Increase in Obligation is an increase in liability and not Debt?

CFA Level II FRA
#1

In Example 4 of Reading 19 ; Employee compensation.

Question 3. If the healthcare costs increase by 1%, the obligation increases by 106 M which increases the Liabilities. But all liabilities are not debt, correct? So how come Debt will increase? Second, could anyone also help me explain why equity is also changing. Ideally it should remain constant? where am missing the point

Thanks for your help

#2

E = A - L

So if L increases, A remains the same - then E decreases by the amount that L increased.

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Liabilities are what is owed by the company. So it is Debt - in that sense of the term.

#3

Thanks a lot!

#4

Debt bears interest; not all liabilities bear interest.

If the healthcare costs bear interest – for example, they’re part of the employees’ post-retirement compensation, which increases each year at a given (interest) rate – then they’re properly classified as debt.

#5

Thanks S2000, that was my point. I dont see any info in the question if those costs bear interest. As of now, am treating it as debt and I hope in the exam, they give some info to consider those as a part of debt

#6

what exactly is your question? I did not understand what you are trying to say in your 2 posts above.

Can you clarify?

#7

My question is that if the Pension obligation increases by X amount, the liabilities do increase but can those liabilities be considered as Debt. As S2000 mentions, if the healthcare obligations bear interests, then it can be considered as Debt. In the question, there is no such information if its interest bearing or not. That was the point I was trying to make.

#8

I guess you need to think of them as liabilities (On the Liabilities side of the balance sheet).

#9

I see Saur’s dilemma. The question is asking to calculate the change in debt/equity ratio as a result of an increase in the growth in the healthcare cost assumption. The CFAI answer is calculating the Debt/Equity ratio using Total Liabilties/Total Equity.

Interestingly, I just pulled my CFAI L1 book from June 2015 and p.352 (Exhibit 14) of the FRA book defines the ratio as Total Debt/Total Shareholder Equity, and then footnotes “Total Debt” as (and I quote) "In this reading, we take total debt in this context to be the sum of interest-bearing short term and long term debt."

Takeaway: there is more than one definiition of Debt/Equity.

#10

Are these current period health care expenses, or future (e.g., post-retirement) health care expenses. Future expenses will bear interest, as the company records the _ present value _ of the benefit earned.

#11

Future expenses

#12

There you go: they bear interest.

#13

yes

#14

Still about this question, something is still not clear for me:

health care obligation isn’t registered like defined contribution pension plans on the balance sheet?

If positive, how can i be sure that 106million impact would cause a liability increase (when there’s a net liability) and not a asset reduction (when there’s a net asset).

Am i mixing the concepts?

#15

The assumption here is that the company isn’t funding the healthcare obligation like they would a pension plan. In other words, there is no asset or inverstment pool the company is paying into to directly offset the liability. So any incremental change in estiamte will hit the liability.