Exam Review - Question 2 Question ID#: 87587 T-Table F-Table 5% F-Table 2.5% Chi-Table Durbin-Watson Z-Table Z-Table Alt Great Plains Grains (GPG) reported the following 2003 year-end data: Net income $45 million Dividends $10 million Total long-term liabilities $100 million Total shareholder’s equity $200 million Effective tax rate 40 percent Deferred Tax Liabilities $6 million Funded Status Underfunded Following the release of this data, GPG discovered that the service and interest costs related to their pension fund accounting had been miscalculated. The new estimates are $5 million and $8 million higher than the original estimates. What is the impact on the debt to equity ratio? The new debt/equity ratio is: A) 61.7%. B) 56.5%. C) 56.1%. . . . . . . . . . . Your answer: B was incorrect. The correct answer was C) 56.1%. The increases in the service and interest costs will decrease net income by $7.8 million ((5 + 8) × (1 − 0.40)). Due to the reduction in income retained earnings will fall by the same amount reducing equity to $192.2 million (200 – 7.8). Moreover, the new calculations will increase net liabilities by $7.8 million. Therefore, the new debt/equity ratio is 56.1% ((100 + 7.8) / (200 – 7.8)). Here’s my question: I understand that pension expense has interest and service costs --> no problem there This will be an expense on the income statement that will reduce net income --> good here The net income is part of ending returned earnings which decreases equity --> good here Now, on your balance sheet, suppose plan assets stay the same. When interest/service costs increase, the FULL amount (not an after tax amt) increases your PBO. What is the remaining offsetting entry for the service/interest costs*tax rate? In this question, they apply the after tax costs to an increase the PBO (the liability). I don’t think Schweser explains the treatment of PBO with taxes. Thanks
the explanation of PBO with taxes is so last year’s LOS. This was the exact same question posted on another thread. They used to take off / add to DTL. So in this case the 5.2 would go to DTL (13-7.8). And in normal circumstances - given that if the DTL has a good chance of never reversing - we adjust it by removing it from Liabs, and adding it to Equity - it would have nicely flowed into Equity.
Sorry CPK, I have 8 pages of analystforum to catch up on so I missed this. Thanks very much for your help, as always.
cpk, i dont have book 2 with me now, but in the fsa stuff on adjusting financial statements, i remember reading something about having to adjust the DTA/DTL for a pension inc or dec. so is all of that irrelevant for this yr? or is it still relevant under ifrs?