Page 44 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

Presentation
READING 14: INTERCORPORATE INVESTMENTS

U.S. GAAP: All components of periodic pension cost that are
reported in the income statement are aggregated and MODULE 15.4: DEFINED BENEFIT PLANS, PART 2—PERIODIC COST EXAMPLE
presented as a single line item.

IFRS: Components may be presented separately.

Both require disclosure of total periodic pension cost in the notes to financial statements.

Capitalizing Pension Costs
Pension costs included in the cost of production of goods (e.g., labor costs included in the value of work-in-process or finished goods) may
be capitalized as part of valuation of ending inventory. When this inventory is eventually sold, such costs are expensed as a component of
cost of goods sold.

NOTE: Key to understanding this reading is to avoid confusing these two measures: 1) periodic pension cost in the income statement (i.e., reported pension
expense) and 2) TPPC.

Reported pension expense: LOS 15.d: Explain and calculate the effect of a defined benefit plan’s
• is what we report in the income statement. assumptions on the defined benefit obligation and periodic pension
• uses EXPECTED return on plan assets. cost. – 3 assumptions must be disclosed!
• is computed differently depending on whether we’re using IFRS or US GAAP.
1. Discount rate : interest rate used to compute the present value of the
Total periodic pension cost (TPPC): benefit obligation and the current service cost component of periodic
• is the true (i.e., economic) cost of the pension plan. pension cost. It is not the risk-free rate, but based on interest rates of high
• does not change depending on the accounting system chosen. quality fixed income investments with a maturity profile similar to the future
• uses ACTUAL return on plan assets. obligation. Its affects the PBO as well as periodic pension cost.

2. Rate of compensation growth: the average annual rate by which
employee compensation is expected to increase over time. It affects both
the PBO and periodic pension cost.

3. Expected return on plan assets: the assumed long-term rate of return on
the plan’s investments. Recall it reduces periodic pension cost in P&L and
the differences between the expected return and actual return are deferred.
Also, recall that it is assumed only under U.S. GAAP. Under IFRS, it is
always equal to the discount rate.