Accounting for pension costs under a DB plan
Mirandolina Inns, a European chain of mid-price hotels, operates a DB pension plan for its employees. The company follows international standards when accounting for the costs of the plan. It has elected to use the corridor treatment to recognise net actuarial gains or losses in its accounts.
The company's pension fund has a deficit of 55 at the end of year 3. (All amounts are in A million.) The deficit has arisen because of the effect of the stock market decline on the value of plan assets. In addition, the fall in long-term interest rates has increased the present value of the pension obliga- tions. Since unrecognised net actuarial losses amount to 50 at end-year 3, the company reports a pension liability of only 5 on its balance sheet then.
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InBm
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Actuarial present value of pension obligations
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(400)
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Plan assets at fair value
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345
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Funded obligations in excess of plan assets
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(55)
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Unrecognised net actuarial losses
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50
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Net liability for funded obligations recognised
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(5)
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The following pension-related events occur in year 4. The cost of pension benefits earned by employees in the year ('Current service cost') is 15. The company contributes 10 in cash to the pen- sion fund. It pays benefits of 8 to retirees. At the end of the year, the pension fund's assets have a fair value of 365 and the DB obligations of the fund have a present value of 433.
In calculating pension liability and expense, the company's actuaries assume a discount rate of 6.5% (the market yield on high-quality corporate bonds) and an expected rate of return on plan assets of 8%. The company estimates the average remaining working life of employees is 10 years.
Required
(a) Calculate Mirandolina Inns' year 4 pension expense and end-year 4 pension liability (or asset).
(b) Mirandolina Inns' management are concerned about the size of the pension fund deficit at the end of year 4. Fabrizio, the chief financial officer, is reviewing the pension scheme with a view to making changes to it in year 5. As input to this review, he asks you to determine the effects on the company's year 4 accounts if the following decisions had been made in year 4. Calculate the effect of each separately.
(i) The company contributes 15 in cash to the pension fund (instead of 10). The pension fund's assets at the end of the year are 5 higher (i.e. 370).
(ii) The company amends the plan at end-year 4 and reduces future benefits. The result is a neg- ative past service cost of 5. This is recognised in income immediately.