 Hello and welcome to this session. This is Professor Farhad in which we would look at a CPA simulation that deals with pension expense This CPA simulation could also you could also see it and in your intermediate accounting textbook So basically what we need to do we need to compute five things prior service cost prior service cost Amortization service cost interest cost and most importantly pension Expand now instead of giving you this as a simulation I can ask you literally 20 multiple choice questions about the information that's given here what I'm trying to say is this a Simulation is no more than multiple choice questions all combined together and the multiple choice is no more than a simulation Framed difference all what they are so the key is you have to understand the topic that you are being given That's why I'm gonna advise you to check out my website for hat lectures calm where I teach about Pension so when you go into the exam you have to understand pension the CPA review course Don't teach you the material the CPA review course Reviews with you the material they assume you know it and we are ready to review it in contrast the farhat lectures calm Where I teach you the material? By the time you're done with my lectures with my practice exercises You will be ready to take full advantage of your backer Roger Wiley and climb I can't replace those all what I can do is I can help you make the more beneficial for you by increasing your grade 10 to 15 points as always I would like to remind you to connect with me on LinkedIn and subscribe to my YouTube channel and obviously my Website I always ask you also to please like my recording and share them if they benefit you It means they might benefit other people Let's go ahead and get started with this problem There's a lot of information in this problem The first thing is you do is you just get an overall picture overall picture what they're asking you okay? JJ defined benefit pension plans specify annual retirement benefit equal to 1.6 times the service years Times the final year salary payable at the end of each year We have one individual Maggie was hired by J&J at the beginning of 2007 and expected to retire At the end of 2041 after 35 years of service her retirement is expected to spend 18 years Maggie's salary is 99,000 at the end of 2021 and The company actually projects her salary to be 325 at retirement the actually discount rate is 9% At the beginning of 2022 The pension formula was amended to 1.8 times service years times final years of service Immended means change and it seems they increase the increase the rate It could be that the company is making more money. They would like to Go ahead and give their employees a push a push up in their retirement The amendment was retroactive to apply to the increased benefit to prior years. Let me tell you this There's a lot of information here a lot of information in this problem The first thing they want you to compute is the prior service cost So here's what I'm gonna do. I'm gonna try to draw a picture of what's going on here. So this way you understand you have to kind of Understand the big picture if you don't understand the big picture, then you will find harder time Answering the questions. First of all, Maggie was hired in 2007. So if this is 2007 we have 2007 and she worked from 2007 all the way to 2020-21 to year 20 21 At the beginning of 2022. So this is year 20 22 so she worked all these years and something happened here They decided to go back and amend the plan which is good for Maggie. So simply put She worked all those years and all those years are 15 Years so she worked all those years and suddenly her company says guess what we are going to increase Your pension payment when you retire. That's great. That's a great So the first thing they ask us is what is the prior service cost simply put when you increase? Maggie's benefit the company will have more obligation and that's what they're asking you about What is the what is the company prior service cost at the beginning of 2021? They're asking us right here What's the prior service cost at at the beginning of 2021? So let's go ahead and compute this number first okay, then We will go ahead and answer the other question. So let's go ahead and compute the number first Here's what's gonna happen. We're gonna look at the old PBO for Maggie and at the amended PBO for Maggie and the difference between them is the new Service cost. I'm sorry another new service cost the prior service costs. We're gonna have to compute the new service cost Okay, so what are we looking at the old paint the old plan header 8 of 1.6? So this is how we compute the payment 1.6. This is the old plan times 15 years, so this is the 15 years that she worked from 2007. So we're we're looking at Those 15 years those 15 years right here. Those are the 15 years because we're gonna have many years We have to know which years are we doing? so supposedly Based on the old amendment the payment is 78,000 now. What's gonna happen is this we need to find What is the present value of those payment? Well, we're gonna take 78,000 times the present value factor Now, how do we compute the present value factor? That's another important computation. Well, what's