FRA - Pensions - Adjusting Cash Flow

can someone explain this:

Example 6 on page 195

  1. If the employer’s contribution exceeds the periodic pension expense why is that amount taken after tax and use to increase Cash flow from financing;

  2. and why is that same amount used to increase Cash Flow from Operations???

if contributions > pension expense, then treat as if you are prepaying a liablility and as a result you reclassiffy from CFO to CFI. hope this is right :slight_smile:

tax will be adjusted as when u shift from cfo to cfi it will increase tax burden

Still don’t understand why the amounts are taken after tax…and added back

the excess contribution decreased the tax bill and you want to determine the net effect on operating cash flow. we add back that excess charge (net of tax savings) back to CFO to arrive at a normalized CFO as if no excess pension contribution had been made (i.e. + excess charge - excess charge*tax rate). we then add that net charge with an opposite sign to cash flow from financing as if we pre-paid a loan. net effect on total CF is zero. this is how i understand it - hope this is not confusing

It may help if you think in terms of the accounting entries. You paid $67 in cash, so assets go down by $67.

On the I/S, since your expense is higher, the corresponding taxes are lower. This means on the B/S, your liabilities go down by $19 ($67 * 28.7%).

Back on the I/S, because taxes consume $19 of the impact, NI goes down by $48, not the entire $67. This negative NI flows to equity via retained earnings. So equity goes down by $48 on the B/S.

Overall assets down by $67, liabilities down by $19, and equity down by $48. B/S balances.

Under regular circumstances, the $48 NI reduction would reduce CFO by $48 (indirect method).

However, we wish to treat the expense as a CFF. So CFO goes up by $48 while CFF inflow goes down (i.e. CFF outflow goes up) by $48. Overall, no net effect on CF/S.

Hope this helps.

Could someone please confirm that

in IFRS- cash flow adjustment is required in CFO and CFF based on funded status

In USGAAP- cash flow goes in only CFO

This point is not very clear in CFA books section 2.6.4 or schweser notes.

Many thanks.

Bumping this because I (and maybe others are confused). Is there a rock solid explanation as to why the after-tax effects are adjusted?

When I look at this question and go through the accounting entries (accountant by trade here), it does not seem to make sense to me. When recording the expense for the period, the entry is Dr. Pension Expense $437, Cr. Net Pension Liability $437.

From there, the company funds the contribution and the entry is Dr. Net Pension Liability $504 and Cr. Cash $504. Anyone have an idea as to why these cash flow adjustments need to be examined on an after-tax basis?

should be CFF right?

Try thinking of the pension obligation and the pension contribution as a loan and loan payment. When the pension contribution exceeds the total pension cost, it reduces the current pension obligation AND the pension obligation in the future.

I thought about it and might be wrong about this (if someone has a stronger accounting background, please chime in) but since the overpayment affects the company’s current and future taxes, the cash flow adjustments are necessary to properly account for taxes in the current period. Similar to the treatment of deferred tax liabilities.