Replacement Questions
The following questions have been written to replace the PassMaster questions that no longer
apply under SFAS No. 158:
Big Books Inc. has the following information related to its defined benefit pension plan:
December 31, 20X6:
Projected benefit obligation
Fair value of plan assets
Unrecognized prior service cost
Unrecognized net transition asset
$1,500,000
1,200,000
200,000
60,000
December 31, 20X7:
Projected benefit obligation
Fair value of plan assets
Service cost
$1,740,000
1,800,000
220,000
Assumptions:
Discount rate
Expected return on plan assets
6%
8%
Big Book’s makes an annual pension plan contribution of $200,000. The company’s employees had an
average remaining service life of 20 years on 12/31/X6 and the company expects to pay benefits totaling
$170,000 to retired employees in 20X8. Big Books has an effective tax rate of 30%. What is the funded
status of Big Book’s pension plan on December 31, 20X6?
a.
b.
c.
d.
$60,000 underfunded
$60,000 overfunded
$300,000 underfunded
$300,000 overfunded
Explanation:
Choice “c” is correct. The funded status of the pension plan at December 31, 20X6 is computed as
follows:
Fair value of plan assets – PBO = $1,200,000 – 1,500,000 = $(300,000)
Because the PBO exceeds the fair value of the pension plan assets, this is an underfunded pension plan.
Choice “a” is incorrect. Although Big Book’s pension plan is underfunded at 12/31/X6, this answer
incorrectly uses the 20X7 PBO and fair value of plan assets to compute the 20X6 funded status.
Choice “b” is incorrect. This is the funded status of Big Book’s pension plan at December 31, 20X7.
Choice “d” is incorrect.
December 31, 20X6.
Big Book’s pension plan is underfunded, not overfunded, but $300,000 at
1
Big Books Inc. has the following information related to its defined benefit pension plan:
December 31, 20X6:
Projected benefit obligation
Fair value of plan assets
Unrecognized prior service cost
Unrecognized net transition asset
$1,500,000
1,400,000
200,000
60,000
December 31, 20X7:
Projected benefit obligation
Fair value of plan assets
Service cost
$1,740,000
1,800,000
220,000
Assumptions:
Discount rate
Expected return on plan assets
6%
8%
The company’s employees had an average remaining service life of 20 years on 12/31/X6 and the
company expects to pay benefits totaling $170,000 to retired employees in 20X8. Big Books has an
effective tax rate of 30%. The funded status of Big Books’ pension plan will be reported on the
December 31, 20X7 balance sheet as a:
a.
b.
c.
d.
Current asset.
Noncurrent asset.
Current liability.
Noncurrent liability.
Explanation:
Choice “b” is correct. Big Books’ pension plan is overfunded at December 31, 20X7:
Fair value of plan assets – PBO = $1,800,000 – 1,740,000 = $60,000
An overfunded pension plan is reported as a noncurrent asset on the balance sheet of the sponsoring
company.
Choice “a” is incorrect. Per SFAS No. 158, the funded status of a pension plan is never reported as a
current asset. This is a change from previous pension accounting, which allowed the reporting of a
current asset or a current liability.
Choice “c” is incorrect. Big Books’ pension plan is overfunded in 20X7, so it would not be reported as a
liability. SFAS No. 158 requires that an underfunded pension plan be reported as current liability (to the
extent that the benefits payable in the next year exceed the fair value of the pension plan assets), a
noncurrent liability, or both.
Choice “d” is incorrect. Big Books’ pension plan is overfunded in 20X7, so it would not be reported as a
liability. SFAS No. 158 requires that an underfunded pension plan be reported as current liability (to the
extent that the benefits payable in the next year exceed the fair value of the pension plan assets), a
noncurrent liability, or both.
2
Big Books Inc. has the following information related to its defined benefit pension plan:
December 31, 20X6:
Projected benefit obligation
Fair value of plan assets
Unrecognized prior service cost
Unrecognized net transition asset
$1,500,000
1,400,000
200,000
60,000
December 31, 20X7:
Projected benefit obligation
Fair value of plan assets
Service cost
$1,740,000
1,800,000
220,000
Assumptions:
Discount rate
Expected return on plan assets
6%
8%
The company’s employees had an average remaining service life of 20 years on 12/31/X6 and the
company expects to pay benefits totaling $170,000 to retired employees in 20X8. Big Books has an
effective tax rate of 30%. What would Big Book’s report as net periodic pension cost on its December 31,
20X7 income statement?
a.
b.
c.
d.
$187,400
$193,400
$205,000
$211,000
Explanation:
Choice “c“ is correct. The 20X7 net periodic pension cost should be calculated as follows:
S
I
R
A
G
E
Service cost
$ 220,000
Interest cost
90,000 = $1,500,000 x 6% = Beg PBO x discount rate
Expected return on plan assets
(112,000) = $1,400,000 x 8% = Beg FV x expected rate
Amortization of prior service cost
10,000 = $200,000 / 20 years
Amortization of (gains)/losses
0
Amortization of transition asset
(3,000) = $60,000 / 20 years
Net periodic pension cost
$ 205,000
Choice “a” is incorrect. This amount includes interest cost incorrectly calculated using the 20X7 PBO
instead of the beginning PBO and return on plan assets incorrectly calculated using the 20X7 fair value of
plan assets instead of the beginning fair value.
