SDSU Employee Contributions and Ethical Dilemma Discussion Questions these are the questions that the student answer QUESTIONS: 1. How does the change in

SDSU Employee Contributions and Ethical Dilemma Discussion Questions these are the questions that the student answer

QUESTIONS:

1. How does the change in the way employee contributions are handled affect VXI International’s financial statements?

2. Who would benefit from this change? Why?

3. Who would be injured from this change? Why?

4. Do you perceive an ethical dilemma? Why?

this is what they answered:

1) The change in the way employee contributions are handled makes VXI International look better, financially speaking. It is because instead of recording the employee’s contribution as a liability under pension expense, it is being recorded as an investment which, in turn, increases their overall assets. With this increased asset, the net income is wrongly portrayed to stockholders and investors.

2) The money wrongly recorded into the company’s investment account will increase their return on investment which will benefit VXI International itself and it’s stockholders.

3) The ones injured in this change will be the employees because they are unknowingly having their 401k being contributed into the company without having their return on investment. Because of this “contribution”, the employee is at risk, not the employer.

4) Yes, I definitely believe there is an ethical dilemma in this situation. The company is using it’s employees money without them knowing to selfishly increase their own investments.

Need help replying to his answers in a discussion 1-4 bullet points answer. Pension plans are designed to provide income to individuals during their retirement
years. This is accomplished by setting aside funds during an employee’s working years
so that at retirement the accumulated funds plus earnings from investing those funds
are available to replace wages. Thus, pension benefits are deferred compensation for
current service. Accordingly, the cost of these benefits is recognized on an accrual
basis during the years employees earn them. Periodic pension costs are one of the
largest expenses many companies report.
Corporations sponsor pension plans to provide employees with some retirement
security, which can contribute to job satisfaction and perhaps loyalty, as well as possibly
enhance productivity and reduce turnover. Motivation to sponsor a pension plan
sometimes comes from union demands and often relates to being competitive in the
labor market.
There are two basic arrangements: (a) defined contribution pension plans and (b)
defined benefit pension plans. A defined contribution plan is where an employer agrees
to periodically contribute a specific amount to a pension fund on behalf of employees,
but makes no commitment regarding benefit amounts at retirement. A defined benefit
plan is where an employer doesn’t specify the amount of annual contributions, but
promises to provide determinable amounts at retirement. Although both types of plans
have a common goal – to provide income to employees during their retirement years –
they differ regarding who bears the risk (i.e., the employer or the employees) of
ensuring the retirement objectives are achieved. Therefore, these two types of plans
also have entirely different implications for accounting and financial reporting.
Defined contribution plans promise fixed periodic contributions to a pension fund (e.g., a
percentage of the employees’ pay or to match contributions by workers). Employees get
to choose (from designated options) where the funds are invested. Retirement pay
depends on the size of the fund at retirement. Retirement income depends on the size
of the fund at retirement. The employer makes no further commitment regarding benefit
amounts at retirement. These plans have several variations. Defined contribution plans
may link the amount of contributions to company performance. When employees make
contributions to the plan in addition to employer contributions, it’s called a contributory
plan. Accounting for defined contribution plans is quite easy. Each year, the employer
simply records pension expense equal to the amount of the annual contribution.
Because pension fund contributions are an expense, as the contribution is paid, we
debit Pension Expense and credit Cash with the same amount. Defined contribution
plans are now by far the most popular type of corporate pension plan, and their relative
simplicity permits a rather straightforward accounting treatment.
Defined benefit pension plans promise fixed retirement benefits defined by a designated
formula. Typically, the pension formula bases retirement pay on the employees’ (a)
years of service, (b) annual compensation (e.g., final pay or an average for the last few
years), and (c) age. Employers are responsible for ensuring that sufficient funds are
available to provide the promised benefits. Defined benefit plans require more complex
accounting treatment.
A typical formula might specify that a retiree will receive annual retirement benefits
based on the employee’s years of service and annual pay at retirement (e.g., amount of
pay in the final year, highest pay achieved, or average pay in the last two or more
years). For example, a pension formula might define annual retirement benefits as 1.5%
