ThechoiceofinventoIymethodaffbctsthefinancia>statementsandanyfinancialratiosthatarebasedonthem.Asaconsequence,theanaIystmustcaefUIIycosideinventoIyvaluationmethoddiffbrenceswhenevaIuatingacompany,sperfbrmanceovertimeorincompansontoindustlydataorindustyandcostofgoodssoldbalancestotheFIFOmethodfbrcompansonpuIposes.

LIOliquidationoccurswhenthenumberofunitsinendinginventoIydeclinesfiomthenumberofunitsthatwerepsentatthebeginningoftheyear.IfinventounitcostshavegenerallyrisenfiDmyeartoyear,thiswiI>produceaninventory-relatedincreaseingrossprofits.

ConsistencyofinventorycostingisrequiredunderbothlFRSandUSGAAP.lfacompanychangesanaccountingpolicy,thechangemustbejustifiableandappliedretrospective>ytothefinancia>statements.AnexceptiontotheretrospectiverestatementiswhenacompanyreportingunderUSGAAPchangestotheLIOmethod.

InventonesaemeasuredattheowerofcostandnetrealisablevalueunderRSandthelowerofcostandmarketunderUSGAAP.Anywrite-downofinventoIytonetrealisablevalueormarketreducesthecaIyingamountofinventoIyonthebalancesheetandprofitontheincomestatement.

Reversa>sofinventorywrite-downsmayoccurunderIFRSbutarenotaI>owedunderUSGAAP.

ChangesinthecarryingamountswithininventoIyclassifications(suchasrawmaterials,work-in-process,andfinishedgoods)mayprovidesignalsaboutacompany,sfhturesalcsandprofits.Re>evantinfbrmationwithrespecttoinventoIymanagementandftlturesalesmaybefbundintheManagementDiscussionandAnalysisorsimilaritemswithintheannua>orquarterlyrepoIts,industIynewsandpublicationsandindustIyeconomicdata.

InventoIymanagementmayhaveasubstantialimpactonacompany,sactivity,profitabiIity,Iiquidity,andsolvencyatios.tisciticaIfbrtheanaysttobeawaeofindustrytrendsaIdmanagement,sintentions.

PacticePbIems

CoIrigh

41

accodancewithUSGAAPPackardisparticuIarIyinteestedmtheeffbctsofthecompany,sIlenheIIFOmethodtoaccountfbritsinventory.Forthispurpose,MartinsoncollectstheuseoftheLIFOmethodtoaccountfbritsinventoryfmancialdatapreseHtedinExhibits>and2.

ExhibitlBlceSheetInfOmti0nUSMii0nS

AS0f31December 2009Z008

CashandcashequivaIents>72Accountsreceivable 626

Inventones 620

Othercurrentassets l25

TotalcuITentassets >,543

PropeItyandequipment,net 3,035T0tMssetS 4,578

TotaIcurrentiabiitiesl,g5

644Long-tenndebt Totalliabi>ities 2,l3g

Commonstockandpaidincapital>,652787Retainedeamings

Totalshareho>ders,equity2,13g

TotlliabiIitieSHdSMeh0lderS,equity4,578-

Exhibit2IC0meSttementInfbrmioUSMii0S

l57

458

539

65

l,2l9

Z,g72

4,l9l--

l,395

601

l,g9gI

>,652

540

2lg2

,l9l-

F0theYemEnded31Decembe 2009Z008

Sales

CostofgoodssoId

Depreciationandamoisationexpense

Selling,geneaI,andadministrativeexpense

Interestexpense

Incometaxexpense

Netincome

4,346

2,2ll

l3g

l656

3l

62

27

,l6l

2,l47

llg

l,637

l8

48

l92

Martinsonfindsthefbllowinginfbnnationinthenotestothefinancialstatements

TheLIOIcservesasof3lDecember2009and2008are$l55mil>ionand$ll7mi>lionespectively,and

TheeffbctiveincometaxrateapplicabletoKarpfbr200gandeaIierperiodsis20percent.

1IfKarphadusedFIFOinsteadofLIFO,theamountofinventoIrepoItedasof3lDecember2009wouldhavebeenc/bses/to:

A$465million

B658million.

C$775mil>ion

2IfKarphadusedFIFOinsteadofLIFO,theamountofcostofgoodsso>dreportedbyKarpfbrtheyearended3lDecember2009wouldhavebeencbssto:

A2,056miion

B2,l73million.

C2249million

3IfKarphadusedFIFOinsteadofLFO,itseportednetincomefbrtheyearended3lDecember2009wouldhavebeenhigherbyanamountcbes

A$30mi>Iion

B$38mi>lion.

C$l55million

1IfKarphadusedFIFOinsteadofLIFO,Kap,sretainedeamingsasof3lDecember2009wouldhavebeenhighebyanamountcbseso:

All7million

B24milion

C$l55milIion

5lfKarphadusedFIFOinsteadofLIFO,whichofthefbllowingratioscomputedasof3lDecember2009wouldosyhavebeenlower?

ACashratio.

BCurrentatio

CGrossprofitmargin

6IfKarphadusedFIFOinsteadofLIFO,itsdebttoequityratiocomputedasof3lDecember200gwouldhave:

Aincreased.

Bdecreased

Cemainedunchanged 15

ThefoowinginfmationelatestoQuestions7122

RobetGroanequityanalystispreparingaeportonCruxCorp.Aspartofhisreport,GroffmakesacomparativefinancialanalysisbetweenCruxanditstwomaincompetitors,RolbyCorpandMikkoIncCmxandMikkorepoItunderUSGAAPandRolbyreportsunderIFRS.

GroffgathersinfbrmationonCmx,Rolby,andMikkoTherelevantfinancialinfbrmationhecompiIesisinExhibit1SomeinfbrmationontheindustIyisinExhibit2.

Exhnbit1SelectedFinancilIfbmti0nUSMilli0ns

R0lby Mikk0Crux

LIOFIFOLIOInventoIyvaluationmethodF0mtheBlanceSheets

As0f31DecemberZ009

InventoIy,gross

Valuationallowance

InventoIy,net

Tota>debt

TotaIshareholders,equityAs0f31DecemberZ008

InventoIy,gross

VaIuationallowance

lnventoIy,net

4806205l0

2025l4-

4605951g6

l,l22850732

2,5432,032,0gl

46560240l

23l5l2

14258738g

FmmtheInC0meStatementS

YeEnded31DecemberZ009

Revenues

Costofgoodssold

Netincome

3503

Z,550

205

5,442

3,782

327

1,60g

3,l20

229

l5l5l

Chargesincludedincostofgoodsso>dfbrinventoIywrite-downs*

*Thisdoesnotmatchthechangeil>t>leiIIcnua{ionallowanceisIeducedofecMhevaluaionlIowanceattachedoiemssoldandincasedfbraddiionalnecessaIywiedows.

LOResee-

Asof3>December200g

Asof3lDecembe2008

77

50

0055

72

46

3Asof3lDecember2007g6 0

TxRHte

Effectivetaxrate 30%30%30%

Exhibit2.InduStyInf0mati0n

Z0092008Z007

l00

l00

l05

l06

Rawmaterialspriceindex

FinishedgoOdspriceindex

24llll

Tocomparethefinancia>perfbnnanceofthethreecompanies,GroffdecidestoconvertLIOfiguresintoFOfigures,andadjustfigustoassumenovaluationallowanceisrecognizedbyanycompany.

AIerreadingGrofPsdraHreport,hissupervisor,RachelBorghi,askshimthefb>>owingquestions:

QuestionlWhichcompany,sgrossprofitmaIginwouldbeStref>ectcurrentcostsoftheindustIy?

WouIdRolby,svaIuationmethodshowahighergossprofitmaginthanCrux,sunderaninf>ationaIyadef>ationaIy,orastablepIicescenario?

OuestionZ

Question3WhichgroupofratiosusualIyappearsmorefhvorabIewithaninventolywrite-down?

7.Crux,sinventoIytumoverratiocomputedasof3lDecemberZ00gaertheadjustmentssuggestedbyGroff;iscm$es/to:

A5.67

B5.83

C6.l3

8.Roby,snetprofitmarginfbrtheyearended3lDecembe200g,affertheadustmentssuggestedbyGroff;iscm$es/to:

A6.0l%.

B620%

C6.28%.17

48

usteddebt-to-equityratio,Mikko,sdebt-to-equityratioasof3>9.ComparedwithitsunausteddebttoequityratoM!kkosdDecember2009,affertheaqustmentssuggestedbyGroff;is:

A>ower.

Bhigher.

Cthesame.

10Thebes/answertoBorghi,sQuestionlis:

ACrux,S.

BRolbys.

CMikko,S.

11Thebes!answertoBorghi,sQuestion2isl

AStable.

BInf>ationaIy.

CDefationay.

I2.ThebesanswetoBorgbi,sOuestion3is

AActivityratios.

BSolvencyratios.

CProfitabi>ityratios

ThefOowinginfOmatinelatestoQuestions13203

ZPCorporationisa(hypothetical)muItinationaIcorporationheadquarteredinJapanthattradesonnumerousstockexchangesZPpreparesitsconsolidatedfinanciaIstatementsinaccordancewithUSGAAP.ExcerptsfibmZP,s200gannualreportareshowninExhibitsl-3.

Exhibitl.C0nS0idtedBCeSheetSMii0nS

31Decembe

CurrentASSetS

CashandcashequivaIents

Inventones

Tota>cunFentassets

2008 2009

512,8498l,760

608,572 186,465

1,028,7423,766,30g

iabiIities

2008 Z00,

--

10,819,409,687,316

3,g80,2473,52g,765

Total>ong-term>iabi>ities

Minorityinterestinconso>idatedsubsidiariesTotalshareho>ders,equity

T0mlIbilitiesHndShareh0lders,equity

2,663795

2l8,889

3,956509

10,819,0

2,624,002

l7g,813

3353,736

,,687,36

ExhibitZC0S0IidtedStatementS0fIC0meMi0nS

F0theyesended31December Z007 Z008 Z009

Netreenues

Salesofproducts

Financingoperations

C0stnndexpenSes

Costofproductssold

Costoffinancingoperations

Se>ling,genera>andadministrative

Opertinginc0mel0ss

NeMnc0me

7,556,69g8,273,5036,3gl,240

425,gg8489,57745l,950=

7,982,6g78,763,0806,813,lg0

6,ll8,742

2g0,7l3

827,005

746,237

68l76

356,005

832,837

5,822,805

329,l28

844,927

756,792-l53,670

-

5480ll572,62645,66

Exhibit3SeeCtCdD!SCl0SreSi1theZ009Aml!Re0.t

Mnagement,sDiScussi0lHndAalysis0fFinmcilC0lditi0MmdResu>ts0fOperations

CostreductioneffbrtsweoffSetbyincreasedpIicesofrawmaterials,otherproductionmaterialsandparts...Inventoriesdecreasedduringfiscal200gbyl221bilion,orZ0l,to86.5biIion.Thisrefectstheimpactsofdecreasedsalesvolumesandf>uctuationsinfbreigncurrencytrans>ationrates.

1g

50

ManagementC0p0rateInmati0n

RiskFactors

Thewor>dwidemarketfbrourproductsishighlycompetitive.ZPfacesintensecompetitionfiFomothermanufacturersintherespectivemarketsinwhichitoperates.Competitionhasintensifiedduetothewor>dwidedeterioIntionineconomicconditions.Inaddition,competitionislikelytofU>therintensifybecauseofcontinuingg>ObalizationpossiblyresultinginindustyoIganizationFactorsaffbctingcompetitionincudeproductqua>ityandfbatures,theamountoftimerequiredfbrinnovationanddevelopmentpricing,reliability,safCty,economyinuse,cuStomerserviceandfinancingtenns.Increasedcompetitionmay>eadtolowerunitsaIesandexcessproductioncapacityandexcessinventoIy.Thismayresu>tinafhrtherdownwaIdpricepressure.

ZP,sabi>itytoadequate>yrespondtotherecentrapidchangesintheindustIyandtomaintainitscompetitivenesswillbefilndamentaltoitsfUturesuccessinmaintainingandexpandingitsmaketshareinexistingandnewmarkets.

N0test0C0ns0lidtedFinancialStatements

2Summy0fSngncntcc0ntingp0les:

Invent0riesInventonesarevaluedatcostnotinexcessofmarket.Cost

isdeteminedontheaveragecosf,basis,exceptfbrthecostoffinishedproductscarriedbycertainsubsidiarycompanieswhichisdeterminedIastin,firstoutLO,,basisInvetonesvaIuedontheLIFObasistotaledg4,578milionand50,037miIionatDecember3l,2008and2009respectiveIy.Hadthefirst-in,first-out,,basisbeenusedfbrthosecompaniesusingtheLIFObasis,inventorleswouIdhavebeen0,20miIlionandg660miIIionhighethanepotedatDecember3l2008and200g,respective>y.

9InVeIt0ries:

Inventoriesconsistofthefbl>owing

31DecemberMii0sZ008

Finishedgoods

Rawmaterials

Workinprocess

Supp!iesandothe

403,856

99,869

7g,g7g

24868

608,572

2009

29l,977

85,966

83,890

2,6320

186,465

l3TheMDAindicatedthatthepicesofawmateiaI,otherproductionmaterials,andpaItsincreasedBasedontheinventoIyvaluationmethodsdescribedinNote2,whichinventorycassificationwouIdmccmIfectcurrentprices?

M

ARawmateIiaIs.

BFinishedgoods.

