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MODULE 11

PRESENT VALUE: D. PENSIONS

SOLUTIONS TO SIMULATION PROBLEMS

Simulation Problem 1

Concepts Situation Pension Calculations Journal Entry Balance Sheet Communication Research

True 1. 2. 3. 4. A defined contribution plan is a plan where an employer agrees to provide a benefit at retirement defined by a formula. The present value of the projected benefit obligation is calculated using the benefits years of service method. Pension liability is calculated by comparing the accumulated benefit obligation with the fair value of plan assets. A company is required to net overfunded pension plans with underfunded pension plans and report the net amount as either noncurrent asset or noncurrent liability on the balance sheet. Prior service costs are caused by new individuals entering the plan after the vesting date. In a defined benefit plan, interest cost represents the increase in the fair value of the plan assets due to the passage of time. Companies must disclose in the notes to the financial statements the effects that a twopercentage-point increase in interest costs would have on the aggregate service and interest costs of the accumulated postretirement benefit obligation on health care benefits. The actual return on plan assets is defined as the difference in the fair value of plan assets at the beginning and the end of the year.

False

5. 6. 7.

8.

Explanation of solutions 1. False. A defined contribution plan is a plan where the employer defines the contribution. No benefit is promised. The benefit is provided by a trust that is funded by the defined contribution of the employer. 2. True. The projected benefit obligation is calculated using the benefits years of service method. 3. False. The funded status of the pension plan is calculated by subtracting the projected benefit obligation and the fair value of plan assets at year-end. 4. False. According to SFAS 158, a company may not net the overfunded and underfunded plans. Overfunded plans must be shown as noncurrent assets on the balance sheet. Underfunded plans should be shown as current liabilities, noncurrent liabilities, or both. 5. False. Prior service costs are caused by amendments to the plan or initiation of a new plan with a retroactive allowance. 6. False. In a defined benefit plan, the interest cost represents the increase in the projected benefit obligation due to the passage of time. 7. False. Companies must disclose the effect that a one percentage point increase would have on the aggregate service and interest costs of the accumulated postretirement benefit obligation on health care benefits. 8. False. The actual return on plan assets is defined as the difference in the fair value adjusted for contributions made to the plan and benefits paid.

Pension Calculations Situation Concepts Journal Entry Balance Sheet

Communication

Research

Part I. 1. 2. 3. 4. 5. 6. $ 36,000 $ 25,200 $ 20,000 $ 0 $110,800 $701,000 Interest cost (PBO at BOY $600,000 × 6% = $36,000) Actual return on plan assets (FV of plan assets BOY $420,000 × 6% = $25,200) Amortization of prior service costs or credits ($240,000/12 years = $20,000 per year) Gain or (Loss) (Actual returns = expected returns) Pension cost for 2008 ($80,000 service cost + $36,000 interest cost ­ $25,200 ROA + $20,000 amortization of prior service cost = $110,800) Projected benefit obligation at December 31, 2008 (PBO at BOY $600,000 + Service Costs $80,000 + Interest Cost $36,000 ­ Benefits Paid $15,000 = $701,000 PBO at EOY)

MODULE 11

Part II.

PRESENT VALUE: D. PENSIONS

421

Increase 1. 2. 3. 4. 5. Service cost Interest cost Actual return on plan assets Amortization of prior service costs or credits Gain or loss in 2008

Decrease

No effect

Explanation of solutions 1. (I) Service cost increases pension cost for the period. 2. (I) Interest cost increases pension cost for the period. 3. (D) Actual return on assets decreases pension costs for the period. 4. (I) Amortization of prior service cost increases pension cost for the period. 5. (N) Winger had no gain or loss because actual and expected return on assets were the same for 2008.

Pension Calculations Journal Entry Balance Sheet

Situation

Concepts

Communication

Research

Debit pension cost Credit cash Credit pension liability

110,800 40,000 70,800

Situation

Concepts

Pension Calculations

Journal Entry

Balance Sheet Communication Research

What is the amount of pension assets or liabilities that will be disclosed in each of the following categories on the balance sheet? 1. 2. 3. 4. Current asset Noncurrent asset Current liability Noncurrent liability _______________0____ _______________0____ _______________0____ _________ $230,800____