x Years of service x Final year’s salary. By this formula, the annual benefits to an
employee who retires after 30 years of service with a final salary of $100,000 would be:
1.5% x 30 years x $100,000 = $45,000.
When setting aside cash to fund a pension plan, the future rate of return on plan assets
is only one of several uncertainties inherent in a defined benefit plan. Employee
turnover affects the number of employees who ultimately will become eligible for
retirement benefits. The age at which employees will choose to retire and their life
expectancies will impact both the length of the retirement period and the amount of the
benefits. Inflation, future compensation levels, and interest rates also influence eventual
benefits. Typically, a firm will hire an actuary to assess the various uncertainties (e.g.,
employee turnover, salary levels, and mortality) and to estimate the company’s
obligation to employees in connection with its pension plan. Such estimates are
inherently subjective, so regardless of the actuary’s skill, estimates will deviate from the
actual outcome.
The return on assets can turn out to be more or less than expected. These deviations
are referred to as gains and losses on pension assets. When it’s necessary to revise
estimates because the pension obligation looks like it will be more or less than
previously thought, these revisions are referred to as losses and gains, respectively, on
the pension liability. With a defined benefit pension plan, the employer bears the risk of
the pension obligation changing unexpectedly or the amount in the pension fund being
inadequate to meet the employer’s obligation. Here are the key elements of a defined
benefit pension plan:
1. The employer’s obligation to pay retirement benefits in the future,
2. The plan assets set aside by the employer to be used to pay the retirement benefits
in the future, and
3. The periodic expense of having a pension plan.
The first two elements are netted and not reported individually in the employer’s
financial statements. Both the pension obligation and the plan assets (a) are reported as
a net amount in the balance sheet, and (b) their balances are reported in disclosure
notes. The pension expense reported in the income statement is a composite of
periodic changes in both (a) the pension obligation and (b) the plan assets.
Interest and investment return are the financing aspects of the pension cost. However,
the recognition of some elements of the pension expense is delayed. For example, the
actual return is adjusted for any difference between actual and expected return, resulting
in the expected return being reflected in pension expense. Any loss or gain from
investing the plan assets is combined with losses and gains from revisions in the
pension liability for deferred inclusion in pension expense.
Unfortunately, there’s not just one definition of the pension obligation, nor is there
uniformity regarding which definition is most appropriate for pension accounting. In
pension accounting, there are three different ways to measure the pension obligation:
1. Accumulated benefit obligation (ABO): The actuary’s estimate of the total retirement
benefits (at their discounted present value) earned so far by employees, applying the
pension formula using existing compensation levels.
2. Vested benefit obligation (VBO): The portion of the accumulated benefit obligation
that plan participants are entitled to receive regardless of their continued employment.
3. Projected benefit obligation (PBO): The actuary’s estimate of the total retirement
benefits (at their discounted present value) earned so far by employees, applying the
pension formula using estimated future compensation levels. If the pension formula
does not include future compensation levels, the PBO and the ABO are the same.
The ABO is an estimate of the discounted present value of the retirement benefits
earned so far by employees, applying the plan’s pension formula
using existing compensation levels. When we look at a detailed calculation of the PBO,
simply substituting the employee’s existing compensation in the pension formula for the
projected salary at retirement would give us the ABO.
If an employee leaves the company to take another job, they will still get earned benefits
at retirement if the benefits are vested under the terms of the pension plan. Vested
benefits are those that employees have the right to receive even if their employment
were to cease immediately. Typically, pension plans require some minimum period of
employment before benefits vest.
However, because it’s unlikely that there will be no salary increases between now and
retirement, a more meaningful measurement should include a projection of what the
salary might be at retirement. This liability is the PBO. The PBO estimates retirement
benefits by applying the pension formula using projected future compensation levels.
When we mention the “pension obligation,” we are referring to the PBO. The PBO
measurement may be less reliable than the ABO, but it is more relevant and
representationally faithful. These are the steps to calculate the PBO:
1. Use the pension formula (including a projection of future salary levels) to determine
the retirement benefits earned to date.
2. Find the present value of the retirement benefits as of the retirement date.
3. Find the present value of retirement benefits as of the current date.
