Mia Park Case Scenario

Mia Park works as a financial analyst at Erica Investments (EI), an investment management firm
with headquarters in Virginia, USA. Park is part of the firm’s portfolio management department
that targets institutional investors including banks, pension funds and insurance companies and is
currently managing the defined benefit pension plan of World Enterprises (WE), a leading U.S.
firm operating in the communications industry. The upper management at the firm just made
some amendments to the pension plan that resulted in an increase in their pension expense. WE
follows the U.S. GAAP for accounting for pension plan assets and liabilities. While talking to
Linda Perlin about these new costs, the CFO at WE, Park made the following comments:

Statement 1: “Relative to a firm that follows the IFRS, WE would report the entire cost arising
from the plan amendment in other comprehensive income in the current period. In
contrast, firms following the IFRS would expense these costs immediately.”

Statement 2: “Once WE reports unamortized past service costs in other comprehensive income,
it will not subsequently amortize and include these amounts in its income
statement.”

David Bolton, a portfolio manager, also works for EI and is part of the portfolio management
team at the institutional investors’ wing. Bolton knows that changes in actuarial assumptions
used in determining the benefit obligation can result in increases or decreases in the pension
expense. However, he is not sure about how such gains and losses are recorded in the financial
statements of a firm. Park stated that under both IFRS and U.S. GAAP actuarial gains/losses can
be recognized immediately; this will serve to increase the volatility of the pension expense. He
also stated that U.S. GAAP allows the recognition of the gains/losses to be deferred by
amortizing just the amounts in excess of a certain pre-specified corridor if the cumulative amount
of unrecognized actuarial gains and losses becomes too large; alternative faster recognition
methods are not allowed under U.S. GAAP.

Bolton has recently been assigned the task of evaluating the defined benefit pension plan of Up-
Break Corporation, and will use a single employee assumption for his estimation. The employee
has a current salary of $75,000 and is expected to work five more years before retirement.
During this time, his salary is expected to increase by 5.45% each year, with salary increases
awarded on the first day of a service year. The employee will receive benefits for twenty years
after retirement and will also be given credit for ten years of prior service with immediate
vesting. The payment will equal 2.5% of the employee’s final salary for each year of service
beyond the date of establishment (which is assumed to be the time since the benefits have started
to accumulate). The appropriate discount rate to use is 6.50%.
Bolton is also responsible for the management of the DB plan of the White-Stripes Corporation,
a firm that produces high-class sports equipment, sports goods and sportswear. Ellen Garner is
the head of the finance department at the firm and is responsible for the management of the
pension fund. The firm uses a discount rate of 7.5% for determining the present value of its
pension obligations. However, due to anticipated changes in the risk of the pension liabilities,
Garner has revised the assumed discount rate to 8.4% and will make the payments over a fixed
ten year time horizon after retirement. In addition, Garner has increased the assumed rate of
annual compensation increase from 6.0% to 6.5%, and has determined that the life expectancy of
employees has increased by five years. While talking to Garner about the change in assumptions,
Bolton made the following comments:

Statement 3: “The change in the assumed discount rate can increase the interest component of
the pension expense. However, the interest component may decrease if the
decrease in the opening obligation more than offsets the effect of the change in
discount rate.”

Statement 4: “The change in the assumed rate of annual compensation growth and life
expectancy will increase the firm’s pension obligation.”

Park is assessing the following post-employment benefit information reported by Care

Medicines, a pharmaceutical firm in USA.

Exhibit 1
Benefit obligation at the beginning of year $18,956
Benefit obligations at the end of the year $24,586
Current service costs $525
Past service costs $125
Interest cost $722
Plan amendments –$67
Benefit payments –$1,120
Fair value of plan assets at the beginning of the year $19,615
Fair value of plan assets at the end of the year $25,670
Expected return on plan assets $933
Actual return on plan assets $980
Net actuarial gains arising from changes in pension obligations $1,500
Care Medicines contributions $65
Discount rate 12%

FinQuiz Question ID: 15566

1. Park is most accurate with respect to:

A. Statement 1 only.
B. Statement 2 only.
C. neither Statement 1 nor Statement 2.
2. Is Park most likely correct with respect to the immediate and deferred recognition of actuarial
gains and losses?

A. With respect to immediate recognition only.

B. Both with respect to immediate and deferred recognition.
C. Neither with respect to immediate recognition nor with respect to deferred recognition.

FinQuiz Question ID: 15568

3. Assuming there is no previous recognition for Up-Break Corporation, for year 1 after
retirement, the benefits attributed to prior years at the beg. of the year and the interest costs
during the year are closest to:

A. $255,453 and $12,119 respectively.

B. 383,179 and $24,907 respectively.
C. 186,450 and $16,604 respectively.

FinQuiz Question ID: 15569

4. Bolton is most accurate with respect to:

A. Statement 3 only.
B. Statement 4 only.
C. both statements 3 and 4.

FinQuiz Question ID: 15570

5. The total periodic pension cost for the current period for Care Medicines is closest to
(ignoring the fact that U.S. GAAP applies):

A. $360.
B. $490.
C. $724.

FinQuiz Question ID: 15571

6. If Care Medicines complied with IFRS, the amount reported as part of other comprehensive
income (OCI), would have been closest to:

A. – $600
B. + $126
C. + $1,547