gonna happen is this? We're gonna have to pay Maggie 78,000 when do we pay the 78,000? Well, let me tell you when do we pay the 78,000? We're gonna pay this 78,000 remember. This is 2021 2022. No life will keep on going until 20 41 when she retires 2041 at the end of 2041 she retires here after retirement. We expect Maggie to live for Let me go back. We expect Maggie to live for 18 years Or at least that's what we're responsible for paying her. We think she's gonna live for 18 years Therefore what's gonna happen in those 18 years and every year based on the old plan? We would have to paid her 78,000 therefore we're gonna take 78,000 78,000 times eight point seven five six six three Therefore we have to have for Maggie at the end of 20. This is the number end of 2041 when she retired we have to have this amount of money ready Assigned to Maggie why because this money it's gonna pay Maggie for the next 18 years 78,000 a year, but this is we need this number at the end of 2041 Well, we need to record the obligation today if we need to record the obligation today We need to find the present value of this amount the present value of this amount is the present value of one payment So we need to find the present value of one payment. So notice The present value of the annuity so notice why did we use n equal to 18 for this figure? Because because Maggie Would need 18 years if she's gonna live 18 years Therefore we have to find the present value of those 18 years now Why did we use the present value using n equal to 20 for the 682,000 939 because we need to record the obligation today How much is Maggie's obligation today today? We need to record the liability for Maggie. Well, we're gonna discount so simply put we're gonna discount the 682 at 20 years because she still have 20 years to work 20 years to work how 20 years and I keep going back and forth now. We have to go back from 2041 all the way Till the end of 2021 or the beginning of 2022 this period is 20 years So notice you have 15 years You have 18 years after retirement and you have 20 years So you have a lot of years being thrown around so after we find our obligation at year 2041 we discount the obligation. So this is we discount the obligation till today So today what we need to have we need to have 100 a liability of 121,857 this liability. Let me show you. Let me just walk you through it again this liability after After 20 years will grow to be 682,000 939 then after that we'll be able to pay Maggie 78,000 78,000 for the next for the next 18 years for the next 18 years thus completing our commitment completing our commitment means Paying off our liability for Maggie which will be 78,000 per year. Okay, so this is the big picture now Now we need to compare this to We need to compare this to the new plan. So this is based on the old plan now We need to do the same computation Assuming Assuming 1.8 1.8 percent again. We're gonna do we're gonna do the same thing We're gonna go back and assume that the that the benefit rate was 1.8 times 15 percent that you were between 2007 till 2021. Let me kind of 2007 to 2021 times her final salary expected now We are responsible to pay Maggie rather than 78 87,750 Maggie is gonna be very happy with that news now We're gonna have to do the same thing. How much are we responsible for at the end of 2041? We are responsible for now 768,307 this is the number that we need to have end of 2041 when Maggie retired well if that's the number if that's our liability How much is the liability today because we need to discount it till today We discounted till today and we find out that using the same rate that 20 and the you know This is for the 18 and this is the 20 and this is an annuity and This is a single single payment factor 137 137 $189 now we can find what is our prior period prior service Prior service cost. It's the difference between those two notice our prior service cost is the difference between the old plan and The new plan therefore the prior service cost is 14,232 simply put we have to increase our obligation by 14,232 as a result of this change as a result of this change How did we find out that while we compare the old plan how much our obligation will be for Maggie? Today versus the new plan and it's 137 89 therefore we answered question one Okay, since the amendment occur at the beginning of 2021 Amortization of the prior year cost begin in 2022 Excellent. What is the prior service cost amortization that would be included in pension expense now? The question is what do we do with this 14,232? Do we make it hit pension expense immediately and the answer is no What do we do with the prior service cost listen to me carefully? We amortize it We amortize it over the remaining life Expected life of Maggie working at our company Maggie is expected to work from 2021 From 2021 to 2041. She's expected to work 20 years. Therefore. We're gonna do we're gonna take this amount and divided by 20 years the expected remaining life and we're gonna amortize every year $762 of this amount into pension expense So this is gonna increase our pension expense every year by 762 we don't hit pension expense by the full amount. We're gonna amortize it spread it out equally So hopefully you