Choice “b” is incorrect. This amount includes interest cost incorrectly calculated using the 20X7 PBO
instead of the beginning PBO and return on plan assets incorrectly calculated using the 20X7 fair value of
plan assets instead of the beginning fair value. This amount also incorrectly adds the amortization of the
net transition asset.
Choice “d” is incorrect. This amount incorrectly adds the amortization of the net transition asset. It is
important to note that the amortization of a net transition obligation increases net periodic pension cost,
while the amortization of a net transition asset decreases net periodic pension cost.
3
At December 31, 20X8, High Horse Company has the following pension plan information:
Fair value of plan assets, beginning of year
Fair value of plan assets, ending of year
Contributions
Benefits paid
Expected rate of return on plan assets
$1,100,000
1,135,000
275,000
340,000
7%
The expected return on plan assets was used to calculate net periodic pension cost. No actuarial gains
or losses were incurred during 20X8. High Horse’s effective tax rate is 30%. What is the net gain to be
reported in 20X8 other comprehensive income?
a.
b.
c.
d.
$0
$16,100
$23,000
$77,000
Explanation:
Choice “b” is correct. Absent any actuarial gains or losses, the net pension gain or loss incurred during
an accounting period is the difference between the expected return on plan assets recorded in net periodic
pension cost and the actual return on plan assets earned during the accounting period. This amount is
reported in other comprehensive, after-tax, in the period incurred.
The expected return on plan assets is calculated as:
Beginning fair value of plan assets x Expected rate of return = $1,100,000 x 7% = $77,000
The actual return on plan assets is calculated as:
Beginning fair value of plan assets
+ Contributions
– Benefits paid
+ Actual return on plan assets
Ending fair value of plan assets
$ 1,100,000
275,000
(340,000)
100,000
$ 1,135,000
Squeeze
Therefore, the difference between the actual return on plan assets and expected return on plan assets is
$23,000 ($100,000 actual – $77,000 expected), which on an after-tax basis is $16,100 [$23,000 x (1 –
30%)].
This gain is recorded with the following journal entry:
Dr. Pension benefit asset/liability
23,000
Dr. Deferred tax expense – OCI
6,900
Cr.
Deferred tax liability
Cr.
Other comprehensive income
6,900
23,000
Choice “a” is incorrect. As explained above, there is a net pension gain equal to the after-tax difference
between actual and expected return on plan assets.
Choice “c” is incorrect. This is the net gain before tax. SFAS No. 158 requires that the difference
between actual and expected return on plan assets be reported in other comprehensive income net of tax.
Choice “d” is incorrect. This is the expected return on plan assets, not the net pension gain to be
reported in 20X8 other comprehensive income.
4
In 20X9, Rhino Robots Inc. has the following information related to its defined benefit pension plan:
Fair value of plan assets, 1/1/X9
Fair value of plan assets, 12/31/X9
Projected benefit obligation, 1/1/X9
Projected benefit obligation, 12/31/X9
Unrecognized net losses
$2,130,000
2,525,000
3,500,000
3,850,000
420,000
The average remaining service period of Rhino’s employees is 20 years. What is the net loss
amortization that Rhino will include in its 20X9 net periodic pension cost?
a.
b.
c.
d.
$0
$1,750
$3,500
$21,000
Explanation:
Choice “c” is correct. Unrecognized pension gains or losses are amortized over the average remaining
service period if, at the beginning of the year, the gain or loss exceeds 10% of the greater of the beginning
of the year PBO or the beginning of the year market related value of plan assets (we will use the fair value
of the plan assets in this example as the market related value is not given and these amounts are
approximately equal).
At 1/1/X9, Rhino’s PBO exceeds the fair value of the plan assets, so the 20X9 net loss amortization is
calculated as:
Unrecognized net loss
Less: 10% of Greater of Beg. PBO/Plan Assets
Excess
$ 420,000
– 350,000 = $3,500,000 PBO x 10%
$ 70,000
Excess / Average Remaining Service Life = $70,000 / 20 = $3,500
Choice “a” is incorrect. Because the unrecognized net loss exceeds 10% of the greater of the beginning
PBO/Plan assets, the excess must be amortized over the average remaining service period.
Choice “b” is incorrect. This amortization is calculated using the 12/31/X9 PBO. The greater of the
beginning PBO/Plan assets must be used to determine the amount to amortize.
Choice “d” is incorrect. This is the total unrecognized net loss amortized over 20 years. GAAP allows
companies to amortize only the portion of net gain or loss in excess of 10% of the greater of PBO/Plan
assets.
