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2015 Cfa Level 2 Book 2 Fsa Qa
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ThechoiceofinventoIymethodaffbctsthefinancia>statementsandanyfinancialratiosthatarebasedonthem.Asaconsequence,theanaIystmustcaefUIIycosideinventoIyvaluationmethoddiffbrenceswhenevaIuatingacompany,sperfbrmanceovertimeorincompansontoindustlydataorindustyandcostofgoodssoldbalancestotheFIFOmethodfbrcompansonpuIposes.
LIOliquidationoccurswhenthenumberofunitsinendinginventoIydeclinesfiomthenumberofunitsthatwerepsentatthebeginningoftheyear.IfinventounitcostshavegenerallyrisenfiDmyeartoyear,thiswiI>produceaninventory-relatedincreaseingrossprofits.
ConsistencyofinventorycostingisrequiredunderbothlFRSandUSGAAP.lfacompanychangesanaccountingpolicy,thechangemustbejustifiableandappliedretrospective>ytothefinancia>statements.AnexceptiontotheretrospectiverestatementiswhenacompanyreportingunderUSGAAPchangestotheLIOmethod.
InventonesaemeasuredattheowerofcostandnetrealisablevalueunderRSandthelowerofcostandmarketunderUSGAAP.Anywrite-downofinventoIytonetrealisablevalueormarketreducesthecaIyingamountofinventoIyonthebalancesheetandprofitontheincomestatement.
Reversa>sofinventorywrite-downsmayoccurunderIFRSbutarenotaI>owedunderUSGAAP.
ChangesinthecarryingamountswithininventoIyclassifications(suchasrawmaterials,work-in-process,andfinishedgoods)mayprovidesignalsaboutacompany,sfhturesalcsandprofits.Re>evantinfbrmationwithrespecttoinventoIymanagementandftlturesalesmaybefbundintheManagementDiscussionandAnalysisorsimilaritemswithintheannua>orquarterlyrepoIts,industIynewsandpublicationsandindustIyeconomicdata.
InventoIymanagementmayhaveasubstantialimpactonacompany,sactivity,profitabiIity,Iiquidity,andsolvencyatios.tisciticaIfbrtheanaysttobeawaeofindustrytrendsaIdmanagement,sintentions.
PacticePbIems
CoIrigh
41
accodancewithUSGAAPPackardisparticuIarIyinteestedmtheeffbctsofthecompany,sIlenheIIFOmethodtoaccountfbritsinventory.Forthispurpose,MartinsoncollectstheuseoftheLIFOmethodtoaccountfbritsinventoryfmancialdatapreseHtedinExhibits>and2.
ExhibitlBlceSheetInfOmti0nUSMii0nS
AS0f31December 2009Z008
CashandcashequivaIents>72Accountsreceivable 626
Inventones 620
Othercurrentassets l25
TotalcuITentassets >,543
PropeItyandequipment,net 3,035T0tMssetS 4,578
TotaIcurrentiabiitiesl,g5
644Long-tenndebt Totalliabi>ities 2,l3g
Commonstockandpaidincapital>,652787Retainedeamings
Totalshareho>ders,equity2,13g
TotlliabiIitieSHdSMeh0lderS,equity4,578-
Exhibit2IC0meSttementInfbrmioUSMii0S
l57
458
539
65
l,2l9
Z,g72
4,l9l--
l,395
601
l,g9gI
>,652
540
2lg2
,l9l-
F0theYemEnded31Decembe 2009Z008
Sales
CostofgoodssoId
Depreciationandamoisationexpense
Selling,geneaI,andadministrativeexpense
Interestexpense
Incometaxexpense
Netincome
4,346
2,2ll
l3g
l656
3l
62
27
,l6l
2,l47
llg
l,637
l8
48
l92
Martinsonfindsthefbllowinginfbnnationinthenotestothefinancialstatements
TheLIOIcservesasof3lDecember2009and2008are$l55mil>ionand$ll7mi>lionespectively,and
TheeffbctiveincometaxrateapplicabletoKarpfbr200gandeaIierperiodsis20percent.
1IfKarphadusedFIFOinsteadofLIFO,theamountofinventoIrepoItedasof3lDecember2009wouldhavebeenc/bses/to:
A$465million
B658million.
C$775mil>ion
2IfKarphadusedFIFOinsteadofLIFO,theamountofcostofgoodsso>dreportedbyKarpfbrtheyearended3lDecember2009wouldhavebeencbssto:
A2,056miion
B2,l73million.
C2249million
3IfKarphadusedFIFOinsteadofLFO,itseportednetincomefbrtheyearended3lDecember2009wouldhavebeenhigherbyanamountcbes
A$30mi>Iion
B$38mi>lion.
C$l55million
1IfKarphadusedFIFOinsteadofLIFO,Kap,sretainedeamingsasof3lDecember2009wouldhavebeenhighebyanamountcbseso:
All7million
B24milion
C$l55milIion
5lfKarphadusedFIFOinsteadofLIFO,whichofthefbllowingratioscomputedasof3lDecember2009wouldosyhavebeenlower?
ACashratio.
BCurrentatio
CGrossprofitmargin
6IfKarphadusedFIFOinsteadofLIFO,itsdebttoequityratiocomputedasof3lDecember200gwouldhave:
Aincreased.
Bdecreased
Cemainedunchanged 15
ThefoowinginfmationelatestoQuestions7122
RobetGroanequityanalystispreparingaeportonCruxCorp.Aspartofhisreport,GroffmakesacomparativefinancialanalysisbetweenCruxanditstwomaincompetitors,RolbyCorpandMikkoIncCmxandMikkorepoItunderUSGAAPandRolbyreportsunderIFRS.
GroffgathersinfbrmationonCmx,Rolby,andMikkoTherelevantfinancialinfbrmationhecompiIesisinExhibit1SomeinfbrmationontheindustIyisinExhibit2.
Exhnbit1SelectedFinancilIfbmti0nUSMilli0ns
R0lby Mikk0Crux
LIOFIFOLIOInventoIyvaluationmethodF0mtheBlanceSheets
As0f31DecemberZ009
InventoIy,gross
Valuationallowance
InventoIy,net
Tota>debt
TotaIshareholders,equityAs0f31DecemberZ008
InventoIy,gross
VaIuationallowance
lnventoIy,net
4806205l0
2025l4-
4605951g6
l,l22850732
2,5432,032,0gl
46560240l
23l5l2
14258738g
FmmtheInC0meStatementS
YeEnded31DecemberZ009
Revenues
Costofgoodssold
Netincome
3503
Z,550
205
5,442
3,782
327
1,60g
3,l20
229
l5l5l
Chargesincludedincostofgoodsso>dfbrinventoIywrite-downs*
*Thisdoesnotmatchthechangeil>t>leiIIcnua{ionallowanceisIeducedofecMhevaluaionlIowanceattachedoiemssoldandincasedfbraddiionalnecessaIywiedows.
LOResee-
Asof3>December200g
Asof3lDecembe2008
77
50
0055
72
46
3Asof3lDecember2007g6 0
TxRHte
Effectivetaxrate 30%30%30%
Exhibit2.InduStyInf0mati0n
Z0092008Z007
l00
l00
l05
l06
Rawmaterialspriceindex
FinishedgoOdspriceindex
24llll
Tocomparethefinancia>perfbnnanceofthethreecompanies,GroffdecidestoconvertLIOfiguresintoFOfigures,andadjustfigustoassumenovaluationallowanceisrecognizedbyanycompany.
AIerreadingGrofPsdraHreport,hissupervisor,RachelBorghi,askshimthefb>>owingquestions:
QuestionlWhichcompany,sgrossprofitmaIginwouldbeStref>ectcurrentcostsoftheindustIy?
WouIdRolby,svaIuationmethodshowahighergossprofitmaginthanCrux,sunderaninf>ationaIyadef>ationaIy,orastablepIicescenario?
OuestionZ
Question3WhichgroupofratiosusualIyappearsmorefhvorabIewithaninventolywrite-down?
7.Crux,sinventoIytumoverratiocomputedasof3lDecemberZ00gaertheadjustmentssuggestedbyGroff;iscm$es/to:
A5.67
B5.83
C6.l3
8.Roby,snetprofitmarginfbrtheyearended3lDecembe200g,affertheadustmentssuggestedbyGroff;iscm$es/to:
A6.0l%.
B620%
C6.28%.17
48
usteddebt-to-equityratio,Mikko,sdebt-to-equityratioasof3>9.ComparedwithitsunausteddebttoequityratoM!kkosdDecember2009,affertheaqustmentssuggestedbyGroff;is:
A>ower.
Bhigher.
Cthesame.
10Thebes/answertoBorghi,sQuestionlis:
ACrux,S.
BRolbys.
CMikko,S.
11Thebes!answertoBorghi,sQuestion2isl
AStable.
BInf>ationaIy.
CDefationay.
I2.ThebesanswetoBorgbi,sOuestion3is
AActivityratios.
BSolvencyratios.
CProfitabi>ityratios
ThefOowinginfOmatinelatestoQuestions13203
ZPCorporationisa(hypothetical)muItinationaIcorporationheadquarteredinJapanthattradesonnumerousstockexchangesZPpreparesitsconsolidatedfinanciaIstatementsinaccordancewithUSGAAP.ExcerptsfibmZP,s200gannualreportareshowninExhibitsl-3.
Exhibitl.C0nS0idtedBCeSheetSMii0nS
31Decembe
CurrentASSetS
CashandcashequivaIents
Inventones
Tota>cunFentassets
2008 2009
512,8498l,760
608,572 186,465
1,028,7423,766,30g
iabiIities
2008 Z00,
--
10,819,409,687,316
3,g80,2473,52g,765
Total>ong-term>iabi>ities
Minorityinterestinconso>idatedsubsidiariesTotalshareho>ders,equity
T0mlIbilitiesHndShareh0lders,equity
2,663795
2l8,889
3,956509
10,819,0
2,624,002
l7g,813
3353,736
,,687,36
ExhibitZC0S0IidtedStatementS0fIC0meMi0nS
F0theyesended31December Z007 Z008 Z009
Netreenues
Salesofproducts
Financingoperations
C0stnndexpenSes
Costofproductssold
Costoffinancingoperations
Se>ling,genera>andadministrative
Opertinginc0mel0ss
NeMnc0me
7,556,69g8,273,5036,3gl,240
425,gg8489,57745l,950=
7,982,6g78,763,0806,813,lg0
6,ll8,742
2g0,7l3
827,005
746,237
68l76
356,005
832,837
5,822,805
329,l28
844,927
756,792-l53,670
-
5480ll572,62645,66
Exhibit3SeeCtCdD!SCl0SreSi1theZ009Aml!Re0.t
Mnagement,sDiScussi0lHndAalysis0fFinmcilC0lditi0MmdResu>ts0fOperations
CostreductioneffbrtsweoffSetbyincreasedpIicesofrawmaterials,otherproductionmaterialsandparts...Inventoriesdecreasedduringfiscal200gbyl221bilion,orZ0l,to86.5biIion.Thisrefectstheimpactsofdecreasedsalesvolumesandf>uctuationsinfbreigncurrencytrans>ationrates.
1g
50
ManagementC0p0rateInmati0n
RiskFactors
Thewor>dwidemarketfbrourproductsishighlycompetitive.ZPfacesintensecompetitionfiFomothermanufacturersintherespectivemarketsinwhichitoperates.Competitionhasintensifiedduetothewor>dwidedeterioIntionineconomicconditions.Inaddition,competitionislikelytofU>therintensifybecauseofcontinuingg>ObalizationpossiblyresultinginindustyoIganizationFactorsaffbctingcompetitionincudeproductqua>ityandfbatures,theamountoftimerequiredfbrinnovationanddevelopmentpricing,reliability,safCty,economyinuse,cuStomerserviceandfinancingtenns.Increasedcompetitionmay>eadtolowerunitsaIesandexcessproductioncapacityandexcessinventoIy.Thismayresu>tinafhrtherdownwaIdpricepressure.
ZP,sabi>itytoadequate>yrespondtotherecentrapidchangesintheindustIyandtomaintainitscompetitivenesswillbefilndamentaltoitsfUturesuccessinmaintainingandexpandingitsmaketshareinexistingandnewmarkets.
N0test0C0ns0lidtedFinancialStatements
2Summy0fSngncntcc0ntingp0les:
Invent0riesInventonesarevaluedatcostnotinexcessofmarket.Cost
isdeteminedontheaveragecosf,basis,exceptfbrthecostoffinishedproductscarriedbycertainsubsidiarycompanieswhichisdeterminedIastin,firstoutLO,,basisInvetonesvaIuedontheLIFObasistotaledg4,578milionand50,037miIionatDecember3l,2008and2009respectiveIy.Hadthefirst-in,first-out,,basisbeenusedfbrthosecompaniesusingtheLIFObasis,inventorleswouIdhavebeen0,20miIlionandg660miIIionhighethanepotedatDecember3l2008and200g,respective>y.
9InVeIt0ries:
Inventoriesconsistofthefbl>owing
31DecemberMii0sZ008
Finishedgoods
Rawmaterials
Workinprocess
Supp!iesandothe
403,856
99,869
7g,g7g
24868
608,572
2009
29l,977
85,966
83,890
2,6320
186,465
l3TheMDAindicatedthatthepicesofawmateiaI,otherproductionmaterials,andpaItsincreasedBasedontheinventoIyvaluationmethodsdescribedinNote2,whichinventorycassificationwouIdmccmIfectcurrentprices?
