Question #25
Reading: Reading 9 Employee Compensation - Post-Employment and Share-Based
PDF File: Reading 9 Employee Compensation - Post-Employment and Share-Based.pdf
Page: 9
Status: Correct
Correct Answer: A
Question
A company reporting under U.S. GAAP reduced the discount rate for its pension obligation from 10% to 8%, reduced the expected long-term rate of return on the assets in its pension plan from 8% to 6%, and changed its compensation growth rate assumption from 4% to 5%. What is the most likely impact of these changes on the current year ending defined benefit obligation and pension expense?
Answer Choices:
A. The reduction in the discount rate will decrease the defined benefit obligation and will increase reported pension expense
B. The decrease in the long-term rate of return on plan assets will decrease reported pension expense
C. The decrease in the long-term rate of return will have no impact on the defined benefit obligation and will increase reported pension expense
Explanation
The decrease in the expected long-term rate of return on plan assets from 8% to 6% will
have no effect on the defined benefit obligation (after all, it is an obligation and not an
asset). The reduction will, however, increase reported pension expense for current and
future periods because the expected return is subtracted while computing pension
expense.
The reduction in the discount rate from 10% to 8% will increase (not decrease) the defined
benefit obligation and will also increase reported pension expense because it will increase
the current service cost. Additionally, the actuarial gains and losses resulting from this
change (the difference between the defined benefit obligation after the increase and the
defined benefit obligation before the increase) will be amortized into pension expense
over time using the corridor approach. Amortization will start in the period after the
change is made.
The decrease in the expected long-term rate of return on its plan assets from 8% to 6%
will increase, not decrease, reported pension expense. Expected return reduces pension
expense.