CWoIkinprocess

The2008inventoIyvalueasreportedonthe200gAnnuaIRepoItifthecompanyhadusedtheFIOinventoIyvaluationmethodinsteadoftheLIOinventoIyvaluationmethodfbraportionofitsinventorywouldbec/bses/to:

Al04,6g8milion.

B506,l25milion.

C6l8,6g2million.

l5WhatisthebrkclcasonwhyZPmayneedtochangeitsaccountingpoliciesregardinginventoIyatsomepointaher2009?

ATheUSSECisikelytorequirecompaniestousethesameinventoIyvaluationmethodralinventones.

BTheUSSECis>ikelytoprohibittheuseofoneofthemethodsZPcurrentlyusesfbrinventoIyvaluation

COneoftheinventoIyvaIuationmethodsusedfbrUStaxpurposesmayberepealedasanacceptablemethod.

16IfZPhadprepareditsfinancialstatementinaccordancewithIFRS,theinventoower.

Bhigher.

Cthesame.

l7InventoIyevesdecreasedom2008to200gfbraofthefbIlowingreasonsexcP:

ALIOliquidahon

BdecreasedsaIesvo>ume.

CfucmationsinfbeigncurencytransIationrates.

l8WhichobservationisosaresuItoflookingonIyattheinfbrmationreportedinNoteg?

AIncreasedcompetitionhasedtoIowerunitsales51

5Z

BTherehavebeensignificantphceincreasesinsuppIies

CManagementexpectsafimherdowntuminsaIesduring20l0.

l9Note2indicatesthat,InventonesvaluedontheLObasistotaledg4,578millionand50037millionatDecember3l,2008and200grespectivey.,,Basedonthis,theLlFOreserveshouldos:

Aincrease.

Bdecrease.

Cremainthesame

Z0.TheIndustryandBusinessRiskexcerptstatesthatIncreasedcompetitionmayleadtolowerunitsa>esandexcessproductioncapacityandexcessinventory.Thismayresu>tinafilrtherdownwardpricepressure.,,ThedownwardpricepressurecouldleadtoinventoIythatisvaluedabovecurrentmarketpricesornetrea>isab>evalue.Anywrite-downsofinventoryarebetohaveasignificanteffbctontheinventoryvaluedusing:

Aweightedaveragecost.

B.firstin,firstoutO.

C.lasbin,firstoutO

SoIutins

1Ciscorrect.Karp,sinventoryunderFIOequalsKarp,sinventoryunderLIOpIustheLIFOreserve.Therefbre,asof3lDecember200gKarp,sinventoIyunderFIFOequa>s

InventoIy(FIFOmethod)=InventoIion+l55million

=$775mi>lion

2.BiscorrectKarp,scostofgoodssold(COGS)underFIOequa>sKarp,scostofgoodssoldunderLIOminustheincreaseintheLIOreserve.Therefbre,fbrtheyearended3lDecember2009,Karp,scostofgoodssoldunderFIFOequaIs:

COGS(FIOmethod)=COGS(LIFOmethod)-IncreaseinLIFOreserve

=$2,2llmiIlion-(l55mi>lion->l7mi>Iion)

=$2l73miIlion

3Aiscorrect.KarpsnetincomeNIunderFIFOequalsKapsnetincomeunderLIFOpIustheaftertaxincaseintheLIFOreserve.Fortheyearended3lDecember2009Kap,snetincomeundeFlFOequaIs:

NIOmethodNILIFOmethodIncreaseinLIFOreservexlTaxrate

=$247mi>lion+38mi!>ionx(l-20%)

=$277.4miIion

TheIBfbre,theincreaseinnetincomeis:

IncreaseinNINIOmethodNILOmethod

=$277miIlion-247miI>ion

=$304mil>ion

4Biscorrect.Karp,sretainedeamingsdlion

=$124mi>lion

5Aiscorrect.Thecashratio(cashandcashequiva>ents+currentliabilities)wouldbelowerbecausecashwouIdhavebeenlessunderPIO.Karp,sincomebefbretaxeswouldhavebeenhigherunderFIFO,andconsequent>ytaxespaidbyKarpwouldhaveaIsobeenhigherandchwouldhavebeenwerTheeisnoimpactonCUreUliahiliUesPothKarpscurrentratloandgrossprofitmaginwoudhavebeenhigherifFIFOhadbeen

usedThecurentratiowouldhavebeenhigherbecauseinventoyunderFlFOincreasesbyalargeramountthanthecashdecreasesfbrtaxespaidBecausethecostofgoodssoIdunderFIFOislowerthanundeLIFO,thegrossprofitmarginwouldhavebeenhigher.

6Biscorect1fKaIphadusedFOinsteadofLIFO,thedebttoequityratiowouldhavedecreasedNochangeindebtwouIdhaveoccured,butshaehoIdes,equitywouIdhaveincreasedasaresultofhigberretainedeamings.

7.Biscorrect.Cruxsadiustedinventoytumoverratiomustbecomputedusingcostofgoodsso>d(COGS)underPIOandexcIudingchargesfbrincreasesinvaluationa>lowances.

COGSadiustedCOGSLIFOmethodChargesincudedincostofgoodssoldfbrinventoIywIitedownsChangeinLIPOreserve

53

51

=$3,>Z0milIion-l3miIIion-(55miIIion-72miIion)

=$3,l24million

bMinusthechangeinLOreserveisequivalenttoplusthedecreaseinLOreserve.TheaustedinventoIytumoverratioiscomputedusingaverageinventoryunderFIo

EndinginventoryFOEndinginventoLIFOLIFOreseve

EndinginventoIy200gO48055535

Endinginventory2008O46572537

AverageinventoIy=($535+537)/2=$536

Therefbre,adjustedinventorytumoverratioequals:

Inventorytumoverratio=COGS/Averageinvento5milIionx(l-30%)

=$337.5miIIion

Therefbre,adjustednetprofitmaIginequaIs:

Netprofitmargin=NI/Revenues=$337.5/$5442=620%

9.Aiscorrect.Mikko,sadiusteddebttoequityratiois!owebecausethedebtnumeratoisunchangedandtheaustedshareholders,equitydenominato0ishighe.Theaqustedsharehoders,equitycoespondstosharehoIders,equityunderFIFO,excludingchargesfbrincreasesinvaIuationaIIowances.Thefbre,aqustedsharehoIders,equityishigher

thanrepoItedunaustedsharehoders,equity.

10Ciscorrect.Mikko,sandCmx,sgrossmarginratioswouldbetterrefectthecurrentgrossmarginoftheindustIythanRolbybecausebothuseLlFO.LIOrecognizesascostofgoodssoldthecostofthemostrecentIypurchasedunits,therefbre,itbetterref>ectsreplacementcost.However,Mikko,sgrossmainratiobestrefectsthecuentgrossmarginoftheindustrybecauseCrux,sLIFOeserveisdeceaSing.ThiscoudrefectaLIFOliquidationbyCIuxwhichwou>ddistortgrossprofitmaationaIyenvironment,theseunitsaretheoneswiththelowestcost.

12Aisconect.AninventoIywrite-downincreasescostofsalesandreducesprofitandeducesthecayingvaIueofinventolyandassets.ThishasanegativeeffbctonprofitabiIityandsoIvencyratios.However,activityratiosappearpositiveIyaffbctedbya

I

writedownbecausetheassetbase,whethertotaIassetsorinventodenominato,isreducedThenumeIator,sales,intotalassettumoverisunchangedandthenumerator,costofsaIes,ininventorytumoverisihcreased.Thus,mrnoveratiosarehigheandappearmorefavorableastheresultofthewrite-down.

13Biscorrect.FinishedgoodseastaccuratelyrefectcurrentpIicesbecausesomeofthefinishedgoodsareva>uedunderthelast-in,first-ouf,(LIO)basis.Thecostsofthenewestunitsavailablefbrsaleareallocatedtocostofgoodssoldleavingtheoldestunitsatlowercostsininventory.ZPvaluesrawmateiaIsandworkinpocessusingtheweightedaveragecostmethod.WhilenotfUIlyref>ectingcurrentprices,someinf>ationaIeffbctwillbeincludedintheinventodnolongerbeallowed

16AisconFect.TheinventoIytumoverratiowouldbelower.TheaverageinventoIywouldbehigherunderFIFOandcostofproductssoldwouldbelowerbytheincreaseinLIOreserve.LIFOisnotpemlittedunderS.

InventoIytumoverratioCostofproductssoIdAverageinventoIy

2009inventoIytumoverratioasrepoltedl0.635,822,805608,572186165)/2>

200ginventoIytumoverratioadjustedtoFlFOasnecessaIyl0.315,822,805lg,660l0,l20608,572l0l20486,65lg,6602.

l7Aiscorect.NoLIFOliquidationoccurredduring200g,theLlFOreserveincreasedfi.om0,20miIIionin2008tolg,660miionin200gManagementstatedintheMDAthatthedeceaseininvehtoriesrefectedtheimpactsofdeceasedsalesvoIumesandf>uctuationsinfbreigncurrencytranslationrates.

l8Ciscorect.PinishedgoodsandrawmatenaIsinventoriesaeIowerin200gwhencomparedtoZ008.ReducedlevelsofinventoIytypicallyindicateananticipatedbusinesscontractlon

l9Biscorrect.ThedecreaseinLIFOinventoIyin2009wouIdtypicaIIyindicatethatmoreinventonunitsweresoIdthanproducedorpurchased.AccodingIy,onewouIdexpectaliquidationofsomeoftheo>derLIFOlayersandtheLIFOreservetodecrease.InactuaIity,theLIFOreservecsefiom020miIIionin2008tog660miionin2009.ThisisnottobeexpectedandislikelycausedbytheincreaseinpricesofrawmateriaIs,otherproductionmateIiaIs,andpasoffbreigncurrenciesasnotedinthe}m&A.AnanaIystshouldseektoconfinnthisexp>anation

20 Biscoect.IfpriceshavebeendecreasingwritedownsuderFIFOareleastIikeIytohaveasignificanteffbctbecausetheinventoIyisvaIuedatcIosetothenew,Iowerpices.Typically,iventonesvaIuedusingLIFOareIessIikeIytoincuinventoywite

55

56

downsthaninventonesvaIuedusingweightedaveagecostorFIFO.UnderLIFO,theoscostsarerefectedintheinventorycarIyingvalueonthebalancesheet.Givenlnceasnglnventorycosts,theinventolycayingvaIuesundertheLlFOmethodae

alreadyconseikeIythatinventoIywitedownswiIIoccuunderLIFandifawntedowdoesoccur,itislikelytobeofalessermagnitude

l12

Whena>essorreportsaIeaseasafinance>easeratherthananoperating>ease,itusual>yappedrsmoreprofitabIeinealyyearsofthelease.

IndirectfinancingleasesunderUSGAAP,a>essoreamson>yinterestrevenue.InasaIestypeeaseunderUSGAAP,aIessoreamsbothinterestrevenueandaprofito>oss)onthesa>eofthe>easedasset.

PacticePoblems

CoIIighl20llbyCFAInstisconcernedaboutsomeoftheaccountingchoicesthatthenewmanagementhasmade.TheSechoicesdifferfi.omthoseofthepreviousmanagementandfibmcommonindustIypractice.Harthashighlightedthefb!owingstatementsomthecompany,sannuareport:

Statementl

Statement2

Statement3

Statement4

In200g,AMRCspentsignificantamountsontrackrepIacementandsimilarimprovements.AMRCexpensedratherthancapitalisedasignificantproportionoftheseexpenditures,,

AhCusesthestraightinemethodofdepreciationfbrbothfinancialandtaxreportingpurposestoaccountfbrplantandequipment.,,

In200g,AMRCrecognizedanimpairmentlossof650mi>liononaf>eetoflocomotives.Theimpairment>osswasreportedasotherincomeintheincomestatementandeducedthecanyingamountoftheassetsontheba>ancesheet.,,

ACacquirestheuseofmanyofitsassetsincIudingaargepoionofitsfeetofrailcars,underlongtermIeasecontracts.In200g,AhCacquiredtheuseofequipmentwithafairvaIueof6200mil!ionunder20-yearleasecontracts.TheseleaseswerecIassifiedasoperating>eases.Prior

,,

to2009,mostoftheseleasecontractswerec>assifiedasfinanceleases.

Exhibits1and2containAMRC,s200gconsolidatedincomestatementandba>ancesheet.