M
ARawmateIiaIs.
BFinishedgoods.
CWoIkinprocess
The2008inventoIyvalueasreportedonthe200gAnnuaIRepoItifthecompanyhadusedtheFIOinventoIyvaluationmethodinsteadoftheLIOinventoIyvaluationmethodfbraportionofitsinventorywouldbec/bses/to:
Al04,6g8milion.
B506,l25milion.
C6l8,6g2million.
l5WhatisthebrkclcasonwhyZPmayneedtochangeitsaccountingpoliciesregardinginventoIyatsomepointaher2009?
ATheUSSECisikelytorequirecompaniestousethesameinventoIyvaluationmethodralinventones.
BTheUSSECis>ikelytoprohibittheuseofoneofthemethodsZPcurrentlyusesfbrinventoIyvaluation
COneoftheinventoIyvaIuationmethodsusedfbrUStaxpurposesmayberepealedasanacceptablemethod.
16IfZPhadprepareditsfinancialstatementinaccordancewithIFRS,theinventoower.
Bhigher.
Cthesame.
l7InventoIyevesdecreasedom2008to200gfbraofthefbIlowingreasonsexcP:
ALIOliquidahon
BdecreasedsaIesvo>ume.
CfucmationsinfbeigncurencytransIationrates.
l8WhichobservationisosaresuItoflookingonIyattheinfbrmationreportedinNoteg?
AIncreasedcompetitionhasedtoIowerunitsales51
5Z
BTherehavebeensignificantphceincreasesinsuppIies
CManagementexpectsafimherdowntuminsaIesduring20l0.
l9Note2indicatesthat,InventonesvaluedontheLObasistotaledg4,578millionand50037millionatDecember3l,2008and200grespectivey.,,Basedonthis,theLlFOreserveshouldos:
Aincrease.
Bdecrease.
Cremainthesame
Z0.TheIndustryandBusinessRiskexcerptstatesthatIncreasedcompetitionmayleadtolowerunitsa>esandexcessproductioncapacityandexcessinventory.Thismayresu>tinafilrtherdownwardpricepressure.,,ThedownwardpricepressurecouldleadtoinventoIythatisvaluedabovecurrentmarketpricesornetrea>isab>evalue.Anywrite-downsofinventoryarebetohaveasignificanteffbctontheinventoryvaluedusing:
Aweightedaveragecost.
B.firstin,firstoutO.
C.lasbin,firstoutO
SoIutins
1Ciscorrect.Karp,sinventoryunderFIOequalsKarp,sinventoryunderLIOpIustheLIFOreserve.Therefbre,asof3lDecember200gKarp,sinventoIyunderFIFOequa>s
InventoIy(FIFOmethod)=InventoIion+l55million
=$775mi>lion
2.BiscorrectKarp,scostofgoodssold(COGS)underFIOequa>sKarp,scostofgoodssoldunderLIOminustheincreaseintheLIOreserve.Therefbre,fbrtheyearended3lDecember2009,Karp,scostofgoodssoldunderFIFOequaIs:
COGS(FIOmethod)=COGS(LIFOmethod)-IncreaseinLIFOreserve
=$2,2llmiIlion-(l55mi>lion->l7mi>Iion)
=$2l73miIlion
3Aiscorrect.KarpsnetincomeNIunderFIFOequalsKapsnetincomeunderLIFOpIustheaftertaxincaseintheLIFOreserve.Fortheyearended3lDecember2009Kap,snetincomeundeFlFOequaIs:
NIOmethodNILIFOmethodIncreaseinLIFOreservexlTaxrate
=$247mi>lion+38mi!>ionx(l-20%)
=$277.4miIion
TheIBfbre,theincreaseinnetincomeis:
IncreaseinNINIOmethodNILOmethod
=$277miIlion-247miI>ion
=$304mil>ion
4Biscorrect.Karp,sretainedeamingsdlion
=$124mi>lion
5Aiscorrect.Thecashratio(cashandcashequiva>ents+currentliabilities)wouldbelowerbecausecashwouIdhavebeenlessunderPIO.Karp,sincomebefbretaxeswouldhavebeenhigherunderFIFO,andconsequent>ytaxespaidbyKarpwouldhaveaIsobeenhigherandchwouldhavebeenwerTheeisnoimpactonCUreUliahiliUesPothKarpscurrentratloandgrossprofitmaginwoudhavebeenhigherifFIFOhadbeen
usedThecurentratiowouldhavebeenhigherbecauseinventoyunderFlFOincreasesbyalargeramountthanthecashdecreasesfbrtaxespaidBecausethecostofgoodssoIdunderFIFOislowerthanundeLIFO,thegrossprofitmarginwouldhavebeenhigher.
6Biscorect1fKaIphadusedFOinsteadofLIFO,thedebttoequityratiowouldhavedecreasedNochangeindebtwouIdhaveoccured,butshaehoIdes,equitywouIdhaveincreasedasaresultofhigberretainedeamings.
7.Biscorrect.Cruxsadiustedinventoytumoverratiomustbecomputedusingcostofgoodsso>d(COGS)underPIOandexcIudingchargesfbrincreasesinvaluationa>lowances.
COGSadiustedCOGSLIFOmethodChargesincudedincostofgoodssoldfbrinventoIywIitedownsChangeinLIPOreserve
53
51
=$3,>Z0milIion-l3miIIion-(55miIIion-72miIion)
=$3,l24million
bMinusthechangeinLOreserveisequivalenttoplusthedecreaseinLOreserve.TheaustedinventoIytumoverratioiscomputedusingaverageinventoryunderFIo
EndinginventoryFOEndinginventoLIFOLIFOreseve
EndinginventoIy200gO48055535
Endinginventory2008O46572537
AverageinventoIy=($535+537)/2=$536
Therefbre,adjustedinventorytumoverratioequals:
Inventorytumoverratio=COGS/Averageinvento5milIionx(l-30%)
=$337.5miIIion
Therefbre,adjustednetprofitmaIginequaIs:
Netprofitmargin=NI/Revenues=$337.5/$5442=620%
9.Aiscorrect.Mikko,sadiusteddebttoequityratiois!owebecausethedebtnumeratoisunchangedandtheaustedshareholders,equitydenominato0ishighe.Theaqustedsharehoders,equitycoespondstosharehoIders,equityunderFIFO,excludingchargesfbrincreasesinvaIuationaIIowances.Thefbre,aqustedsharehoIders,equityishigher
thanrepoItedunaustedsharehoders,equity.
10Ciscorrect.Mikko,sandCmx,sgrossmarginratioswouldbetterrefectthecurrentgrossmarginoftheindustIythanRolbybecausebothuseLlFO.LIOrecognizesascostofgoodssoldthecostofthemostrecentIypurchasedunits,therefbre,itbetterref>ectsreplacementcost.However,Mikko,sgrossmainratiobestrefectsthecuentgrossmarginoftheindustrybecauseCrux,sLIFOeserveisdeceaSing.ThiscoudrefectaLIFOliquidationbyCIuxwhichwou>ddistortgrossprofitmaationaIyenvironment,theseunitsaretheoneswiththelowestcost.
12Aisconect.AninventoIywrite-downincreasescostofsalesandreducesprofitandeducesthecayingvaIueofinventolyandassets.ThishasanegativeeffbctonprofitabiIityandsoIvencyratios.However,activityratiosappearpositiveIyaffbctedbya
I
writedownbecausetheassetbase,whethertotaIassetsorinventodenominato,isreducedThenumeIator,sales,intotalassettumoverisunchangedandthenumerator,costofsaIes,ininventorytumoverisihcreased.Thus,mrnoveratiosarehigheandappearmorefavorableastheresultofthewrite-down.
13Biscorrect.FinishedgoodseastaccuratelyrefectcurrentpIicesbecausesomeofthefinishedgoodsareva>uedunderthelast-in,first-ouf,(LIO)basis.Thecostsofthenewestunitsavailablefbrsaleareallocatedtocostofgoodssoldleavingtheoldestunitsatlowercostsininventory.ZPvaluesrawmateiaIsandworkinpocessusingtheweightedaveragecostmethod.WhilenotfUIlyref>ectingcurrentprices,someinf>ationaIeffbctwillbeincludedintheinventodnolongerbeallowed
16AisconFect.TheinventoIytumoverratiowouldbelower.TheaverageinventoIywouldbehigherunderFIFOandcostofproductssoldwouldbelowerbytheincreaseinLIOreserve.LIFOisnotpemlittedunderS.
InventoIytumoverratioCostofproductssoIdAverageinventoIy
2009inventoIytumoverratioasrepoltedl0.635,822,805608,572186165)/2>
200ginventoIytumoverratioadjustedtoFlFOasnecessaIyl0.315,822,805lg,660l0,l20608,572l0l20486,65lg,6602.
l7Aiscorect.NoLIFOliquidationoccurredduring200g,theLlFOreserveincreasedfi.om0,20miIIionin2008tolg,660miionin200gManagementstatedintheMDAthatthedeceaseininvehtoriesrefectedtheimpactsofdeceasedsalesvoIumesandf>uctuationsinfbreigncurrencytranslationrates.
l8Ciscorect.PinishedgoodsandrawmatenaIsinventoriesaeIowerin200gwhencomparedtoZ008.ReducedlevelsofinventoIytypicallyindicateananticipatedbusinesscontractlon
l9Biscorrect.ThedecreaseinLIFOinventoIyin2009wouIdtypicaIIyindicatethatmoreinventonunitsweresoIdthanproducedorpurchased.AccodingIy,onewouIdexpectaliquidationofsomeoftheo>derLIFOlayersandtheLIFOreservetodecrease.InactuaIity,theLIFOreservecsefiom020miIIionin2008tog660miionin2009.ThisisnottobeexpectedandislikelycausedbytheincreaseinpricesofrawmateriaIs,otherproductionmateIiaIs,andpasoffbreigncurrenciesasnotedinthe}m&A.AnanaIystshouldseektoconfinnthisexp>anation
20 Biscoect.IfpriceshavebeendecreasingwritedownsuderFIFOareleastIikeIytohaveasignificanteffbctbecausetheinventoIyisvaIuedatcIosetothenew,Iowerpices.Typically,iventonesvaIuedusingLIFOareIessIikeIytoincuinventoywite
55
56
downsthaninventonesvaIuedusingweightedaveagecostorFIFO.UnderLIFO,theoscostsarerefectedintheinventorycarIyingvalueonthebalancesheet.Givenlnceasnglnventorycosts,theinventolycayingvaIuesundertheLlFOmethodae
alreadyconseikeIythatinventoIywitedownswiIIoccuunderLIFandifawntedowdoesoccur,itislikelytobeofalessermagnitude
l12
Whena>essorreportsaIeaseasafinance>easeratherthananoperating>ease,itusual>yappedrsmoreprofitabIeinealyyearsofthelease.
IndirectfinancingleasesunderUSGAAP,a>essoreamson>yinterestrevenue.InasaIestypeeaseunderUSGAAP,aIessoreamsbothinterestrevenueandaprofito>oss)onthesa>eofthe>easedasset.
PacticePoblems
CoIIighl20llbyCFAInstisconcernedaboutsomeoftheaccountingchoicesthatthenewmanagementhasmade.TheSechoicesdifferfi.omthoseofthepreviousmanagementandfibmcommonindustIypractice.Harthashighlightedthefb!owingstatementsomthecompany,sannuareport:
Statementl
Statement2
Statement3
Statement4
In200g,AMRCspentsignificantamountsontrackrepIacementandsimilarimprovements.AMRCexpensedratherthancapitalisedasignificantproportionoftheseexpenditures,,
AhCusesthestraightinemethodofdepreciationfbrbothfinancialandtaxreportingpurposestoaccountfbrplantandequipment.,,
In200g,AMRCrecognizedanimpairmentlossof650mi>liononaf>eetoflocomotives.Theimpairment>osswasreportedasotherincomeintheincomestatementandeducedthecanyingamountoftheassetsontheba>ancesheet.,,
ACacquirestheuseofmanyofitsassetsincIudingaargepoionofitsfeetofrailcars,underlongtermIeasecontracts.In200g,AhCacquiredtheuseofequipmentwithafairvaIueof6200mil!ionunder20-yearleasecontracts.TheseleaseswerecIassifiedasoperating>eases.Prior
,,
to2009,mostoftheseleasecontractswerec>assifiedasfinanceleases.
Exhibits1and2containAMRC,s200gconsolidatedincomestatementandba>ancesheet.
