[superfreak]

For all Becker students, could I get some help for the reasoning behind this answer?

Pension Homework question 5:

I’m having trouble grasping when to use the actual return on assets as opposed to expected. Since they are both given in the question, I would assume we use actual because then we don’t need to make an “adjustment” in gains/losses section further down in the SIR-AGE. However, the answer not only uses the expected rate, but doesn’t make the adjustment for gains/losses. I was wondering if anyone can explain this. Thanks in advance!

[Anonymous]

Ok, I think I understand what you are asking and will do my best to help you, but let me know if I'm not hitting on your question.

So the “R” in SIRAGE is the expected return on plan assets, not the actual. So for that component of pension expense, you take the plan assets at the beginning of the year x the expected return on assets (this is a negative number to your total pension expense). However, later on in your computation, you have to amortize gains or losses on the pension which can arise from two areas: 1) expected return greater than or less than actual return on assets or 2) change in actuarial assumptions. This is where it is important to know both your expected and actual return on plan assets. For example:

Say you are given a fact pattern that says your actual and expected returns for 2002 are the same (say, 12%), but you have a net loss on plan assets of $50,000. Well you could accurately deduce that the net loss came from a change in actuarial assumptions that increased the pension benefit obligation (because expected and actual were the same!). However, say actual return was $60,000 and expected (when calculated) yields an expected return of $54,000, this results in a gain from actual/expected differences of $6,000. Now, combined with the change in actuarial assumption that resulted in your $50,000 loss, you now have a net loss of $44,000. So far so good?

The last part is how much you are going to have to amortize…you must amortize MINIMUM the excess of the unamortized gains or losses over 10% of the GREATER of beginning plan assets or PBO, divided by the expected remaining service life of your employees (let's say, in this hypothetical scenario, 30 years). Thus, if you have the following information:

12/31/2001 12/31/2002

FV Plan Assets $100,000 $200,000

PBO $1,500,000 $1,750,000

Unamortized G/(L) ($450,000) ($484,000)*

So, in this case, to find out how much I had to amortize, I needed to calculate 10% of both beginning plan assets and pbo and see if my unamortized g/l (in this case, loss), exceeded the greater amount. 10% of the PBO was greater in this scenario at $150,000 and unamortized G/L was $450,000 at the beginning of the year. This gives us eligible amortization of $300,000 divided by remaining service life (30 years) = $10,000 of amortization this year.

*Ending balance calculated as follows: Beginning unamortized loss – amortization of loss + current year loss = ending unamortized loss. ($450,000) – $10,000 + ($44,000) = ($484,000).

I hope I didn't confuse you…this whole convoluted example was my attempt at explaining that you only need the ACTUAL return on assets in order to see if there is anything that needs to be added/subtracted from unamortized gain or loss for the year. Let me know if that makes sense…good luck!

[Anonymous]

When do you take FAR, anyway?

[superfreak]

Hey BaseballCPA,

Thanks for the clarification on the question. Just to clarify, if I was had both expected return and actual return, I would use expected return for the SIR-AGE formula. The actual return is just there for reference if there is a balance in the unrecognized gains/losses? In this question, there was no gain/loss, therefore the actual return was just there for reference purposes only?

My exam is on this coming Tuesday, I know, if I don't understand it now, it's probably too late… lol. Thanks again for your help!

[Anonymous]

Superfreak-

Well, yes and no…you are correct, the “R” in SIRAGE is computed ONLY using the expected return on plan assets. However, the actual return is not just there for reference, it is actually very important in determining what you need to add/subtract from unamortized gains or losses. Assume the following:

1) year 1 you have $0 unamortized gains or losses. Well this tells you that for year 1, you have no “G” component of pension expense in the “SIRAGE” formula because we always compute current year amortization of G/L based on the BEGINNING BALANCE. Thus, since your beginning balance was $0, you will have no G/L amortization.

2)Assume that in year 1, your expected return exceeded your actual return by $20,000 (thereby creating a loss that will need to be amortized in the future). Additionally, assume that you had gains resulting from changes in actuarial assumptions in the amount of $70,000 (bear in mind that these two events [difference between expected and actual return/change in actuarial assumption] are the only components that will affect your unamortized gain/losses area in pensions. Additionally, keep in mind that all this is only with respect to the “G” component…the “A” and “E” components are different amortization animals altogether). After year 1, you will have a balance of unamortized gain of $50,000. ($20,000 loss netted against $70,000 gain). While the actual return wasn't necessarily important in computing pension expense for year 1, it becomes critical for computing year 2 expense because now you have unamortized gains of $50,000 that must be evaluated for amortization (your year 2 beginning balance).

So, the actual return is indirectly important. It won't necessarily have any bearing on your current year pension expense, however, if you get a simulation where you need to compute pension expense over several years, it will be very important that you understand that concept.

If this is your only weak area, Superfreak, I wouldn't be too concerned…pensions are inherently complex and difficult to understand. Do the best you can to sharpen your skills on them by cranking out MCQ's and hammering yourself on the different “SIRAGE” components as much as you can. I would recommend making flashcards of what the different components mean as well as the rules pertaining to HOW we amortize the “A”, “G”, and “E” components. Best of luck to you!

[Anonymous]

Just out of curiosity, is this the first exam you're taking?

[superfreak]

Yea, FAR is the first one and I'm doing BEC on the 30th of August. I actually work overseas, so the time for me to study is relatively tight.

Do you, or any other future CPAers have advice on how to go about the research part of the SIMS? Do I just have to know the key words? Any other advice on the SIMs part would also be great!

[Anonymous]

My biggest recommendation would be to work through the practice research tabs in Becker (if you're using Becker, that is…). That will help you to learn the best way to find the answers to the question. I found that the functionality of Becker's research tabs paralleled those of the CPA exam.

[Author]

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