SOLUTIONS

1. B is correct. The £28,879 million year-end benefit obligation represents the defined benefit obligation.
2. C is correct. The net interest expense of £273 million represents the interest cost on the beginning net pension obligation (beginning funded status) using the discount rate that the company uses in estimating the present value of its pension obligations. This is calculated as −£4,984 million times 5.48 percent = −£273 million; this represents an interest expense on the amount that the company essentially owes the pension plan.
3. C is correct. The remeasurement component of periodic pension cost includes both actuarial gains and losses on the pension obligation and net return on plan assets. Because Kensington does not have any actuarial gains and losses on the pension obligation, the remeasurement component includes only net return on plan assets. In practice, actuarial gains and losses are rarely equal to zero. The net return on plan assets is equal to actual returns minus beginning plan assets times the discount rate, or £1,302 million − (£23,432 million × 0.0548) = £18 million.

4. A is correct. The actual return on plan assets was 1,302/23,432 = 0.0556, or 5.56 percent. The rate of return included in the interest income/expense is the discount rate, which is given in this example as 5.48 percent.

   The rate of 1.17 percent, calculated as the net interest income divided by beginning plan assets, is not used in pension cost calculations.

5. C is correct. Under IFRS, the component of periodic pension cost that is shown in OCI rather than P&L is remeasurments.
6. A is correct. The relation between the periodic pension cost and the plan's funded status can be expressed as Periodic pension cost = Ending funded status − Employer contributions − Beginning funded status.
7. B is correct. Kensington's periodic pension cost was £483. The company's contributions to the plan were £693. The £210 difference between these two numbers can be viewed as a reduction of the overall pension obligation. To adjust the statement of cash flows to reflect this view, an analyst would reclassify the £210 million (excluding income tax effects) as an outflow related to financing activities rather than operating activities.
8. C is correct. The retirement benefits paid during the year were closest to 4,000. The beginning obligation plus current and past service costs plus interest expense plus increase in obligation due to actuarial loss less ending obligation equals benefits paid (= 42,000 + 200 + 120 + (42,000 × 0.07) + 460 − 41,720 = 4,000). Beginning plan assets plus contributions plus actual return on plan assets less ending plan assets equals benefits paid (= 39,000 + 1,000 + 2,700 − 38,700 = 4,000).
9. B is correct. The total periodic pension cost is the change in the net pension liability adjusted for the employer's contribution into the plan. The net pension liability increased from 3,000 to 3,020, and the employer's contribution was 1,000. The total periodic pension cost is 1,020. This will be allocated between P&L and OCI.
10. B is correct. Under IFRS, the components of periodic pension cost that would be reported in P&L are the service cost (composed of current service and past service costs) and the net interest expense or income, calculated by multiplying the net pension liability or net pension asset by the discount rate used to measure the pension liability. Here, the service costs are 320 (= 200 + 120) and the net interest expense is 210 [= (42,000 − 39,000) × 7%]. Thus, the total periodic pension cost is equal to 530.
11. A is correct. Under US GAAP—assuming the company chooses not to immediately recognise the actuarial loss and assuming there is no amortisation of past service costs or actuarial gains and losses—the components of periodic pension cost that would be reported in P&L include the current service cost of 200, the interest expense on the pension obligation at the beginning of the period of 2,940 (= 7.0% × 42,000), and the expected return on plan assets, which is a reduction of the cost of 3,120 (= 8.0% × 39,000). Summing these three components gives 20.
12. B is correct. The component of periodic pension cost that would be reported in OCI is the remeasurements component. It consists of actuarial gains and losses on the pension obligation and net return on plan assets. Here, the actuarial loss was 460. In addition, the actual return on plan assets was 2,700, which was 30 lower than the return of 2,730 (= 39,000 × 0.07) incorporated in the net interest income/expense. Therefore, the total remeasurements are 490.
13. A is correct. In 2009, XYZ used a lower volatility assumption than it did in 2008. Lower expected volatility reduces the fair value of an option and thus the reported expense. Using the 2008 volatility estimate would have resulted in higher expense and thus lower net income.
14. C is correct. The assumed long-term rate of return on plan assets is not a component that is used in calculating the pension obligation, so there would be no change.
15. B is correct. A higher discount rate (5.38 percent instead of 4.85 percent) will reduce the present value of the pension obligation (liability). In most cases, a higher discount rate will decrease the interest cost component of the net periodic cost because the decrease in the obligation will more than offset the increase in the discount rate (except if the pension obligation is of short duration). Therefore, periodic pension cost would have been lower and reported net income higher. Cash flow from operating activities should not be affected by the change.
16. B is correct. In 2009, the three relevant assumptions were lower than in 2008. Lower expected salary increases reduce the service cost component of the periodic pension cost. A lower discount rate will increase the defined benefit obligation and increase the interest cost component of the periodic pension cost (the increase in the obligation will, in most cases, more than offset the decrease in the discount rate). Reducing the expected return on plan assets typically increases the periodic pension cost.
17. A is correct. The company's inflation estimate rose from 2008 to 2009. However, it lowered its estimate of future salary increases. Normally, salary increases will be positively related to inflation.
18. B is correct. A higher volatility assumption increases the value of the stock option and thus the compensation expense, which, in turn, reduces net income. There is no associated liability for stock options.
19. C is correct. A higher dividend yield reduces the value of the option and thus option expense. The lower expense results in higher earnings. Higher risk-free rates and expected lives result in higher call option values.