AhCprepaIsitsfinanciastatementsinaccordancewithIntemationaIFinanciaReportingStadadS.
xhibit1C0ns0lMatedStement0fIncome
F0theYerSEnded
31December
Operatingrevenues
Operatingexpenses
Depreciation
Leasepayments
Otheroperatingexpense
Tota>operatingexpenses
OperatingincomeOtherincome
Interestexpense
Incomebefbretaxes
Incometaxes
Netincome
6
Mllh0ns
2009
%
ReVenues
6
Milli0ns
2008
%
ReVenIes
2,600l00.02,300l000=
(200)
(2l0)
(7.7)
(8.l)
(lg0)
(lg5)
(83)
(8.5)
(l,590)(6l1)(l,5l5)(65.g).-I
(2,000)(769)(l,g00)(82.6)-I-
60023100z(50)(lg)0.0
(73)(2.8)(6g)(30)---I
477l8433ll4.4
(l89)(73)(l25)(5.4)`-=---
288ll.l206g.0--=-
Exlibit2C0nsolidmedBMnceSheet
Asof31Decembe
AssetS
Currentassets
Propelty&equipment:Land
PIant&equipment
Totalproperty&equipment
Accumulateddepreciation
Netproperty&equipment
Tota>assets
LiabilitieSa>ld
ShaIeh0lders,Equity
Curentiabilities
Long-termdebt
Z009
e %
MIIi0ns AssetS
Z008--
e %
MbIi0Uls Assets
5009.445085
700 l3.l 700 >3.Z
6,000ll2.l5,800l094c
6,700 l252 6,500 l22.6
(l,850)(346)(l,650)(3ll).----
4850g0.64,850gl5--
5,350l00.05,300l00.0--
480g.04308.l----
l,030lg3l,080204l,24023.l,4027.2 1l3
II4
Asof31Decembe
Assets
Other>ong-termprovisionsand>iabilihes
Total>iabilities
Shareholders,equity
Commonstockand
paid-in-surplus
Retainedeamings
OthercomprehensiveIosses
Totalshareholders,equity
Total>iabilities&
shareholders,equity
Z009I
6 %
MiIi0Is ASsets
2008--
6 %
MiIi0ns AsSets
-
27505l4--2,g50-55Z--
760
l,888
l4.2
355
760
l,600
l43
302
(48)(0g)(l0)(02)`=-I
2,60048.62,35043)
5,350l00.05,300l00.0==---
1WithrespecttoStatementl,whichofthefblowingistheeffbctofmanagement,sdecisiontoexpenseratherthancapitalisetheseexpenditures?
Ab200gnetprofitmarginishigherthaniftheexpenditureshadbeencapita>ised.
B200gtotalassettumoverisIowethaniftheexpenditureshadbeencapitalised
CFutureprofitgowthwiIIbehigherthaniftheexpeditushadbeencapitalised
2.WithrespecttoStatement2,whatwouldbetheosyeffbctin20l0ifAMRCweret0switchtoanaccelerateddepreciationmethodfbrbothfinancialandtaxreporting?
ANetprofitmarginwouldincrease.
BTota>assettumoverwoulddecrease.
CCashfowfiomoperatmgactMtieswouldincrease.
3WithrespecttoStatement3,whatisthe!keyeffbctoftheimpairmentIoss?
ANetincomeinyearspriorto2009waslikelyunderstated.
BNetprofitmaginsinyearsafer200gwilIlikelyexceedthe2009netprofitmargin.
CCashf>owfiPomoperatingactivitiesin200gwasIikeIy>owerduetotheimpairmentlOSS.
qBasedonExhibits1and2,thebeseseoftheaverageremainingusefUIifbofthecompany,splantandequipmentattheendof2009is:
A.20.75yeas
B2425years.
C30.00years.
5WithrespecttoStatement1,ifAMRChaduseditsodclassificationmethodfbritsleasesinsteadofitsnewcassificationmethod,its2009totaIassetturnoverratiowould?os
ybe:
A>ower.
B.higher.
Cthesame.
6WithrespecttoStatement4andExhibit1ifAChaduseditsoldclassificationmethodfbritsleasesinsteadofitsnewclassificationmethodthejeeffbctonits200gratioswouldbea:
AhighernetprofitmaIgin.
Bhigherfixedassettumover.
Chighertotalliabilities-to-totalassetsratio.
ThefoowinginfOmationeatestoOuestions7132
BrianJordanisinterviewingfbrajuniorequityanalystpositionatOrionInvestmentAdvisors.AspaItoftheinterviewprocess,MayBennOrion,sDirectorofReseamh,providesJordanwithinfbImationabouttwohypotheticaIcompanies,AlphaandBeta,andaskshimtocommentontheinfbrmationontheirfinancialstatementsandratios.BothcompaniespreparetheirfinancialstatementsinaccordancewithIntemationalFinancialReportingStandards(IRS)andareidenticalina>lrespectsexceptfbrtheiraccountingchoices.
Jordanisto>dthatatthebeginningofthecurrentfiscaIyear,bothcompaniespurchasedama>ornewcomputersystemandbeganbui>dingnewmanufhcmringplantsfbrtheirownuse.AlphacapitaIisedandBetaexpensedthecostofthecomputersystem;AIphacapitaIisedandBetaexpensedtheinterestcostsassociatedwiththeconstructionofthemanufactunngplants.lnmid-year,bothcompaniesIeasednewofficeheadquaIters.AlphacIassifiedtheIeaseasaopeatinglease,andBetaclassifieditasafinanceIease.
BennasksJordan,Whatwastheimpactofthesedecisionsoneachcompany,scurrentf>scaIyearfinancia>statementsandratios?,,
Jordanresponds,Alpha,sdecisiontocapitalisethecostofitsnewcomputersysteminsteadofexpensingitresuItsinIowernetincome,IowertotaIassets,andhighercashfowfTomopeatingactivitiesinthecurrentfisca>year.Alpha,sdecisiontocapitaliseitsinterestcostsinsteadofexpensingthemresultsinalowerfixedassetturnoverratioandahigherimeestcoverageratiAlpha,sdecisiontoc>assifyitsIeaseasanoperatingleaseinSteadofafinanceIeaseresuItsinhighernetincomehighercashf>owfiFomoperatingactivities,andstrongersoIvencyandactivityratloscomparedtoBeta.
>15
JodanistoIdthatAphausesthestraightIinedepreciationmethodandBetausesanacceIerateddepreciationmethod;bothcompaniesestimatethesameusefhl>ivesfbr}ong-Iivedassets.Manycompaniesintheirindustryusetheunits-oFproductionmethod.
BennasksJordan,Whatarethefinancialstatementimplicationsofeachdepreciationmethod,andhowdoyoudetermineacompany,sneedtoeinvestinitsproductivecapacity?,,
JordanpiesAllothethingsbeingequal,thestraight-inedepreciationmethodresultsinthe>eastvariabilityofnetprofitmarginovertime,whiIeanaccelerateddepreciationmethodresu>tsinadecliningtIndinnetprofitmaIgmovertime.Theunitsofproductioncanresutinanet
profitmagmtIndthatisquitevariabIe.Iuseathreestepapproachtoestimateacompany,s
needtoinvestinitsproductivecapacity.First,IestimatetheaverageageoftheassetsbydividingnetpIopeIty,pIant,andequipmentbyannualdepreciationexpense.Second,IestimatetheaveragemainingusefilIlifeoftheassetsbydividingaccumuIateddepreciationbydepreciatiOnexpense.Third,IaddtheestimatesoftheaverageremainingusefhllifbandtheaverageageoftheassetsinordertodeterminethetotaIusefU>life.,,
lI6
JordanistoldthatattheendofthecurrentfiscaIyear,AlphaIcvaIuedamanufacturingplant;thisinceaseditsrepoItedcarryingamountbyl5percentTherewasnopreviousdownwardrevaluatjonoftheplant.Betarecordedanimpairmentlossonamanufactunngp>ant;thisreduceditscarIyingbyl0percent.
BennasksJordanWhatwastheimpactofthesedecisionsoneachcompany,scurrentfiscaIyearfinanCialratios?,,
JordanspondsBeta,simpairmentlossincreasesitsdebttototaassetsandfixedassettumovertios,andlowersitscashflowfmmoperatingactivities.Alpha,srevauationincreasesitsdebttocapitalandetumonassetsratiosandreducesitsretumonequity,,
Attheendoftheinteiew,BennthanksJodanfbhistimeandstatesthatahiingdecisionwiI>bemadeshortly.
7.JodansresponseaboutthefinanciastatementimpactofAlpha,sdecisiontocapitalisethecostofitsnewcomputersystemismostlike!ycoecwithrespectto:
Alowernetincome.
B!owertotaIassets.
Chighercashfowfibmoperatingactivities
8Jordan,sresponseabouttheratioimpactofAlpha,sdecisiontocapitaiseinterestcostsismoStlikeIycocwithespecttothe:
Ainterestcoverageratio.
Bfixedassettumoverratio.
Cinterestcoverageandfixedassettumoverratios.
9.JordansresponseabouttheimpactofAlpha,sdecisiontoclassifyitsleaseasanoperatingleaseinsteadoffinanceleaseismostIikelycocwithrespectto:
A.netincome
B.soIvencyandactMtymt>os.
CcashflowhFomoperatlngactivities.
l0Jordan,sresponseabouttheimpactofthediffbrentdepciationmethodsonnetprofitmarginismostlikelycoqecwithrespectto:.
Aacce>erateddepreciation.
B.straight-linedepreciation
Cunitsofproductiondepciation
11Jordan,sresponseabouthisapproachtoest1matingacompany,sneedtoreinvestinitsproductivecapacityismostlikeycoecregarding:
Aestimatingtheaverageageoftheassetbase.
Bestimatingthetotalusefhlifboftheassetbase.
CestimatmgtheaverageremainingusefUIlifboftheassetbase.
12JordansresponseabouttheeffbctofBeta,simpairmentlossismostlikeyco1recwithrespecttotheimpactonits:
Adebttototalassets.
Bfixedassettumover.
Ccashf>owfromoperatingactivitieS
l3Jordan,sresponseabouttheeffectofAlpha,srevaluationismostlikelycowithrespecttotheimpactonits:
Aretumonequity.
Bretumonassets
Cdebttocapitalratio
SIutins
1Ciscorrect.Expensingratherthancapitalisinganinvestmentinong-tennassetswillresuItinhigherexpensesandIowernetincomeandnetproftmaIgininthecurentyear.Futuyears,incomeswillnotincludedepreciationexpenserelatedtotheseexpendituresConsequentIy,year-to-yeargrowthinprofitabilitywiIbehigher.Iftheexpenseshadbeencapitalisedthecarryingamountoftbeassetswouldhavebeenhigherandthe2009totalassettumoverwou>dhavebeenlower.
1l7
>18
ZCiscorrectIn200,switchingtoanacceIerateddepreciationmethodwouIdincreasedepreciationexpenseanddecreaseincomebefbretaxes,taxespayable,andnetincome.CashfowomopeatingactivitieswouIdincreasebecauseoftheresuItingtaxsavings
3Biscorrect.200gnetincomeandnetprofitmarginarelowerbecauseoftheimpaiImentI0ss.Consequent>y,netprofitmarginsinsubsequentyearsarelikelytobehigherAnimpairmentIosssuggeststhatinsufficientdepreciationexpensewasrecognizedinpnoryearS,andnetincomewasoverstatedinpnoryears.Theimpainnentlossisanon-cashitemandwi>>notaffbctoperatingcashf>ows.
1Aiscorrect.TheestimatedaverageremainingusefUllifeis20.75years.
EstimateofremaininguseMlifeNetplantandeqUipmemAnnualdepreciationexpense
NetpIantandequipmentGossPEAccumuateddepreciation
=e6000-el850=e4l50
EstimateofremainingusefUllifbNetPEDepreciationexpense
=64l50=e200=20.75
5Aiscorrect.WhenIeasesalccIassifiedasfinanceleases,thelesseeinitiaIIyreportsa
assetandliabilityatacarIymgamountequaltothelowerofthefhirvalueofthe>easedaSsetorthepresentvalueoftheflltureleasepayments.UnderanoperatingleasetheIesseedoesnotreportanassetoriabiIity.TherefbretotalassettumovertotaIrevenueaveragetotalassets)wouldbeIoweriftheleaseswereclassifiedasfinanceleases
6Ciscorrect.Total>iabilities-to-assetswouldbehigher.Whenleasesareclassifiedasfinanceleasesthe>esseeinitia>>yreportsanassetand>iabilityatacarIyingamountequaltothelowerofthefairvalueoftheeasedassetorthepIsentvalueofthefUturelease
payments.Boththenumeratoranddenominatorwou>dincreasebyanequalamount,buttheproportionaincreaseinthenumeatorishigherandtherat1owouldbehigher.Thefb>Iowingexhibitshowswhatwouldhappento200gtota>Iiabilities,assets,andtotaIIiabiIities-to-assetsife200miIIion,thefhirvaIueoftheleasedequipment,isaddedtoAMRC,stotalIiabiIitiesandassets.ThissimpleexampIeignorestheimpactofaccountingfbrthe2009leasepayment
TotaIIiabiIities
Totalassets
TotalIiabilities-to-
assets
2009ActIa>Under
OpertingLese
62,750
65,350
5l.1%
Z009Hyp0thetiClUndeFiIanceLease
e2,950
e5,550
53.2%
ThCdepreciationandinteestexpenseunderafinanceleasetendstobehigherthantheoperatingIeasepaymentintheearlyyearsofthelease.ThefinanceIeasewouldresuItinIowernetincomeandnetprofitmaIginLong->ived(fixed)assetsarehigherunderafinanceIcaseandf>xedassettumoveris>ower.
7Ciscorrect.ThedecisiontocapitaIisethecostsofthenewcomputersystemresuItsinhighercashf>owfiomoperatingactivities;theexpenditureisreportedasanoutf>owofinvestingactivities.ThecompanyaIIocatesthecapitaIisedamouHtovertheasset,susefilI>ifbasdepreciationoramortisationexpenseratherthanexpensingitintheyearofexpenditue.NetincomeandtotaassetsarehigheinthecuentfiscaIyear.
