In drafting the memo:
(a) You should explain the circumstances the company finds itself in.
(b) Address the requirements under GAAP for the discount rate and expected rate of return on plan assets based on the FASB’s Accounting Standards Codification. When discussing the GAAP requirements, you should cite the relevant subsections of the FASB Accounting Standards Codification by section/paragraph number. Make sure you locate the paragraphs of the codification (not just the definitions) that address the discount rate and the expected long-term rate of return on plan assets. Your primary guidance should be from the recognition and measurement sections (25-35) although you can cite the implementation guidance (section 55) to support the other guidance.
(c) Address whether in the current economic environment, using any of the assumptions suggested other than the 5% discount rate–8% expected rate of return assumption is feasible. Address whether it would be ethical to follow the golfing buddy’s suggestion and back into interest rates that the company can live with, i.e., that give the desired results. In this regard, you should discuss how much flexibility you think there might be in selecting these discount/return rate assumptions for the purposes of determining the PBO and pension expense and still remaining in compliance with GAAP
Discussion Memorandum #2 Requirements Pension Expense/Obligation In 2013, Cowboyz Rustic Furniture Inc, a manufacturer of rustic furniture, has had its profits severely affected by a recession that commenced in 2013. The recession was accompanied by a significant fall in the stock market and plummeting interest rates as the U.S. Federal Reserve attempted to stabilize the economy. The company’s CEO, Mr. Wrangler, finds himself battling reduced profitability from the core business because of a dramatic decline in new furniture purchases as the housing market has slowed down. Given the fall in value of plan assets and the dramatic decline in interest rates to 5% related to the Fed’s actions, the company’s CEO, Mr. Wrangler is extremely concerned about the effect of these changes on the size of the company’s pension plan obligation after being alerted to the issue by yourself, the company controller. The CEO is worried that the current economic conditions could make the pension plan virtually unaffordable because of having to record a sizable adjustment to the pension obligation making the company more leveraged and increased pension expense reducing its profitability. Because the company has always funded an amount equal to the service cost he is concerned that there the company may have to provide added cash to the plan if the service cost goes up. Mr. Wrangler indicated that he had been talking to a fellow CEO, a golfing buddy, who suggested that the company do what his buddy’s company has done after talking with a consultant. The consultant suggested that a way to reduce the impact on earnings and reduce the potential increase in the obligation without laying off people or reducing or eliminating pension benefits would be to get the board of directors to allow the company to use discount/settlement rates that are as high as possible in determining the present value of the pension obligation and the expected rate of return on plan assets. The CEO was…
Attachments:
dm2.doc