Finquiz FSA Answer

Reading 17 Employee Compensation: Post-Employment and Share-Based FinQuiz.
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CFA Level II Item-set - Solution
Study Session 5
June 2017
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Reading 17 Employee Compensation: Post-Employment and Share-Based FinQuiz.com
FinQuiz Level II 2017 Item-sets Solution
Reading 17: Employee Compensation: Post-Employment and Share-Based
1. Question ID: 15566

Correct Answer: A
Statement 1 is correct. Firms following IFRS would expense the entire cost immediately. Past service
costs are generated as a result of plan amendments. Under IFRS past service costs are recognized as
an expense in the P&L. In contrast, under U.S. GAAP, past service costs are reported in other
comprehensive income in the period in which the change giving rise to the cost occurs.
Statement 2 is incorrect. Under U.S. GAAP, unamortized past service costs are reported in
accumulated other comprehensive income and subsequently amortized over the average service lives
of the affected employees; the amortized amounts are included in the income statement.

Correct Answer: C
Under U.S. GAAP, actuarial gains and losses that are recognized immediately are included as a
component of pension expense. However, under IFRS, actuarial gains and losses are recognized as
part of other comprehensive income and are not subsequently amortized to P&L. If they are treated as
other comprehensive income, this can reduce the volatility of pension expense (but increase the
volatility of equity).
U.S. GAAP only allows the deferred recognition of actuarial gains and losses using either the corridor
method or the faster recognition method to determine the minimum amount to be reported on the
income statement. Park has defined only the corridor method; under the faster recognition method the
actuarial gains and losses can be amortized more quickly.

Correct Answer: A
Estimated final years salary: $92,736
Estimated annual payment for each of the 20 years: (92,7360.025)(10+5) = $34,776
Value at the end of Year 5, of the estimated future payments: $383,179.6
Annual unit credit: 383,179.6/15 = $25,545.30
Benefits attributed to prior years: Annual unit credit (10) = $255,453.
Opening obligation: 255,453/(1.065)5 = $186,450.25
Interest cost = 186.450.25(0.065) = $12,119.269

Correct Answer: A
Statement 3 is correct. An increase in the assumed discount rate can increase the interest cost.
However, the interest component of the pension obligation and pension expense may decrease if the
decrease in the opening obligation more than offsets the effect of the increase in the discount rate (this
is the typical effect).
Statement 4 is incorrect. An increase in life expectancy will have no effect on the promised pension
payments because the payments are to be paid over a fixed time period.


Correct Answer: A
Total periodic pension costs = Ending funded status contributions beginning funded status
Total periodic pension costs = ($25,670 $24,586) ($19,615 $18,956) $65 = $360

Correct Answer: B
If Care Medicines complied with IFRS, it would report remeasurement amounts as part of net
income:
Remeasurements = net return on plan assets* - actuarial gains and losses
*Net return on plan assets = Actual return (Plan assets Interest rate)
Remeasurements = [$980 (12% $19,615)] + $1,500 = $126.20 $126

Correct Answer: A
The amount of pension liability recognized under U.S. GAAP for the year 2009 is 466 million.
Under U.S. GAAP the amount recognized under a defined benefit plan is the pension plans funded
status. The funded status represents the difference between the fair value of the plan assets and the
projected benefit obligation (present value of the pension liabilities). If the projected benefit
obligation exceeds the fair value of the plan assets, this suggests that the plan is underfunded.
In the case of Hewer Corporation, the projected obligation as at December 31, 2009 exceeds the fair
value of the corporations plan assets on the same date ($589 million vs. $123 million).

Correct Answer: B
For both the 2008 and 2009 periods, total periodic pension costs exceeded employer/employee
contributions (in 2008 periodic pension costs exceeded contributions by $54 million and in 2009
pension costs exceeded contributions by $75 million). In the event that periodic pension costs exceed
contributions, the excess can be viewed from an economic perspective as a source of financing. In the
case of both 2008 and 2009, the appropriate adjustment would be to reclassify the excess as an inflow
related to financing activities rather than to operating activities, i.e. decrease operating cash flows and
increase financing cash flows.
Since the corporation has not made these cash flow adjustments, its operating cash flows are
overstated financing flows are understated for both the periods presented.