AhCprepaIsitsfinanciastatementsinaccordancewithIntemationaIFinanciaReportingStadadS.

xhibit1C0ns0lMatedStement0fIncome

F0theYerSEnded

31December

Operatingrevenues

Operatingexpenses

Depreciation

Leasepayments

Otheroperatingexpense

Tota>operatingexpenses

OperatingincomeOtherincome

Interestexpense

Incomebefbretaxes

Incometaxes

Netincome

6

Mllh0ns

2009

%

ReVenues

6

Milli0ns

2008

%

ReVenIes

2,600l00.02,300l000=

(200)

(2l0)

(7.7)

(8.l)

(lg0)

(lg5)

(83)

(8.5)

(l,590)(6l1)(l,5l5)(65.g).-I

(2,000)(769)(l,g00)(82.6)-I-

60023100z(50)(lg)0.0

(73)(2.8)(6g)(30)---I

477l8433ll4.4

(l89)(73)(l25)(5.4)`-=---

288ll.l206g.0--=-

Exlibit2C0nsolidmedBMnceSheet

Asof31Decembe

AssetS

Currentassets

Propelty&equipment:Land

PIant&equipment

Totalproperty&equipment

Accumulateddepreciation

Netproperty&equipment

Tota>assets

LiabilitieSa>ld

ShaIeh0lders,Equity

Curentiabilities

Long-termdebt

Z009

e %

MIIi0ns AssetS

Z008--

e %

MbIi0Uls Assets

5009.445085

700 l3.l 700 >3.Z

6,000ll2.l5,800l094c

6,700 l252 6,500 l22.6

(l,850)(346)(l,650)(3ll).----

4850g0.64,850gl5--

5,350l00.05,300l00.0--

480g.04308.l----

l,030lg3l,080204l,24023.l,4027.2 1l3

II4

Asof31Decembe

Assets

Other>ong-termprovisionsand>iabilihes

Total>iabilities

Shareholders,equity

Commonstockand

paid-in-surplus

Retainedeamings

OthercomprehensiveIosses

Totalshareholders,equity

Total>iabilities&

shareholders,equity

Z009I

6 %

MiIi0Is ASsets

2008--

6 %

MiIi0ns AsSets

-

27505l4--2,g50-55Z--

760

l,888

l4.2

355

760

l,600

l43

302

(48)(0g)(l0)(02)`=-I

2,60048.62,35043)

5,350l00.05,300l00.0==---

1WithrespecttoStatementl,whichofthefblowingistheeffbctofmanagement,sdecisiontoexpenseratherthancapitalisetheseexpenditures?

Ab200gnetprofitmarginishigherthaniftheexpenditureshadbeencapita>ised.

B200gtotalassettumoverisIowethaniftheexpenditureshadbeencapitalised

CFutureprofitgowthwiIIbehigherthaniftheexpeditushadbeencapitalised

2.WithrespecttoStatement2,whatwouldbetheosyeffbctin20l0ifAMRCweret0switchtoanaccelerateddepreciationmethodfbrbothfinancialandtaxreporting?

ANetprofitmarginwouldincrease.

BTota>assettumoverwoulddecrease.

CCashfowfiomoperatmgactMtieswouldincrease.

3WithrespecttoStatement3,whatisthe!keyeffbctoftheimpairmentIoss?

ANetincomeinyearspriorto2009waslikelyunderstated.

BNetprofitmaginsinyearsafer200gwilIlikelyexceedthe2009netprofitmargin.

CCashf>owfiPomoperatingactivitiesin200gwasIikeIy>owerduetotheimpairmentlOSS.

qBasedonExhibits1and2,thebeseseoftheaverageremainingusefUIifbofthecompany,splantandequipmentattheendof2009is:

A.20.75yeas

B2425years.

C30.00years.

5WithrespecttoStatement1,ifAMRChaduseditsodclassificationmethodfbritsleasesinsteadofitsnewcassificationmethod,its2009totaIassetturnoverratiowould?os

ybe:

A>ower.

B.higher.

Cthesame.

6WithrespecttoStatement4andExhibit1ifAChaduseditsoldclassificationmethodfbritsleasesinsteadofitsnewclassificationmethodthejeeffbctonits200gratioswouldbea:

AhighernetprofitmaIgin.

Bhigherfixedassettumover.

Chighertotalliabilities-to-totalassetsratio.

ThefoowinginfOmationeatestoOuestions7132

BrianJordanisinterviewingfbrajuniorequityanalystpositionatOrionInvestmentAdvisors.AspaItoftheinterviewprocess,MayBennOrion,sDirectorofReseamh,providesJordanwithinfbImationabouttwohypotheticaIcompanies,AlphaandBeta,andaskshimtocommentontheinfbrmationontheirfinancialstatementsandratios.BothcompaniespreparetheirfinancialstatementsinaccordancewithIntemationalFinancialReportingStandards(IRS)andareidenticalina>lrespectsexceptfbrtheiraccountingchoices.

Jordanisto>dthatatthebeginningofthecurrentfiscaIyear,bothcompaniespurchasedama>ornewcomputersystemandbeganbui>dingnewmanufhcmringplantsfbrtheirownuse.AlphacapitaIisedandBetaexpensedthecostofthecomputersystem;AIphacapitaIisedandBetaexpensedtheinterestcostsassociatedwiththeconstructionofthemanufactunngplants.lnmid-year,bothcompaniesIeasednewofficeheadquaIters.AlphacIassifiedtheIeaseasaopeatinglease,andBetaclassifieditasafinanceIease.

BennasksJordan,Whatwastheimpactofthesedecisionsoneachcompany,scurrentf>scaIyearfinancia>statementsandratios?,,

Jordanresponds,Alpha,sdecisiontocapitalisethecostofitsnewcomputersysteminsteadofexpensingitresuItsinIowernetincome,IowertotaIassets,andhighercashfowfTomopeatingactivitiesinthecurrentfisca>year.Alpha,sdecisiontocapitaliseitsinterestcostsinsteadofexpensingthemresultsinalowerfixedassetturnoverratioandahigherimeestcoverageratiAlpha,sdecisiontoc>assifyitsIeaseasanoperatingleaseinSteadofafinanceIeaseresuItsinhighernetincomehighercashf>owfiFomoperatingactivities,andstrongersoIvencyandactivityratloscomparedtoBeta.

>15

JodanistoIdthatAphausesthestraightIinedepreciationmethodandBetausesanacceIerateddepreciationmethod;bothcompaniesestimatethesameusefhl>ivesfbr}ong-Iivedassets.Manycompaniesintheirindustryusetheunits-oFproductionmethod.

BennasksJordan,Whatarethefinancialstatementimplicationsofeachdepreciationmethod,andhowdoyoudetermineacompany,sneedtoeinvestinitsproductivecapacity?,,

JordanpiesAllothethingsbeingequal,thestraight-inedepreciationmethodresultsinthe>eastvariabilityofnetprofitmarginovertime,whiIeanaccelerateddepreciationmethodresu>tsinadecliningtIndinnetprofitmaIgmovertime.Theunitsofproductioncanresutinanet

profitmagmtIndthatisquitevariabIe.Iuseathreestepapproachtoestimateacompany,s

needtoinvestinitsproductivecapacity.First,IestimatetheaverageageoftheassetsbydividingnetpIopeIty,pIant,andequipmentbyannualdepreciationexpense.Second,IestimatetheaveragemainingusefilIlifeoftheassetsbydividingaccumuIateddepreciationbydepreciatiOnexpense.Third,IaddtheestimatesoftheaverageremainingusefhllifbandtheaverageageoftheassetsinordertodeterminethetotaIusefU>life.,,

lI6

JordanistoldthatattheendofthecurrentfiscaIyear,AlphaIcvaIuedamanufacturingplant;thisinceaseditsrepoItedcarryingamountbyl5percentTherewasnopreviousdownwardrevaluatjonoftheplant.Betarecordedanimpairmentlossonamanufactunngp>ant;thisreduceditscarIyingbyl0percent.

BennasksJordanWhatwastheimpactofthesedecisionsoneachcompany,scurrentfiscaIyearfinanCialratios?,,

JordanspondsBeta,simpairmentlossincreasesitsdebttototaassetsandfixedassettumovertios,andlowersitscashflowfmmoperatingactivities.Alpha,srevauationincreasesitsdebttocapitalandetumonassetsratiosandreducesitsretumonequity,,

Attheendoftheinteiew,BennthanksJodanfbhistimeandstatesthatahiingdecisionwiI>bemadeshortly.

7.JodansresponseaboutthefinanciastatementimpactofAlpha,sdecisiontocapitalisethecostofitsnewcomputersystemismostlike!ycoecwithrespectto:

Alowernetincome.

B!owertotaIassets.

Chighercashfowfibmoperatingactivities

8Jordan,sresponseabouttheratioimpactofAlpha,sdecisiontocapitaiseinterestcostsismoStlikeIycocwithespecttothe:

Ainterestcoverageratio.

Bfixedassettumoverratio.

Cinterestcoverageandfixedassettumoverratios.

9.JordansresponseabouttheimpactofAlpha,sdecisiontoclassifyitsleaseasanoperatingleaseinsteadoffinanceleaseismostIikelycocwithrespectto:

A.netincome

B.soIvencyandactMtymt>os.

CcashflowhFomoperatlngactivities.

l0Jordan,sresponseabouttheimpactofthediffbrentdepciationmethodsonnetprofitmarginismostlikelycoqecwithrespectto:.

Aacce>erateddepreciation.

B.straight-linedepreciation

Cunitsofproductiondepciation

11Jordan,sresponseabouthisapproachtoest1matingacompany,sneedtoreinvestinitsproductivecapacityismostlikeycoecregarding:

Aestimatingtheaverageageoftheassetbase.

Bestimatingthetotalusefhlifboftheassetbase.

CestimatmgtheaverageremainingusefUIlifboftheassetbase.

12JordansresponseabouttheeffbctofBeta,simpairmentlossismostlikeyco1recwithrespecttotheimpactonits:

Adebttototalassets.

Bfixedassettumover.

Ccashf>owfromoperatingactivitieS

l3Jordan,sresponseabouttheeffectofAlpha,srevaluationismostlikelycowithrespecttotheimpactonits:

Aretumonequity.

Bretumonassets

Cdebttocapitalratio

SIutins

1Ciscorrect.Expensingratherthancapitalisinganinvestmentinong-tennassetswillresuItinhigherexpensesandIowernetincomeandnetproftmaIgininthecurentyear.Futuyears,incomeswillnotincludedepreciationexpenserelatedtotheseexpendituresConsequentIy,year-to-yeargrowthinprofitabilitywiIbehigher.Iftheexpenseshadbeencapitalisedthecarryingamountoftbeassetswouldhavebeenhigherandthe2009totalassettumoverwou>dhavebeenlower.

1l7

>18

ZCiscorrectIn200,switchingtoanacceIerateddepreciationmethodwouIdincreasedepreciationexpenseanddecreaseincomebefbretaxes,taxespayable,andnetincome.CashfowomopeatingactivitieswouIdincreasebecauseoftheresuItingtaxsavings

3Biscorrect.200gnetincomeandnetprofitmarginarelowerbecauseoftheimpaiImentI0ss.Consequent>y,netprofitmarginsinsubsequentyearsarelikelytobehigherAnimpairmentIosssuggeststhatinsufficientdepreciationexpensewasrecognizedinpnoryearS,andnetincomewasoverstatedinpnoryears.Theimpainnentlossisanon-cashitemandwi>>notaffbctoperatingcashf>ows.

1Aiscorrect.TheestimatedaverageremainingusefUllifeis20.75years.

EstimateofremaininguseMlifeNetplantandeqUipmemAnnualdepreciationexpense

NetpIantandequipmentGossPEAccumuateddepreciation

=e6000-el850=e4l50

EstimateofremainingusefUllifbNetPEDepreciationexpense

=64l50=e200=20.75

5Aiscorrect.WhenIeasesalccIassifiedasfinanceleases,thelesseeinitiaIIyreportsa

assetandliabilityatacarIymgamountequaltothelowerofthefhirvalueofthe>easedaSsetorthepresentvalueoftheflltureleasepayments.UnderanoperatingleasetheIesseedoesnotreportanassetoriabiIity.TherefbretotalassettumovertotaIrevenueaveragetotalassets)wouldbeIoweriftheleaseswereclassifiedasfinanceleases

6Ciscorrect.Total>iabilities-to-assetswouldbehigher.Whenleasesareclassifiedasfinanceleasesthe>esseeinitia>>yreportsanassetand>iabilityatacarIyingamountequaltothelowerofthefairvalueoftheeasedassetorthepIsentvalueofthefUturelease

payments.Boththenumeratoranddenominatorwou>dincreasebyanequalamount,buttheproportionaincreaseinthenumeatorishigherandtherat1owouldbehigher.Thefb>Iowingexhibitshowswhatwouldhappento200gtota>Iiabilities,assets,andtotaIIiabiIities-to-assetsife200miIIion,thefhirvaIueoftheleasedequipment,isaddedtoAMRC,stotalIiabiIitiesandassets.ThissimpleexampIeignorestheimpactofaccountingfbrthe2009leasepayment

TotaIIiabiIities

Totalassets

TotalIiabilities-to-

assets

2009ActIa>Under

OpertingLese

62,750

65,350

5l.1%

Z009Hyp0thetiClUndeFiIanceLease

e2,950

e5,550

53.2%

ThCdepreciationandinteestexpenseunderafinanceleasetendstobehigherthantheoperatingIeasepaymentintheearlyyearsofthelease.ThefinanceIeasewouldresuItinIowernetincomeandnetprofitmaIginLong->ived(fixed)assetsarehigherunderafinanceIcaseandf>xedassettumoveris>ower.

7Ciscorrect.ThedecisiontocapitaIisethecostsofthenewcomputersystemresuItsinhighercashf>owfiomoperatingactivities;theexpenditureisreportedasanoutf>owofinvestingactivities.ThecompanyaIIocatesthecapitaIisedamouHtovertheasset,susefilI>ifbasdepreciationoramortisationexpenseratherthanexpensingitintheyearofexpenditue.NetincomeandtotaassetsarehigheinthecuentfiscaIyear.