8Biscorrect.Alpha,sfixedassettumoverwillbelowerbecausethecapitalisedinterestwillappearonthebalancesheetaspartoftheassetbeingconstructedTherefbre,fixedassetswillbehigherandthefixedassetmmoverratio(tota>revenue/averagenetfixedassets)wil>belowerthanifithadexpensedthesecosts.CapitaIisedinterestappearsontheba>ancesheetaspartoftheassetbeingconstIuctedinsteadofbeingreportedasinterestexpenseinthepeIiodincued.HoweveLtheinteestcoverageratioshouIdbebasedoninterestpayments,notinterestexpense(eamingsbefbreinterestandtaxesinterestpayments,andshoudbeunchanged.Toprovideatuepictueofacompany,sinterestcoverage,theentireamountofinterestexpenditureboththecapitalisedportionandtheexpensedportionshoudbeusedincalculatingintestcoverageratios.
9Ciscorrect.ThecashfIowfibmoperatingactivitieswiIIbeIower,nothigher,becausethefU>>>easepaymentistreatedasanoperatingcashoutfIow.WithafinanceleaseonlytheportionoftheeasepaymentreatingtointeestexpensepotentiaIIyeducesoperatmgcashoutf>ows.AcompanyrepoItmga>easeasanoperatingleasewiItypica>lyshowhigherprofitsinearlyyears,becausethe>easeexpenseislessthanthesumoftheinterestanddepreciationexpense.Thecompanyreportingthe>easeasanoperatingleasewi>>typicallyreportstrongerso>vencyandactMtyratios.
10Aiscorrect.AccelerateddepreciationwilIresu>tinanimproving,notdec>ining,netprofitmargmovertlmebecausetheamountofdepreciationexpensedecIineseachyear.Uhderstraight-Iinedepreciation,theamountofdepreciationexpensewillremainthesameeachyear.Undertheunitsoroductionmethod,theamountofdepreciationexpenserepoItedeachyearvaIieswiththenumberofunitspIoduced.
IIBiscoect.TheestimatedaveragetotaluselIifbofacompany,sassetsiscaIcuIatedbyaddingtheestimatesoftheaverageremainingusefU>>ifbandtheaverageageoftheassets.TheaverageageoftheassetsisestimatedbydividingaccumuIateddepreciationbydepreciationexpense.TheaverageremainingusefU>Iifboftheassetbaseisestimatedbydividingnetpoperty,plant,andequipmentbyannuaIdepreciationexpense.
12CiscorrectTheimpainnentossisanoncashchargeandwiIlnotaffbctcashfowfiDmoperatingactivities.ThedebttototaIassetsandfixedassettumoveratioswillincrease,becausetheimpairmentIosswiIreducethecanyingamountoffixedassetsandtherefbretotalassets
13.Aiscoect.InanassetrevaIuation,thecarIyingamountoftheassetsincreases.Theincreaseintheasset,scanyingamountbypassestheincomestatementandisreportedasothercomprehensiveincomeandappearsinequityundertheheadingofrevaluationsurplus.TherefbresharehoIdersequitywilIincreasebutnetincomewillnotbeaffbcted,soretumonequitywi>Idecline.RetumonassetsanddebttocapitaIratioswillalsodecrease.
1l9
>76
CurrentIFRSandUSGAAPaccountmgstandardsrequiretheuseoftheacquisitionmethodtoaccountfbrbusinesscombinations.FaivaIueoftheconsiderationgivenisthe
appropIiatemeasurementfbridentifiableassetsandIiabilitiesacquiredinthebusinesscombination.
GoodwillisthediffbencebetweentheacquisitionvalueandthefhirvaIueofthetarget,sidentifiab>enettangibIeandintangib>eassets.Becauseitisconsideredtohaveanindefinitelifb,itisnotamo>tized.Instead,itisevaIuatedat>eastannua!Iyfbrimpairment.ImpaiIment>ossesarereportedontheincomestatement.IFRSuseaone-stepapproachtodetermineandmeasuretheimpainnentIoss,whereasUSGAAPusesatwo-stepapproach
IftheacquiIingcompanyacquireslessthanl00,noncontrollingminorityshareholders,interestsarereportedontheconsolidatedfinancialstatements.IRSallowsthenoncontrollinginteresttobemeasuredateitheritsfhivaluefnllgoodwilloratthenon-controIinginterest,spropoItionateshareoftheacquiree,sidentifiab>enetassets(paltialgoodwi>l).USGAAPrequiresthenon-controllinginteresttobemeasuredatfairvaIue(fU>>goodwi>l).
ConsolidatedfinancialstatementsapreparedineachrepoItingperi0d
SpecialpuIposeSPEsandvariableinterestentitiesVsarerequiredtobeconsolidatedbytheent1tywhichisexpectedtoabsorbthema>ontyoftheexpectedlosses
orreceivethemontyofexpectedresidualbenefits.
PacticePobIems
Corigh20lCFAInsitute
ThefoowinginfOmatiheIatestoQuestions16
CinnamonInc.isadivesifiedmanufhctuingcompanyheadquaIteredintheUnitedKingdom.Itcomp>ieswithIFRS.In200g,CinnamonheIdalgpercentpassiveequityownershipinterestinCambridgeProcessingthatwasclassifiedasavai}able-fbr-saleDuIingtheyear,theva>ueofthisinvestmentroseby2miionInDecember200g,Cinnamonannouncedthatitwouldbeincreasingitsownershipinterestto50percenteffbctivelJanuary20l0throughacashpurchase.CinnamonandCambridgehavenointecompanytransactions.
PeterLubbock,ananalystfbllowingbothCinnamonandCambridge,iscunoushowtheincreasedstakewiIlaffbctCinnamon,sconsolidatedfinancialstatementsHeasksCinnamon,sCFOhowthecompanywilIaccountfbrtheinvestment,andistoldthatthedecisionhasnotyetbeenmade.Lubbockdecidestousehisexistingfbrecastsfbrbothcompanies,financialstatementstocomparetheoutcomesofaItemat1veaccountingtreatments.
Lubbockassemb!esabbreviatedfinanciaIstatementdatafbrCinnamon(Exhibitl)and
Cambridge(ExhibitZ)fbrthispu!pose.
Exhibit1.SelectedFiMmcilStemetImi0Cim0n,Ic
Mi>li0ns)
Yerendhng31December20092010
Revenue
OperatingincomeNetincome
31December
Totalassets
Shaholdersequity
l,400
l26
62
l,575
l42
6g
Z0092010*
l,l70l,3l7
6l6685
EstimaesmadepoloannouncementofincasedsakeinCambridgC
ExhibitZSeeCtedFinCialStementInfbrmati0nfbrCmbidgeP0cesSig
Milli0ns
Yerending31DecemberZ0092010
Revenue
OperatingincomeNetincome
Dividendspaid
31Decembe
Totalassets
Shaeholders,equity
>,000
80
10
20
I>00
88
44
22
200920>0*
800
40
836
462
EsimaesmadepriortoannouncememofincasedstakebyCinnamon.
.In200g,Cinnamon,seamingsbefbretaxesincudesacontributioninmillionsfiPomitsinvestmentinCambridgeProcessingthatiscb!to:
A.3.8
B5.8
C7.6
2.In20l0,ifCinnamonisdeemedtohavecontrooverCambridge,itwilosaccountfbritsinvestmentinCambridgeusing:
Atheequitymethod
l77
l78
Btheacquisitionmethod
Cproportionateconsolidation
3.At3lDecember200,Cinnamon,sshahoders,equityonitsbalancesheetwouldosbe:
AhighestifCinnamonisdeemedtohavecontrolofCambridge.
BindependentoftheaccountingmethodusedfbrtheinvestmentinCambridge.
ChighestifCinnamonisdeemedtohavesignificantinfuenceoverCambridge.
4.In20l0,Cinnamon,snetprofitmarginwouldbeesif
AitisdeemedtohavecontrolofCambridge
BithadnotincreaseditsstakeinCambIidge.
CitisdeemedtohavesignificantinfuenceoverCambidge.
5At3lDecember20l0assumingcontroandrecognitionofgoodwil,Cinnamon,sreporteddebttoequityranowill0behighestifitaccountsfbritsinvestmentinCambridgeusingthe:
Aequitymethod.
BfhlIgoodwiI>method
Cpartialgoodwilmethod.
6ComparedtoCinnamon,soperatingmalginin2009ifitisdeemedtohavecontrolofCambridge,itsoperatingmargininZ0l0willosehbe;
A>ower
Bhigher.
Cthesame
TheoowinginfmationeIatestQuestions712
Zimt,AGisaconsumerproductsmanufhcmrerheadquarteredinAustria.ItcomplieswithIFRS.In200g,Zimtheldal0peIentpassivestakeinOxbowLimitedthatwasclassiedasheldfbrtradingsecunties.DuIingtheyeaEthevaIueofthisstakedecIinedbye3mi>Iion.InDecember200g,Zimtannouncedthatitwouldbeincreasingitsowneshipto50percenteffbctivelJanuaIy20l0.
FranzGeIbIum,ananaIystfbllowingbothZimtandOxbow,iscunoushowtheincreasedstakewillaffbctZimt,sconsolidatedfinancialstatements.BecauseGelblumisuncertainhowthecompanywi>>accountfbrtheincreasedstake,heuseshisexistingfbrecastsfbrbothcompanies,financialstatementstocompavariousalternativeoutcomes.
I
GeIbumgathesabbeviatedfinanciaIstatementdatafbZimtExhibitandOxbowExhibit2)fbrthispurpose.
xhdbit1.SeectedFimncilStatememEsthmHtesZimtAG6Miios
Yearending3IDecembe20092010
Revenue
OperatingincomeNetincome
31December
Totalassets
Shareholders,equity
>,500
l35
66
l,700
l53
75
Z0092010*
l,254l,42l
660735
EstimaesmadeprioroannolmcemeofincasedsakemOxbow
Exhdbit2.SelectedFiancilStatementEStimhteSOxb0wMm!tede
Milli0ns)
Yeending31Decembe200gZ010
Revenue
OperatingincomeNetincome
Dividendspaid
31Decembe
Totalassets
Shareholders,equity
l,200
l20
60
20
l,350
l35
68
2Z
2009Z010*
l,200l,283
660706
EslimaesmadepriortoannouncemenofincasedsakebyZim
7.In200g,Zimt,seamingsbefbretaxesincludesacontibutionin6millionsfiomitsinvestmentinOxbowLimitedcbesto:
A.(e0.6)miIion
B.(el.0)million
Ce2.0mi>lion
8.At3lDecember20l0,ZimtstotaIassetsbalancewouldoskebe:
179
l80
AhighestifZimtisdeemedtohavecontroIofOxbow.
B.highestifZimtisdeemedtohavesignificantinf>uenceoverOxbow.
CunaffbctedbytheaccountingmethodusedfbrtheinvestmentinOxbow.
9BasedonGeIbusestimates,ifZimtisdeemedtohavesignificantinfuenceoverOxbow,its20l0netincome(in6millions)wou>dbec/O$Bs/to:
Ae75.
B6l09.
C6l43.
10BasedonGe>blum,sestimates,ifZimtisdeemedtohavejointcontrolofOxbow,andZimtusestheproportionateconsolidationmethod,its3lDecember20l0totaIIiabilitiesinemilionswilbecesto:
A6686.
Beg75.
Cel263.
I1BasedonGebum,sestimatesifZimtisdeemedtohavecontroloverOxbow,its20l0consolidatedsales(inemillions)wil>bec/bs/to:
A6l,700.
B62,375.
Ce3,050.
1Z.BasedonGeblusestimates,Zimt,snetincomein20l0wiIIos0be;
AhighestifZimtisdeemedtohavecontro>ofOxbow
BhighestifZimtisdeemedtohavesignificantinfuenceoverOxbow.
CindependentoftheaccountingmethodusedfbrtheinvestmentinOxbow
ThefowinginfomatioeIatestoQuestions1318
BurtonHoward,CPA,isanequityanaIystwitbMapIewoodSecurities.HowadispreparmgaresearchrepoItonConfabulatedMateriaIs,SA,apublicIytradedcompanybasedinPrancethatcompIieswithIFRSAspatofhisanaIysis,HowardhasassembIeddatagatheedfibmthe5nancialstatementfbotnotesofConfhbuIated,s200gAnnualReportandfiFomdiscussionswithcompanymanagementHowardisconcemedabouttheeffbctofthisinfbnnationonConfhbuIated,sfUtureeamings.
lnfbrmationaboutConfabuated,sinvestmentportfbliofbrtheyeasended3lDecembe2008and200gispesentedinExhibitlAspaItofhisresearch,HowardisconsideingthepossibIe
I
effectonportedincomeofConfhbuIated,saccountigcIassificationfbrfixedincomeinvestments.
Exibit1.C0nbuHted,sIvestmetP0tMio6Th0SMs
Characteristic BIg>eAGCHthHyC0rpDImasSA
C>assification
Cost*
Marketvalue,3lDecember2008
MaIketvalue,3lDecember2009
AvailabIe-fbr-
saIe
625,000
29,000
28,000
AllsecuIitiesweacquidatparvalue.
He>d-to-
mamnty
e40,000
38,000
37,000
Held-to-
matunty
e50000
51000
55,000
InadditionConfhbu>ated,sannualreportdiscussesatransactionunderwhichreceivab>esweresecuIitizedthroughaspecia>purposeentity(SPE)fbrConfhbulatedsbenefit.
l3.ThebaIancesheetcarlyingvaIueofConfHbulated,sinvestmentpoItfb!io(inethousands)at3lDecember200giscm$es/to:
All2,000
Bll5,000
Cll8000
l4ThebalancesheetcarIyingvalueofConfabulated,sinvestmentpoItfblioat3lDecember200gwouIdhavebeenhigherifwhichofthesecuitieshadbeenclassifiedasaheldfbrtadingsecuity?