5
Big Sports Inc. and its subsidiaries, Batter Up, Slam Dunk and Touchdown, had the following defined
benefit pension plans at December 31, 20X8:
Fair Value - Plan Assets
PBO
Benefits Payable – 20X9
Big Sports
$1,000,000
$1,600,000
$ 425,000
Batter Up
$1,275,000
$ 850,000
$ 360,000
Slam Dunk
$ 900,000
$ 700,000
$ 150,000
Touchdown
$ 200,000
$ 800,000
$ 245,000
How would these pension plans be reported on Big Sports’ December 31, 20X8 consolidated balance
sheet?
a.
b.
c.
d.
Noncurrent asset
$
0
$
0
$ 625,000
$ 625,000
Current liability
$
0
$ 45,000
$
0
$ 45,000
Noncurrent liability
$ 575,000
$ 530,000
$1,200,000
$1,155,000
Explanation:
Choice “d” is correct. SFAS No. 158 requires that all overfunded (FV plan assets > PBO) pension plans
be aggregated and reported as a noncurrent asset, and that all underfunded (FV plan assets < PBO)
pension plans be aggregated and reported as a current liability (to the extent that the benefits payable in
the next year exceed the fair value of the pension plan assets), a noncurrent liability, or both. Big Sports
and subsidiaries would report their pension plans as follows:
Big Sports
FV Plan Assets
$ 1,000,000
Less: PBO
1,600,000
Funded Status
$ (600,000)
Noncurrent Asset
–
Current liability
–
Noncurrent liability $ 600,000
Batter Up
$ 1,275,000
850,000
$ 425,000
$ 425,000
–
–
Slam Dunk
$ 900,000
700,000
$ 200,000
$ 200,000
–
–
Touchdown
$ 200,000
800,000
$ (600,000)
–
$
45,000
$ 555,000
Total
$ 625,000
$
45,000
$ 1,155,000
Note that Touchdown’s pension plan must be reported as a current and noncurrent liability because it is
underfunded and the benefits payable in 20X9 exceed the fair value of the plan assets by $45,000
($245,000 benefits payable – $200,000 plan assets).
Choice “a” is incorrect. SFAS No. 158 does not permit the netting of all pension plans. Overfunded
pension plans must be aggregated separately from underfunded pension plans.
Choice “b” is incorrect. This presentation is not supported by SFAS No. 158.
Choice “c” is incorrect. SFAS No. 158 requires that Touchdown’s underfunded pension plan be reported
as a current liability of $45,000 and noncurrent liability of $555,000 because it is underfunded and the
benefits payable in 20X9 exceed the fair value of the plan assets by $45,000 ($245,000 benefits payable –
$200,000 plan assets).
6
Zen Transportation Inc.’s pension trustee provided the company with the following information for its
defined benefit pension plan at December 31, 20X7:
Projected benefit obligation
Fair value of pension plan assets
Unrecognized prior service cost
Unrecognized net gain
Unrecognized transition obligation
20X7 Net periodic pension cost
$2,500,000
1,950,000
375,000
50,000
135,000
440,000
Zen has an effective tax rate of 40%. What amount would Zen report in accumulated other
comprehensive income related to its pensions plan on its December 31, 20X7 balance sheet?
a.
b.
c.
d.
$276,000
$336,000
$460,000
$560,000
Explanation:
Choice “a” is correct. Unrecognized prior service cost, unrecognized transition obligations and
unrecognized net gains or losses must be reported in accumulated other comprehensive income, net of
tax, until recognized as a component of net periodic pension cost through amortization. Unrecognized
prior service cost, transition obligations and net losses all increase pension expense when recognized and
are therefore recorded as a debit to accumulated OCI. Unrecognized transition assets and net gains
decrease pension expense when recognized and are therefore recorded as a credit to accumulated OCI.
For Zen, the total pension related amount to be reported in accumulated OCI (before tax) is:
Unrecognized prior service cost
Unrecognized transition obligation
Unrecognized net gain
$ 375,000
135,000
(50,000)
$ 460,000
SFAS No. 158 requires that this amount be reported on an after-tax basis: $460,000 x (1 – 40%) =
$276,000. Note that this would be a $276,000 offset (debit) to accumulated OCI.
Choice “b” is incorrect. This amount is calculated by adding the unrecognized net gain to the
unrecognized prior service cost and transition obligation. The unrecognized net gain should be
subtracted.
Choice “c” is incorrect. This is the total of the unrecognized amounts that must be reported in
accumulated other comprehensive income on a pre-tax basis. SFAS No. 158 requires that these
amounts be reported in accumulated OCI after-tax.
Choice “d” is incorrect. This amount is calculated by adding the unrecognized net gain to the
unrecognized prior service cost and transition obligation. The unrecognized net gain should be
subtracted. Additionally, this is a pre-tax amount. SFAS No. 158 requires that these amounts be
reported in accumulated OCI after-tax.