8Biscorrect.Alpha,sfixedassettumoverwillbelowerbecausethecapitalisedinterestwillappearonthebalancesheetaspartoftheassetbeingconstructedTherefbre,fixedassetswillbehigherandthefixedassetmmoverratio(tota>revenue/averagenetfixedassets)wil>belowerthanifithadexpensedthesecosts.CapitaIisedinterestappearsontheba>ancesheetaspartoftheassetbeingconstIuctedinsteadofbeingreportedasinterestexpenseinthepeIiodincued.HoweveLtheinteestcoverageratioshouIdbebasedoninterestpayments,notinterestexpense(eamingsbefbreinterestandtaxesinterestpayments,andshoudbeunchanged.Toprovideatuepictueofacompany,sinterestcoverage,theentireamountofinterestexpenditureboththecapitalisedportionandtheexpensedportionshoudbeusedincalculatingintestcoverageratios.

9Ciscorrect.ThecashfIowfibmoperatingactivitieswiIIbeIower,nothigher,becausethefU>>>easepaymentistreatedasanoperatingcashoutfIow.WithafinanceleaseonlytheportionoftheeasepaymentreatingtointeestexpensepotentiaIIyeducesoperatmgcashoutf>ows.AcompanyrepoItmga>easeasanoperatingleasewiItypica>lyshowhigherprofitsinearlyyears,becausethe>easeexpenseislessthanthesumoftheinterestanddepreciationexpense.Thecompanyreportingthe>easeasanoperatingleasewi>>typicallyreportstrongerso>vencyandactMtyratios.

10Aiscorrect.AccelerateddepreciationwilIresu>tinanimproving,notdec>ining,netprofitmargmovertlmebecausetheamountofdepreciationexpensedecIineseachyear.Uhderstraight-Iinedepreciation,theamountofdepreciationexpensewillremainthesameeachyear.Undertheunitsoroductionmethod,theamountofdepreciationexpenserepoItedeachyearvaIieswiththenumberofunitspIoduced.

IIBiscoect.TheestimatedaveragetotaluselIifbofacompany,sassetsiscaIcuIatedbyaddingtheestimatesoftheaverageremainingusefU>>ifbandtheaverageageoftheassets.TheaverageageoftheassetsisestimatedbydividingaccumuIateddepreciationbydepreciationexpense.TheaverageremainingusefU>Iifboftheassetbaseisestimatedbydividingnetpoperty,plant,andequipmentbyannuaIdepreciationexpense.

12CiscorrectTheimpainnentossisanoncashchargeandwiIlnotaffbctcashfowfiDmoperatingactivities.ThedebttototaIassetsandfixedassettumoveratioswillincrease,becausetheimpairmentIosswiIreducethecanyingamountoffixedassetsandtherefbretotalassets

13.Aiscoect.InanassetrevaIuation,thecarIyingamountoftheassetsincreases.Theincreaseintheasset,scanyingamountbypassestheincomestatementandisreportedasothercomprehensiveincomeandappearsinequityundertheheadingofrevaluationsurplus.TherefbresharehoIdersequitywilIincreasebutnetincomewillnotbeaffbcted,soretumonequitywi>Idecline.RetumonassetsanddebttocapitaIratioswillalsodecrease.

1l9

>76

CurrentIFRSandUSGAAPaccountmgstandardsrequiretheuseoftheacquisitionmethodtoaccountfbrbusinesscombinations.FaivaIueoftheconsiderationgivenisthe

appropIiatemeasurementfbridentifiableassetsandIiabilitiesacquiredinthebusinesscombination.

GoodwillisthediffbencebetweentheacquisitionvalueandthefhirvaIueofthetarget,sidentifiab>enettangibIeandintangib>eassets.Becauseitisconsideredtohaveanindefinitelifb,itisnotamo>tized.Instead,itisevaIuatedat>eastannua!Iyfbrimpairment.ImpaiIment>ossesarereportedontheincomestatement.IFRSuseaone-stepapproachtodetermineandmeasuretheimpainnentIoss,whereasUSGAAPusesatwo-stepapproach

IftheacquiIingcompanyacquireslessthanl00,noncontrollingminorityshareholders,interestsarereportedontheconsolidatedfinancialstatements.IRSallowsthenoncontrollinginteresttobemeasuredateitheritsfhivaluefnllgoodwilloratthenon-controIinginterest,spropoItionateshareoftheacquiree,sidentifiab>enetassets(paltialgoodwi>l).USGAAPrequiresthenon-controllinginteresttobemeasuredatfairvaIue(fU>>goodwi>l).

ConsolidatedfinancialstatementsapreparedineachrepoItingperi0d

SpecialpuIposeSPEsandvariableinterestentitiesVsarerequiredtobeconsolidatedbytheent1tywhichisexpectedtoabsorbthema>ontyoftheexpectedlosses

orreceivethemontyofexpectedresidualbenefits.

PacticePobIems

Corigh20lCFAInsitute

ThefoowinginfOmatiheIatestoQuestions16

CinnamonInc.isadivesifiedmanufhctuingcompanyheadquaIteredintheUnitedKingdom.Itcomp>ieswithIFRS.In200g,CinnamonheIdalgpercentpassiveequityownershipinterestinCambridgeProcessingthatwasclassifiedasavai}able-fbr-saleDuIingtheyear,theva>ueofthisinvestmentroseby2miionInDecember200g,Cinnamonannouncedthatitwouldbeincreasingitsownershipinterestto50percenteffbctivelJanuary20l0throughacashpurchase.CinnamonandCambridgehavenointecompanytransactions.

PeterLubbock,ananalystfbllowingbothCinnamonandCambridge,iscunoushowtheincreasedstakewiIlaffbctCinnamon,sconsolidatedfinancialstatementsHeasksCinnamon,sCFOhowthecompanywilIaccountfbrtheinvestment,andistoldthatthedecisionhasnotyetbeenmade.Lubbockdecidestousehisexistingfbrecastsfbrbothcompanies,financialstatementstocomparetheoutcomesofaItemat1veaccountingtreatments.

Lubbockassemb!esabbreviatedfinanciaIstatementdatafbrCinnamon(Exhibitl)and

Cambridge(ExhibitZ)fbrthispu!pose.

Exhibit1.SelectedFiMmcilStemetImi0Cim0n,Ic

Mi>li0ns)

Yerendhng31December20092010

Revenue

OperatingincomeNetincome

31December

Totalassets

Shaholdersequity

l,400

l26

62

l,575

l42

6g

Z0092010*

l,l70l,3l7

6l6685

EstimaesmadepoloannouncementofincasedsakeinCambridgC

ExhibitZSeeCtedFinCialStementInfbrmati0nfbrCmbidgeP0cesSig

Milli0ns

Yerending31DecemberZ0092010

Revenue

OperatingincomeNetincome

Dividendspaid

31Decembe

Totalassets

Shaeholders,equity

>,000

80

10

20

I>00

88

44

22

200920>0*

800

40

836

462

EsimaesmadepriortoannouncememofincasedstakebyCinnamon.

.In200g,Cinnamon,seamingsbefbretaxesincudesacontributioninmillionsfiPomitsinvestmentinCambridgeProcessingthatiscb!to:

A.3.8

B5.8

C7.6

2.In20l0,ifCinnamonisdeemedtohavecontrooverCambridge,itwilosaccountfbritsinvestmentinCambridgeusing:

Atheequitymethod

l77

l78

Btheacquisitionmethod

Cproportionateconsolidation

3.At3lDecember200,Cinnamon,sshahoders,equityonitsbalancesheetwouldosbe:

AhighestifCinnamonisdeemedtohavecontrolofCambridge.

BindependentoftheaccountingmethodusedfbrtheinvestmentinCambridge.

ChighestifCinnamonisdeemedtohavesignificantinfuenceoverCambridge.

4.In20l0,Cinnamon,snetprofitmarginwouldbeesif

AitisdeemedtohavecontrolofCambridge

BithadnotincreaseditsstakeinCambIidge.

CitisdeemedtohavesignificantinfuenceoverCambidge.

5At3lDecember20l0assumingcontroandrecognitionofgoodwil,Cinnamon,sreporteddebttoequityranowill0behighestifitaccountsfbritsinvestmentinCambridgeusingthe:

Aequitymethod.

BfhlIgoodwiI>method

Cpartialgoodwilmethod.

6ComparedtoCinnamon,soperatingmalginin2009ifitisdeemedtohavecontrolofCambridge,itsoperatingmargininZ0l0willosehbe;

A>ower

Bhigher.

Cthesame

TheoowinginfmationeIatestQuestions712

Zimt,AGisaconsumerproductsmanufhcmrerheadquarteredinAustria.ItcomplieswithIFRS.In200g,Zimtheldal0peIentpassivestakeinOxbowLimitedthatwasclassiedasheldfbrtradingsecunties.DuIingtheyeaEthevaIueofthisstakedecIinedbye3mi>Iion.InDecember200g,Zimtannouncedthatitwouldbeincreasingitsowneshipto50percenteffbctivelJanuaIy20l0.

FranzGeIbIum,ananaIystfbllowingbothZimtandOxbow,iscunoushowtheincreasedstakewillaffbctZimt,sconsolidatedfinancialstatements.BecauseGelblumisuncertainhowthecompanywi>>accountfbrtheincreasedstake,heuseshisexistingfbrecastsfbrbothcompanies,financialstatementstocompavariousalternativeoutcomes.

I

GeIbumgathesabbeviatedfinanciaIstatementdatafbZimtExhibitandOxbowExhibit2)fbrthispurpose.

xhdbit1.SeectedFimncilStatememEsthmHtesZimtAG6Miios

Yearending3IDecembe20092010

Revenue

OperatingincomeNetincome

31December

Totalassets

Shareholders,equity

>,500

l35

66

l,700

l53

75

Z0092010*

l,254l,42l

660735

EstimaesmadeprioroannolmcemeofincasedsakemOxbow

Exhdbit2.SelectedFiancilStatementEStimhteSOxb0wMm!tede

Milli0ns)

Yeending31Decembe200gZ010

Revenue

OperatingincomeNetincome

Dividendspaid

31Decembe

Totalassets

Shareholders,equity

l,200

l20

60

20

l,350

l35

68

2Z

2009Z010*

l,200l,283

660706

EslimaesmadepriortoannouncemenofincasedsakebyZim

7.In200g,Zimt,seamingsbefbretaxesincludesacontibutionin6millionsfiomitsinvestmentinOxbowLimitedcbesto:

A.(e0.6)miIion

B.(el.0)million

Ce2.0mi>lion

8.At3lDecember20l0,ZimtstotaIassetsbalancewouldoskebe:

179

l80

AhighestifZimtisdeemedtohavecontroIofOxbow.

B.highestifZimtisdeemedtohavesignificantinf>uenceoverOxbow.

CunaffbctedbytheaccountingmethodusedfbrtheinvestmentinOxbow.

9BasedonGeIbusestimates,ifZimtisdeemedtohavesignificantinfuenceoverOxbow,its20l0netincome(in6millions)wou>dbec/O$Bs/to:

Ae75.

B6l09.

C6l43.

10BasedonGe>blum,sestimates,ifZimtisdeemedtohavejointcontrolofOxbow,andZimtusestheproportionateconsolidationmethod,its3lDecember20l0totaIIiabilitiesinemilionswilbecesto:

A6686.

Beg75.

Cel263.

I1BasedonGebum,sestimatesifZimtisdeemedtohavecontroloverOxbow,its20l0consolidatedsales(inemillions)wil>bec/bs/to:

A6l,700.

B62,375.

Ce3,050.

1Z.BasedonGeblusestimates,Zimt,snetincomein20l0wiIIos0be;

AhighestifZimtisdeemedtohavecontro>ofOxbow

BhighestifZimtisdeemedtohavesignificantinfuenceoverOxbow.

CindependentoftheaccountingmethodusedfbrtheinvestmentinOxbow

ThefowinginfomatioeIatestoQuestions1318

BurtonHoward,CPA,isanequityanaIystwitbMapIewoodSecurities.HowadispreparmgaresearchrepoItonConfabulatedMateriaIs,SA,apublicIytradedcompanybasedinPrancethatcompIieswithIFRSAspatofhisanaIysis,HowardhasassembIeddatagatheedfibmthe5nancialstatementfbotnotesofConfhbuIated,s200gAnnualReportandfiFomdiscussionswithcompanymanagementHowardisconcemedabouttheeffbctofthisinfbnnationonConfhbuIated,sfUtureeamings.

lnfbrmationaboutConfabuated,sinvestmentportfbliofbrtheyeasended3lDecembe2008and200gispesentedinExhibitlAspaItofhisresearch,HowardisconsideingthepossibIe

I

effectonportedincomeofConfhbuIated,saccountigcIassificationfbrfixedincomeinvestments.

Exibit1.C0nbuHted,sIvestmetP0tMio6Th0SMs

Characteristic BIg>eAGCHthHyC0rpDImasSA

C>assification

Cost*

Marketvalue,3lDecember2008

MaIketvalue,3lDecember2009

AvailabIe-fbr-

saIe

625,000

29,000

28,000

AllsecuIitiesweacquidatparvalue.

He>d-to-

mamnty

e40,000

38,000

37,000

Held-to-

matunty

e50000

51000

55,000

InadditionConfhbu>ated,sannualreportdiscussesatransactionunderwhichreceivab>esweresecuIitizedthroughaspecia>purposeentity(SPE)fbrConfhbulatedsbenefit.

l3.ThebaIancesheetcarlyingvaIueofConfHbulated,sinvestmentpoItfb!io(inethousands)at3lDecember200giscm$es/to:

All2,000

Bll5,000

Cll8000

l4ThebalancesheetcarIyingvalueofConfabulated,sinvestmentpoItfblioat3lDecember200gwouIdhavebeenhigherifwhichofthesecuitieshadbeenclassifiedasaheldfbrtadingsecuity?

A.Bugle.

