Question

Clark Industries has a defined benefit pension plan that specifies annual retirement benefits equal to:

1.5% × Service years × Final year’s salary

Stanley Mills was hired by Clark at the beginning of 1997. Mills is expected to retire at the end of 2041 after 45 years of service. His retirement is expected to span 15 years. At the end of 2016, 20 years after being hired, his salary is $90,000. The company’s actuary projects Mills’s salary to be $370,000 at retirement. The actuary’s discount rate is 6%. Required: 1.) Estimate the amount of Stanley Mills’s annual retirement payments for the 15 retirement years earned as of the end of 2016. 2.) Suppose Clark’s pension plan permits a lump-sum payment at retirement in lieu of annuity payments. Determine the lump-sum equivalent as the present value as of the retirement date of annuity payments during the retirement period. 3.) What is the company’s projected benefit obligation at the end of 2016 with respect to Stanley Mills? 4.) Even though pension accounting centers on the PBO calculation, the ABO still must be disclosed in the pension disclosure note. What is the company’s accumulated benefit obligation at the end of 2016 with respect to Stanley Mills? 5.) If we assume no estimates change in the meantime, what is the company’s projected benefit obligation at the end of 2017 with respect to Stanley Mills? 6.) What portion of the 2017 increase in the PBO is attributable to 2017 service (the service cost component of pension expense) and to accrued interest (the interest cost component of pension expense)?

Answer 1

1.  Estimate the amount of Stanley Mills’s annual retirement payments for the 15 retirement years earned as of the end of 2016.

= 1.5% x Service years x Final year's salary

= 1.5% x 20 x 3,70,000

= 1,11,000

2.  Suppose Clark’s pension plan permits a lump-sum payment at retirement in lieu of annuity payments. Determine the lump-sum equivalent as the present value as of the retirement date of annuity payments during the retirement period.

Annual retirement benefit 1,11,000

Present value of an ordinary annuity (n=15, i = 6%) 9.71225

Present value o the retirement benefit's at the end of 2041 10,78,060

3.  What is the company’s projected benefit obligation at the end of 2016 with respect to Stanley Mills

Present value of retirement benefit at the end of 2016 10,78,060

Present value of an ordinary annuity (n=20, i = 6%) 0.31180

Project benefit obligation 3,36,140

4. Even though pension accounting centers on the PBO calculation, the ABO still must be disclosed in the pension disclosure note. What is the company’s accumulated benefit obligation at the end of 2016 with respect to Stanley Mills.

Salary at the end of 2016 90,000

Pension benefit at the end of 2016 = 1.5% x 20 x 90,000 = 27,000

present value of annuity end of 2016 = 27,000 x 9.71225 = 2,62,231

Accumulated benefit obligation = 2,62,231 x 0.31180 = 81,764

5.  If we assume no estimates change in the meantime, what is the company’s projected benefit obligation at the end of 2017 with respect to Stanley Mills.

Retirement salary = 3,70,000

Retirement benefit payment = 1.5% x 21 x 3,70,000 = 1,16,550

Present value of retirement annuity at the end of = 1,16,550 x 9.71225 = 11,31,963

Project benefit obligation = 11,31,963 x 0.31180 = 3,52,946

6. What portion of the 2017 increase in the PBO is attributable to 2017 service (the service cost component of pension expense) and to accrued interest (the interest cost component of pension expense)

PBO at the end of 2017 3,52,946

PBO at the end of 2016 (3,36,140)

Change in PBO 16,806

Less:Interest cost (3,36,140 x 6%) ( 20,168)

Service cost (3362)