7
AmeriGene Inc. reported net periodic pension cost of $400,000 in 20X9, calculated as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of net gain
Net periodic pension cost
$ 300,000
175,000
(100,000)
40,000
(15,000)
$ 400,000
AmeriGene has an overfunded pension plan. The company’s effective tax rate is 30%. How will the
service cost component of the 20X9 net periodic pension cost affect the 20X9 balance sheet?
a.
b.
c.
d.
$300,000 increase in noncurrent pension benefit asset.
$300,000 decrease in retained earnings.
$90,000 increase in deferred tax asset.
$90,000 increase in accumulated other comprehensive income.
Explanation:
Choice “c” is correct. SFAS No. 158 requires that SFAS No. 109 – Accounting for Income Taxes be
considered when recording net periodic pension cost and changes in pension plan funded status due to
prior service cost, net gains and losses, and net transition assets and obligations. Therefore, the service
cost component of AmeriGene’s net periodic pension cost would be recorded with the following JE:
Dr. Net periodic pension cost
Dr. Deferred tax asset
Cr.
Deferred tax benefit – income statement
Cr.
Pension benefit asset
Choice “a” is incorrect.
benefit asset.
300,000
90,000
90,000
300,000
As demonstrated in the journal entry above, service cost decreases the pension
Choice “b” is incorrect. Net periodic pension cost affects retained earnings on an after-tax basis.
Therefore, the service component will decrease retained earnings by $210,000 [$300,000 x (1 – 30%)].
Choice “d” is incorrect. Service cost does not affect accumulated other comprehensive income. The
pension component of accumulated other comprehensive income reflects changes in the funded status of
a pension plan due to prior service cost, net gains and losses, and net transition assets or obligations.
8
AmeriGene Inc. reported net periodic pension cost of $400,000 in 20X9, calculated as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of net gain
Net periodic pension cost
$ 300,000
175,000
(100,000)
40,000
(15,000)
$ 400,000
AmeriGene has an overfunded pension plan. The company’s effective tax rate is 30%. How will the
amortization of the net gain affect the 20X9 balance sheet?
a.
b.
c.
d.
No effect.
$10,500 increase in retained earnings.
$15,000 increase in net pension asset.
$15,000 decrease in accumulated other comprehensive income.
Explanation:
Choice “b” is correct. SFAS No. 158 requires that net gains and losses be reported as a component of
accumulated other comprehensive income until recognized in net periodic pension cost through
amortization. The 20X9 amortization of the net gain would be recorded as a reclassification adjustment
from accumulated other comprehensive income with the following journal entry:
Dr. Other comprehensive income
Dr. Deferred tax expense – net income
Cr.
Deferred tax expense – OCI
Cr.
Net periodic pension cost
15,000
4,500
4,500
15,000
The reclassification adjustment affects net income and retained earnings on an after-tax basis.
Choice “a” is incorrect. As demonstrated by the journal entry above, the amortization of the net gain
increases retained earnings and decreases accumulated other comprehensive income by $10,500.
Choice “c” is incorrect. The amortization of the net gain does not change the net pension asset. The
net pension asset was increased when the net gain was incurred.
Choice “d” is incorrect. SFAS No. 158 requires that pensions be accounted for on an after-tax basis. As
a result, the amortization of the net gain decreases accumulated other comprehensive income by $10,500
($15,000 debit to other comprehensive income – $4,500 credit to deferred tax expense – OCI).
9
Replacement Questions
The following questions have been written to replace the Final Exam questions that no longer
apply under SFAS No. 158:
Replacement for Exam 1, Testlet 1, Question 27
The following information pertains to the defined benefit pension plan of the Cabot Corporation as of
December 31, 20X5 and 20X6:
Projected benefit obligation
Fair value of plan assets
12/31/X5
$250,000
200,000
12/31/X6
$285,000
295,000
The pension plan had unrecognized prior service cost of $50,000 and unrecognized net gain of $30,000 at
December 31, 20X5. Service cost for 20X6 was $30,000. The discount rate was 8% and the expected
return on plan assets was 10% for both 20X5 and 20X6. Cabot’s employees have an average remaining
service life of 10 years. For the last three years, Cabot has made benefit payments of $15,000 per year.
The company expects to pay the same amount in 20X7. Cabot’s effective tax rate is 30%.
How would the funded status of Cabot’s pension plan be reported on December 31, 20X5?
a.
b.
c.
d.
$10,000 noncurrent asset
$50,000 current liability
$15,000 current liability and 35,000 noncurrent liability
$50,000 noncurrent liability
Explanation:
Choice “d” is correct. The funded status of a Cabot’s pension plan at December 31, 20X5 is calculated
as:
FV of plan assets – Projected benefit obligation = $200,000 – $250,000 = $(50,000)
On 12/31/X5, this pension plan is underfunded because the PBO exceeds the fair value of the plan assets.
This underfunded pension plan will be reported as a noncurrent liability rather than a current liability
because the fair value of the plan assets is sufficient to pay the benefits payable in 20X6.
