i 'm going throught the Qbank schweser and i find a question in the pension plan section which says : Coastal Drilling Corp (CDC) reported the following year-end data: Net income $23 million Total liabilities $50 million Total shareholder’s equity $50 million Effective tax rate 40 percent CDC also reported that it had changed the expected return on plan assets assumption which resulted in an increased return on plan assets of $5 million. This change resulted in an increase in the market-related value of plan assets with no long-term effect on the income statement. What is the impact on the debt/equity ratio? the answer with the explanation is : The new debt/equity ratio is 86.2%. The increase in return on plan assets will increase overall assets and equity by $5 million. The increase will also reduce pension expense by $5 million resulting in an increase in net income and retained earnings of $3 million (5 × (1 − 0.40)). Therefore, the new debt/equity ratio is 86.2% (50 / (50 + 5 + 3)). but i didn’t understand why they add also to pension expense the amount net of tax and what will be the debit side , (because pension expense was credited by this amount) if someone could help please
Pension expense will reduce because of the Expected Return on Plan Assets Increase. Pension Expense = Service Cost + Interest Cost - Return on Plan Assets. When Return on Plan Assets goes up, Pension Expense goes down. When Pension Expense goes down the Net Income goes up by the after tax component, and this would directly increase the Equity Portion of the Balance sheet - thro’ the Retained Earnings. Also the Expected Return on Plan Assets increase - would increase the Assets and since A=L+E, and no liability is changing the E would increase by the 5 Million $. So total Change in Equity would be by +5 + (5*.6) = +8
and here’s my question : why the assets will go up after an increase in the expected return ? usually it should go up when the actual return go up not the expected
both would cause the plan assets to go up. either one of them is used to smooth the pension expense. depending on availability of data when creating the financial statements, if the actual return is available and is more than the expected return, that is used to estimate the Plan Assets ending balance. If not the expected return is used. remember the co. is depositing funds into an asset account (with a trust) and maintaining that return is the prerogative of the employer in a Defined benefit plan.
there’s a missing point here , if i’m taking it accounting wise , first i should decrease expense by 5*0.6 =3 so credit and debit what ? and the other entry will be debit pension asset 5 and credit other comprehensive income in equity with 5 ? please correct me if i’m wrong and thanks a lot
the decrease in expense is on the income statement. so you decreased expense - which resulted in an increased Net Income which flowed thro’ to Equity section thro’ retained earnings. remember you are comparing effects here, not trying to set up the balance sheet and income statement with the various accounting rules.