A.Bugle.
BCathay
CDumas
l5ComparedtoConfhbulated,sreportedinterestincomein200g,ifDumashadbeenc>aSsifiedasavai>abIe-fbFsale,tI]einterestincomewou>dhavebeen:
A.>ower.
Bthesame
Chigher.
18l
I82
l6ComparedtoConfhbuated,seportedeamingSbefbretaxesin200g,ifBugIehadbeenclassifiedasaheIdfbrtradingsecuIitytheeamingsbefbretaxes(inethousands)wouIdhavebeen:
Athesame.
B6l,000Iower.
C63000highe.
17Confhbuated,sreportedinterestincomewoudbelowerifthecostwasthesamebuttheparvaIue(in6thousands)of:
ABugIewas628,000
BCathaywase37,000.
CDumaswase55,000.
18.Confhbulated,sspecialpurposeentityisosMetobe:
Ahe>dofFbaIancesheet
BconsolidatedonConfhbuIated,sfinancialstatements.
C.consolidatedonConfhbu>ated,sfinancialstatementsonlyifitisaqualifyingSPE,,
ThefowinginfOmationeIatestoQuestions1924
BetterCareHospita>s,IncoperatesachainofhospitalsthroughouttheUnitedStates.Thecompanyhasbeenexpandingbyacquiringocalhospitas.ItsIagestacquisition,thatofStatewideMedical,wasmadein200lunderthepoolingofinterestsmethod.BetterCarecomplieswithUSGAAP.
BetterCareiscurrentlyfbIninga50/50jointvenmrewithSupremeHea>thcareunderwhichthecompanieswillsharecontrolofseveraIhospitaIs.BetterCareplanstousetheequitymethodtoaccountfbrthejointvenmre.SupremeHeaIthcarecomp>ieswithIFRSandwillusetheproportionateconsoIidationmethodtoaccountfbthejointventu
ErikOhalinisanequityanaIystwhocoversbothcompanies.Hehasestimatedthejointventure,sfinanciaIinfbnnationfbr20l0inordertopreparehisestimatesofeachcompany,searningsandfinancia>pes)
Yerending3lDecemberZ0l0
Revenue >,130
YeaedingIDecemberZ0l0128
62
OperatingincomeNetincome
201031Decembe
l,500
740
Tota>assets
Shareho>ders,equity
SupremeHealthcarerecentlyannouncedithadfbImedaspecialpurposeentitythroughwhichitp>anstose>>upto$l00miIlionofitsaccountsreceivableSupremeHealthcarehasnovotmginterestintheSPE,butitisexpectedtoabsoIbanylossesthatitmayincurOhalinwantstoestlmatetheimpactthiswi>lhaveonSupremeHealthcare,sconsoIidatedfinancialstatements.
l9ComparedtoaccountingpIinciplescurrentlyinuse,thepoolingmethodBetterCareusedfbritsStatewideMedicalacquisitionhasosycauseditsIBpoIted:
A.revenuetobehigher.
Btotalequitytobelower
CtotaIassetstobehigher
20.BasedonOhaIin,sestimates,theamountofjointventurerevenue(in$millions)incIudedonBetterCare,sconso>idated20l0financialstatementsshou>dbec/bses/to:
A$0.
B7l5.
C.$l430
|||
2.BasedonOhaIinsestimatestheamountofjointventuenetincomeincIudedontheconsoIidatedfinanciaIstatementsofeachventuerwiIMjosh0be:
AhigherfbrBetteCare.
BhigherfbrSupremeHealthcare.
CthesamefbrbothBetterCareandSupemeHealthcare
22.BasedonOhaIin,sestimates,theamountofthejointventure,s3lDecember20l0totaIassets(in$mi>>ions)thatwilIbeincludedonSupremeHealthcare,sconso>idatedfinancialstatementswiIbecsesto:
A$0
B.$750.
C$l,500
>83
23.BasedonOhaIin,sestimates,theamountofjointventuresllaehoIders,equityat3December20l0includedontheconso>idatedfinancia>statementsofeachventurerwill!Okcybe:
AhigherfbrBetterCare.
B.higherfbrSupremeHealthcare
CtheSamefbrbothBetteCaeandSupemeHeaIthcare.
2IfSupremeHeathcaresellsitsreceivabIestotheSPE,itsconsolidatedfinanciaIresultswilloscshow:
Aahigherrevenuefbr20l0.
Bthesamecashbalanceat3lDecember20l0.
Cthesameaccountsreceivablebalanceat3lDecember20l0.
ThefowinginfOmationeIatestoQuestiohs2530
PercyByron,CFA,isanequityana>ystwithaUK-basedinvestmentfinnOnefiImByronfblowsisNinMountPLC,aUKbasedcompany.On3lDecember2008NinMountpaid320miIliontopurchasea50percentstakeinBosweIlCompany.TheexcessofthepurchasepriceoverthefhirvaueofBosweII,snetassetswasattributabletopreviousIyuncordedIicenses.Theselicenseswereestimatedtohaveaneconomiclifbofsixyears.ThefhirvalueofBoswe>l,sassetsandliabilitiesotherthanlicenseswasequaItotheirrecordedbookvalues.NinMountandBoswelbothusethepoundsterlingastheirepoItingcurrencyandpreparetheirfinanciastatementsinaccoaccountingmethodstoreporttheresuItsofitsinvestment,butNinMounthasnotannouncedwhichmethoditwilIuseByronfbrecaststhatbothcompanies200gfinanciaIresuIts(excludinganymergeraccountingaqustments)wi}IbeidenticaItothoseof2008`
NinMount,sandBosweI,scondensedincomestatementsfbrtheyearended3lDecember2008,andcondensedbaIancesheetsat3lDecember2008,arepresentedinExhibits>and2,respectively.
ExhibitINinM0utPLCndB0sweICompayInc0meSttemetsfb.tIleYeEnded3lDecembeZ008iios
MnM0untB0swell
0
0
5G
g50
(495)
(50)
(l36)
Netsales
Costofgoodssold
SelIingexpenses
AdministrativeexpensesI8
|
Depreciation&amoiabi>ities
Commonstock
Retainedeamings
Totalequity
TotaIliabilitiesandequity
NinM0utB0sWe
50
70
l30
250
l,570
3200
2,l40-
ll0
600
7l0
850
580I
l,430I
2l10
20
45
75I
>40
930
>,070-
g0
400U
g0
535
45
580
l,070-
jVb:BalancesheesfecMhepuIchasepricepaidbyNinMounbudonoveconsiderheimpacofaccoumingmetlodchoice.
25.NinMount,scurrentratioon3December2008oswiIlbehighestiftheresults
oftheacquisitionarerepoItedusing:
A.theequitymethod.
BconsoIidationwithfUlgoodwill
CconsolidationwithpaItiaIgoodwil
26.NmMousIong-termdebttoequityratioon3IDecember2008oskeywiIIbeowestifthesuItsoftheacquisitionaereportedusing: 185
l86
Atheequitymethod.
Bconsolidationwithfilllgoodwi>>
CconsoIidationwithpartialgoodwill
Z7BasedonByron,sfbrecast,ifNinMountdeemsithasacquiredcontrolofBoswe,NinMount,sconsolidated200gdepreciationandamoItlzanonexpenseinmillionswiIIbecsesto:
Al02.
Bl48.
C201.
28.BasedonByron,sfbIccast,NinMount,snetprofitmarginfbr200gjwilIbehighestiftheesuItsoftheacquisitionarereportedusing:
Atheequitymethod
B.consolidationwithfUllgoodwill.
Cconsolidationwithpartialgo0dwill.
29.BasedonByron,sfbccastNinMount,s2009retumonbeginningequityywi!bethesameunder:
A.eitheroftheconsoIidations,butdiffeIntundertheequitymethod
B.theequitymethod,consolidationwithfUlIgoodwil>,andconsolidationwithpartialgoodwil>.
Cnoneoftheequitymethod,consolidationwithfUllgoodwill,orconso!idationwithpatiaIgoodwiI
30BasedonByron,sfbrecast,NinMount,s2009totalassettumoverratioonbeginningassetsundertheequitymethodisosy:
A>owerthaniftheresuItsarereportedusingconsolidation
Bthesameasiftheresultsarerepoedusingconsolidation.
ChigherthanifthesultsarereportedusingconsoIidation
SIutiIs
1Aiscoect.DividendsfibmequitysecuritiesthatarecassifedasavaiabefbrsaIeareincludedinincomewhenearnedCinnamonwouldrecordits>gpercentshareofthedividendspaidbyCambridge;thisis3.8miIlionZ0x01g.ThoughthevaIueof
|
Cinnamon,sstakeinCambridgeProcessingroseby2miIIiondingtheyear,undeIFRSanyunrealizedgainsorossesfbravailablefbIsaIesecuritiesarerepoItedintheequitysectionofthebalancesheetaspaofothecomprehensiveincomeuntiIthesecuIitiesareso>d
2Biscorrect.IfCinnamonisdeemedtohavecontroloverCambridge,itwouldusethe
acquisitionmethodtoaccountfbrCambridgeandprepareconso>idatedfinanciaIstatements.Proportionateconso>idationisusedfbrjointventures;theequitymethodisusedfbrsomejointventuresandwhenthereissignificantinf>uencebutnotcontrol
3AiScorrect.IfCinnamonisdeemedtohavecontroloverCambridge,consolidatedfinancialstatementswouldbepreparedandCinnamon,ssharehoIders,equitywouldincreaseandincludetheamountofthenoncontIol>inginterestIfCinnamonisdeemedtohavesignificantinf>uence,theequitymethodwouldbeusedandtherewouldbenochangeintheshareholdersequityofCinnamon
4Ciscorrect.IfCinnamonisdeemedtohavesignificantinfuence,itwoudrepothalfofCambridge,snetincomeasalineitemonitsincomestatement,butnoadditionalrevenueisshownItSprofitmaIginisthushigherthanifitconsoIidatedCambridge,sresultswhichwouldimpactrevenueandincomeorifitonlyreportedlgpercentofCambridge,sdividends(nochangeinownership).
5Ciscorrect.ThefUl>andpartialgoodwiImethodwillhavethesameamountofdebt;however,shareholders,equitywi>>behigherunderMlgoodwiI>(andthedebttoequityrat1owillbelower.Thefbre,thedebttoequitywilbehigherunderpartialgoodwillIfcontrolisassumed,Cinnamoncannotusetheequitymethod
6Aiscorrect.CambridgehasaloweropeatingmaIgin88ll008.0thanCinnamon(l42/l,575=g.0%]IfCambridge,sresultsareconso>idatedwithCinnamon,s,theconso>idatedoperatlngmaIginwillref>ectthatofthecombinedcompanyor230/2,675=86%.
7Biscorrect.Oxbowwasclassifiedasaheldfbrtradingsecurity.Heldfbrtradingsecunt>esarereportedatfairvaIuewithunreaIizedgainsandIossesincludedinincome.TheincomestatementalsoincIudesdividendsfromequitysecuritiesthatareclassifiedasheldfbrtrading.Thee3milliondeclineintheva>ueofZimt,sstakewouldreduceincomebythatamountZimtwouldrecorditsshareofthedividendspaid(0.lxeZ0miIIion=62miI>ion)TheneteffbctofZimt,sstakeinOxbowLimitedwouIdbetoreduceZimt,sincomebefbretaxesby6lmilIionfbr2009.
8.Aiscoect.WhenacompanyisdeemedtohavecontroIofanotherentity,itrecodsaIIoftheotherentity,sassetsonitsownconsoIidatedbaIancesheet.
9BiscorIct.IfZimtisdeemedtohavesignificantinfuence,itwouIdusetheequitymethodtorecorditsownership.Undertheequitymethod,Zimt,sshareofOxbow,snetincomewouIdberecordedasasingleIineitem.NetincomeofZimt=75+05(68)=l09.
10 Biscorrect.Undertheproportionateconsolidationmethod,Zimt,sbalancesheetwou>dshowitsowntotaIliabilitiesof6l42l-735=e686plushalfofOxbow,sliabilitiesofel283-706=6577.6686+(05x577]=6g74.5.
l1Ciscorrect.Undertheassumptionofcontol,ZimtwouIdrecoditsownsaIesplusl00percentofOxbow,s6l,700+>,350=e3,050.
187
l88
l2.Ciscorrect.Netincomeisnotaffectedbytheaccountingmethodusedtoaccountfbactiveinvestmentsinothercompanies.One-lineconsolidation,,andconso>idationresu>tinthesameimpactonnetincome;itisthediscIosurethatdis.
l3CiscorrectHeldfbrtradingandavaiIablefbrsaesecuritiesarecaiedatmarketvaue,whereasheldtomaturitysecuritiesarecariedathistoricalcost.628,0000,00050,000=ell8000.
14Ciscorrect.IfDumashadbeencassifiedasaheldfbrtIadingsecuityitscarryingvaluewouIdhavebeenthee55,000fhirva>ueratherthanthee50,000historicaIcost.
15Biscorrect.ThecouponpaymentisrecordedasinterestincomewhethersecuIitiesareheIdtomatuntyoravailablefbrsae.Noadjustmentisrequiredfbramotizationsincethebondswereboughtatpar.