Choice “a” is incorrect. The funded status of Cabot’s pension plan would be reported as a noncurrent
asset of $10,000 ($295,000 – $285,000) at December 31, 20X6. All overfunded (FV plan assets > PBO)
pension plans are reported as noncurrent assets.
Choice “b” is incorrect. The funded status of Cabot’s underfunded pension plan at December 31, 20X5
would be reported as a noncurrent liability. An underfunded pension plan is only reported as a current
liability to the extent that benefits payable in the next 12 months exceed the fair value of the pension plan
assets. At December 31, 20X5, Cabot’s $200,000 fair value of plan assets is sufficient to pay the 20X7
benefits of $15,000, so no current liability is necessary.
Choice “c” is incorrect. The funded status of Cabot’s underfunded pension plan at December 31, 20X5
would be reported as a noncurrent liability only. An underfunded pension plan is only reported as a
current liability to the extent that benefits payable in the next 12 months exceed the fair value of the
pension plan assets. At December 31, 20X5, Cabot’s $200,000 fair value of plan assets is sufficient to
pay the 20X7 benefits of $15,000, so no current liability is necessary.
10
Replacement for Exam 1, Testlet 2, Question 13
The following information pertains to the defined benefit pension plan of the Cabot Corporation as of
December 31, 20X5 and 20X6:
Projected benefit obligation
Fair value of plan assets
12/31/X5
$250,000
200,000
12/31/X6
$285,000
295,000
The pension plan had unrecognized prior service cost of $50,000 and unrecognized net gain of $30,000 at
December 31, 20X5. Service cost for 20X6 was $30,000. The discount rate was 8% and the expected
and actual return on plan assets was 10% for both 20X5 and 20X6. Cabot’s employees have an average
remaining service life of 10 years. For the last three years, Cabot has made benefit payments of $15,000
per year. The company expects to pay the same amount in 20X7. Cabot’s effective tax rate is 30%.
Calculate Cabot’s net periodic pension expense for 20X6.
a.
b.
c.
d.
$27,800
$32,000
$34,500
$35,500
Explanation:
Choice “c” is correct. Cabot’s net periodic pension expense should be calculated as follows:
Service cost
Interest cost
Return on assets
Amort.of prior service cost
Gain amortization
Existing net obligation amort.
Net periodic pension cost
1
2
3
4
$ 30,000
20,000 1
(20,000)2
5,000 3
(500)4
0
$ 34,500
Interest cost = Beg. PBO x Discount rate = $250,000 x 8% = $20,000
Return on plan assets = Beg. FV assets x Return on plan assets = $200,000 x 10% = $20,000
Amortization of prior service cost = Prior service cost / Average remaining service life = $50,000 /
10 years = $5,000
Gain amortization = (Excess of unrecognized gain over the greater of 10% of beg. PBO or 10% of
beg. FV plan assets) / Average remaining service life = [$30,000 – (10% x $250,000)] / 10 years =
$5,000 / 10 years = $500.
Choice “a” is incorrect. This choice is calculated by incorrectly using the 12/31/X6 PBO to calculate the
20X6 interest cost and the 12/31/X6 fair value of plan assets to calculate the 20X6 return on plan assets.
Beginning values, not ending values, should be used in these computations.
Choice “b” is incorrect. This choice is calculated by incorrectly amortizing the entire unrecognized net
gain rather than only the excess of the net gain over 10% of the PBO (which is greater than 10% of the FV
of plan assets at December 31, 20X5).
Choice “d” is incorrect. This choice is calculated by incorrectly adding the net gain amortization to net
periodic pension cost. The amortization of the net gain should offset net periodic pension cost, as shown
above.
11
Replacement for Exam 1, Testlet 2, Question 15
The following information pertains to the defined benefit pension plan of the Cabot Corporation as of
December 31, 20X5 and 20X6:
Projected benefit obligation
Fair value of plan assets
12/31/X5
$250,000
200,000
12/31/X6
$285,000
295,000
The pension plan had unrecognized prior service cost of $50,000 and unrecognized net gain of $30,000 at
December 31, 20X5. Service cost for 20X6 was $30,000. The discount rate was 8% and the expected
and actual return on plan assets was 10% for both 20X5 and 20X6. Cabot’s employees have an average
remaining service life of 10 years. For the last three years, Cabot has made benefit payments of $15,000
per year. The company expects to pay the same amount in 20X7. Cabot’s effective tax rate is 30%.
What amount will Cabot report in accumulated other comprehensive income for this pension plan on
December 31, 20X5?
a.
b.
c.
d.
$14,000
$20,000
$56,000
$80,000
Explanation:
Choice “a” is correct. Changes in the funded status of a pension plan due to gains/losses, prior service
cost and net transition assets/obligations are recognized in other comprehensive income, net of tax, in the
period incurred and are reported as components of accumulated other comprehensive income on the
balance sheet until recognized in net periodic pension cost through amortization.