BCathay

CDumas

l5ComparedtoConfhbulated,sreportedinterestincomein200g,ifDumashadbeenc>aSsifiedasavai>abIe-fbFsale,tI]einterestincomewou>dhavebeen:

A.>ower.

Bthesame

Chigher.

18l

I82

l6ComparedtoConfhbuated,seportedeamingSbefbretaxesin200g,ifBugIehadbeenclassifiedasaheIdfbrtradingsecuIitytheeamingsbefbretaxes(inethousands)wouIdhavebeen:

Athesame.

B6l,000Iower.

C63000highe.

17Confhbuated,sreportedinterestincomewoudbelowerifthecostwasthesamebuttheparvaIue(in6thousands)of:

ABugIewas628,000

BCathaywase37,000.

CDumaswase55,000.

18.Confhbulated,sspecialpurposeentityisosMetobe:

Ahe>dofFbaIancesheet

BconsolidatedonConfhbuIated,sfinancialstatements.

C.consolidatedonConfhbu>ated,sfinancialstatementsonlyifitisaqualifyingSPE,,

ThefowinginfOmationeIatestoQuestions1924

BetterCareHospita>s,IncoperatesachainofhospitalsthroughouttheUnitedStates.Thecompanyhasbeenexpandingbyacquiringocalhospitas.ItsIagestacquisition,thatofStatewideMedical,wasmadein200lunderthepoolingofinterestsmethod.BetterCarecomplieswithUSGAAP.

BetterCareiscurrentlyfbIninga50/50jointvenmrewithSupremeHea>thcareunderwhichthecompanieswillsharecontrolofseveraIhospitaIs.BetterCareplanstousetheequitymethodtoaccountfbrthejointvenmre.SupremeHeaIthcarecomp>ieswithIFRSandwillusetheproportionateconsoIidationmethodtoaccountfbthejointventu

ErikOhalinisanequityanaIystwhocoversbothcompanies.Hehasestimatedthejointventure,sfinanciaIinfbnnationfbr20l0inordertopreparehisestimatesofeachcompany,searningsandfinancia>pes)

Yerending3lDecemberZ0l0

Revenue >,130

YeaedingIDecemberZ0l0128

62

OperatingincomeNetincome

201031Decembe

l,500

740

Tota>assets

Shareho>ders,equity

SupremeHealthcarerecentlyannouncedithadfbImedaspecialpurposeentitythroughwhichitp>anstose>>upto$l00miIlionofitsaccountsreceivableSupremeHealthcarehasnovotmginterestintheSPE,butitisexpectedtoabsoIbanylossesthatitmayincurOhalinwantstoestlmatetheimpactthiswi>lhaveonSupremeHealthcare,sconsoIidatedfinancialstatements.

l9ComparedtoaccountingpIinciplescurrentlyinuse,thepoolingmethodBetterCareusedfbritsStatewideMedicalacquisitionhasosycauseditsIBpoIted:

A.revenuetobehigher.

Btotalequitytobelower

CtotaIassetstobehigher

20.BasedonOhaIin,sestimates,theamountofjointventurerevenue(in$millions)incIudedonBetterCare,sconso>idated20l0financialstatementsshou>dbec/bses/to:

A$0.

B7l5.

C.$l430

|||

2.BasedonOhaIinsestimatestheamountofjointventuenetincomeincIudedontheconsoIidatedfinanciaIstatementsofeachventuerwiIMjosh0be:

AhigherfbrBetteCare.

BhigherfbrSupremeHealthcare.

CthesamefbrbothBetterCareandSupemeHealthcare

22.BasedonOhaIin,sestimates,theamountofthejointventure,s3lDecember20l0totaIassets(in$mi>>ions)thatwilIbeincludedonSupremeHealthcare,sconso>idatedfinancialstatementswiIbecsesto:

A$0

B.$750.

C$l,500

>83

23.BasedonOhaIin,sestimates,theamountofjointventuresllaehoIders,equityat3December20l0includedontheconso>idatedfinancia>statementsofeachventurerwill!Okcybe:

AhigherfbrBetterCare.

B.higherfbrSupremeHealthcare

CtheSamefbrbothBetteCaeandSupemeHeaIthcare.

2IfSupremeHeathcaresellsitsreceivabIestotheSPE,itsconsolidatedfinanciaIresultswilloscshow:

Aahigherrevenuefbr20l0.

Bthesamecashbalanceat3lDecember20l0.

Cthesameaccountsreceivablebalanceat3lDecember20l0.

ThefowinginfOmationeIatestoQuestiohs2530

PercyByron,CFA,isanequityana>ystwithaUK-basedinvestmentfinnOnefiImByronfblowsisNinMountPLC,aUKbasedcompany.On3lDecember2008NinMountpaid320miIliontopurchasea50percentstakeinBosweIlCompany.TheexcessofthepurchasepriceoverthefhirvaueofBosweII,snetassetswasattributabletopreviousIyuncordedIicenses.Theselicenseswereestimatedtohaveaneconomiclifbofsixyears.ThefhirvalueofBoswe>l,sassetsandliabilitiesotherthanlicenseswasequaItotheirrecordedbookvalues.NinMountandBoswelbothusethepoundsterlingastheirepoItingcurrencyandpreparetheirfinanciastatementsinaccoaccountingmethodstoreporttheresuItsofitsinvestment,butNinMounthasnotannouncedwhichmethoditwilIuseByronfbrecaststhatbothcompanies200gfinanciaIresuIts(excludinganymergeraccountingaqustments)wi}IbeidenticaItothoseof2008`

NinMount,sandBosweI,scondensedincomestatementsfbrtheyearended3lDecember2008,andcondensedbaIancesheetsat3lDecember2008,arepresentedinExhibits>and2,respectively.

ExhibitINinM0utPLCndB0sweICompayInc0meSttemetsfb.tIleYeEnded3lDecembeZ008iios

MnM0untB0swell

0

0

5G

g50

(495)

(50)

(l36)

Netsales

Costofgoodssold

SelIingexpenses

AdministrativeexpensesI8

|

Depreciation&amoiabi>ities

Commonstock

Retainedeamings

Totalequity

TotaIliabilitiesandequity

NinM0utB0sWe

50

70

l30

250

l,570

3200

2,l40-

ll0

600

7l0

850

580I

l,430I

2l10

20

45

75I

>40

930

>,070-

g0

400U

g0

535

45

580

l,070-

jVb:BalancesheesfecMhepuIchasepricepaidbyNinMounbudonoveconsiderheimpacofaccoumingmetlodchoice.

25.NinMount,scurrentratioon3December2008oswiIlbehighestiftheresults

oftheacquisitionarerepoItedusing:

A.theequitymethod.

BconsoIidationwithfUlgoodwill

CconsolidationwithpaItiaIgoodwil

26.NmMousIong-termdebttoequityratioon3IDecember2008oskeywiIIbeowestifthesuItsoftheacquisitionaereportedusing: 185

l86

Atheequitymethod.

Bconsolidationwithfilllgoodwi>>

CconsoIidationwithpartialgoodwill

Z7BasedonByron,sfbrecast,ifNinMountdeemsithasacquiredcontrolofBoswe,NinMount,sconsolidated200gdepreciationandamoItlzanonexpenseinmillionswiIIbecsesto:

Al02.

Bl48.

C201.

28.BasedonByron,sfbIccast,NinMount,snetprofitmarginfbr200gjwilIbehighestiftheesuItsoftheacquisitionarereportedusing:

Atheequitymethod

B.consolidationwithfUllgoodwill.

Cconsolidationwithpartialgo0dwill.

29.BasedonByron,sfbccastNinMount,s2009retumonbeginningequityywi!bethesameunder:

A.eitheroftheconsoIidations,butdiffeIntundertheequitymethod

B.theequitymethod,consolidationwithfUlIgoodwil>,andconsolidationwithpartialgoodwil>.

Cnoneoftheequitymethod,consolidationwithfUllgoodwill,orconso!idationwithpatiaIgoodwiI

30BasedonByron,sfbrecast,NinMount,s2009totalassettumoverratioonbeginningassetsundertheequitymethodisosy:

A>owerthaniftheresuItsarereportedusingconsolidation

Bthesameasiftheresultsarerepoedusingconsolidation.

ChigherthanifthesultsarereportedusingconsoIidation

SIutiIs

1Aiscoect.DividendsfibmequitysecuritiesthatarecassifedasavaiabefbrsaIeareincludedinincomewhenearnedCinnamonwouldrecordits>gpercentshareofthedividendspaidbyCambridge;thisis3.8miIlionZ0x01g.ThoughthevaIueof

|

Cinnamon,sstakeinCambridgeProcessingroseby2miIIiondingtheyear,undeIFRSanyunrealizedgainsorossesfbravailablefbIsaIesecuritiesarerepoItedintheequitysectionofthebalancesheetaspaofothecomprehensiveincomeuntiIthesecuIitiesareso>d

2Biscorrect.IfCinnamonisdeemedtohavecontroloverCambridge,itwouldusethe

acquisitionmethodtoaccountfbrCambridgeandprepareconso>idatedfinanciaIstatements.Proportionateconso>idationisusedfbrjointventures;theequitymethodisusedfbrsomejointventuresandwhenthereissignificantinf>uencebutnotcontrol

3AiScorrect.IfCinnamonisdeemedtohavecontroloverCambridge,consolidatedfinancialstatementswouldbepreparedandCinnamon,ssharehoIders,equitywouldincreaseandincludetheamountofthenoncontIol>inginterestIfCinnamonisdeemedtohavesignificantinf>uence,theequitymethodwouldbeusedandtherewouldbenochangeintheshareholdersequityofCinnamon

4Ciscorrect.IfCinnamonisdeemedtohavesignificantinfuence,itwoudrepothalfofCambridge,snetincomeasalineitemonitsincomestatement,butnoadditionalrevenueisshownItSprofitmaIginisthushigherthanifitconsoIidatedCambridge,sresultswhichwouldimpactrevenueandincomeorifitonlyreportedlgpercentofCambridge,sdividends(nochangeinownership).

5Ciscorrect.ThefUl>andpartialgoodwiImethodwillhavethesameamountofdebt;however,shareholders,equitywi>>behigherunderMlgoodwiI>(andthedebttoequityrat1owillbelower.Thefbre,thedebttoequitywilbehigherunderpartialgoodwillIfcontrolisassumed,Cinnamoncannotusetheequitymethod

6Aiscorrect.CambridgehasaloweropeatingmaIgin88ll008.0thanCinnamon(l42/l,575=g.0%]IfCambridge,sresultsareconso>idatedwithCinnamon,s,theconso>idatedoperatlngmaIginwillref>ectthatofthecombinedcompanyor230/2,675=86%.

7Biscorrect.Oxbowwasclassifiedasaheldfbrtradingsecurity.Heldfbrtradingsecunt>esarereportedatfairvaIuewithunreaIizedgainsandIossesincludedinincome.TheincomestatementalsoincIudesdividendsfromequitysecuritiesthatareclassifiedasheldfbrtrading.Thee3milliondeclineintheva>ueofZimt,sstakewouldreduceincomebythatamountZimtwouldrecorditsshareofthedividendspaid(0.lxeZ0miIIion=62miI>ion)TheneteffbctofZimt,sstakeinOxbowLimitedwouIdbetoreduceZimt,sincomebefbretaxesby6lmilIionfbr2009.

8.Aiscoect.WhenacompanyisdeemedtohavecontroIofanotherentity,itrecodsaIIoftheotherentity,sassetsonitsownconsoIidatedbaIancesheet.

9BiscorIct.IfZimtisdeemedtohavesignificantinfuence,itwouIdusetheequitymethodtorecorditsownership.Undertheequitymethod,Zimt,sshareofOxbow,snetincomewouIdberecordedasasingleIineitem.NetincomeofZimt=75+05(68)=l09.

10 Biscorrect.Undertheproportionateconsolidationmethod,Zimt,sbalancesheetwou>dshowitsowntotaIliabilitiesof6l42l-735=e686plushalfofOxbow,sliabilitiesofel283-706=6577.6686+(05x577]=6g74.5.

l1Ciscorrect.Undertheassumptionofcontol,ZimtwouIdrecoditsownsaIesplusl00percentofOxbow,s6l,700+>,350=e3,050.

187

l88

l2.Ciscorrect.Netincomeisnotaffectedbytheaccountingmethodusedtoaccountfbactiveinvestmentsinothercompanies.One-lineconsolidation,,andconso>idationresu>tinthesameimpactonnetincome;itisthediscIosurethatdis.

l3CiscorrectHeldfbrtradingandavaiIablefbrsaesecuritiesarecaiedatmarketvaue,whereasheldtomaturitysecuritiesarecariedathistoricalcost.628,0000,00050,000=ell8000.

14Ciscorrect.IfDumashadbeencassifiedasaheldfbrtIadingsecuityitscarryingvaluewouIdhavebeenthee55,000fhirva>ueratherthanthee50,000historicaIcost.

15Biscorrect.ThecouponpaymentisrecordedasinterestincomewhethersecuIitiesareheIdtomatuntyoravailablefbrsae.Noadjustmentisrequiredfbramotizationsincethebondswereboughtatpar.

