Mini-Case 4

Postemployment Benefit Plans

United Parcel Service (“UPS”)

A) From a purely economic point of view define what constitutes the following: (i)
pension obligation, (ii) pension plan assets, (iii) net economic position of the
pension plan, and (iv) economic pension cost.

Response:
 Pension obligation: This is the present value of expected benefit payments to
the employees based on current service.
 Pension asset: This is the fair market value of the plan assets on the date of
the balance sheet.
 Net economic position of the plan: This is the difference between the fair
market value of the pension assets and the pension obligation. When this
difference is positive the plan is referred to as overfunded and when negative
the plan is termed underfunded.
 Economic pension cost: This is the net cost arising from changes in net
economic position (or funded status) for the period. Economic pension cost
includes both recurring (or normal) and nonrecurring (or abnormal)
components. Any return on pension plan assets is used to offset these costs in
arriving at a net economic pension cost.

B) The pension cost included in net income is the net periodic pension cost. How
does it differ from the economic pension cost? What is the rationale for
recognizing the smoothed net periodic pension cost instead of the economic
pension cost?

Response:
The net periodic pension cost is a smoothed version of the economic pension cost. For
determining net periodic pension cost, all non-recurring or unusual components of
economic pension cost (e.g. actuarial gain/loss, prior service cost, excess of actual
plan return over expected return) are deferred and amortized over a period of time.
The difference between economic pension cost and net periodic pension cost is
included in accumulated other comprehensive income.

The rationale for this smoothing mechanism is that the economic pension cost is very
volatile. Including this in income would cause income to be very volatile, masking the
true operating profitability of the firm.

ACTG 553 Mini-Case 4 (JE Solution) Page 1

C) What is the funded status of UPS’s employee benefit plans at December 31, 2018
(i.e., the “U.S. Pension Benefits,” “U.S. Postretirement Medical Benefits” and
“International Pension Benefits” plans are collectively referred to as employee
benefit plans)? How is the asset or liability reported on the Consolidated Balance
Sheet?

Response:
The benefit plans are underfunded as follows (in millions) (Footnote 5 - Page ):
U.S. Pension Benefits ($5,779)
U.S. Postretirement Medical Benefits (2,484)
International Pension Benefits (268)
Net liability ($8,531)

The asset and liabilities are reported on the Consolidated Balance Sheets as follows

U.S.
Postretirement International
U.S. Pension Medical Pension
Benefits Benefits Benefits
Other non-current assets $ 0 $ 0 $ 35
Other current liabilities (20) (195) (4)
Pension and postretirement
benefit obligations (5,759) (2,289) (299)
Net liability ($5,779) ($2,484) ($268)

D) What does UPS report on its Statements of Consolidated Income for the year
ended December 31, 2018 for costs arising from its employee benefit plans?

Response:
UPS reports the following net periodic benefit cost on its Statements of Consolidated
Income (in millions):
U.S. Pension Benefits $2,055
U.S. Postretirement Medical Benefits 132
International Pension Benefits 55
Net periodic benefit cost $2,242

ACTG 553 Mini-Case 4 (JE Solution) Page 2

E) UPS reports $272 gain, net of tax, in its Statements of Consolidated
Comprehensive Income for the year ended December 31, 2018. Assume this is a
$460 gain pre-tax. Show in detail how UPS arrived at the $460 amount (i.e.,
show the amount related to the smoothing of actuarial gain or loss, plan
amendments, actual versus expected return on assets, etc.).

Response:

DR (CR)
Balance Income
Sheet Statement OCI
U.S. Pension Benefits
Service cost ($1,661) $ 1,661 $ 0
Interest cost (1,799) 1,799 0
Return on plan assets (1,007) (3,201) 4,208
Prior service cost (331) 193 138
Actuarial (gain) or loss 2,915 1,603 (4,518)
Subtotal (172)
U.S. Postretirement Medical Benefits
Service cost (29) 29 0
Interest cost (104) 104 0
Return on plan assets (7) (8) 15
Prior service cost 0 7 (7)
Actuarial (gain) or loss 178 0 (178)
Subtotal (170)
International Pension Benefits
Service cost (62) 62 0
Interest cost (45) 45 0
Return on plan assets (6) (77) 83
Prior service cost (13) 1 12
Actuarial (gain) or loss 81 24 (105)
Foreign currency changes and other 108 0 (108)
Subtotal (118)
Total, pre-tax gain $ (460)

ACTG 553 Mini-Case 4 (JE Solution) Page 3

F) Compare the fair value of the plan assets at December 31, 2018 to the expected
benefit payments for 2019 and assess UPS’s ability to make those payments for
its employee benefit plans.

Response:
UPS’s fair value of plan assets and expected 2019 payments are as follows (in
millions):

U.S.
Postretirement International
U.S. Pension Medical Pension
Benefits Benefits Benefits
Fair value of plan assets $39,554 $ 26 $1,284
Expected benefit payments in 2019 1,505 227 29

The U.S. Pension Benefits and the International Pension Benefits funds have more
than sufficient funds to meet current demands. The Company is also expected to
have sufficient cash on hand to meet the U.S. Postretirement Medical Benefit
requirements, based on $4,225 million of cash reserves and strong operating cash
flows ($12,711 million for 2018).

G) Discuss UPS’s pension intensity and the extent to which the risk profile of the
employee benefit plans assets is matched to that of the pension obligation (as
those terms are defined in the textbook).

Response:
Pension intensity is defined as the size of the pension obligation in relation to the size
of the Company’s other assets. The Company’s pension and postretirement benefit
obligations are sizable at $8,347 million. This constitutes almost 17% of total assets
at December 31, 2018. With net income at almost $5,000 a year and strong cash
flows, while sizable the pension obligations will not negatively impact the company.
In reviewing the risk profile of the plan assets, the Company has significant
investments in U.S. Government and Corporate Bonds (approximately 42%) and a
mixture of equity securities (approximately 35%). The risk profile is conservative and
matches well to the pension obligation.

ACTG 553 Mini-Case 4 (JE Solution) Page 4