Cabot’s pension related accumulated other comprehensive income at December 31, 20X5 is calculated as
follows:
Unrecognized prior service cost
Unrecognized net gain
Total items not yet recognized in net periodic pension cost
$ 50,000
(30,000)
$ 20,000
The total of $20,000 is reported in accumulated OCI net of tax:
$20,000 x (1 – 30%) = $14,000
Choice “b” is incorrect. Total items not yet recognized in net periodic pension cost are reported in
accumulated other comprehensive income net of tax.
Choices “c” and “d” are incorrect. These answers incorrectly add the unrecognized prior service cost and
the unrecognized net gains. Unrecognized prior service cost, unrecognized losses and unrecognized net
transition obligations decrease accumulated other comprehensive income, while unrecognized gains and
unrecognized net transition assets increase accumulated other comprehensive income. Additionally,
choice “d” does not consider the effects of income taxes.
12
Replacement for Exam 1, Testlet 3, Question 27
All Wheels Corporation and its subsidiaries, Big Bikes, Inc. and Fast Trucks, Inc., had the following
defined benefit pension plans at December 31, 20X6:
Fair Value - Plan Assets
PBO
Benefits Payable – 20X7
All Wheels
$1,500,000
$1,425,000
$ 300,000
Big Bikes
$ 950,000
$1,000,000
$ 210,000
Fast Trucks
$ 150,000
$ 900,000
$ 175,000
How would these pension plans be reported on Big Sports’ December 31, 20X8 consolidated balance
sheet?
a.
b.
c.
d.
Noncurrent asset
$
0
$
0
$ 75,000
$ 75,000
Current liability
$
0
$ 25,000
$ 25,000
$ 175,000
Noncurrent liability
$ 725,000
$ 700,000
$ 775,000
$ 625,000
Explanation:
Choice “c” is correct. SFAS No. 158 requires that all overfunded (FV plan assets > PBO) pension plans
be aggregated and reported as a noncurrent asset, and that all underfunded (FV plan assets < PBO)
pension plans be aggregated and reported as a current liability (to the extent that the benefits payable in
the next year exceed the fair value of the pension plan assets), a noncurrent liability, or both. All Wheels
and subsidiaries would report their pension plans as follows:
All Wheels
FV Plan Assets
$ 1,500,000
Less: PBO
1,425,000
Funded Status
$
75,000
Noncurrent Asset
75,000
Current liability
–
Noncurrent liability
–
Big Bikes
$ 950,000
1,000,000
$ (50,000)
–
–
$
50,000
Fast Trucks
$ 150,000
900,000
$ 750,000
–
$
25,000
$ 725,000
Total
$
$
$
75,000
25,000
775,000
Note that Fast Truck’s pension plan must be reported as a current and noncurrent liability because it is
underfunded and the benefits payable in 20X7 exceed the fair value of the plan assets by $25,000
($175,000 benefits payable – $150,000 plan assets).
Choice “a” is incorrect. SFAS No. 158 does not permit the netting of all pension plans. Overfunded
pension plans must be aggregated separately from underfunded pension plans.
Choice “b” is incorrect. This presentation is not supported by SFAS No. 158.
Choice “d” is incorrect. The current liability related to Fast Trucks pension plan is not equal to the
benefits payable in 20X7. The current liability must be calculated as described above.
13
Replacement for Exam 2, Testlet 1, Question 17
The following information pertains to the defined benefit pension plan of Sonic Corporation as of
December 31, 20X6 and 20X7:
Projected benefit obligation
Fair value of plan assets
20X6
$600,000
750,000
20X7
$660,000
850,000
During 20X7, Sonic paid benefits of $100,000 and made a $50,000 contribution to the pension plan. The
expected return on plan assets included in Sonic’s 20X7 net pension cost was calculated using an
expected rate of return of 8%. Sonic’s effective tax rate is 30%. Based on this information, what
amount would be reported in other comprehensive income as an unrecognized gain on December 31,
20X7?
a.
b.
c.
d.
$0
$63,000
$82,000
$90,000
Explanation:
Choice “b” is correct. In 20X7, Sonic has an unrecognized gain equal to the difference between the
expected return on plan assets recognized in net periodic pension cost and the actual return on plan
assets. This unrecognized gain is included in other comprehensive income, net of tax, in the period
incurred.
The expected return on plan assets is:
Beginning FV of plan assets x Expected return = $750,000 x 8% = $60,000
The actual return on plan assets is:
Beginning FV of plan assets
+ Contributions
– Benefits
+ Actual return on plan assets
Ending FV of plan assets
$ 750,000
50,000
(100,000)
150,000
$ 850,000
Therefore, the unrecognized gain is $150,000 – 60,000 = $90,000, which on an after-tax basis is $63,000
[$90,000 x (1 – 30%)].
The gain is recorded with the following journal entry:
Dr. Pension benefit asset/liability
Dr. Deferred tax expense - OCI
Cr.
Deferred tax liability
Cr.
OCI
90,000
27,000
27,000
90,000
Choice “a” is incorrect. As explained above, there is an unrecognized gain equal to the after-tax
dfference between actual and expected return on plan assets.
