- CFA Exams
- CFA Level I Exam
- Study Session 5. Financial Reporting and Analysis (1)
- Reading 14. Employee Compensation: Post-Employment and Share-Based
- Subject 3. Analysis of Pension Plan Disclosures

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**CFA Practice Question**

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

II. The projected benefit obligation (PBO) of the firm is simply the present value of the firm's future obligations, using the actuarial discount rate in the computation.

III. If the discount rate is reduced, an actuarial gain will occur.

IV. If the discount rate is increased, the reported pension expense for the period will decrease.

I. The higher the discount rate, the lower will be the present value of future projected accumulated assets in the pension plan.

II. The projected benefit obligation (PBO) of the firm is simply the present value of the firm's future obligations, using the actuarial discount rate in the computation.

III. If the discount rate is reduced, an actuarial gain will occur.

IV. If the discount rate is increased, the reported pension expense for the period will decrease.

A. II and IV

B. I and II

C. I and IV

**Explanation:**I is incorrect because the discount rate only affects the obligation (or liability) part of the pension plan. More specifically, the higher the discount rate, the lower will be the present value of future projected benefits (which is really equal to the firm's current pension obligations). For this reason, II is correct.

III is incorrect because if the discount rate is reduced, the present value of future obligations will increase (in today's terms). Hence, this increase in current pension liability will produce an actuarial loss for the period.

IV is correct because as the discount rate increases, the present value of future obligations will decrease, and hence the resulting pension expenses that would need to be reported, would decrease as well.

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**User Contributed Comments**
6

User |
Comment |
---|---|

PedroEdmundo |
pay attention to word |

volkovv |
very true |

derekm |
Can (IV) be stated with certainty? If the discount rate increases, interest expense increases. Service cost decreases but is it clear which will be the larger effect on pension expense? |

yxten1 |
can't believe i fall for the trap in I. |

sikwingo |
Trap caught me too heeey |

Dilaraj |
It all is under GAAP, but under IFRS many things are different for this topic. So, in the answer I is correct under IFRS. But as I see, here they use GAAP in other questions as well. |