Correct Answer: B
The actuarial loss recognized by Hewer Corporation in its 2009 income statement is $7.0 million.
Under the corridor method, the net cumulative unrecognized actuarial gains and losses at the
beginning of the reporting period are compared with defined benefit obligation and the fair value of
the plan assets at the beginning of the period.

If this cumulative unrecognized amount exceeds 10% of the greater of the PBO or the fair value of
plan assets, the excess is amortized over the expected average remaining working lives of the
employees participating in the plan and is included as a component of pension expense.
PBO at the beginning of 2009 = $448 million

Fair value of plan assets at the beginning of 2009 = $149 million
Net cumulative unrecognized actuarial gains/losses at the beginning of 2009 = $150 million
PBO balance ($448 million) > Fair value of plan assets ($149 million). Thus the PBO value is
used.
10% of the PBO amount = $44.8 million ($448 million 10%)
Unamortized portion of net actuarial loss = $105.2 million ($150 million $44.8 million)
Amortized portion of actuarial loss (recognized in 2009s income statement) = $7.01 million
($105.2 million 15 years)

Correct Answer: C
Amongst the actions listed, a(n):
increase in the discount rate to 12.2% in 2010 from 12.1% in 2009, will decrease the value of
the PBO being reported in 2010.
decrease in the actual return on plan assets to 8.5% will not affect the PBO amount as actual
return on plan assets are not used in the PBO computation.
increase in the rate of compensation increases to 3.8% in 2010 from 3.5% in 2009 will
increase the value of PBO being reported in 2010.

Correct Answer: C
Amongst the rate assumptions listed in Exhibit 2, the discount rate assumptions, expected return on
plan assets, and annual compensation rate increases are internally consistent. This is because these
rates are all increasing over the periods, 2008 and 2009 and thus correspond to the increase in the
expected inflation rate over the two periods. However, the actual return on plan assets is internally
inconsistent with these rates (including the expected inflation rate) as this rate of return remains
constant at 8% over the two years.

Correct Answer: B
On January 1, 2008, 2 years of the vesting period have elapsed and 1.5 years remain.
For the year 2008, the compensation expense recognized is $360 million ($540 million 1.5 years).
For the year 2009, the compensation expense recognized is $180 million ($540 million $360
million).

Correct Answer: C
The funded status is equal to $17,236 ($87,200 $69,964) which the difference between the ending
defined benefit obligation and fair value of plan assets,


Correct Answer: B
Net interest expense = Change in beginning of period funded status discount rate
Net interest expense = $(54,500 60,000) 12% = $660

Correct Answer: C
Using the sponsors 2010 contributions of $15,425 and a $6,000 total pension costs, the sponsors
contributions exceed the pension expense by a pre-tax amount of $9,425 ($15,425 $6,000). The
after-tax amount by which the sponsor companys contributions exceed the pension costs is $7,068.75
or approximately $7,069 [$9,425 (1 0.25)].
Since the sponsors contributions exceed the total pension costs, the excess is equivalent to a
repayment on a loan in excess of the scheduled payment (financing use of funds). This excess is
treated as an increase in cash inflow from operating activities and an increase in cash outflow from
financing activities by $7,069. Put another way, the $7,069 excess is treated as a decrease in cash
outflow from operating activities and a decrease in cash inflow from financing activities.

Correct Answer: A
Periodic pension costs are calculated as follows:
Total periodic pension costs (income) = Ending funded status Employer contributions beginning
funded status.
Total costs (income) = ($87,200 $69,964) $15,425 ($60,000 $54,500)

= ($3,689)

Correct Answer: B
Benefit 1: s
Stock options have payoffs, which can be characterized as asymmetric or one-sided. In other words,
the potential for profits (when the underlying stock price exceeds the option exercise price) is
unlimited on the upside and losses (when the stock price falls below the exercise price) are limited to
the option premium.
Thus the potential for risk aversion is limited and the potential for returns is unlimited on the upside.
This benefit accurately reflects a benefit of issuing stock to firm employees.
Benefit 2:
Although the issuance of stock option will dilute shareholder ownership in the future, as the options
are exercised and underlying shares are issued, the firm does not simultaneously issues shares with its
stock options issue. Regardless of whether the stock options dilute shareholdings immediately or in
the future, the firms existing shareholders will be affected by the issue once the options are exercised
(and associated shares issued). Thus benefit 2 does not accurately reflect a benefit of issuing stock
options to existing firm shareholders.
Benefit 3:
When stock options are issued an annual compensation expense in recorded on the firms income
statement thereby reducing the firms profitability. Additionally, stock options can dilute the firms

earnings per share. Thus the issuance of stock options can reduce the firms overall profitability as
well an individual shareholders share in firm profitability. Benefit 3 misrepresents the benefit as well
as effect of issuing stock options on firm profitability.