I6BiscorrectUnreaIizedgainsandlossesareincludedinincomewhensecuitiesarecIassifiedasheldfbrtradingsecuritiesDuring2009therewasanunrealizedlossof6l,000
I7BiscorrectThediffbrencebetweenhistoicalcostandparvaluemustbeamortizedundertheeffectiveinterestmethodIftheparvaIueislessthantheinitia>cost(statedlnterestrateisgreaterthantheeffbctiverate),theinterestincomewouldbelowerthantheinterestreceivedbecauseofamozationofthepremium
18Biscorrect.UnderRS,SPEsmustbeconsolidatediftheyareconductedfbrthebenetofthesponsonngentity.Further,underIFRSSPEscannotbec>assifiedasqualifying.UnderUSGAAP,qualifyingSPEs(acIassificationwhichhasbeene!iminated)donothavetobeconsolidated.
19Biscorrect.StatewideMedicalwasaccountedfbrunderthepoolingofinterestmethod,whichcausesallofStatewide,sassetsandliabilitiestoberepoItedathistoIicalbookvalue.TheexcessofassetsoverliabiIitiesgenerallyislowerusingthehistoicalbookvaluemethodthanusingthefairvaIuemethod(this>attermethodmustbeusedundercurrent>yrequiredacquisitionaccounting).Itwou}dhavenoeffbctonrevenue.
20.Aiscorrect.Undertheequitymethod,BetterCaewouIdcorditsinteestinthejointvemre,snetprofitasasingIeIineitem,butwouIdshownoIinebyIinecontibutionto
2l
22
revenuesorexpenses
Ciscoect.NetincomewiIIbethesameundertheequitymethodandpropoIhonaIconsolidationHowever,sales,costofsaIes,andexpensesaediffbrentbecauseundertheequitymethodtheneteffectofsales,costofsales,andexpensesisefectedinasingIeline
Bisconct.UnderthepropoltionateconsoIidationmethod,SupemeHeaIthcare,sconsolidatedfinanciaIstatementswiIincludeits50percentshareofthejointventure,stotaIassets
23Ciscorrect.ThechoiceofequitymethodorproportionateconsolidationdoesnotaffbctreportedshahoIders,equity
21. Ciscorect.AlthoughSupremeHeaIthcaehasnovotinginterestintheSPE,itisexpectedtoabsorbanylossesthattheSPEincurs.Thefbre,SupremeHeaIthcareinsubstance,,controIstheSPEandwouIdconsoIidateit.Ontheconsolidatedbalancesheet,
theaccountsreceivab>ebaIancewiI>bethesamesihcethesaletotheSPEwiIbereverseduponconsoIidation.
Z5Aiscoect.ThecurentatiousingtheequitymethodofaccountingisCurrentassetsCurrentIiabilities250ll0227.Usingconsoidationeitherfhlorpartiagoodwillthecurentratio390200195.Therefbre,thecuIrentratioishighestusingtheequitymethod
26Aiscoect.Usingtheequitymethodlongtermdebttoequity600l,4300.42.Usingtheconsolidationmethod>ong-termdebttoequity=>ongptenndebt/equity=l,000l,750057Equityincludesthe320noncontrollingintestundereitherconsolidationItdoesnotmatterifthefh>>orpartialgoodwillmethodisusedsincethereisnogoodwi>l
Z7Ciscorrect.TheprO>ecteddepreciationandamoItizationexpensewillincludeNinMount,srepoteddepreciationandamortizationl02,Boswellsreporteddepreciationandamotizationg2,andamortizationofBoswell,slicensesl0milion.Theicenseshaveafhirvaueof60milion.320purchasepriceindicatesafhirvaIueof60fbrthenetassetsofBoswell.ThenetbookfaiIvaIueoftherecorded
assetsis580.Thepreviouslyunrecordedicenseshaveafaivalueof60millionThe>icenseshavearemaininglifbofsixyears;theamortizationadiustmentfbr2008wi>>bel0miIionTherefbre,Pqecteddepreciationandamortizationl0292l0204million.
28Aiscoect.NetincomeisthesameusinganyofthemethodsbutundertheequitymethodnetsaIesareonly950;Boswell,ssaesarenotincludedinthenetsalesfigureTherefbrenetprofitmarginishighestusingtheequitymethod.
Z9AiscorrectNetincomeisthesameusinganyofthechoices.Beginningequityundertheequitymethodisl,130.Undereitheroftheconsolidations,beginningequityis,750sinceitincudesthe320noncontrollinginterestRetumonbeginningequityishighestundertheequitymethod.
30Aiscoect.Usingtheequitymethod,TotalassettumoverNetsalesBeginningtotalassetsg502,M00444Totalassettumoveronbeginningassetsusingconsolidationl4602,9500495.Underconsolidation,Assets2,40320l,070602,950Theefbre,totaIassettumoverislowestusingtheequitymethod.
189
ThiseadingcovestwocompexaspectsofempIoyeecompensation:postemployment(retirement)bene&tsandshare-basedcompensation.RetirementbenefitsincludepensionsandotherpostempIoymentbenefits,suchasheaIthinsurance.ExampIesofshaebasedcompensationarestockoptionsandstockgants.
AcommonissueunderlyingbothoftheseaspectsofempIoyeecompensationisthedifficu>tyinmeasuIingtheva>ueofthecompensation.OnefactorcontributingtothedifficuityisthatemployeeseamthebenefitsintheperiodsthattheyprovideseIicebuttypica!>yreceivethebenefitsinfUtureperiodssomeasurementrequiresasignificantnumberofassumpt1ons.
ThisreadingprovidesanoverviewofthemethodscompaniesusetoestimateandmeasurethebenefitstheyprovidetotheiremployeesandhowthisinfbrmationisrepoItedinfinancialstatements.Therehasbeensomeconveoymentbenefits.1UnderUSGAAP,theguidanceisspreadacrossseveraIsectionsoftheFASBCodification.2
ThediscussionbeginswithanoverviewofthetypesofbenefitsandmeasurementissuesivoIved,includingtheaccountingtreatmentfbdefmedcontributiopIansItthencontinueswithfinancialstatementreportingofpensionp>ansandotherpost-empIoymentbenefits,includinganoverviewofcriticaIassumptionsusedtovaIuethesebenefits.Thesectionconcludeswithadiscussionofevaluatingdefinedbenefitpensionplanandotherpost-empIoymentbenefitdisclosures.
2.1.TypesoPostEmpIoymentBenefitPlans
CompaniesmayoffbrvaIioustypesofbenefitstotheirempIoyeesfbllowingretirement,incIudingpensionplans,healthcaep!ansmedicaIinsurance,andIifbinsurance.Someofthesebenefitsinvolvepaymentsinthecurrentperiod,butmanyarepomisesoffUtuebenefits.The
l91
obectivesofaccountingfbempIoyeebenefitsistomeasuethecostassociatedwithprovidingthesebenefitsandt0recognisethesecostsinthesponsonngcompany,sfinancialstatementsduringtheempIoyees,periodsofservice.CompIexityarlsesbecausethesponsormgcompanymustmakeassumpt1onstoestimatethevalueoffUturebenefits.Theassumpt1onsrequiredtoestmateandrecognisethesefUtuebenefitscanhaveasignicantimpactonthecompany,sreportedperfbrmanceandfinanciaIposition.Inaddition,diffCrencesinassumpt1onscanreduce
comparabiIityacosscompanies.
Pensionp>ansaswel>asotherpost-empIoymentbenefitsmaybeeitherdefinedcontributionplansordefinedbenefitplans.Underadefinedcontribution(DC)pensionplan,specific(oragreed-upon)contributionsaremadetoanemp>oyee,spensionplanTheagreeduponamountisthepenslonexpense.TypicaIIy,inaDCpensionpIananindMdualaccountisestabIishedfbreachpart1clpatlngemployee.Theaccountsaregenerallyinvestedthroughafinancial
oyeesandtheemployermayeachcontributetotheplanAHertheemployermakesitsagreeduponcontributiontothepIanonbehalfofanemployeegeneralyinthesameperiodinwhichtheemployeeprovidesthesevicetheemp!oyerhasnoObligationtomakepaymentsbeyondthisamount.Thefhmrevalueofthep>an,sassetsdependsontheperfbrmanceofthelnvestmentswithintheplanAnygainsorlossesre>atedtothoseinvestmentsaccruetothe
employee.Therefbre,inDCpensionp>anstheempIoyeebearstheriskthatplanassetswil>notbesufficienttomeetfUtureneeds.Theimpactonthecompany,sfinancialstatementsofDCpenslonplanslseasilyassessedbecausethecompanyhasnoob>igationsbeyondtherequired
contributions.
IncontrasttoDCpenslonplans,definedbenefitBpensionplansareessentialypromisesby
theemp>oyertopayadefinedamountofpensioninthefUture.AspartoftotalcompensationtheempIoyeeworksinthecurrentpeIiodinexchangefbrapensiontobepaidaherret1ement.InaDBpensionplan,theamountofpensionbenefittobeprovidedisdefined,usuallybyrefbrencetoageyearsofservice,compensation,etc.ForexampIe,aDBpensionplanmayprovidefbrtheretieetobepaid,annuallyuntildeath,anamountequaltolpercentofthefinalyear,ssalarytlmesthenumberofyearsofservice.Thefhturepensionpaymentsrepresenta>iabilityorobligationoftheempIoyer(ie.thesponsonngcompany)TomeasurethisobIigation,theempIoyermustmakevanousactuaria|assumptlons(emp>oyeetumover,average
retlrementage,Iifbexpectancyaferetirementandcomputations.ItisimportantfbrananalysttoevaluatesuchassumptionsfbrtheirreasonablenessandtoanalysetheimpactoftheseassumptionsonthefinanciaIreportsofthecompany.
UnderIFRSandUSGAAP,allplansfbrpensionsandotherpost-employmentbenefitsotherthanthoseexp>icitlystmcturedasDCplansareclassifiedasDBplans.3DBplansincIudebothfbrmalp>ansandthoseinfbrmaIarrangementsthatcreateaconstluctiveObligationbytheempIoyertoltsemployees4TheemployermustestimatethetotaIcostofthebenefitspromisedandthenaIIocatethesecoststotheperiodsinwhichtheemployeesprovideservice.ThisestlmationandaIIocationfUrtherincreasesthecompIexityofpensionrepoItingbecausethetlmlngofcashf>ows(contributionsintotheplanandpaymentsfiFomtheplan)candiffbrsignificantIyfTomthetimingofaccuaIbasisepoting.AccruaIbasisreportingisbasedonwhentheservicesarerenderedandthebenefitsareearned
MostDBpenslonplansaeflmdedthroughaseparatelegalentity,typicallyapensiontrust,and
theassetsofthetrustareusedtomakethepaymentstoretirees.ThesponsonngcompanyisresponsiblefbrmakingcontributionstothepIanThecompanya>somustensurethattherearesufficientassetsintheplantopaytheultimatebenefitspromisedtoplanparticipants.Regu>atoryrequirementsusuaIIyspecifyminimumfimdingIevelsfbrDBpensionplansbutthoserequirementsvalybycountI.TheflmdedstatusofapensionpIan-oveIfUndedor
219
|
underfllndedfbrstowhethertheamountofassetsmthepensiontrustisgreatethanorIessthantheestimatedliability.IftheamountofassetsintheDBpensiontrustexceedsthepresentvaIueoftheestimatedIiability,theDBpensiopanissaidtobeovenmded;conveseIy,iftheamountofassetsinthepensiontmstislessthantheestimatedliability,theplanissaidtobeunderfInded.BecausethecompanyhaspromisedadefiIedamountofbenefittotheempIoyees,itisobligatedtomakethosepensionpaymentswhentheyaredueregardlessofwhetherthepensionpIanassetsgeneratesuffcientretumstopovidethebenefitslothewods,thecompanybearstheinvestmentIiskManycompaniesarereducingtheuseofDBpensionp>ansbecauseofthisrisk
SimilartoDBpensionplans,otherpost-employmentbenefits(OPB)arepromisesbythecompanytopaybenefitsinthefUture,suchasIifeinsurancepremiumsandaIIopaofheaIthcareinsurancefbritsretirees.OPBaretypical!yc>assifiedasDBp>ans,withaccountingteatmentsimiartoDBpensionpans.Howeve,thecompexityinrepoItingfbrOPBmaybeevengIaterthanfbrDBpensionplansbecauseoftheneedtoestimatefhtureincreasesincosts,suchashea>thcareoveralongtimehorizon.UnIikeDBpensionplanshowever,companiesmaynotberequiredbyregulationtofUndanOPBinadvancetothesamedegreeasDBpensionp>ans.Thisispartlybecausegovernments,throughsomemeans,oheninsureDBpensionplansbutnotOPB,paItlybecauseOPBmayrepresentamuchsmallerfmancialliabiIity,andpartlybecauseOPBareoReneasiertoeliminateshou>dthecostsbecomeburdensomeItisimportant
thatananalystdeteIminewhatOPBareoffbredbyacompanyandtheobligationtheyrepresent
Typesofpost-employmentbenefitsoffbredbyemployersdiffbracrosscountIies.Forinstance,incountrieswheregovernment-sponsoreduniversalhealthcareplansexist(suchasGennanyFranceCanada,Brazil,Mexico,NewZealand,SouthAfhcaIndiaIsrael,Bhutan,andSingapoI,companiesarelesslikelytopIovidepostretirementhealthcarebenefitstoemp>oyees.TheextenttowhichcompaniesoffbrDCorDBpensionp>ansalsovaIiesbycountIy.
Exhibit1summanzesthesethreetypesofpost-employmentbenefits.
ExhibntlTypes0fP0stEmpI0ymentBenes
Type0Benet
Defined
contIibution
pensionplan
Am0Int0fP0St-
Emp>0ymemBenefitt0
Emp!0yee
AmountoffUtu
benefitisnot
defined.AcmaI
fUmrebenefitwiIl
dependoninvestment
peIfbrmanceofpIanassets.
