Correct Answer is “C” and my answer is A.
My reasoning:-
Under US GAAP:
Interest Income = Plan Assets x Expected Return (So rate of return dropping from 2007 to 2009 should reduce the pension obligation).
Can someone please correct me and explain as to why my reasoning and thinking is wrong.
Thanks,
Why do you think that the return on plan assets will affect the pension obligation?
Interest cost is part of pension obligation and under US GAAP it is reported as two lines:-
Interest Expense (Beginning PO x Discount Rate)
Interest Income (Plan Assets x Expected Return). Lower rate of return should result in lower interest income and as a result the pension obligation should be higher with a lower rate of return.
Please let me know how I am straying away from the path in my thinking.
I actually reviewed this question today and made the same mistake. Remember higher discount rate of future cash flows gives you a smaller PV. The pension obligation under GAAP & IFRS uses the discount rate to determine the obligation (liability). The plan (assets) are reported at fair value, the expected rate of return has no impact on the fair value of the plan assets. The net of both plan asset and obligation is the value reported in the FSs. Hence the answer being ‘the same’. Definitely one to revisit and think about during final review. Hope that helps.
Interest cost, which is beginning PBO × discount rate, increases the pension obligation.
Interest income, which is beginning plan assets × expected return, does not affect the pension obligation; it is shown as part of interest expense on the income statement.
Thanks S2 and mrlowery.
My understanding of the interest cost was incorrect. Was mixing up between I/S and B/S component.
I need to go back and review this again.
My pleasure.
Thanks to this thread, I’ve started to write an article on pension cost and pension expense. We’ll see how long it takes me to finish it (because of all of the other teaching I’m doing at the moment).