Explanation The funded status of the plan is determined by comparing the Projected Benefit Obligation at year-end to the fair value of plan assets on December 31, 2008. The PBO of $701,000 ­ FV of plan assets of $470,200 = $230,800, which is the amount of the pension plan that is underfunded. A liability of $230,800 must be recognized on the balance sheet. A liability of $70,800 exists for the portion of the current year pension cost that was unfunded. Therefore, the increase in pension liability due to items not recognized in pension costs is $160,000 ($230,800 ­ $70,800). This is recognized as a noncurrent liability because Winger does not expect to pay any pension benefits within the next 12 months. 5. Amount in AOCI ___________$112,000_____ Debit Explanation The journal entry to record this would be as follows:

Other comprehensive income Deferred tax asset Pension liability

*

112,000* 48,000 160,000

$160,000 × 70% = $112,000 (net of tax)

MODULE 13 STOCKHOLDERS' EQUITY

523

Disclosures for share-based payments should include the following: · The nature and terms of arrangements during the period and potential effects on shareholders · The effect of compensation cost from share-based arrangements on the income statement · The method of estimating the fair value of goods or services received, or fair value of the equity instruments granted during the period · The cash flow effects from share-based payments K. Basic Earnings Per Share CPA candidates must be able to compute both basic and diluted earnings per share (EPS). In addition to the computations, candidates should also understand the presentation and disclosure requirements. Only public entities (those who trade their stock on the major stock exchanges and over the counter) are required to present earnings per share. Nonpublic companies often choose to present such information, but they are not required to do so. Before continuing, it is recommended that candidates read the outline of SFAS 128, Earnings Per Share, in the back of the FARE section. The objective of EPS is to measure the performance of an entity over the reporting period. Required presentation calls for a basic EPS in all situations and a diluted EPS in those situations where an entity's capital structure includes potential dilutive securities. Basic and dilutive (when applicable) earnings per share amounts must be presented on the face of the income statement for two elements. 1. Income from continuing operations and 2. Net income In those situations where an entity also reports discontinued operations, extraordinary items, and/or cumulative effects of an accounting change in principle, the entity may report EPS on the face of the income statement or disclose such information in the footnotes to the financial statements. Note that the only required EPS presentations are for income from continuing operations and net income. All other presentations of EPS are optional. Public corporations begin by computing basic earnings per share. In this calculation, only those shares of common stock outstanding are included. Any potential issuance of securities is ignored. The computational formula is as follows:

Basic EPS = Net income available to common stockholders Weighted-average number of common shares outstanding

The numerator (net income available to common stockholders) for EPS on net income is computed by taking the net income and subtracting 1. The dividends declared in the period on the noncumulative preferred stock (whether paid or not) and 2. The dividends accumulated for the period on the cumulative preferred stock (whether or not declared). The numerator (net income available to common stockholder1s) for EPS on net income from continuing operations is computed by taking the net income and subtracting any net income or adding any net loss from the following: · Discontinued operations · Extraordinary items The net income from continuing operations is then adjusted by subtracting the preferred stock dividends as described in points number 1. and 2. above. The following example will illustrate the application of this formula:

Numerator information a. Net income b. Extraordinary loss (net of tax) c. 6% preferred stock, $100 par, 1,000 shares issued and outstanding ($100,000 × .06) $100,000 30,000 a. b. c. d. 6,000 Denominator information Common shares outstanding 1/1/07 Shares issued for cash 4/1 Shares issued in 10% stock dividend declared in July Shares of treasury stock purchased 10/1 100,000 20,000 12,000 10,000

MODULE 16 BUSINESS COMBINATIONS AND CONSOLIDATIONS

Liabilities and Equity Accounts payable Bonds payable Capital stock ($10 par) Additional paid-in capital Retained earnings Total liabilities and equity

699

$ 6,000 80,000 120,000 20,000 62,000 $288,000

$ 7,000 -60,000 10,000 34,000 $111,000

Additional Information: 1. At the time of the acquisition, it was determined that Swan had a client list with a fair value of $5,000, and a trademark with a fair value of $14,000. The client list has a remaining life of five years, and the trademark has a remaining life of ten years. 2. The fair values of Swan's assets and liabilities on the date of the acquisition are shown below. 3. The existing equipment of Swan will be depreciated over its remaining useful life of four years. 4. The patent on Swan's books will be depreciated over a remaining life of six years.