Investmentriskis
bomebyemp>oyee.
AmountoffUture
benefitisdefmed,
Obligti0n0Sp0ns0ingC0mpny
Amountofthe
company,sob>igation(contribution)isdefinedineach
peIiodThecontribution,ifanyistypica>IymadeonaperiodicbasiswithnoadditionaIfiture
obligation.AmountofthefUture
obligation,basedon
Sp0ns0l>ngC0mp&my,sPefmding0fitsFutue
Obl&gnti0n
NotapplicabIe.
Companiestypicallypre-
l93
I94
TyPe0Benefit
Defined
benet
pensionpIan
Otherpost-emp>oymentbenefits(e.gretirees,
healthcare)
Am0unt0fP0st=
ImpI0ymemBenett0
Empl0yee
basedontheplan,sfbmuIaoenafilnctionoflengthofseIviceandfinal
year,scompensation).Investmentriskis
bomebycompany.
Amountoffnture
benefitdependsonpIanspecificationsandtypeofbenefit
ObIigtd00Sp0ns0ingCOmpny
Sp0nS0ingC0mpany,sPre-fimding0fitsFuture
ObligHt0nhmdtheDBthepIan,sfbnnula,
mustbeestlmatedinplansbythecurrentperiod.contributing
fimdstoa
pensiontrust.RegulatoIyrequirementstopre-fimdvabenefitsareCompaniesspecifiedThe typicallydonotamountofthefUturepre-fhndotherobligationmustbe pOSt-estimatedintheemploymentcurIntperiodbenefit
obIigations.
ThefbllowingsectionsprovideadditionaldetailonhowDBpensionplan>iabilitiesandpeIiodiccostsaremeasuedthefinancialstatementimpactofrepomngpensionandotherpostemploymentbenefits,andhowdisclosuresinthenotestothefinancialstatementscanbeusedtogaininsightsabouttheunderlyingeconomicsofacompany,sdefinedbenefitplans.Section2.ZdescribeshowaDBpensionp>an,sobIigationisestimatedandthekeyinputsintoandassumptionsbehindtheestimate.Section2.3describesfinanciaIstatementreportingofpensionandOPBpIansanddemonstratestheca!culationofdefinedbeefitobIigationsandcuentcostsandtheeffbctsofassumptions.Section2.4desclibesdisclosuresinfinancialrepoItsaboutpensionandOPBpIans.Theseinc>udediscIosuresaboutassumptionsthatcanbeusefUlinanalysingandcompanngpensionandOPBplanswithinandamongcompanies.
22MeasuingaDefinedBenefitPensionPIan,s0bIigations
BothlFRSandUSGAAPmeasurethepensionOb>igationasthepresentvaIueoffUturebenefitseanedbyempIoyeesfbrserviceprovidedtodate.TheobligationiscalledthepresentvalueofthedefinedbenefitobligationBOunderRSandtheprOjectedbenefitobligationPBOunderUSGAAP.5ThismeaSureisdefinedasthepresentvaIue,withoutdeductinganyplanassets,ofexpectedfUturepaymentsrequiredtosettletheobIigationaIisingfiFomemployeeserviceinthecurrentandpriorpe
l
|
compensationincreasesandIeveIsdiscountates,ahdexpectedvestmgForinstanceanestimateofftlturecompensationismadeifthepensionbenefitfbImulaisbasedonfUturecompensationIeveIsexampIesinCudepayeIated,finalpayfinaaverage-pay,orcareeraverage-payp>ans)Theexpectedannua>increaseincompensationovertheemployeeserviceperiodcanhaveasignificantimpactonthedefinedbenefitobIigationThedeterminationofthebenefitobligationimp>icitlyassumesthatthecompanywi>lcontinuetooperateinthefUturethegoingconcemassumption,,adcognisesthatbenefitswiIIincreasewithfUtuecompensationincreases.
Anotherkeyassumptionisthediscountrate-theinterestrateusedtocalcu>atethepresentvalueofthefhturebenefits.Thisrateisbasedoncurrentratesofretumonhigh-qualitycorporatebonds(orgovemmentbondsintheabsenceofadeepmarketincorporatebonds)withcurrencyanddurationsconsistentwiththecurrencyanddurations0fthebenefits.
UnderbothDBandDCpensionp>ans,thebenefitsthatempIoyeeseammaybeconditionalonremainingwiththecompanyfbraspecifiedperiodoftime.Vesting,refbrstoapIovisioninpensionsplanswherebyanemployeegainsrightstofhmrebenefitson>yahermeetingcertaincriteria,suchasapre-specifiednumberofyearsofservice.Iftheemployee>eavesthecompanybefbremeetingtheciteIia,heorshemaybeentitIedtononeoaportionofthebenefitseamedupuntilthatpoint.However,oncetheemp>oyeehasmetthevestingrequirements,heorsheisentitledtoeceivethebenefitseamedinpnorperiodsie.,oncetheemployeehasbecomevested,benefitsarenotfbIfbitediftheempIoyeeIeavesthecompany).InmeasunngthedefinedbenefitObligation,thecompanyconsiderstheprObabiIitythatsomeemployeesmaynotsatisfythevestingrequirements(ie.,mayleavebefbrethevestingperiod)andusesthisprobabi>itytocalculatethecurrentservicecostandthepresentvalueoftheobligation.Currentservicecostistheincreaseinthepresentvalueofadefinedbenefitobligationasaresultofemployeeserviceinthecurrentperiod.CurrentseIvicecostisnottheonlycauseofchangeinthepresentvaIueofadefinedbenefitobligation
TheestimatesandassumptionsaboutfUturesaIaincases,thediscountrate,andtheexpectedvestingcanchange.Ofcourse,anychangesintheseeStimatesandassumptionswillchangetheest1matedpensionobigationIfthechangesincreasetheobigation,theinceaseisrefbrredtoasanactuarialoss.Ifthechangesdecasetheobligationthechangeisrefbedtoasanactuarialgain.Section2.3.3fUrtherdiscussesestimatesandassumpnonsandtheeffbctonthepensionobIigationandexpense.
2.3FinanciaIStatementReptingofPensionPIansandOthePostEmpIoymentBenefits
Sections2.3.lto2.3.3describehowpensionplansandotherpost-employmentbenefitsaIcrepoItedinthefinancia>statementsofthesponsonngcompanyandhowassumptionsaffbcttheamountsreportedDisclosuresre>atedtopensionsplansandOPBaredescribedinSectionZ4.
231DeedCbnPesionans
Theaccountingtreatmentfbrdefinedcontributionpensionp>ansisrelativelysimple.Fromafinancia>statementperspective,theemployer,sobligationfbrcontributionsintothepIan,ifany,isIcordedasanexpenseontheincomestatement.Becausetheemployer,sObligationislimitedtoadefinedamountthattypicalIyequaIsitscontributionnosignificantpension-re>atedIiability
1g5
accuesonthebaIancesheet.AnaccmalcuentIiabiIityisrecogHisedattheendofthereportingperiodonlyfbranyunpaidcontributions.
232DeedBenePesjOas
TheaccountingtreatmentfbrdefinedbenefitpensionplansismorecompIex,pnmarilybecauseofthecomplexitiesofmeasunngthepensionOb>igationandexpense.
2321.BaIanceSheetPesentation
BothRSandUSGAAPrequireapensionplan,sfilndedstatustoberepotedonthebalancesheet.ThefimdedstatusisdeteIminedbynettingthepensionob>igationagainstthefairvalueofthepensionpIanassets.Ifthepensionobligationexceedsthepensionplanassets,theplanhasadeficit.Iftheplanassetsexceedthepensionobligation,theplanhasasurplus.Summarizingthisinfbnnationinequationfbrmgives
FundedstatusFairvalueoftheplanassetsPVoftheDefinedbenefitobigation
lg6
lftheplanhasadeficitanamountequaltothenetundeIfhndedpensionobligationisrepoItedonthebalancesheetasanetpensionliability.IftheplanhasasurpIus,anassetequa>totheoveIfimdedpensionobligationisportedonthebalancesheetasanetpensionassetexceptthattheamountofrepoItedassetsissuhjecttoaceilingdefinedasthepresentvalueoffUtureeconomicbenefits,suchasrefimdsfiomtheplanorreductionsoffUturecontributions).DiscIosuresinthenotesprovideadditiona>infbrmationaboutthenetpensionliabi>ityorassetreportedontheba>ancesheet.
ExampIe1
DeteinatinfAmuntstbeReptentheBalahceSheet
Thefb>lowinginfbrmationpeItainstotwohypotheticalcompanies,definedbenefitpensionpIansasof3lDecember20l0:
ForcompanyABCthepresentvaIueofthecompany,sdefinedbenefitobligationise6,723andthefhirvalueofthepensionpan,sassetsis6,880
ForcompanyDEF,thepresentvaIueofthecompany,sdefinedbeIefitobIigationise5,485andthefhirvalueofthepensionp>anassetsise5,9g8InadditionthepresentvaueofavaiIabIeflltuerefimdsandeductionsihfUturecontributionsise326.
CaIculatetheamounteachcompanywou>dreportasapensionassetorliabilityonits20l0baIancesheet.
SoIution:
CompanyABCwouIdreportthefUllunderfhndedstatusofitspensionpIan(ie.,theamountbywhichthepresentvalueofthedefinedbenefitob>igationexceedsthefhirvalue
ofpIahassets)asaIiabiIity.SpecificaIIythecompanywouIdreportapensionIiabiIityofel,843
Presentva>ueofdefinedbenefitobligation
FairvaIueofp>anassets
NetpensionIiability
66,723
(4,880)
el,843
CompanyDEF,spensionplanisovefUndedby65l3whichistheamountbywhichthefairvalueofthep>an,sassetsexceedthedefinedbenefitobligation(65,g98-65,485)However,whenacompanyhasasurplusinadefinedbenefitp>an,theamountofassetthatcanbepoItedisthelowerofthesuIp!usandtheassetceilingthepresentvalueoffUtureeconomicbenefits,suchasIcftmdsfTomtheplanorreductionsoffnturecontributions)Inthiscase,theassetceilingisgivenas6326sotheamountofcompanyDEF,sreportednetpensionassetwou>dbe>imitedtoe326.
2322PeiodicPensionCost
Theperiodiccostofacompany,sDBpensionplanisthechangeinthenetpensionliabilityorassetadjustedfbrtheemployer,scontributions.Eachperiod,theperiodicpensioncostisrecognisedinprofitorloss(P&L)and/orinothercomprehensiveincome(OCI).(Insomecases,amountsofpensioncostsmayquaIifyfbrinclusionaspartofthecostsofsuchassetsasinventonesandthusbeincludedinP&Laspartofcostofgoodssoldwhenthoseinventoriesarelaterso>dThefbcushereisontheamountsnotcapitalised.)IRSandUSGAAPdiffbrinthewaythatthepeiodicpensioncostisdMdedbetweenPLandOCI
UnderIFRS,theperiodicpensioncostisviewedashavingthreecomponents,twoofwhicharerecognisedinP&LandoneofwhichisrecognisedinOCI.
1SbWc2c.Thefirstcomponentofperiodicpensioncostisservicecost.Currentservicecostistheamountbywhichacompany,spensionob>igationincreasesasaresuItofempIoyees,serviceinthecurrentperiodPastservicecostistheamountbywhichacompany,spensionobligationreIatingtoemployees,seIviceinpnorperiodschangesasaresuItofpIanamendmentsoraplancuItailment.7UnderIRS,seIicecosts(incIudingbothcurrentservicecostsandpastseIvicecosts)arerecognisedasanexpenseinP&L
2Veesexpesecoe.Thesecondcomponentofperiodicpensioncostisnetinterestexpenseorincome,whichwewi>lrefertoasnetinterestexpense/income.,,Netinterestexpense/incomeiscaIcu>atedbymultipIyingthenetpensionIiabi>ityornetpensionassetbythediscountrateusedindetenniningthepIsentvalueofthepension>iabiIity.AnetinterestexpenserepresentsthefinancingcostofdefbrringpaymentsreIatedtotheplan,andanetinterestincomerepresentsthefinancingincomeomprepayingamountsrelatedtothepIanUnderRS,thenetinterestexpenseincomeisrecognisedinP&L
3Reeoee.ThethidcomponentofpeiodicpensioncostisremeasuementofthenetpensionIiabiIityorasset.RemeasurementincIudes(a)actuariaIgainsandIossesand(b)anydiffbrencesbetweentheactua>retumonplanassetsandtheamountinc>udedin
197
thenetinteestexpenseincomecaIcuIation.UnderRS,remeasurementamountsarerecognisedinOCI.RemeasurementamountsarenotsubsequentlyamortisedtoP&L
SimilartoRS,underUSGAAPcurentseicecostisrecognisedinPLHowever,underUSGAAP,pastservlcecostsareportedinOCIintheperiodinwhichthechangegivingnse
tothecostoccurs.Insubsequentperiods,thesepastseIicecostsareamortisedtoP&LovertheaverageseIvicelivesoftheaffectedemployees.