I6BiscorrectUnreaIizedgainsandlossesareincludedinincomewhensecuitiesarecIassifiedasheldfbrtradingsecuritiesDuring2009therewasanunrealizedlossof6l,000

I7BiscorrectThediffbrencebetweenhistoicalcostandparvaluemustbeamortizedundertheeffectiveinterestmethodIftheparvaIueislessthantheinitia>cost(statedlnterestrateisgreaterthantheeffbctiverate),theinterestincomewouldbelowerthantheinterestreceivedbecauseofamozationofthepremium

18Biscorrect.UnderRS,SPEsmustbeconsolidatediftheyareconductedfbrthebenetofthesponsonngentity.Further,underIFRSSPEscannotbec>assifiedasqualifying.UnderUSGAAP,qualifyingSPEs(acIassificationwhichhasbeene!iminated)donothavetobeconsolidated.

19Biscorrect.StatewideMedicalwasaccountedfbrunderthepoolingofinterestmethod,whichcausesallofStatewide,sassetsandliabilitiestoberepoItedathistoIicalbookvalue.TheexcessofassetsoverliabiIitiesgenerallyislowerusingthehistoicalbookvaluemethodthanusingthefairvaIuemethod(this>attermethodmustbeusedundercurrent>yrequiredacquisitionaccounting).Itwou}dhavenoeffbctonrevenue.

20.Aiscorrect.Undertheequitymethod,BetterCaewouIdcorditsinteestinthejointvemre,snetprofitasasingIeIineitem,butwouIdshownoIinebyIinecontibutionto

2l

22

revenuesorexpenses

Ciscoect.NetincomewiIIbethesameundertheequitymethodandpropoIhonaIconsolidationHowever,sales,costofsaIes,andexpensesaediffbrentbecauseundertheequitymethodtheneteffectofsales,costofsales,andexpensesisefectedinasingIeline

Bisconct.UnderthepropoltionateconsoIidationmethod,SupemeHeaIthcare,sconsolidatedfinanciaIstatementswiIincludeits50percentshareofthejointventure,stotaIassets

23Ciscorrect.ThechoiceofequitymethodorproportionateconsolidationdoesnotaffbctreportedshahoIders,equity

21. Ciscorect.AlthoughSupremeHeaIthcaehasnovotinginterestintheSPE,itisexpectedtoabsorbanylossesthattheSPEincurs.Thefbre,SupremeHeaIthcareinsubstance,,controIstheSPEandwouIdconsoIidateit.Ontheconsolidatedbalancesheet,

theaccountsreceivab>ebaIancewiI>bethesamesihcethesaletotheSPEwiIbereverseduponconsoIidation.

Z5Aiscoect.ThecurentatiousingtheequitymethodofaccountingisCurrentassetsCurrentIiabilities250ll0227.Usingconsoidationeitherfhlorpartiagoodwillthecurentratio390200195.Therefbre,thecuIrentratioishighestusingtheequitymethod

26Aiscoect.Usingtheequitymethodlongtermdebttoequity600l,4300.42.Usingtheconsolidationmethod>ong-termdebttoequity=>ongptenndebt/equity=l,000l,750057Equityincludesthe320noncontrollingintestundereitherconsolidationItdoesnotmatterifthefh>>orpartialgoodwillmethodisusedsincethereisnogoodwi>l

Z7Ciscorrect.TheprO>ecteddepreciationandamoItizationexpensewillincludeNinMount,srepoteddepreciationandamortizationl02,Boswellsreporteddepreciationandamotizationg2,andamortizationofBoswell,slicensesl0milion.Theicenseshaveafhirvaueof60milion.320purchasepriceindicatesafhirvaIueof60fbrthenetassetsofBoswell.ThenetbookfaiIvaIueoftherecorded

assetsis580.Thepreviouslyunrecordedicenseshaveafaivalueof60millionThe>icenseshavearemaininglifbofsixyears;theamortizationadiustmentfbr2008wi>>bel0miIionTherefbre,Pqecteddepreciationandamortizationl0292l0204million.

28Aiscoect.NetincomeisthesameusinganyofthemethodsbutundertheequitymethodnetsaIesareonly950;Boswell,ssaesarenotincludedinthenetsalesfigureTherefbrenetprofitmarginishighestusingtheequitymethod.

Z9AiscorrectNetincomeisthesameusinganyofthechoices.Beginningequityundertheequitymethodisl,130.Undereitheroftheconsolidations,beginningequityis,750sinceitincudesthe320noncontrollinginterestRetumonbeginningequityishighestundertheequitymethod.

30Aiscoect.Usingtheequitymethod,TotalassettumoverNetsalesBeginningtotalassetsg502,M00444Totalassettumoveronbeginningassetsusingconsolidationl4602,9500495.Underconsolidation,Assets2,40320l,070602,950Theefbre,totaIassettumoverislowestusingtheequitymethod.

189

ThiseadingcovestwocompexaspectsofempIoyeecompensation:postemployment(retirement)bene&tsandshare-basedcompensation.RetirementbenefitsincludepensionsandotherpostempIoymentbenefits,suchasheaIthinsurance.ExampIesofshaebasedcompensationarestockoptionsandstockgants.

AcommonissueunderlyingbothoftheseaspectsofempIoyeecompensationisthedifficu>tyinmeasuIingtheva>ueofthecompensation.OnefactorcontributingtothedifficuityisthatemployeeseamthebenefitsintheperiodsthattheyprovideseIicebuttypica!>yreceivethebenefitsinfUtureperiodssomeasurementrequiresasignificantnumberofassumpt1ons.

ThisreadingprovidesanoverviewofthemethodscompaniesusetoestimateandmeasurethebenefitstheyprovidetotheiremployeesandhowthisinfbrmationisrepoItedinfinancialstatements.Therehasbeensomeconveoymentbenefits.1UnderUSGAAP,theguidanceisspreadacrossseveraIsectionsoftheFASBCodification.2

ThediscussionbeginswithanoverviewofthetypesofbenefitsandmeasurementissuesivoIved,includingtheaccountingtreatmentfbdefmedcontributiopIansItthencontinueswithfinancialstatementreportingofpensionp>ansandotherpost-empIoymentbenefits,includinganoverviewofcriticaIassumptionsusedtovaIuethesebenefits.Thesectionconcludeswithadiscussionofevaluatingdefinedbenefitpensionplanandotherpost-empIoymentbenefitdisclosures.

2.1.TypesoPostEmpIoymentBenefitPlans

CompaniesmayoffbrvaIioustypesofbenefitstotheirempIoyeesfbllowingretirement,incIudingpensionplans,healthcaep!ansmedicaIinsurance,andIifbinsurance.Someofthesebenefitsinvolvepaymentsinthecurrentperiod,butmanyarepomisesoffUtuebenefits.The

l91

obectivesofaccountingfbempIoyeebenefitsistomeasuethecostassociatedwithprovidingthesebenefitsandt0recognisethesecostsinthesponsonngcompany,sfinancialstatementsduringtheempIoyees,periodsofservice.CompIexityarlsesbecausethesponsormgcompanymustmakeassumpt1onstoestimatethevalueoffUturebenefits.Theassumpt1onsrequiredtoestmateandrecognisethesefUtuebenefitscanhaveasignicantimpactonthecompany,sreportedperfbrmanceandfinanciaIposition.Inaddition,diffCrencesinassumpt1onscanreduce

comparabiIityacosscompanies.

Pensionp>ansaswel>asotherpost-empIoymentbenefitsmaybeeitherdefinedcontributionplansordefinedbenefitplans.Underadefinedcontribution(DC)pensionplan,specific(oragreed-upon)contributionsaremadetoanemp>oyee,spensionplanTheagreeduponamountisthepenslonexpense.TypicaIIy,inaDCpensionpIananindMdualaccountisestabIishedfbreachpart1clpatlngemployee.Theaccountsaregenerallyinvestedthroughafinancial

oyeesandtheemployermayeachcontributetotheplanAHertheemployermakesitsagreeduponcontributiontothepIanonbehalfofanemployeegeneralyinthesameperiodinwhichtheemployeeprovidesthesevicetheemp!oyerhasnoObligationtomakepaymentsbeyondthisamount.Thefhmrevalueofthep>an,sassetsdependsontheperfbrmanceofthelnvestmentswithintheplanAnygainsorlossesre>atedtothoseinvestmentsaccruetothe

employee.Therefbre,inDCpensionp>anstheempIoyeebearstheriskthatplanassetswil>notbesufficienttomeetfUtureneeds.Theimpactonthecompany,sfinancialstatementsofDCpenslonplanslseasilyassessedbecausethecompanyhasnoob>igationsbeyondtherequired

contributions.

IncontrasttoDCpenslonplans,definedbenefitBpensionplansareessentialypromisesby

theemp>oyertopayadefinedamountofpensioninthefUture.AspartoftotalcompensationtheempIoyeeworksinthecurrentpeIiodinexchangefbrapensiontobepaidaherret1ement.InaDBpensionplan,theamountofpensionbenefittobeprovidedisdefined,usuallybyrefbrencetoageyearsofservice,compensation,etc.ForexampIe,aDBpensionplanmayprovidefbrtheretieetobepaid,annuallyuntildeath,anamountequaltolpercentofthefinalyear,ssalarytlmesthenumberofyearsofservice.Thefhturepensionpaymentsrepresenta>iabilityorobligationoftheempIoyer(ie.thesponsonngcompany)TomeasurethisobIigation,theempIoyermustmakevanousactuaria|assumptlons(emp>oyeetumover,average

retlrementage,Iifbexpectancyaferetirementandcomputations.ItisimportantfbrananalysttoevaluatesuchassumptionsfbrtheirreasonablenessandtoanalysetheimpactoftheseassumptionsonthefinanciaIreportsofthecompany.

UnderIFRSandUSGAAP,allplansfbrpensionsandotherpost-employmentbenefitsotherthanthoseexp>icitlystmcturedasDCplansareclassifiedasDBplans.3DBplansincIudebothfbrmalp>ansandthoseinfbrmaIarrangementsthatcreateaconstluctiveObligationbytheempIoyertoltsemployees4TheemployermustestimatethetotaIcostofthebenefitspromisedandthenaIIocatethesecoststotheperiodsinwhichtheemployeesprovideservice.ThisestlmationandaIIocationfUrtherincreasesthecompIexityofpensionrepoItingbecausethetlmlngofcashf>ows(contributionsintotheplanandpaymentsfiFomtheplan)candiffbrsignificantIyfTomthetimingofaccuaIbasisepoting.AccruaIbasisreportingisbasedonwhentheservicesarerenderedandthebenefitsareearned

MostDBpenslonplansaeflmdedthroughaseparatelegalentity,typicallyapensiontrust,and

theassetsofthetrustareusedtomakethepaymentstoretirees.ThesponsonngcompanyisresponsiblefbrmakingcontributionstothepIanThecompanya>somustensurethattherearesufficientassetsintheplantopaytheultimatebenefitspromisedtoplanparticipants.Regu>atoryrequirementsusuaIIyspecifyminimumfimdingIevelsfbrDBpensionplansbutthoserequirementsvalybycountI.TheflmdedstatusofapensionpIan-oveIfUndedor

219

|

underfllndedfbrstowhethertheamountofassetsmthepensiontrustisgreatethanorIessthantheestimatedliability.IftheamountofassetsintheDBpensiontrustexceedsthepresentvaIueoftheestimatedIiability,theDBpensiopanissaidtobeovenmded;conveseIy,iftheamountofassetsinthepensiontmstislessthantheestimatedliability,theplanissaidtobeunderfInded.BecausethecompanyhaspromisedadefiIedamountofbenefittotheempIoyees,itisobligatedtomakethosepensionpaymentswhentheyaredueregardlessofwhetherthepensionpIanassetsgeneratesuffcientretumstopovidethebenefitslothewods,thecompanybearstheinvestmentIiskManycompaniesarereducingtheuseofDBpensionp>ansbecauseofthisrisk

SimilartoDBpensionplans,otherpost-employmentbenefits(OPB)arepromisesbythecompanytopaybenefitsinthefUture,suchasIifeinsurancepremiumsandaIIopaofheaIthcareinsurancefbritsretirees.OPBaretypical!yc>assifiedasDBp>ans,withaccountingteatmentsimiartoDBpensionpans.Howeve,thecompexityinrepoItingfbrOPBmaybeevengIaterthanfbrDBpensionplansbecauseoftheneedtoestimatefhtureincreasesincosts,suchashea>thcareoveralongtimehorizon.UnIikeDBpensionplanshowever,companiesmaynotberequiredbyregulationtofUndanOPBinadvancetothesamedegreeasDBpensionp>ans.Thisispartlybecausegovernments,throughsomemeans,oheninsureDBpensionplansbutnotOPB,paItlybecauseOPBmayrepresentamuchsmallerfmancialliabiIity,andpartlybecauseOPBareoReneasiertoeliminateshou>dthecostsbecomeburdensomeItisimportant

thatananalystdeteIminewhatOPBareoffbredbyacompanyandtheobligationtheyrepresent

Typesofpost-employmentbenefitsoffbredbyemployersdiffbracrosscountIies.Forinstance,incountrieswheregovernment-sponsoreduniversalhealthcareplansexist(suchasGennanyFranceCanada,Brazil,Mexico,NewZealand,SouthAfhcaIndiaIsrael,Bhutan,andSingapoI,companiesarelesslikelytopIovidepostretirementhealthcarebenefitstoemp>oyees.TheextenttowhichcompaniesoffbrDCorDBpensionp>ansalsovaIiesbycountIy.

Exhibit1summanzesthesethreetypesofpost-employmentbenefits.

ExhibntlTypes0fP0stEmpI0ymentBenes

Type0Benet

Defined

contIibution

pensionplan

Am0Int0fP0St-

Emp>0ymemBenefitt0

Emp!0yee

AmountoffUtu

benefitisnot

defined.AcmaI

fUmrebenefitwiIl

dependoninvestment

peIfbrmanceofpIanassets.