understand this big picture The third question. It's what's the service cost for year 2022? What's the service cost the service cost is How much Maggie because she worked an additional year remember we amended the plan we amended the plan at the beginning At the beginning of 2022 now she worked 2022 and when she worked 2022 One additional year our our service cost will go up Well, we have to use the new rate the new rate is this 1.8 That's the new benefit rate times one which is one year times her expected future salary 325,000 therefore the service cost Is expected to be 5,858 now what we're gonna do this is how much the service cost Is this is what the service cost but when when are we gonna need this money? Well, we're gonna need this money How many years from now? 18 years 18 years from now 18 years from now. Well, what's gonna happen is we're gonna Compute okay What's 18 years how much he's gonna live so basically for because she worked like let me put for you this way Because she worked for us year 2022 because she worked for us year 2022 After After she retired because of that of that year we're responsible for that particular year For responsible for 51,222 we have to have this amount available because look she's after this think of 2041 Because she worked that year for us because she worked that year for us Okay, because that for that i'm computing the service cost for only one year. So this is 2041 After 2041 remember we pay we make 18 payments for her because she worked that year We're that year included an additional 5850 which is for 18 years the present value of those we need to have for that year 51,220 Well 51,220 that's we need this amount at year 2041 What's the present value of this amount today the present value of this amount today is 9,962 9,962 now, how do we compute 9,962 we discounted based on 19 years Hold on a second. This is really confusing. Why am I using 19 years? Because After she worked here 2022 What she have left till till 2040 one is only 19 years therefore We discount the present value back only 19 years. That's why we're using now 19 years What do we use by the end of 2023 when we do this discount? We use 18 years So one and so forth. Okay, because now we are looking at the discount from 2041 back to 2022, which is 19 years. Therefore the service cost is 9,962 now I know this is a little bit confusing once again if you have any questions about this particular problem email me But I'm trying you have to understand the picture or go to my website and this is what I explained This is a little bit further. What is the interest cost for year 2022 with respect to Maggie? Now, how do you compute the uh interest cost well the interest cost it's the beginning PBO Times the rate well, we have to know what's the beginning PBO the beginning means not the ending PBO beginning means a forelooking for 20 For year 2022. We have to look at the beginning of the year. How much was the PBO times? The rate how much was the beginning PBO? Well, the beginning PBO is 137 $137,089. Okay, this is the beginning of the year PBO. We already did this computation Therefore, we're going to take this amount times 9 and this is going to give us interest cost and interest cost as part of pension expense, which is they ask us to compute compute the pension expense for 2022 with respect to Maggie Assuming a plant asset a tree a tree able to her is 150,000 And rate of return. What's the rate of return here? That's that's interesting. I don't have the rate of return And assume the rate of return. Let's assume I don't know. I don't know what the rate of return is. Let's assume. I think it's 10% Okay, let's take a look at how we compute now the pension expense The pension expense is composed of the current service year cost. So this number here This is part of the pension expense your service year cost interest cost This number here the interest cost is part of the pension expense formula then Return on plant asset because she has assets in her in her retirement account 150 and those assets earned Were expected to earn 10% Therefore as a result We're going to reduce the pension expense by 15,000 because her assets are working for her Therefore, it's going to reduce the pension expense Then we're going to amortize the $762. You remember because we amended the plan now every year we add 762 Therefore the pension expense is 8,000 and 62 dollars. So that's the current pension expense that goes on the income statement So I understand this problem Is challenging this problem is not easy But if you can understand this problem, then you would you have a basic I would not say you're good for pension because pensions we did not do any journal entries We did not deal with the OCI accounters many things I did not deal with in this session because I will overwhelm you So all all what I did is ask you to do the basic computation for the numbers Now i'm sure I will have another simulation that deals with journal entries But if you want to learn more about this topic go to farhatlectures.com Subscribe to my CPA supplemental material if you're an intermediate accounting students Subscribe to my intermediate accounting. It doesn't really matter. 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