AlsosimilartoIRS,underUSGAAPtheperiodicpensioncostfbrP&Lincludesinterestexpenseonpensionob>igations(Whichincreasestheamountoftheperiodiccost)andremmsonthepenslonplanassets(whichreducetheamountofthepeliodiccost).Un>ikeIRShowever,
underUSGAAP,thetwocomponentsaInotpresentednet.Aso,underUSGAAP,retumsonpIanassetsincludedintheP&Lrecognitionofpensioncosts(pensionexpense)useanexpectedretumratherthantheactua>retum.(UnderIRS,retumsonplanassetsinc!udedintheP&Lrecognitionofpensioncosts(pensionexpense)usethediscountrateastheexpectedretum.)Thus,underUSGAAPdiffbrencesbetweentheexpectedretumandtheactuaIremmonplanassetsrepresentanothersourceofactuarialgainsorlosses.Asnoted,actuarialgainsandlossescanalsoresultfiFomchangesintheactuaria>assumptionsusedindeterminingthebenefitobIigationUnderUSGAAP,aIIactuariaIgainsandIossesareincludedinthenetpensionliabilityornetpensionassetandcanbereportedeitherinP&LorinOCI.Typically,compamesreportactuariaIgainsandIossesinOClandrecognisegainsandIossesinP&LoIIywhencertainconditionsaremetunderaso-ca>ledcorridorapproach.
Underthecorridorappoach,thenetcumuativeunrecognisedactuarialgainsahdIossesatthebeginningofthereportingperiodarecomparedwiththedefinedbenefitob>igationandthefairvaueofpIanassetsatthebeginningoftheperiod.IfthecumulativeamountofuncognisedactuarialgainsandIossesbecomestooargei.eexceedsl0percentofthegreaterofthedefmedbenefitobligationorthefhirvaueofpIanassetsthentheexcessisamoisedovertheexpectedaverageremainingworkinglivesoftheemp>oyeesparticipatingintheplanandisincludedasacomponentofpeIiodicpensioncostinP<heteImcorridor,,referstothel0percentrange,andonlyamountsinexcessofthecorridormustbeamortised.
Toiustatethecorridorapproach,assumethatthebeginningbalanceofthedefinedbenefitObIigationis$5,000,000thebeginningbalanceoffhirvalueofplanassetsis$4,850,000,andthebeginningbalanceofunrecognisedactuariaIlossesis$6l0,000.Theexpectedaverageremainingworkinglivesoftheplanemp}oyeesisl0years.Inthisscenario,thecorridoris500,000,whichisl0pecentofthedefinedbenefitobIigationselectedasthegreaterofthedefinedbenefitobligationorthefhirvalueofpIanassets).Becausethebalanceofunrecognisedactuariallossesexceedsthe$500,000corIidor,amortisationisrequired.Theamountoftheamortisationisll,000,whichistheexcessoftheunIccognisedactuaialossoverthecorIidordividedbytheexpectedaverageremainingworkingIivesoftheplanemployeesiesthemethodofamortisationtobothgainsandIossesconsistentlyinallpeIiodspresented
Tosummanze,underlFRS,theperiodicpensioncostsrecognisedinP&LincIudeservicecosts(bothcurrentandpast)andnetinterestexpense/income.TheperiodicpensioncostsrecognisedinOCIinc>uderemeasurementsthatcompnsenetreturnonp>anassetsandactuarialgainsand>osses.UnderUSGAAPtheperiodicpensioncostsrecognisedinP&Lincludecurrentservicecosts,interestexpenseonplanIiabilitiesexpectedretumsonplanassets(whichisareductionofthecost)theamoItisationofpastservicecosts,andactuarialgainsandlossestotheextentnotreportedinOCI.Thecomponentsofacompany,sdefinedbenefitperiodicpensioncostsaresummarizedinExhibit2.
198
ExhibitZC0mp0ems0ffhC0mpay,sDefinedBenefitPenSi0lPei0dicC0ss
USGAAP
IFRSC0mp0neItIFRSRec0gniti0nC0mp0nent
Servicecosts
Netinterest
income/expense
Remeasurements:
NetmmonpIanassetsand
actuarialgainsand>osses
RecognisedinP&L.
RecognisedinP&Lasthefbllowingamount:Netpension>iabilityorassetxinterestratea
RecognisedinOCIandnotsubseqUentlyamoItisedtoP&L
Netremmon
planassets=Actualretum
TanassetsxInterest
rate)
ActuariaI
gainsandlosses=
Changesinacompany,spenslon
obligationaIisingfiOmchangesinactuarial
assumptions.
Current
seIicecosts
Pastservice
cOStS
Interest
expenseon
penslon
obligation
Expectedretumonplanassets
AchariHl
gainsand!osses
incIudingdiffCrences
betweenthe
actualand
expectedretumson
planassets
USGAAP
Rec0gHiti0n
RecOgnisedinP&L
RecognisedinOCIandsubsequentIyamoItisedtoP&L
overtheservice>ife
ofemployees.
RecognisedinP&L
RecognisedinP&Lasthefb>>owingamOUnt:PIanaSSetSx
expectedIBtum.
Recognisedimmediate>yinP&Lganassetsx
Expectedretum)
ActuariaIgainsandlosses=
Changesinacompany,spenslon
ob>igationaIisingfomchangesinactuarial
assumptions
1g9
ThcinteIcslHteusedisequaltothcdiscourateuscdtomcasuthcpensionabiliytheyicldonhighualitycop0mtebonds.
bIfthecummativeamolmtofuncognisedactuaialgainsandlossesexceedsl0perceofthegaerofthcva>ueof[heplaIasseengthoftimethepensionpaymentswi>lbemaderequiresassumpt1onsaboutemployees,>ifbexpectancypost-empIoyment.Fina>Iy,thepresentvaIueofthesefUtuIcpaymentsrequiresassumptionsabouttheappropnatediscountrate(whichisusedastheIateatwhichinterestexpenseorincomewil>subsequentIyaccrueonthenetpensionliabilityorasset)
ChangesinanyoftheassumptionswiI>increaseordecreasethepensionobligationAnincreaseinpensionobigationsultingfibmchangesinactuarialassumptlonsisconsideredanactuarialloss,andadecreaseisconsideredanactuarialgain.Theestlmateofacompany,spensionIiabilityaIsoaffectsseveralcomponentsofperiodicpensioncosts,apartfiomactuarialgainsand>osses.Firsttheservicecostcomponentofannualpensioncostisessentia!>ytheamountbywhichthepensionliabiIityincreasesasaesultoftheemployees,serviceduIingtheyear.Secondtheinterestexpensecomponentofannualpensioncostisbasedontheamountoftheliability.Third,thepastservicecostcomponentofannualpensioncostistheamountbywhichthepensionliabilityincreasesbecauseofchangestothepIan.
Estimatesrelatedtop>anassetscanaIsoaffbctannualpensioncostreportedinP&L(pensionexpense),primarilyunderUSGAAP.Becauseacompany,speriodicpensioncostrepoItedinPLunderUSGAAPincludestheeecedretumonpensionassetsratherthantheactuaIretum,theassumptlonsabouttheexpectedretumonplanassetscanhaveasignificantimpactAlsotheexpectedretumonplanassetsequiresestlmatinginwhichfUtureperiodthebeneftswiIIbepaid.Asnotedabove,adivegenceofactualretumsonpensionassetsfiomexpectedretumsresultsinanactuaiaIgainorloss
|
I
UnderstandingtheeffbctofassumptionsontheestimatedpensionobligationandonpenodicpensioncostsisimportantbothfbrinteIpretingacompany,sfinancialstatementsandfbrevaIuatingwhetheracompanysassumptiosappeareIativelyconseativeoraggressive.
TheprO>ectedunitcreditmethodistheIRSapproachtomeasuringtheDBobligationUndertheprqectedunitceditmethod,eachperiodofseIvicee.g.,yeaofempoymentgivesnsetoanadditionalunitofbenefittowhichtheemp>oyeeisentitIedatretirement.Inother.words,fbreachperiodinwhichanemployeeprovidesservice,theyeamaportionofthepost-emp>oymentbenefitsthatthecompanyhaspromisedtopay.AnequivalentwayofthinkingaboutthisisthattheamountofeventualbenefitiIcreaseswitheachadditionalyearofservice.TheemployermeasureseachunitofseIiceasitiseamedtodetemlinetheamountofbenefitsitisobligatedtopayinfiturereportingperiods
TheOIectiveoftheprOjectedunitcreditmethodistoallocatetheentireexpectedretirementcosts(benefits)fbranemployeeovertheemp>oyee,sseIiceperiods.Thedefinedbenefitobligationrepresentstheactuarialpresentvalueofallunitsofbenefit(credit)towhichtheempIoyeeisentitled(ie.,thosethattheemployeehaseamed)asaresultofpriorandcurrentperiodsofservice.Thisobligationisbasedonactuaria>assumptionsaboutdemOgraphicvaiabIessuchasempIoyeetumoverandifbexpectancy,andonestimatesoffinancia!variab!es,suchasfUtureinf>ationandthediscountrate.Ifthepensionbenefitfbnnu>aisbasedonempIoyees,filturecompensation>eveIs,thentheunitofbenefiteamedeachpeIiodwiIIref>ectthisestimate
UnderbothRSandUSGAAP,theassumedrateofinceaseincompensationtheexpectedannualincreaseincompensationovertheemployeeserviceperiod-canhaveasignificantimpactonthedefinedbenefitobigationAnothekeyassumptioisthediscountateusedtocacuatethepsentvalueofthefUturebenefitsItrepresentstherateatwhichthedefinedbenefitobIigationcouIdbeeffectivelysettIedThisrateisbasedoncurentratesofretumonhighqualitycorporatebondswithdurationsconsistentwiththeduIationsofthebenefit.
Thefbllowingexamplei>lustratestheca>cu>ationofthedefinedbenefitpensionobligationandcurrentservicecosts,usingtheprOiectedunitcreditmethod,fbranindividualemployeeunderfburdiffbrentscenarios.InterestontheopeningobligatioIaIsoincreasestheobIigationandispartofcunPentcosts.ThefbuIthscenarioisusedtodemonstatetheimpactonacompany,spensionobligationofchangesincertainkeyestimates.Examples2and3fbcusonthepensionob>igationThechangeinpensionobIigationovertheperiodisincludedinthecalculationofpensionexpense(pensioncostreportedinP&L)
ExampIe2
CaIcuIationfDefihedBenefitPehsih
ObIigatinahIhdMduaIEmpIoYeeThefbIlowinginfbImationappliestoeachofthefburscenariosAssumethata(hypotheticaI)companyestabIishesaDBpensionplan.TheempIoyeehasasa>aIinthecomingyearof650000andisexpectedtoworkfivemoeyearsbefbreretiring.Theassumeddiscountrateis6percentandtheassumedannuaIcompensationincreaseis4.75percent.Forsimp>icity,assumethattherearenochangesinactuaria>assumptions,allcompensationincreasesareawadedonthefirstdayoftheseiceyear,andnoadditionalaustmentsamadetorefectthepossibilitythattheemployeemayeavethecompanyatanearIierdate
201
202
Currentsalary
Yearsuntilretirement
AnnualcompensationincreasesDiscountrate.
Finalyear,sestimatedsalaIya
650,000.00
5
475%
6.00%
e60,lg8.56
aFinalyear,sestimatedsalayCunmyearssalayxlAnnualcompensaionincaseau!i!!etim!.
AtthccndofYearl,thefinalyearsestimatedsalaye50,000xl00475e60,lg8.56,assumingthattheemployee,ssa>aryincreasesby475percenteachyear.Withnochangeinassumptionabouttherateofincreaseincompensationorthedateofretirementtheestimateofthefinalyear,ssalaIwillremalnunchanged.
AttheendofYear2assumingtheempIoyee,ssala>yactual>yincreasedby4.75percent,thefinalyear,sestimatedsala5)x5=e4,5>48g.
AnnualunitcreditbenefitperserviceyearValueatretiementYearsofservicee,5l4.895690Z.98.
Ifthediscountrate(theinterestrateatwhichthedefinedbenefitob>igationcouldbeeffbctive>ysettled)isassumedtobe0percenttheamountofannuaIunitcreditperseIviceyearistheamountofthecompany,sannualobligationandtheclosingobligationeachyearissimplytheannualunitcreditmu>tip>iedbythenumberofpastandcurrentyearsofserviceHowever,becausetheassumeddiscountratemustbebasedontheyieldonhigh-qualitycorporatebondsandwilIthusnotequal0percent,thefUtueobligationresultingomcurrentandpriorserviceisdiscountedtodeterminethevaueoftheobligationatanypointintime.
ThefbIowingtabeshowshowtheobIigationbuildsupfbthisemployee.
Yer
Estimated
annual
saIa
V
|
|
|
Po
yearsaCureht
yeaigationcInterest
costat6
perCentdCurrent
servlce
cOstse
CIosingob>igationf
g0298 g02g8 90298 g0298 g02.97I
6g02.g8el,8059662,708.g463,6ll.92e4,5l4.8
e0.00 e7l5.24el,5l6.3le2,l0.g4e3,4074
0.00 42.g> g0g8 >4466 20415
7l524758.l6803.6585187g02.g7---
e7l524el,5l6.3le2,4l09e3,4074764,5l48
Finalamountsmdiffers!igMytocompcnsatefbrIulmdinginearlierycas
aTllebeefitattributedtopnoryeasAnIaImitcditxYeaBofpIiorseice.FOrYear26902.98xl=690298.
ForYear36g02.98x2=6l80596.
bThebenefiattIibutedocunntyearAnnualumcdibasedonbencfitIbnnulaFinalyeareStimatedsalaIyxBenefifbnnuIaValueatt1ImemdaeYearsofseMce660:l,8.56xl5%)=645l4.89/5=690298.
cThcopc