Correct Answer: B
The fair value of an option tends to decrease with a(n):
increase in underlying exercise price;
increase in assumed dividend yields; and
decrease in stock price volatilities.
Relative to current estimates for:

underlying exercise price ($52.10), selecting alternative 2 will result in a lower fair value
estimate for the option as it assumes a higher exercise price estimate ($57.45).
dividend yields (3.00%), selecting alternative 2 will result in a lower fair value estimate for
the option as it assumes a higher dividend yield estimate (3.85%) whereas alternative 1 will
lead to a higher price estimate due to the lower dividend yield estimate.
stock price volatility (23%), selecting alternative 1 will result in a lower fair value estimate as
it assumes a lower stock price volatility estimate (22%) whereas alternative 2 will lead to a
higher price estimate to the higher volatility estimate.

Correct Answer: B
Final salary= ($75,000) (1.0525)14 = $153,522

Correct Answer: C
Lump Sum Payment at Retirement = (0.025 161,581)15 = $60,593.

Correct Answer: A
Annual Unit Benefit = Value at Retirement/ Years of Service
= $56,553/15
= $3,770

Correct Answer: A
Benefits attributed to prior years in year 5 = Annual unit credit ($3,770) 4
= $15,080

Correct Answer: C
Lump Sum Payment at Retirement = (0.025 $161,581)20
= $80,791.

Correct Answer: B
Annual Unit Benefit = Value at Retirement/ Years of Service
= $20,197/20
= $1,010


Correct Answer: B
The number of employees relevant for an accumulated benefit obligation calculation for 10 years =
Currently Vested + Expected to meet Vesting Conditions in the next ten years = 25,000+ 125,000 =
150,000.

Correct Answer: C
The projected benefit obligation is based on the going concern assumption as it assumes the business
to maintain its operations for the foreseeable futures. Calculations are made using the assumed
turnover rates and salary increases in future periods.

Correct Answer: A
Interest Cost = Discount rate Beginning pension obligation
= 9% * 48 million
= 4.32 million.

Correct Answer: B
Past service costs is the amount by which a companys pension obligation relating to employees
service in prior periods changes as a result of plan amendments or plan curtailments. These costs
represent an obligation of the company and are thus included within a companys pension obligation.

Correct Answer: C
The return on plan assets does not have any effect on the benefit obligation. The return increases the
fair value of the plan assets.

Correct Answer: A
Curtailment occurs when the number of employees covered by the existing plan is reduced. This
reduction may be due to any number of reasons i.e. redundancy, restructuring etc.

Correct Answer: A
Share based payments are recorded as an expense in the income statement. Regardless of the absence
of a cash outflow, the income statement will recognize an expense according to the accrual principle.

Correct Answer: A
The compensation expense relevant to restricted stock grants is measured based on the fair value of
the stock on the grant date.

Correct Answer: B
When the option price is dependent upon future contingent events to be known after the grant date,
the compensation expense is measured at the exercise date.


Correct Answer: A
A lower assumed dividend yield would lead to an increase in the estimated fair value of a stock
option according to the option pricing model.

Correct Answer: A
In 2010, the company will recognize $187.5 million ($750 million/4) as compensation expense. After
recognizing this amount, the unrecognized non-vested compensation expense will reduce to $562.5
million ($750 million $187.5 million) on December 31, 2010. With 3 years remaining, the
compensation expense recognized in 2011 is $187.5 million ($562.5 million/3).

Correct Answer: B
Stock appreciation rights provide the flexibility to employees to benefit from increases in stock price
without requiring them to hold shares. They require a current period cash outflow.

Correct Answer: A
It is compulsory under U.S. GAAP to make individual accounts for each participating employee.

Correct Answer: A
Under the defined contribution plan, employers are obligated only to make the designated
contribution at the required times. The return on the contributions and the overall pension benefit
received by the employees is not a responsibility of the employer.

