Natalie Holmstead, a senior portfolio manager, works with Daniel Rickards, a junior analyst. Together they are evaluating the financial statements of Company XYZ (XYZ) with a focus on post-employment benefits. XYZ has a defined benefit pension plan and prepares financial statements according to IFRS requirements. Rickards calculates the current service cost for a single employee’s defined benefit pension obligation using the projected unit credit method. The employee is expected to work for 7 years before retiring and has 15 years of vested service. Rickards assumes a discount rate of 4.00% and a lump sum value of the employee’s benefit at retirement of $393,949.

Next, Holmstead and Rickards discuss the present value of the defined benefit obligation (PVDBO). Rickards makes the following statements to clarify his understanding:

Statement 1 An increase in the PVDBO will result in an actuarial loss for the company.

Statement 2 The PVDBO measures the present value of future benefits earned by plan participants and includes plan assets.

Statement 3 The company should use the expected long-term rate of return on plan assets as the discount rate to calculate the PVDBO.

XYZ’s pension plan offers benefits based on the employee’s final year’s salary.

Rickards calculates the PVDBO as of the end of the current period, based on the information presented in Exhibit 1. 

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Exhibit 1 Select XYZ Defined Benefit Pension Plan Data Assumed future compensation growth rate Plan assets (in $ millions) Current Period 2.5% 3,108 Prior Period 3.0% Exhibit 1 (Continued) Net pension liability (in $ millions) Present value of reductions of future contributions (in $ millions) Current Period 525 48 Rickards adjusts the balance sheet and cash flow statement information presented in Exhibit 2 to better reflect the economic nature of certain items related to the pen- sion plan. Item Total assets Total liabilities Total equity Exhibit 2 Select XYZ Balance Sheet and Cash Flow Data (in $ millions) Total pension cost Pension contribution Financing cash flow Operating cash flow Effective tax rate Current Period 24,130 17,560 6,570 Prior Period 96 66 2,323 -1,087 30% Finally, Rickards examines the data in Exhibit 3 and calculates the effect of a 100-basis-point increase in health care inflation on XYZ s debt-to-equity ratio. Exhibit 3 Sensitivity of Accumulated Post-Employment Benefit Obligations to Changes in Assumed Health Care Inflation (in $ millions) 100-bp Increase 100-bp Decrease Item Benefit obligation change Benefit expense change $93 $12 26 The current service cost is closest to: A $14,152. B $15,758.. ( $17,907. 27 Which of Rickards s statements about the PVDBO is correct? A Statement 1 B Statement 2 -$76 -$10 C Statement 3 28 Based on Exhibit 1, the PVDBO is closest to: A $3,585 million. B $3,633 million. ( $3,681 million. 29 Based on Exhibit 1 and the method XYZ uses to link pension benefits to salaries, the change in the compensation growth rate compared with the prior period will most likely result in: A lower periodic pension cost. B no change in the periodic pension cost. (higher periodic pension cost. 30 Based on the change in the assumed future compensation growth rate pre- sented in Exhibit 1, which of the following pension cost components is affected? A Service cost B Remeasurement (Net interest expense/income 31 Based on Exhibit 2, Rickards should adjust the operating and financing cash flows by: A $21 million. B $30 million. ( $96 million. 32 Based on Exhibits 2 and 3, as well as Holmstead s assumption about future health care inflation, the debt-to-equity ratio calculated by Rickards for XYZ should be closest to: A 2.69. B 2.71. ( 2.73. Exhibit 1 Select XYZ Defined Benefit Pension Plan Data Assumed future compensation growth rate Plan assets (in $ millions) Current Period 2.5% 3,108 Prior Period 3.0% Exhibit 1 (Continued) Net pension liability (in $ millions) Present value of reductions of future contributions (in $ millions) Current Period 525 48 Rickards adjusts the balance sheet and cash flow statement information presented in Exhibit 2 to better reflect the economic nature of certain items related to the pen- sion plan. Item Total assets Total liabilities Total equity Exhibit 2 Select XYZ Balance Sheet and Cash Flow Data (in $ millions) Total pension cost Pension contribution Financing cash flow Operating cash flow Effective tax rate Current Period 24,130 17,560 6,570 Prior Period 96 66 2,323 -1,087 30% Finally, Rickards examines the data in Exhibit 3 and calculates the effect of a 100-basis-point increase in health care inflation on XYZ s debt-to-equity ratio. Exhibit 3 Sensitivity of Accumulated Post-Employment Benefit Obligations to Changes in Assumed Health Care Inflation (in $ millions) 100-bp Increase 100-bp Decrease Item Benefit obligation change Benefit expense change $93 $12 26 The current service cost is closest to: A $14,152. B $15,758.. ( $17,907. 27 Which of Rickards s statements about the PVDBO is correct? A Statement 1 B Statement 2 -$76 -$10 C Statement 3 28 Based on Exhibit 1, the PVDBO is closest to: A $3,585 million. B $3,633 million. ( $3,681 million. 29 Based on Exhibit 1 and the method XYZ uses to link pension benefits to salaries, the change in the compensation growth rate compared with the prior period will most likely result in: A lower periodic pension cost. B no change in the periodic pension cost. (higher periodic pension cost. 30 Based on the change in the assumed future compensation growth rate pre- sented in Exhibit 1, which of the following pension cost components is affected? A Service cost B Remeasurement (Net interest expense/income 31 Based on Exhibit 2, Rickards should adjust the operating and financing cash flows by: A $21 million. B $30 million. ( $96 million. 32 Based on Exhibits 2 and 3, as well as Holmstead s assumption about future health care inflation, the debt-to-equity ratio calculated by Rickards for XYZ should be closest to: A 2.69. B 2.71. ( 2.73.

Answer rating: 100% (QA)

26 The current service cost is closest to A 14152 B 15758 C 17907 Answer A is correct The current service cost is the present value of the annual unit credit earned in the current period Annual unit c... View the full answer