Swan Corporation BALANCE SHEETS 1/1/09 (Immediately before combination) Assets Cash Accounts receivable Inventories Equipment Less: Accumulated depreciation Patents Client list Trademark Total assets Liabilities and Equity Accounts payable Bonds payable Capital stock ($10 par) Additional paid-in capital Retained earnings Total liabilities and equity Book value $ 24,000 9,000 16,000 60,000 (10,000) 12,000 --$111,000 $ 7,000 -60,000 10,000 34,000 $111,000 Fair value 24,000 9,000 17,000 72,000 (12,000)* 15,000 5,000 14,000 $144,000 $ 7,000 -Difference between BV and FV $ --1,000 12,000 (2,000) 3,000 5,000 14,000

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* When the asset is revalued and increased by 20% ($60,000 × 20% = $12,000), there is also a corresponding increase in the accumulated depreciation account ($10,000 × 20% =$2,000).

Note that although there are no previously held interests or noncontrolling interest in this example, these items are shown in the following formulas for completeness. The entry to record the investment in Swan is

Investment in Swan Common stock (Pelican) Additional paid-in capital 160,000 16,000 144,000

To record the issuance of 16,000 shares of Pelican's $1 par value stock with a fair value of $10 per share to acquire Swan Corp.

Goodwill should be calculated using a three-step process. Step 1: Compute the difference between (1) the aggregate of acquisition cost, the fair value of previously held shares, and the fair value of noncontrolling interest and (2) the book value of Swan's net assets:

Acquisition cost Plus: Fair value of previously held shares Plus: Fair value of noncontrolling interest Less: Book value of Swan Differential $160,000 --104,000 $ 56,000

This differential can be attributed to assets written up to fair value, newly identified intangible assets, and goodwill. Step 2: Compute the fair value of net identifiable assets.

Book value ($111,000 assets ­ $7,000 liability) Plus: Asset write-ups ($1,000 + $12,000 ­ $2,000 + $3,000) Plus: Newly identified Intangibles ($5,000 + $14,000) Fair value of net identifiable assets $104,000 14,000 19,000 $137,000

MODULE 16 BUSINESS COMBINATIONS AND CONSOLIDATIONS

709

2. The effects of intercompany transactions are eliminated. 3. A portion of net income and dividends of the acquiree are allocated to the noncontrolling interest. The financial statements are consolidated and combined with the parent including 100% of the acquiree's revenues and expenses after the date of acquisition. The noncontrolling interest's share of the acquiree's income is shown as a deduction on the consolidated income statement. For this example, assume the facts in our previous problem with one exception. Let us assume that on January 1, 2009, Pelican purchases 90% of Swan by issuing 15,000 shares of Pelican's $1 par value common stock with a fair value of $10 per share on the date of acquisition. At the date of acquisition Swan had 6,000 shares of stock outstanding with a value of $28 per share. The financial statements at date of acquisition for Pelican and Swan were as follows:

Pelican Company and Swan Company BALANCE SHEETS 1/1/09 (Immediately Before Combination) Assets Cash Accounts receivable Inventories Equipment Accumulated Depreciation Patents Total assets Liabilities and Equity Accounts payable Bonds payable Capital stock ($10 par) Additional paid-in capital Retained earnings Total liabilities and equity Pelican Corp. $ 30,000 35,000 23,000 240,000 (40,000) -$288,000 $ 6,000 80,000 120,000 20,000 62,000 $288,000 Swan Corp. $ 24,000 9,000 16,000 60,000 (10,000) 12,000 $111,000 $ 7,000 -60,000 10,000 34,000 $111,000

Additional Information: 1. At the time of the acquisition, it was determined that Swan had a client list with a fair value of $5,000, and a trademark with a fair value of $14,000. The client list has a five-year remaining life, and the trademark has a ten-year remaining life. 2. The fair values of Swan's assets and liabilities on their balance sheet on the date of acquisition are shown below.

Swan Corporation BALANCE SHEETS 1/1/09 (Immediately Before Combination) Assets Cash Accounts receivable Inventories Equipment Less: Accumulated depreciation Patents Client list Trademark Total assets Liabilities and Equity Accounts payable Bonds payable Capital stock ($10 par) Additional paid-in capital Retained earnings Total liabilities and equity Book value $ 24,000 9,000 16,000 60,000 (10,000) 12,000 --$111,000 $ 7,000 -60,000 10,000 34,000 $111,000 Fair value 24,000 9,000 17,000 72,000 (12,000)* 15,000 5,000 14,000 $144,000 $ 7,000 -Difference between BV and FV $ --1,000 12,000 (2,000) 3,000 5,000 14,000

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* When the asset is revalued and increased by 20% ($60,000 × 20% = $12,000), there is also a corresponding increase in the accumulated depreciation account ($10,000 × 20% = $2,000).

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