FAR · Select balance sheet accounts · 6 practice questions
Plan Assets: Actual vs. Expected Return and Rollforward
Actual return changes plan assets; expected return reduces pension cost, with the difference recognized in OCI. Below: a worked rollforward separates investment return from contributions and benefit payments, then compares actual and expected return.
Try one first
Hint
Set up the plan asset rollforward and isolate the return amount.
Answer D. Use the plan asset rollforward: ending fair value equals beginning fair value plus contributions plus actual return minus benefits paid. Solving for actual return gives $760,000 - $700,000 - $50,000 + $90,000 = $100,000. Benefits paid are added back because they reduced ending plan assets.
Why not A: This is just the increase from beginning to ending fair value. The change in fair value alone is not the actual return because contributions and benefit payments also changed plan assets during the year.
Why not B: This results from adding benefit payments to the asset increase but forgetting to remove employer contributions. Contributions raise plan assets, but they are not part of actual return.
Why not C: This comes from subtracting contributions from the increase in plan assets and then stopping. That misses the benefit payments, which also affected the ending asset balance and must be added back.
Worked example
Harbor Co.'s pension plan begins the year with $2,000,000 at fair value. The employer contributes $300,000, and the plan pays $200,000 in benefits. Ending fair value is $2,180,000. Expected return is 5% of beginning fair value. Calculate actual return, the pension cost reduction, and the OCI difference. Ignore taxes and amortization.
| 1 | Increase in fair value$2,180,000 - $2,000,000 | $180,000 |
| 2 | Net cash added to the plan$300,000 contributions - $200,000 benefits | $100,000 |
| 3 | Actual return$180,000 asset increase - $100,000 net cash added | $80,000 |
| 4 | Expected return5% × $2,000,000 | $100,000 reduction of pension cost |
| 5 | Asset loss in OCI$100,000 expected return - $80,000 actual return | $20,000 loss |
Actual return is $80,000, expected return reduces net periodic pension cost by $100,000, and the $20,000 asset loss goes to OCI.
Check: Assets grew $180,000, but net contributions added $100,000; the remaining $80,000 is actual return.
Key points
- Expected return equals the expected long-term rate times the stated beginning fair value or market-related value.
- With other components unchanged, a higher expected return lowers net periodic pension cost.
- Calculated market-related value may smooth fair value changes systematically over no more than five years.
- Measure plan assets at fair value, including contributions received by the trustee by year-end, not at historical cost.
How the exam traps you
- Treating the increase in plan assets as actual return. Subtract contributions and add back benefits paid to isolate investment performance.
- Using expected return in the asset rollforward or actual return as the pension cost reduction. Use actual return in the fair value rollforward and expected return as the pension cost reduction.
- Omitting a contribution because the trustee received it on the last day of the year. Include contributions received by the trustee by the measurement date in ending plan assets.
Question 2
Hint
Focus on the maximum smoothing horizon allowed when using a calculated market-related value instead of fair value.
Answer D. Under U.S. GAAP, market-related value may be fair value or a calculated value. If a calculated value is used, changes in fair value must be recognized systematically and rationally over not more than five years. Therefore, five years is the longest permitted smoothing period.
Why not A: This answer results from overstating how long fair value changes may be deferred. A calculated market-related value cannot spread changes over more than five years.
Why not B: This answer comes from assuming GAAP requires a shorter smoothing period. A three-year period is permitted, but it is not the longest period allowed.
Why not C: This answer reflects knowing smoothing is allowed but missing the maximum period. Four years is acceptable, yet GAAP permits one additional year.
Question 3
Hint
Ask what pension expense is trying to represent: one year's market result or a long-term estimate.
Answer C. Expected return is used because pension expense is intended to reflect the long-term earning potential of plan assets, not each year's market swing. This approach keeps pension expense from rising or falling sharply just because actual returns were unusually high or low in one period.
Why not A: This mistake treats funding and expense as the same thing. Employer contributions affect plan funding, but they do not determine the return component used in pension expense.
Why not B: This answer assumes the expected return assumption replaces the asset measurement basis. Plan assets are measured at fair value, while expected return is used only in calculating pension expense.
Why not D: This answer comes from confusing pension expense measurement with the timing of benefit payments. Expected return is not used to postpone recognizing gains until retirees are paid.
Question 4
Hint
Compare the old and new expected return amounts on beginning plan assets, then remember how expected return enters pension cost.
Answer A. Expected return on plan assets equals the assumed rate times beginning plan assets. Raising the assumption from 6% to 10% increases expected return by 4% of $600,000, or $24,000. Because expected return reduces net periodic pension cost, pension cost decreases by that amount.
Why not B: This comes from computing the $24,000 change correctly but giving it the wrong direction. A higher expected return assumption reduces pension cost because expected return is subtracted in the cost calculation.
Why not C: This comes from using the full 10% of $600,000 as the change in expected return. The change in the assumption is only 4 percentage points, so the effect is $24,000, not $60,000.
Why not D: This results from applying the full 10% rate to plan assets and also treating the effect as an increase. The question asks for the change from 6% to 10%, so only the 4% difference matters, not the entire 10% expected return.
Question 5
Hint
Compare actual return with expected return. The pension-related OCI balance reflects the difference, not the entire return.
Answer B. Actual return exceeded expected return by $12,000, creating an asset gain. That gain is recognized in other comprehensive income when it arises. Ignoring taxes and amortization, the pension-related accumulated other comprehensive income balance is a $12,000 credit.
Why not A: This uses expected return as the amount recorded in accumulated other comprehensive income. Expected return is used in pension cost calculations; only the difference between actual and expected return creates the actuarial gain or loss recorded in OCI.
Why not C: This records the full actual return in accumulated other comprehensive income. The total actual return changes plan assets, but OCI captures only the gain amount relative to expected return.
Why not D: This comes from treating the favorable asset difference as a loss. Because actual return exceeded expected return, the difference is a gain, so the balance is a credit, not a debit.
Question 6
Hint
Compute expected return from beginning plan assets and the expected rate, then compare that amount with actual return.
Answer D. Expected return equals beginning plan assets multiplied by the expected rate. An asset loss arises when actual return is less than expected return. Here, expected return is $66,000 and actual return is $55,000, so the difference is an $11,000 asset loss.
Why not A: This choice can result from computing expected return but not comparing direction correctly. Expected return is $64,000, and actual return is $72,000, so plan assets earned more than expected and produced an asset gain.
Why not B: This choice can result from focusing on the size of the plan rather than the comparison. Expected return is $63,000, while actual return is $70,000, which is an asset gain, not a loss.
Why not C: This choice can result from assuming a lower dollar base makes a loss more likely. Expected return is $60,000, and actual return is $66,000, so actual return exceeded expected return and created an asset gain.
Common questions
How do you calculate actual return on pension plan assets?
Actual return = ending fair value - beginning fair value - contributions + benefits paid. Contributions and benefits change plan assets but are not investment returns.
What is the difference between actual and expected return on plan assets?
Actual return measures investment performance at fair value. Expected return is the assumed return used to reduce net periodic pension cost.
When does actual versus expected return create an OCI loss?
An asset loss occurs when actual return is below expected return, even if actual return is positive. Only the shortfall goes to OCI, not the full actual or expected return.
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