Investmentriskis

bomebyemp>oyee.

AmountoffUture

benefitisdefmed,

Obligti0n0Sp0ns0ingC0mpny

Amountofthe

company,sob>igation(contribution)isdefinedineach

peIiodThecontribution,ifanyistypica>IymadeonaperiodicbasiswithnoadditionaIfiture

obligation.AmountofthefUture

obligation,basedon

Sp0ns0l>ngC0mp&my,sPefmding0fitsFutue

Obl&gnti0n

NotapplicabIe.

Companiestypicallypre-

l93

I94

TyPe0Benefit

Defined

benet

pensionpIan

Otherpost-emp>oymentbenefits(e.gretirees,

healthcare)

Am0unt0fP0st=

ImpI0ymemBenett0

Empl0yee

basedontheplan,sfbmuIaoenafilnctionoflengthofseIviceandfinal

year,scompensation).Investmentriskis

bomebycompany.

Amountoffnture

benefitdependsonpIanspecificationsandtypeofbenefit

ObIigtd00Sp0ns0ingCOmpny

Sp0nS0ingC0mpany,sPre-fimding0fitsFuture

ObligHt0nhmdtheDBthepIan,sfbnnula,

mustbeestlmatedinplansbythecurrentperiod.contributing

fimdstoa

pensiontrust.RegulatoIyrequirementstopre-fimdvabenefitsareCompaniesspecifiedThe typicallydonotamountofthefUturepre-fhndotherobligationmustbe pOSt-estimatedintheemploymentcurIntperiodbenefit

obIigations.

ThefbllowingsectionsprovideadditionaldetailonhowDBpensionplan>iabilitiesandpeIiodiccostsaremeasuedthefinancialstatementimpactofrepomngpensionandotherpostemploymentbenefits,andhowdisclosuresinthenotestothefinancialstatementscanbeusedtogaininsightsabouttheunderlyingeconomicsofacompany,sdefinedbenefitplans.Section2.ZdescribeshowaDBpensionp>an,sobIigationisestimatedandthekeyinputsintoandassumptionsbehindtheestimate.Section2.3describesfinanciaIstatementreportingofpensionandOPBpIansanddemonstratestheca!culationofdefinedbeefitobIigationsandcuentcostsandtheeffbctsofassumptions.Section2.4desclibesdisclosuresinfinancialrepoItsaboutpensionandOPBpIans.Theseinc>udediscIosuresaboutassumptionsthatcanbeusefUlinanalysingandcompanngpensionandOPBplanswithinandamongcompanies.

22MeasuingaDefinedBenefitPensionPIan,s0bIigations

BothlFRSandUSGAAPmeasurethepensionOb>igationasthepresentvaIueoffUturebenefitseanedbyempIoyeesfbrserviceprovidedtodate.TheobligationiscalledthepresentvalueofthedefinedbenefitobligationBOunderRSandtheprOjectedbenefitobligationPBOunderUSGAAP.5ThismeaSureisdefinedasthepresentvaIue,withoutdeductinganyplanassets,ofexpectedfUturepaymentsrequiredtosettletheobIigationaIisingfiFomemployeeserviceinthecurrentandpriorpe

l

|

compensationincreasesandIeveIsdiscountates,ahdexpectedvestmgForinstanceanestimateofftlturecompensationismadeifthepensionbenefitfbImulaisbasedonfUturecompensationIeveIsexampIesinCudepayeIated,finalpayfinaaverage-pay,orcareeraverage-payp>ans)Theexpectedannua>increaseincompensationovertheemployeeserviceperiodcanhaveasignificantimpactonthedefinedbenefitobIigationThedeterminationofthebenefitobligationimp>icitlyassumesthatthecompanywi>lcontinuetooperateinthefUturethegoingconcemassumption,,adcognisesthatbenefitswiIIincreasewithfUtuecompensationincreases.

Anotherkeyassumptionisthediscountrate-theinterestrateusedtocalcu>atethepresentvalueofthefhturebenefits.Thisrateisbasedoncurrentratesofretumonhigh-qualitycorporatebonds(orgovemmentbondsintheabsenceofadeepmarketincorporatebonds)withcurrencyanddurationsconsistentwiththecurrencyanddurations0fthebenefits.

UnderbothDBandDCpensionp>ans,thebenefitsthatempIoyeeseammaybeconditionalonremainingwiththecompanyfbraspecifiedperiodoftime.Vesting,refbrstoapIovisioninpensionsplanswherebyanemployeegainsrightstofhmrebenefitson>yahermeetingcertaincriteria,suchasapre-specifiednumberofyearsofservice.Iftheemployee>eavesthecompanybefbremeetingtheciteIia,heorshemaybeentitIedtononeoaportionofthebenefitseamedupuntilthatpoint.However,oncetheemp>oyeehasmetthevestingrequirements,heorsheisentitledtoeceivethebenefitseamedinpnorperiodsie.,oncetheemployeehasbecomevested,benefitsarenotfbIfbitediftheempIoyeeIeavesthecompany).InmeasunngthedefinedbenefitObligation,thecompanyconsiderstheprObabiIitythatsomeemployeesmaynotsatisfythevestingrequirements(ie.,mayleavebefbrethevestingperiod)andusesthisprobabi>itytocalculatethecurrentservicecostandthepresentvalueoftheobligation.Currentservicecostistheincreaseinthepresentvalueofadefinedbenefitobligationasaresultofemployeeserviceinthecurrentperiod.CurrentseIvicecostisnottheonlycauseofchangeinthepresentvaIueofadefinedbenefitobligation

TheestimatesandassumptionsaboutfUturesaIaincases,thediscountrate,andtheexpectedvestingcanchange.Ofcourse,anychangesintheseeStimatesandassumptionswillchangetheest1matedpensionobigationIfthechangesincreasetheobigation,theinceaseisrefbrredtoasanactuarialoss.Ifthechangesdecasetheobligationthechangeisrefbedtoasanactuarialgain.Section2.3.3fUrtherdiscussesestimatesandassumpnonsandtheeffbctonthepensionobIigationandexpense.

2.3FinanciaIStatementReptingofPensionPIansandOthePostEmpIoymentBenefits

Sections2.3.lto2.3.3describehowpensionplansandotherpost-employmentbenefitsaIcrepoItedinthefinancia>statementsofthesponsonngcompanyandhowassumptionsaffbcttheamountsreportedDisclosuresre>atedtopensionsplansandOPBaredescribedinSectionZ4.

231DeedCbnPesionans

Theaccountingtreatmentfbrdefinedcontributionpensionp>ansisrelativelysimple.Fromafinancia>statementperspective,theemployer,sobligationfbrcontributionsintothepIan,ifany,isIcordedasanexpenseontheincomestatement.Becausetheemployer,sObligationislimitedtoadefinedamountthattypicalIyequaIsitscontributionnosignificantpension-re>atedIiability

1g5

accuesonthebaIancesheet.AnaccmalcuentIiabiIityisrecogHisedattheendofthereportingperiodonlyfbranyunpaidcontributions.

232DeedBenePesjOas

TheaccountingtreatmentfbrdefinedbenefitpensionplansismorecompIex,pnmarilybecauseofthecomplexitiesofmeasunngthepensionOb>igationandexpense.

2321.BaIanceSheetPesentation

BothRSandUSGAAPrequireapensionplan,sfilndedstatustoberepotedonthebalancesheet.ThefimdedstatusisdeteIminedbynettingthepensionob>igationagainstthefairvalueofthepensionpIanassets.Ifthepensionobligationexceedsthepensionplanassets,theplanhasadeficit.Iftheplanassetsexceedthepensionobligation,theplanhasasurplus.Summarizingthisinfbnnationinequationfbrmgives

FundedstatusFairvalueoftheplanassetsPVoftheDefinedbenefitobigation

lg6

lftheplanhasadeficitanamountequaltothenetundeIfhndedpensionobligationisrepoItedonthebalancesheetasanetpensionliability.IftheplanhasasurpIus,anassetequa>totheoveIfimdedpensionobligationisportedonthebalancesheetasanetpensionassetexceptthattheamountofrepoItedassetsissuhjecttoaceilingdefinedasthepresentvalueoffUtureeconomicbenefits,suchasrefimdsfiomtheplanorreductionsoffUturecontributions).DiscIosuresinthenotesprovideadditiona>infbrmationaboutthenetpensionliabi>ityorassetreportedontheba>ancesheet.

ExampIe1

DeteinatinfAmuntstbeReptentheBalahceSheet

Thefb>lowinginfbrmationpeItainstotwohypotheticalcompanies,definedbenefitpensionpIansasof3lDecember20l0:

ForcompanyABCthepresentvaIueofthecompany,sdefinedbenefitobligationise6,723andthefhirvalueofthepensionpan,sassetsis6,880

ForcompanyDEF,thepresentvaIueofthecompany,sdefinedbeIefitobIigationise5,485andthefhirvalueofthepensionp>anassetsise5,9g8InadditionthepresentvaueofavaiIabIeflltuerefimdsandeductionsihfUturecontributionsise326.

CaIculatetheamounteachcompanywou>dreportasapensionassetorliabilityonits20l0baIancesheet.

SoIution:

CompanyABCwouIdreportthefUllunderfhndedstatusofitspensionpIan(ie.,theamountbywhichthepresentvalueofthedefinedbenefitob>igationexceedsthefhirvalue

ofpIahassets)asaIiabiIity.SpecificaIIythecompanywouIdreportapensionIiabiIityofel,843

Presentva>ueofdefinedbenefitobligation

FairvaIueofp>anassets

NetpensionIiability

66,723

(4,880)

el,843

CompanyDEF,spensionplanisovefUndedby65l3whichistheamountbywhichthefairvalueofthep>an,sassetsexceedthedefinedbenefitobligation(65,g98-65,485)However,whenacompanyhasasurplusinadefinedbenefitp>an,theamountofassetthatcanbepoItedisthelowerofthesuIp!usandtheassetceilingthepresentvalueoffUtureeconomicbenefits,suchasIcftmdsfTomtheplanorreductionsoffnturecontributions)Inthiscase,theassetceilingisgivenas6326sotheamountofcompanyDEF,sreportednetpensionassetwou>dbe>imitedtoe326.

2322PeiodicPensionCost

Theperiodiccostofacompany,sDBpensionplanisthechangeinthenetpensionliabilityorassetadjustedfbrtheemployer,scontributions.Eachperiod,theperiodicpensioncostisrecognisedinprofitorloss(P&L)and/orinothercomprehensiveincome(OCI).(Insomecases,amountsofpensioncostsmayquaIifyfbrinclusionaspartofthecostsofsuchassetsasinventonesandthusbeincludedinP&Laspartofcostofgoodssoldwhenthoseinventoriesarelaterso>dThefbcushereisontheamountsnotcapitalised.)IRSandUSGAAPdiffbrinthewaythatthepeiodicpensioncostisdMdedbetweenPLandOCI

UnderIFRS,theperiodicpensioncostisviewedashavingthreecomponents,twoofwhicharerecognisedinP&LandoneofwhichisrecognisedinOCI.

1SbWc2c.Thefirstcomponentofperiodicpensioncostisservicecost.Currentservicecostistheamountbywhichacompany,spensionob>igationincreasesasaresuItofempIoyees,serviceinthecurrentperiodPastservicecostistheamountbywhichacompany,spensionobligationreIatingtoemployees,seIviceinpnorperiodschangesasaresuItofpIanamendmentsoraplancuItailment.7UnderIRS,seIicecosts(incIudingbothcurrentservicecostsandpastseIvicecosts)arerecognisedasanexpenseinP&L

2Veesexpesecoe.Thesecondcomponentofperiodicpensioncostisnetinterestexpenseorincome,whichwewi>lrefertoasnetinterestexpense/income.,,Netinterestexpense/incomeiscaIcu>atedbymultipIyingthenetpensionIiabi>ityornetpensionassetbythediscountrateusedindetenniningthepIsentvalueofthepension>iabiIity.AnetinterestexpenserepresentsthefinancingcostofdefbrringpaymentsreIatedtotheplan,andanetinterestincomerepresentsthefinancingincomeomprepayingamountsrelatedtothepIanUnderRS,thenetinterestexpenseincomeisrecognisedinP&L

3Reeoee.ThethidcomponentofpeiodicpensioncostisremeasuementofthenetpensionIiabiIityorasset.RemeasurementincIudes(a)actuariaIgainsandIossesand(b)anydiffbrencesbetweentheactua>retumonplanassetsandtheamountinc>udedin

197

thenetinteestexpenseincomecaIcuIation.UnderRS,remeasurementamountsarerecognisedinOCI.RemeasurementamountsarenotsubsequentlyamortisedtoP&L

SimilartoRS,underUSGAAPcurentseicecostisrecognisedinPLHowever,underUSGAAP,pastservlcecostsareportedinOCIintheperiodinwhichthechangegivingnse

tothecostoccurs.Insubsequentperiods,thesepastseIicecostsareamortisedtoP&LovertheaverageseIvicelivesoftheaffectedemployees.

