys pension plan is useful for and indicate where it may be found in a financial statement package. Does this amount impact the liability balance of the company? Why or why not? Funding status is the relationship between the PBO, the long term goal set by the actuary for assets necessary to pay for the plan and the actual asset set aside in the plan. It is helpful for the treasurer or finance people in a company to help them make funding decisions to the plan. It is found in the footnotes not on the B/S or I/S. Accountants do not consider it part of their liabilities because this amount includes future salary levels of employer which have notbeen obtained they are technically not a liability at this date since the employee has not attained that salary level.