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    Employers' Accounting for Pension Plans

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    (Implications of FASB Statement No. 87) Ruth Moore and Carl Nies have to do a class presentation on the pension pronouncement "Employers' Accounting for Pension Plans." In developing the class presentation, they decided to provide the class with a series of questions related to pensions and then discuss the answers in class. Given that the class has all read FASB Statement No. 87, they felt this approach would provide a lively discussion. Here are the situations:

    1. In an article in Business Week prior to FASB No. 87, it was reported that the discount rates used by the largest 200 companies for pension reporting ranged from 5% to 11%. How can such a situation exist, and does the pension pronouncement alleviate this problem?

    2. An article indicated that when FASB Statement No. 87 was issued, it caused an increase in the liability for pensions for approximately 20% of companies. Why might this situation occur?

    3. A recent article noted that while "smoothing" is not necessarily an accounting virtue, pension accounting has long been recognized as an exception. An area of accounting in which at least some dampening of market swings is appropriate. This is because pension funds are managed so that their performance is insulated from the extremes of short-term market swings. A pension expense that reflects the volatility of market swings might, for that reason, convey information of little relevance. Are these statements true?

    4. Companies as diverse as American Hospital Supply, Ashland Oil, Digital Equipment, GTE, Ralston Purina, and Signal Cos. held assets twice as large as they needed to fund their pension plans at one time. Are these assets reported on the balance sheet of these companies per the pension pronouncement? If not, where are they reported?
    5. Understanding the impact of the changes required in pension reporting requires detailed information about its pension plan(s) and an analysis of the relationship of many factors, particularly:

    a. the type of plan(s) and any significant amendments.
    b. the plan participants.
    c. the funding status.
    d. the actuarial funding method and assumptions currently used. What impact does each of these items have on financial statement presentation?

    6. An article noted "You also need to decide whether to amortize gains and losses using the corridor method, or to use some other systematic method. Under the corridor approach, only gains and losses in excess of 10% of the greater of the projected benefit obligation or the plan assets would have to be amortized." What is the corridor method and what is its purpose?

    7. Some companies may have to establish an intangible asset-deferred pension cost if the plan assets at fair value are less than the accumulated benefit obligation. What is the nature of this intangible asset and how is it amortized each period?

    8. In its exposure draft on pensions, the Board required a note that discussed the sensitivity of pension expense to changes in the interest rate and the salary progression assumption. This note might read as follows:

    At December 31, 2004, the weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 9% and 6%, respectively. Those assumptions can have a significant effect on the amounts reported. To illustrate, increasing the discount rate assumption to 10% would have decreased the projected benefit obligation and net periodic pension expense by $340,000 and $50,000, respectively, for the year ended December 31, 2004. Increasing the rate of change of future compensation levels to 7% would have increased the projected benefit obligation and net periodic pension cost by $180,000 and $30,000, respectively, for the year ended December 31, 2004. Why do you believe this disclosure was eliminated from the final pronouncement?

    What answers do you believe Ruth and Carl gave to each of these questions?

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    Solution Preview

    Question 1
    Prior to FASB Statement No. 87, the selection of actuarial assumptions including the discount rate used were not addressed, hence both the implicit and explicit rates were found in practice leading to a large range of discount rates used by the largest 200 companies. However, FASB Statement No. 87 mandates that the explicit rate be used. The explicit rate is the rate at which the obligation can be effectively settled.

    Question 2
    The increase in the liability for pensions for approximately 20% of companies might have resulted from the use of these companies of actuarial assumptions that are overly optimistic. More conservative assumptions can significantly affect pension recognition. For example, a lower discount rate results to a ...

    Solution Summary

    This solution provides various answers to questions involving pension plans and employer's accountability.