AlsosimilartoIRS,underUSGAAPtheperiodicpensioncostfbrP&Lincludesinterestexpenseonpensionob>igations(Whichincreasestheamountoftheperiodiccost)andremmsonthepenslonplanassets(whichreducetheamountofthepeliodiccost).Un>ikeIRShowever,

underUSGAAP,thetwocomponentsaInotpresentednet.Aso,underUSGAAP,retumsonpIanassetsincludedintheP&Lrecognitionofpensioncosts(pensionexpense)useanexpectedretumratherthantheactua>retum.(UnderIRS,retumsonplanassetsinc!udedintheP&Lrecognitionofpensioncosts(pensionexpense)usethediscountrateastheexpectedretum.)Thus,underUSGAAPdiffbrencesbetweentheexpectedretumandtheactuaIremmonplanassetsrepresentanothersourceofactuarialgainsorlosses.Asnoted,actuarialgainsandlossescanalsoresultfiFomchangesintheactuaria>assumptionsusedindeterminingthebenefitobIigationUnderUSGAAP,aIIactuariaIgainsandIossesareincludedinthenetpensionliabilityornetpensionassetandcanbereportedeitherinP&LorinOCI.Typically,compamesreportactuariaIgainsandIossesinOClandrecognisegainsandIossesinP&LoIIywhencertainconditionsaremetunderaso-ca>ledcorridorapproach.

Underthecorridorappoach,thenetcumuativeunrecognisedactuarialgainsahdIossesatthebeginningofthereportingperiodarecomparedwiththedefinedbenefitob>igationandthefairvaueofpIanassetsatthebeginningoftheperiod.IfthecumulativeamountofuncognisedactuarialgainsandIossesbecomestooargei.eexceedsl0percentofthegreaterofthedefmedbenefitobligationorthefhirvaueofpIanassetsthentheexcessisamoisedovertheexpectedaverageremainingworkinglivesoftheemp>oyeesparticipatingintheplanandisincludedasacomponentofpeIiodicpensioncostinP&LTheteImcorridor,,referstothel0percentrange,andonlyamountsinexcessofthecorridormustbeamortised.

Toiustatethecorridorapproach,assumethatthebeginningbalanceofthedefinedbenefitObIigationis$5,000,000thebeginningbalanceoffhirvalueofplanassetsis$4,850,000,andthebeginningbalanceofunrecognisedactuariaIlossesis$6l0,000.Theexpectedaverageremainingworkinglivesoftheplanemp}oyeesisl0years.Inthisscenario,thecorridoris500,000,whichisl0pecentofthedefinedbenefitobIigationselectedasthegreaterofthedefinedbenefitobligationorthefhirvalueofpIanassets).Becausethebalanceofunrecognisedactuariallossesexceedsthe$500,000corIidor,amortisationisrequired.Theamountoftheamortisationisll,000,whichistheexcessoftheunIccognisedactuaialossoverthecorIidordividedbytheexpectedaverageremainingworkingIivesoftheplanemployeesiesthemethodofamortisationtobothgainsandIossesconsistentlyinallpeIiodspresented

Tosummanze,underlFRS,theperiodicpensioncostsrecognisedinP&LincIudeservicecosts(bothcurrentandpast)andnetinterestexpense/income.TheperiodicpensioncostsrecognisedinOCIinc>uderemeasurementsthatcompnsenetreturnonp>anassetsandactuarialgainsand>osses.UnderUSGAAPtheperiodicpensioncostsrecognisedinP&Lincludecurrentservicecosts,interestexpenseonplanIiabilitiesexpectedretumsonplanassets(whichisareductionofthecost)theamoItisationofpastservicecosts,andactuarialgainsandlossestotheextentnotreportedinOCI.Thecomponentsofacompany,sdefinedbenefitperiodicpensioncostsaresummarizedinExhibit2.

198

ExhibitZC0mp0ems0ffhC0mpay,sDefinedBenefitPenSi0lPei0dicC0ss

USGAAP

IFRSC0mp0neItIFRSRec0gniti0nC0mp0nent

Servicecosts

Netinterest

income/expense

Remeasurements:

NetmmonpIanassetsand

actuarialgainsand>osses

RecognisedinP&L.

RecognisedinP&Lasthefbllowingamount:Netpension>iabilityorassetxinterestratea

RecognisedinOCIandnotsubseqUentlyamoItisedtoP&L

Netremmon

planassets=Actualretum

TanassetsxInterest

rate)

ActuariaI

gainsandlosses=

Changesinacompany,spenslon

obligationaIisingfiOmchangesinactuarial

assumptions.

Current

seIicecosts

Pastservice

cOStS

Interest

expenseon

penslon

obligation

Expectedretumonplanassets

AchariHl

gainsand!osses

incIudingdiffCrences

betweenthe

actualand

expectedretumson

planassets

USGAAP

Rec0gHiti0n

RecOgnisedinP&L

RecognisedinOCIandsubsequentIyamoItisedtoP&L

overtheservice>ife

ofemployees.

RecognisedinP&L

RecognisedinP&Lasthefb>>owingamOUnt:PIanaSSetSx

expectedIBtum.

Recognisedimmediate>yinP&Lganassetsx

Expectedretum)

ActuariaIgainsandlosses=

Changesinacompany,spenslon

ob>igationaIisingfomchangesinactuarial

assumptions

1g9

ThcinteIcslHteusedisequaltothcdiscourateuscdtomcasuthcpensionabiliytheyicldonhighualitycop0mtebonds.

bIfthecummativeamolmtofuncognisedactuaialgainsandlossesexceedsl0perceofthegaerofthcva>ueof[heplaIasseengthoftimethepensionpaymentswi>lbemaderequiresassumpt1onsaboutemployees,>ifbexpectancypost-empIoyment.Fina>Iy,thepresentvaIueofthesefUtuIcpaymentsrequiresassumptionsabouttheappropnatediscountrate(whichisusedastheIateatwhichinterestexpenseorincomewil>subsequentIyaccrueonthenetpensionliabilityorasset)

ChangesinanyoftheassumptionswiI>increaseordecreasethepensionobligationAnincreaseinpensionobigationsultingfibmchangesinactuarialassumptlonsisconsideredanactuarialloss,andadecreaseisconsideredanactuarialgain.Theestlmateofacompany,spensionIiabilityaIsoaffectsseveralcomponentsofperiodicpensioncosts,apartfiomactuarialgainsand>osses.Firsttheservicecostcomponentofannualpensioncostisessentia!>ytheamountbywhichthepensionliabiIityincreasesasaesultoftheemployees,serviceduIingtheyear.Secondtheinterestexpensecomponentofannualpensioncostisbasedontheamountoftheliability.Third,thepastservicecostcomponentofannualpensioncostistheamountbywhichthepensionliabilityincreasesbecauseofchangestothepIan.

Estimatesrelatedtop>anassetscanaIsoaffbctannualpensioncostreportedinP&L(pensionexpense),primarilyunderUSGAAP.Becauseacompany,speriodicpensioncostrepoItedinPLunderUSGAAPincludestheeecedretumonpensionassetsratherthantheactuaIretum,theassumptlonsabouttheexpectedretumonplanassetscanhaveasignificantimpactAlsotheexpectedretumonplanassetsequiresestlmatinginwhichfUtureperiodthebeneftswiIIbepaid.Asnotedabove,adivegenceofactualretumsonpensionassetsfiomexpectedretumsresultsinanactuaiaIgainorloss

|

I

UnderstandingtheeffbctofassumptionsontheestimatedpensionobligationandonpenodicpensioncostsisimportantbothfbrinteIpretingacompany,sfinancialstatementsandfbrevaIuatingwhetheracompanysassumptiosappeareIativelyconseativeoraggressive.

TheprO>ectedunitcreditmethodistheIRSapproachtomeasuringtheDBobligationUndertheprqectedunitceditmethod,eachperiodofseIvicee.g.,yeaofempoymentgivesnsetoanadditionalunitofbenefittowhichtheemp>oyeeisentitIedatretirement.Inother.words,fbreachperiodinwhichanemployeeprovidesservice,theyeamaportionofthepost-emp>oymentbenefitsthatthecompanyhaspromisedtopay.AnequivalentwayofthinkingaboutthisisthattheamountofeventualbenefitiIcreaseswitheachadditionalyearofservice.TheemployermeasureseachunitofseIiceasitiseamedtodetemlinetheamountofbenefitsitisobligatedtopayinfiturereportingperiods

TheOIectiveoftheprOjectedunitcreditmethodistoallocatetheentireexpectedretirementcosts(benefits)fbranemployeeovertheemp>oyee,sseIiceperiods.Thedefinedbenefitobligationrepresentstheactuarialpresentvalueofallunitsofbenefit(credit)towhichtheempIoyeeisentitled(ie.,thosethattheemployeehaseamed)asaresultofpriorandcurrentperiodsofservice.Thisobligationisbasedonactuaria>assumptionsaboutdemOgraphicvaiabIessuchasempIoyeetumoverandifbexpectancy,andonestimatesoffinancia!variab!es,suchasfUtureinf>ationandthediscountrate.Ifthepensionbenefitfbnnu>aisbasedonempIoyees,filturecompensation>eveIs,thentheunitofbenefiteamedeachpeIiodwiIIref>ectthisestimate

UnderbothRSandUSGAAP,theassumedrateofinceaseincompensationtheexpectedannualincreaseincompensationovertheemployeeserviceperiod-canhaveasignificantimpactonthedefinedbenefitobigationAnothekeyassumptioisthediscountateusedtocacuatethepsentvalueofthefUturebenefitsItrepresentstherateatwhichthedefinedbenefitobIigationcouIdbeeffectivelysettIedThisrateisbasedoncurentratesofretumonhighqualitycorporatebondswithdurationsconsistentwiththeduIationsofthebenefit.

Thefbllowingexamplei>lustratestheca>cu>ationofthedefinedbenefitpensionobligationandcurrentservicecosts,usingtheprOiectedunitcreditmethod,fbranindividualemployeeunderfburdiffbrentscenarios.InterestontheopeningobligatioIaIsoincreasestheobIigationandispartofcunPentcosts.ThefbuIthscenarioisusedtodemonstatetheimpactonacompany,spensionobligationofchangesincertainkeyestimates.Examples2and3fbcusonthepensionob>igationThechangeinpensionobIigationovertheperiodisincludedinthecalculationofpensionexpense(pensioncostreportedinP&L)

ExampIe2

CaIcuIationfDefihedBenefitPehsih

ObIigatinahIhdMduaIEmpIoYeeThefbIlowinginfbImationappliestoeachofthefburscenariosAssumethata(hypotheticaI)companyestabIishesaDBpensionplan.TheempIoyeehasasa>aIinthecomingyearof650000andisexpectedtoworkfivemoeyearsbefbreretiring.Theassumeddiscountrateis6percentandtheassumedannuaIcompensationincreaseis4.75percent.Forsimp>icity,assumethattherearenochangesinactuaria>assumptions,allcompensationincreasesareawadedonthefirstdayoftheseiceyear,andnoadditionalaustmentsamadetorefectthepossibilitythattheemployeemayeavethecompanyatanearIierdate

201

202

Currentsalary

Yearsuntilretirement

AnnualcompensationincreasesDiscountrate.

Finalyear,sestimatedsalaIya

650,000.00

5

475%

6.00%

e60,lg8.56

aFinalyear,sestimatedsalayCunmyearssalayxlAnnualcompensaionincaseau!i!!etim!.

AtthccndofYearl,thefinalyearsestimatedsalaye50,000xl00475e60,lg8.56,assumingthattheemployee,ssa>aryincreasesby475percenteachyear.Withnochangeinassumptionabouttherateofincreaseincompensationorthedateofretirementtheestimateofthefinalyear,ssalaIwillremalnunchanged.

AttheendofYear2assumingtheempIoyee,ssala>yactual>yincreasedby4.75percent,thefinalyear,sestimatedsala5)x5=e4,5>48g.

AnnualunitcreditbenefitperserviceyearValueatretiementYearsofservicee,5l4.895690Z.98.

Ifthediscountrate(theinterestrateatwhichthedefinedbenefitob>igationcouldbeeffbctive>ysettled)isassumedtobe0percenttheamountofannuaIunitcreditperseIviceyearistheamountofthecompany,sannualobligationandtheclosingobligationeachyearissimplytheannualunitcreditmu>tip>iedbythenumberofpastandcurrentyearsofserviceHowever,becausetheassumeddiscountratemustbebasedontheyieldonhigh-qualitycorporatebondsandwilIthusnotequal0percent,thefUtueobligationresultingomcurrentandpriorserviceisdiscountedtodeterminethevaueoftheobligationatanypointintime.

ThefbIowingtabeshowshowtheobIigationbuildsupfbthisemployee.

Yer

Estimated

annual

saIa

V

|

|

|

Po

yearsaCureht

yeaigationcInterest

costat6

perCentdCurrent

servlce

cOstse

CIosingob>igationf

g0298 g02g8 90298 g0298 g02.97I

6g02.g8el,8059662,708.g463,6ll.92e4,5l4.8

e0.00 e7l5.24el,5l6.3le2,l0.g4e3,4074

0.00 42.g> g0g8 >4466 20415

7l524758.l6803.6585187g02.g7---

e7l524el,5l6.3le2,4l09e3,4074764,5l48

Finalamountsmdiffers!igMytocompcnsatefbrIulmdinginearlierycas

aTllebeefitattributedtopnoryeasAnIaImitcditxYeaBofpIiorseice.FOrYear26902.98xl=690298.

ForYear36g02.98x2=6l80596.

bThebenefiattIibutedocunntyearAnnualumcdibasedonbencfitIbnnulaFinalyeareStimatedsalaIyxBenefifbnnuIaValueatt1ImemdaeYearsofseMce660:l,8.56xl5%)=645l4.89/5=690298.

cThcopc