There two reasons to increase in the PBO amount:
1. Service cost: One more service year is included in the pension formula calculation.
2. Interest cost: The employee is one year closer to retirement, causing the present
value of benefits to increase due to the time value of future benefits.
There are five events that can cause the balance of the PBO to change:
1. Service cost: Each year, the PBO increases by the amount of that year’s service
cost. This is the increase in the PBO attributable to employee service performed during
the period. In addition, it is the primary component of the annual pension expense.
2. Interest cost: The PBO is still a liability, even though it is not formally recognized as a
liability in the company’s balance sheet. As with other liabilities, interest cost accrues on
its balance as time passes. This amount can be calculated directly as the assumed
discount rate multiplied by the PBO at the beginning of the year.
3. Prior service cost: The PBO might also change if the pension plan itself is amended
to revise the way benefits are determined. In addition to increasing the annual service
cost from this date forward, an amendment might also cause an immediate increase in
the PBO. This is because most companies choose to make amendments retroactive to
prior years. In other words, usually the more beneficial terms of the revised pension
formula are not applied only to future service years, but benefits attributable to all prior
service years are recomputed under the more favorable terms. Making the amendment
retroactive to prior years adds an extra layer of retirement benefits, increasing the
company’s benefit obligation. The increase in the PBO attributable to making a plan
amendment retroactive is referred to as prior service cost. Such a plan amendment
would affect not only the year in which it occurs, but also each subsequent year
because the revised pension formula determines each year’s service cost.
4. Gains and losses: When one or more of the estimates necessary to derive the PBO
requires revision, the estimate of the PBO will also require revision. The resulting
decrease or increase in the PBO is referred to as a gain or loss, respectively. If a
revised estimate causes the PBO to be lower than previously expected, a gain would be
indicated. Other possible estimate changes that would affect the PBO are: (a) A change
in life expectancies might cause the retirement period estimate to also change, which
would cause the estimate of the PBO to increase or decrease. (b) The expectation that
retirement will occur earlier or later than previously thought would cause the retirement
period estimate to change, which would probably also cause the final salary estimate to
change. The net effect on the PBO would depend on the circumstances. (c) A change in
the assumed discount rate would affect the present value calculations. A lower rate
would increase the estimate of the PBO, while a higher rate would decrease the
estimate of the PBO.
5. Payments of retirement benefits to retired employees: Another change in the PBO
occurs when the obligation is reduced as benefits are actually paid to retired
employees.
A company’s PBO is not reported separately in the balance sheet as a liability. Similarly,
the plan assets a company sets aside to pay those benefits are not separately reported
among assets in the balance sheet. However, firms do report the net difference
between those two amounts, referred to as the “funded status” of the plan. A company
must report in its balance sheet a liability for the underfunded (or asset for the
overfunded) status of its postretirement plans. If plan assets at the end of the year are
less than the required amount, the pension plan is said to be underfunded. Factors that
may impact a plan’s funded status include (a) prior service cost from amending the
pension plan, (b) increasing the PBO due to an estimate revision, and (c) the actual
performance of the investments. For example, if a plan is underfunded, the company
would report a net pension liability in its balance sheet. If the plan were to become
overfunded in the future, the company would report a net pension asset instead.
Note: The “net pension liability” is not an actual account balance. Instead, it is the PBO
and the plan assets account balances simply reported in the balance sheet as a single
net amount. We report the funded status of the plan, which is the difference between
the PBO and plan assets, in the balance sheet. If the plan is underfunded (i.e., the PBO
exceeds plan assets), it’s a net pension liability.
Like the PBO, the pension plan assets – the resources with which the company will
satisfy the employer’s obligation to provide retirement benefits in the future – are not
reported separately in the employer’s balance sheet, but are netted together with the
PBO to report either (a) a net pension asset (debit balance) or (b) a net pension liability
(credit balance). Along with the separate PBO balance, the pension plan asset’s
separate balance must be reported in the disclosure notes to the financial statements.
The return on these assets is included in the calculation of periodic pension expense.
A pension fund’s assets must be held by a trustee, which accepts employer
contributions, invests the contributions, accumulates the earnings on the investments,
