This is for Schweser question ID#: 87579 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? A) The new debt/equity ratio is 86.2%. B) The new debt/equity ratio is 90.9%. C) The debt/equity ratio is still 100%. The correct answer was A. 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)). ========================= The first adjustment seems right to me, you add both assets and RE by $5 million. My question is about the second adjustment, the increase of NI and RE by $3 million will definitely violate the basic accounting equation: A = L + E. Could someone give it a shot? CPK maybe? Thanks!
Expected Return on plan assets would NOT INCREASE Assets. Hence this problem is wrong as stated. Only the Actual Return on Plan Assets would increase assets. When that happens - A goes up 5, hence E goes up 5. And that will have no impact on anything remotely connected to the reported pension Expense on the Income statement, so that is all the adjustment will be. This problem is wrong as given, and the solution is even more WRONG. (IMHO).
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I don’t think assets or liabilities would change due to a change in the expected return on plan assets, but won’t NI increase by $3M ( $5M (1-T) ) because pension expense booked is based on estimated returns rather than actual? …increasing Equity so that the new Debt/Equity ratio is 50/53. It sounds as if the question is missing a sentence e.g. Due to some actual economic event, CDC changed the expected return and the economic event also impacted markets increasing the actual fair value blah blah blah