Choice “c” is incorrect. This is the unrecognized gain, before tax, that would be calculated if the ending
fair value of plan assets is incorrectly used to calculate the expected return on plan assets.
Choice “d” is incorrect. This is the before-tax unrecognized gain.
other comprehensive income on an after-tax basis.
14
The unrecognized gain is reported in
Replacement for Exam 2, Testlet 1, Question 18
On December 31, 20X8, Spacer Inc. amended its overfunded pension plan and recorded prior service
cost of $250,000. On that date, Spacer had an effective tax rate of 30% and its employees had an
average future service period of 25 years. What effect will the plan amendment have on Spacer’s 20X8
financial statements?
a.
b.
c.
d.
Increase net periodic pension cost.
Decrease accumulated other comprehensive income.
Increase pension benefit asset.
Decrease retained earnings.
Answer:
Choice “b” is correct. Changes in the funded status of a pension plan due to plan amendment must be
reported in other comprehensive income in the period incurred. Therefore, at December 31, 20X8,
Spacer will record prior service cost as a debit to other comprehensive income, which will decrease
Spacer’s accumulated other comprehensive income balance at December 31, 20X8:
Dr. Other comprehensive income
Dr. Deferred tax asset
Cr.
Deferred tax benefit – OCI
Cr.
Pension benefit asset
$250,000
75,000
75,000
250,000
Choice “a” is incorrect. As shown in the journal entry above, recognizing prior service cost when a
pension plan is amended does not affect net periodic pension cost. The amortization of the prior service
cost to net periodic pension cost in future periods will increase net periodic pension cost in those periods.
Choice “c” is incorrect. As shown in the journal entry above, recognizing prior service cost when an
overfunded pension plan is amended decreases, rather than increases, the pension benefit asset.
Choice “d” is incorrect. As shown in the journal entry above, recognizing prior service cost when a
pension plan is amended has no effect on retained earnings.
15
Replacement Questions
The following questions have been written to replace the F6 Online Quiz questions that no longer
apply under SFAS No. 158:
Replacement for Online Quiz Question #1:
Barrel Corporation had service and interest costs of $50,000 related to its defined benefit pension plan for
the year ended December 31, 20X7. The company’s unrecognized prior service cost was $200,000 at
December 31, 20X6 and the average remaining service life of the company’s employees was 20 years.
Plan assets earned an expected and actual return of 10% during 20X7. The company made
contributions to the plan of $25,000 and paid benefits of $30,000 during the year. The pension plan had
plan assets with a fair value of $300,000 at December 31, 20X6. The PBO was $400,000 at December
31, 20X6 and $420,000 at December 31, 20X7. Barrel’s effective tax rate is 30%.
What is funded status of Barrel Corporation’s pension plan at December 31, 20X7?
a.
b.
c.
d.
$ 20,000 underfunded
$ 75,000 overfunded
$ 95,000 underfunded
$120,000 overfunded
Explanation:
Choice “c” is correct. The funded status of Barrel Corporation’s pension plan at 12/31/X7 is the
difference between the ending fair value of plan assets and the PBO. The ending PBO of $420,000 is
given, but the ending fair value of plan assets must be calculated:
FV plan assets, 12/31/X6
+ Contributions
– Benefits paid
+ Return on plan assets
FV plan assets, 12/31/X7
$ 300,000
25,000
(30,000)
30,000 = $300,000 x 10%
$ 325,000
The funded status is then calculated: $325,000 – $420,000 = $(95,000). Because the PBO exceeds the
fair value of the plan assets, this pension plan is underfunded.
Choice “a” is incorrect. The funded status of the pension plan is not the difference between the
beginning and ending PBO.
Choice “b” is incorrect. This answer is determined by subtracting the 12/31/X6 PBO of $400,000 from the
12/31/X7 fair value of plan assets of $325,000. The ending, not beginning, PBO should be used to
calculate the year-end funded status. Additionally, this is an underfunded pension plan because the PBO
exceeds the fair value of the plan assets.
Choice “d” is incorrect. This answer is determined by subtracting the 12/31/X7 PBO of $420,000 from the
12/31/X6 fair value of plan assets of $300,000. The ending, not beginning, fair value of plan assets
should be used to calculate the year-end funded status. Additionally, this is an underfunded pension plan
because the PBO exceeds the fair value of the plan assets.
16
Replacement for Online Quiz Question #2:
Barrel Corporation had service and interest costs of $50,000 related to its defined benefit pension plan for
the year ended December 31, 20X7. The company’s unrecognized prior service cost was $200,000 at
December 31, 20X6 and the average remaining service life of the company’s employees was 20 years.
Plan assets earned an expected and actual return of 10% during 20X7. The company made
contributions to the plan of $25,000 and paid benefits of $30,000 during the year. The pension plan had
plan assets with a fair value of $300,000 at December 31, 20X6. The PBO was $400,000 at December
31, 20X6 and $420,000 at December 31, 20X7. Barrel’s expected tax rate is 30%.