and pays benefits from the plan assets to retired employees or their beneficiaries. The
annual employer contributions plus the return on the investments (e.g., interest,
dividends, and appreciation) must be sufficient to pay benefits as they come due.
Like wages, salaries, commissions, and other forms of pay, pension expense is part of a
company’s compensation for employee services each year. Accordingly, the accounting
objective is to achieve a matching of the costs of providing this form of compensation
with the benefits of the services performed. However, the fact that this form of
compensation actually is paid to employees many years after the service is performed
means that other elements in addition to the annual service cost will affect the ultimate
pension cost. These other elements are related to changes that occur over time in both
(a) the pension obligation and (b) the pension plan assets. Illustration17–11 provides a
useful summary of how some of these changes influence pension expense.
From the viewpoint of their effect on the PBO or on plan assets, the five components of
pension expense are (a) service cost, (b) interest cost, (c) the return on plan assets, (d)
prior service cost amortization, and (e) net gain or loss amortization.
1. The service cost represents the increase in the PBO attributable to employee service
performed (benefits earned by employees) during the year. Each year, this is the first
component of the pension expense.
2. The interest cost is calculated as the interest rate (discount rate) multiplied by the
PBO at the beginning of the year. Although the PBO balance is not separately reported
as a liability in the company’s balance sheet, it is still a liability, which is combined with
pension assets, with the net difference reported in the balance sheet as either a net
pension liability or a net pension asset. The interest expense that accrues on its balance
is not separately reported in the income statement, but instead becomes the second
component of the annual pension expense.
3. Plan assets are funds invested in securities that will presumably generate dividends,
interest, and capital gains. The return earned on investment securities increases the
plan asset balance and reduces the net cost of having a pension plan. When accounting
for the return, we need to differentiate between (a) the expected return and (b) the
actual return. Actually, both the interest and return-on-assets components of pension
expense do not directly represent employee compensation. Instead, they are financial
items created only because the future obligation to retirees must be funded currently.
Because the net cost of having a pension plan is reduced by the actual return on plan
assets, theoretically the charge to pension expense should be the actual return on plan
assets. However, the actual return should first be adjusted by any difference between
that return and the return amount that had been expected. So, actually it’s the expected
return that is included in the calculation of pension expense. The difference between the
actual and expected return is considered a loss or gain on plan assets. Although
we don’t include these losses and gains as part of pension expense when they occur, they
may affect pension expense at a later time.
4. Amortization of prior service cost is computed by (a) assuming the average
remaining service life of the active employee group, and then (b) amortizing the prior
service cost, using the straight-line method. According to the straight-line method, prior
service cost is recognized over the average remaining service life of the active
employee group. Thus, by dividing the prior service cost over the average remaining
service life of the active employee group, we determine the amount amortized as an
increase in pension expense each year.
Amortization of prior service cost is reported as a component of accumulated other
comprehensive income (AOCI), a shareholders’ equity account. Considering prior
service cost as other comprehensive income (OCI) and not reported among the gains
and losses in the income statement is just like several other losses and gains also
categorized the same way (e.g., unrealized holding gain and loss on available-for-sale
(AFS) securities). The prior service cost balance in AOCI declines each year by the
amount calculated using the straight-line method. Thus, we calculate the prior service
cost balance at the end of each year.
5. Gains and losses can occur when expectations are revised concerning either (a) the
PBO or (b) the return on plan assets. Like the prior service cost, we don’t include these
gains and losses as part of pension expense in the income statement, but instead report
them as OCI in the statement of comprehensive income as they occur. We then report
the gains and losses (net of subsequent amortization) on a cumulative basis as a “net
loss – AOCI” or a “net gain – AOCI,” depending on whether we have greater losses or
gains over time. We report this amount in the balance sheet as a part of AOCI. Although
there is no conceptual justification for not including losses and gains in earnings,
income statement recognition of gains and losses from either source is delayed, which
smooths net income.
Gains and losses – either (a) from changing assumptions regarding the PBO or (b) from
the return on assets bein…
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