Correct Answer: B
The defined benefit is funded in advance by the employer over the service life of the employee. Thus,
the investment risk is borne only by the employer under defined benefit plans.

Correct Answer: A
Each additional year of service gives rise to additional benefit which the employee is entitled to at
retirement.

Correct Answer: B
Theoretically, the differences between expected and actual returns arise from short term market
fluctuations over the long term, these returns should converge. Therefore, in the long term, actuarial
gains and losses arising from differences between actual and expected returns on the plan assets
should converge.

Correct Answer: C
The IFRS provides the flexibility of choosing between either converged disclosure of the overall
pension expense, or disclosure as separate line items.


Correct Answer: A
(All figures in $000)
The companys pension plan is overfunded by $19,370 ($108,800 $89,430)
When a company reports a surplus, the amount that can be reported as an asset is the lower of the
surplus and asset ceiling (present value of future economic benefits, such as refunds or reductions in
future contributions). Since the value of the ceiling ($54,500,000) is greater than the surplus, the asset
will be reported at the surplus amount.

Correct Answer: A
All figures in $000
The companys pension plan is overfunded by $19,370 ($108,800 $89,430)
When a company reports a surplus, the amount that can be reported as an asset is the lower of the
surplus and asset ceiling (present value of future economic benefits, such as refunds or reductions in
future contributions). Since the value of the ceiling ($54,500,000) is greater than the surplus, the asset
will be reported at the surplus amount.

Correct Answer: C
Given that the company complies with U.S. GAAP, it will include the following items in other
comprehensive income, equity:
Past service costs

Remeasurements:
o Difference between actual and expected return on plan assets
o Actuarial gains and losses changes arising in a companys pension obligation due to
changes in actuarial assumptions.
Service costs include current and past service costs. The former is immediately recognized in profit
and loss while the latter is included in other comprehensive income and subsequently amortized to
profit and loss.

Correct Answer: A
A higher discount rate reduces the PV of the defined obligation by a greater amount. This would lead
o a lower pension charge because of lower pension obligation.

Correct Answer: C
When the actual return is lower than the expected return by a significant amount, with the
significance being large enough to require amortization, the amortization would lead to a decrease in
pension expense.

Correct Answer: B
When the cumulative unrecognized actuarial gains or losses exceed 10% of either the PV of defined
obligation or the FV of the plan asset, the difference is mortised over the service life of the
employees.

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Reading 17 Employee Compensation: Post-Employment and Share-Based FinQuiz.

Copyright 2010-2017. FinQuiz.com. All rights reserved. Copying, reproduction or

FinQuiz.com 2017 - All rights reserved.

FinQuiz Level II 2017 Item-sets Solution

Reading 17: Employee Compensation: Post-Employment and Share-Based

1. Question ID: 15566

2. Question ID: 15567

3. Question ID: 15568

4. Question ID: 15569

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5. Question ID: 15570

6. Question ID: 15571

Remeasurements = net return on plan assets* - actuarial gains and losses

Remeasurements = [$980 (12% $19,615)] + $1,500 = $126.20 $126

7. Question ID: 15594

8. Question ID: 15595

9. Question ID: 15596

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PBO at the beginning of 2009 = $448 million

10. Question ID: 15597

11. Question ID: 15598

12. Question ID: 15599

13. Question ID: 11621

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14. Question ID: 11622

Net interest expense = $(54,500 60,000) 12% = $660

15. Question ID: 11623

16. Question ID: 11624

Total costs (income) = ($87,200 $69,964) $15,425 ($60,000 $54,500)

17. Question ID: 11625

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18. Question ID: 11626

Relative to current estimates for:

19. Question ID: 17563

20. Question ID: 17564

21. Question ID: 17565

22. Question ID: 17566

23. Question ID: 17567

24. Question ID: 17568

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25. Question ID: 17570

26. Question ID: 17571

27. Question ID: 17572

28. Question ID: 17573

29. Question ID: 17574

30. Question ID: 17575

31. Question ID: 17577

32. Question ID: 17578

33. Question ID: 17579

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34. Question ID: 17580

35. Question ID: 17581

36. Question ID: 17582

37. Question ID: 17584

38. Question ID: 17585

39. Question ID: 17586

40. Question ID: 17587

41. Question ID: 17588

42. Question ID: 17589

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43. Question ID: 17591

44. Question ID: 17592

45. Question ID: 17593

Past service costs