CFA Practice Question

There are 334 practice questions for this study session.

CFA Practice Question

Which of the following statements is (are) true with respect to the effects that changes in the rate of return on plan asset estimates will have on financial position of the firm?

I. An increase in the estimate for the rate of return on plan assets will have absolutely no effect on the firm's pension obligation.
II. A decrease in the estimate for the rate of return on plan assets will ultimately result in lower reported earnings for the current period.
III. Ideally, estimates for the rate of return on plan asset should be revised every period in order to better reflect market conditions.
IV. An increase in the estimate for the rate of return on plan assets will result in reduced service costs for the period.
A. I and III
B. II and III
C. I and II
Explanation: I is true because an increase in the estimate for the rate of return on plan assets will only affect the estimated value of plan assets in the future. The firm's pension obligation, on the other hand, depends on the size and timing of future promised benefits.

II is true because a decrease in the estimate for the rate of return on plan assets will mean that the firm can rely less on asset returns and therefore must increase its funding rate in order to meet its future pension obligations. Thus, this will result in lower reported earnings for the current period.

III is incorrect because estimates for the rate of return on plan asset should be based on long term expectations and thus, it should not change from period to period.

IV is incorrect because as was pointed out in (I), a change in the estimate for the rate of return on plan assets will have no impact on pension liabilities. Consequently, service costs for the period will not be affected by changes in asset return estimates.

User Contributed Comments 3

User Comment
mazen1967 an increase in expected rate of return decreses pension expense which is one of the componant of pbo
yxten1 rate of return on plan assets should based on long term trend...
dariorf7 No Mazen, PBO is related to the obligations regarding employees and depends on years of service and retirement, compensation growth and discount rate. Expected rate of return affects plan assets and thus pension expense but NOT the PBO (this is why statement I is correct)
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