1. B is correct. The year-end benefit obligation represents the defined benefit obligation.

2. A is correct. The economic pension expense (in £ millions) is calculated as follows:

3. A is correct. The economic pension expense is £135 million. Kensington’s reported net periodic pension cost for the period is £43 million. The difference is £135 million − £43 million=£92 million.

4. B is correct. The company’s economic pension expense is £135 million, but its reported net periodic pension cost is £43 million, a difference of £92 million. That amount must be adjusted for taxes: £92 million × (1 − 0.28)=£66.2 million. The economic pension expense is higher than the reported net periodic pension cost so net income would be adjusted down by about £66 million.

5. B is correct. The liability reported on Kensington’s balance sheet is £4,559 million. However, the funded status of the plan is £4,426 million (underfunded), the difference between the defined benefit obligation and the fair value of plan assets (£28,531 million − £24,105 million). To adjust the balance sheet to reflect the funded status of the plan, the liability on the balance sheet would be decreased by £133 million, the difference between the reported liability and the funded status of the plan (£4,559 million − £4,426 million).

6. B is correct. Kensington’s economic pension expense for the period was £135 million. The company’s contributions to the plan for the year were £693 million and were included as an operating cash outflow. The £558 million difference between these 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 £558 million (excluding income tax effects) as an outflow related to financing activities rather than operating activities.

7. A is correct. Under U.S. GAAP, the funded status of the DB plan is reported without adjustment. Passaic would report an asset of €621 million. Under IFRS, Passaic’s balance sheet reflects the present value of the defined benefit obligation at the balance sheet date, plus any unrecognized actuarial gains (less any actuarial losses not recognized), minus any past service cost not yet recognized, minus the fair value at the balance sheet date of plan assets. The resulting amount is an asset of €962 million as shown at the bottom of Exhibit B.

8. B is correct. The net periodic pension cost recorded in the income statement is €1,050 million, the net periodic benefit cost. Unlike U.S. GAAP, IFRS does not require that the various components of pension cost be reported as a net amount. As a result, companies are allowed to disclose the individual components within different line items on the income statement.

9. A is correct. The company’s net periodic benefit cost (noncash expense) of €1,050 million is added back and the contributions (cash outflow) of €526 million are deducted from net income as part of the reconciliation between net income and cash flow from operating activities. The net effect is to add €524 million to the net income in the reconciliation to cash flow from operations.

10. A is correct. In 2009 the service cost was €908 million. Service costs represent the estimated increase in the pension obligation resulting from employees’ service during the period.

11. C is correct. The actual return on plan assets is €4,239 million, which is the expected return on plan assets plus actuarial gains (€3,455 million+€784 million).

12. A is correct. In 2009 Passaic 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.

13. 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.

14. 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, net periodic pension cost would have been lower, and reported net income higher. Cash flow from operating activities should not be affected by the change.

15. B is correct. In 2009 the three relevant assumptions were lower than in 2008. Lower expected salary increases reduces 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.

16. 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.

17. 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.

18. 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.

19. C is correct. The defined benefit obligation at year-end 2009 is €11,582 million and represents the actuarial present value of all benefits (future payments) that all employees have earned based on their service up until 31 December 2009, regardless of whether the benefits have vested.

20. A is correct. The economic pension expense (in € millions) is calculated as follows:

21. A is correct. The net periodic pension cost of €143 million is the amount recognized in the income statement. Unlike U.S. GAAP, IFRS does not require the various components of pension cost as a net amount. As a result, companies are allowed to disclose the individual components within different line items on the income statement.

22. C correct. The net funded status of the plan is €1,822 million, but only €1,155 million is recognized on the balance sheet: an asset of €2,097 million, a liability of €942 million, and net assets (equity) of €1,155 million. The net result of balance sheet adjustments would be an increase (in € millions) of €1,822 − €1,155=€667 to shareholders’ equity. The actual funded status shows the underlying financial position, and that is a net asset (equity) of €1,822 million, or €667 million higher than is reported. The amounts reported in the balance sheet for pension asset and provision for retirement benefits would each change to reflect the net impact of €667 million.

23. B is correct. Using the higher 2007 expected rate of salary increases would have increased current service cost and the benefit obligation, reducing net income. It would not affect past service costs and related recognition.

24. C is correct. Using the lower 2007 expected return on plan assets would increase pension expense, reduce net income, and have no effect on net assets.