What should Barrel Corporation report in accumulated other comprehensive income for this pension plan
at December 31, 20X7?
a.
b.
c.
d.
$133,000
$140,000
$190,000
$200,000
Explanation:
Choice “a” is correct. The unrecognized prior service cost should be reported in accumulated other
comprehensive income, net of tax, until recognized as a component of net periodic pension cost through
amortization.
At December 31, 20X7, the unrecognized prior service cost, before tax, is:
12/31/X6 Unrecognized prior service cost
– Amortization of prior service cost
12/31/X7 Unrecognized prior service cost
$ 200,000
10,000 = $200,000 / 20 years
$ 190,000
Amount reported in accumulated other comprehensive income is therefore $190,000 x (1 – 30%) =
$133,000.
Choice “b” is incorrect. This is the amount that would be reported in accumulated other comprehensive
income at December 31, 20X6.
Choice “c” is incorrect. This is the unrecognized prior service cost at December 31, 20X7. This amount
is reported in accumulated other comprehensive income on an after-tax basis.
Choice “d” is incorrect. This is the unrecognized prior service cost at December 31, 20X6. This amount
was reported in accumulated other comprehensive income on 12/31/X6 on an after-tax basis.
17
Replacement for Online Quiz Question #5:
Klubby Klubhaus, Inc. offers its retired employees lifetime health benefits. At December 31, 20X6 Klubby
computed an accumulated postretirment benefit obligation of $300,000, while the fair value of the
postretirement plan assets was $50,000. Klubby expects to pay postretirement benefits of $60,000 in
20X7. In its December 31, 20X6 financial statements, Klubby Klubhaus will display:
a.
b.
c.
d.
A footnote disclosure of the funded status of the postretirement benefit plan.
A noncurrent liability of $250,000.
A current liability of $10,000 and a noncurrent liability of $240,000.
A current liability of $60,000 and a noncurrent liability of $190,000.
Explanation:
Choice “c” is correct. Klubby Klubhaus has an underfunded postretirement benefit plan:
Funded status = Fair value of plan assets – APBO = $50,000 – $300,000 = $(250,000)
This underfunded plan must be reported as a current liability to the extent that the benefits payable in the
next 12 months exceed the fair value of the plan assets ($60,000 benefits payable – $50,000 FV plan
assets = $10,000 current liability). The balance of $240,000 is reported as a noncurrent liability.
Choice “a” is incorrect. SFAS No. 158 requires that the funded status of a postretirement plan be
reported on the balance sheet.
Choice “b” is incorrect. Because the benefits payable in the next 12 months exceed the fair value of the
plan assets, the funded status of this postretirement benefit plan must be reported as a current liability and
a noncurrent liability, as described in the explanation above.
Choice “d” is incorrect. The current liability is equal to the excess of the benefits payable in the next 12
months over the fair value of the plan assets. The current liability is not equal to postretirement benefits
payable.
18
FARE 6 Replacement Flashcards
The following flashcards should be used to replace the FARE 6 flashcards that no longer apply
under SFAS No. 158:
FARE 6-5 (front):
Define pension plan funded status and describe how funded status is reported.
FARE 6-5 (back):
Funded status = Fair value of plan assets – PBO
A positive funded status means the pension plan is overfunded. Overfunded pension plans are
aggregated and reported as a noncurrent asset on the balance sheet.
A negative funded status means the pension plan is underfunded. Underfunded pension plans are
aggregated and reported as a current liability (to the extent benefits payable in the next 12 months
exceed the fair value of the plans’ assets), a noncurrent liability, or both.
FARE 6-6 (front):
Describe the recognition of pension gains/losses, prior service costs, and net transition
assets/obligations.
FARE 6-6 (back):
Changes in the funded status of a pension plan due to pension gains/losses, prior service costs, and
net transition assets/obligations are recognized in other comprehensive income, net of tax, in the period
incurred. A reclassification adjustment is recorded to other comprehensive income when the
gains/losses, prior service costs, and net transition assets/obligations are recognized as components of
net periodic benefit cost through amortization.
FARE 6-8 (front):
No changes
FARE 6-8 (back):
Replace:
Reconciling items:
With:
Report OCI effects:
A schedule reconciling funded status of the plan including all reconciling
items (FVPA, PBO, etc.)
Disclosures related to the effects of pension accounting on accumulated
OCI and other comprehensive income;
19
FARE 6-10 (front):
Define postretirement benefit plan funded status.
FARE 6-10 (back):
Funded status = Fair value of plan assets – APBO*
* The APBO is the accumulated postretirement benefit obligation, which is the present value of the
future postretirement benefits that have vested as of the measurement date.
FARE 6-11 (front):
No changes
Replace:
Reconciling items:
With:
Report OCI effects:
A schedule reconciling funded status of the plan including all reconciling
items (FVPA, APBO, EPBO, etc.);
Disclosures related to the effects of postretirement benefit accounting on
accumulated OCI and other comprehensive income;
20