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 discount rate will have on financial position of the firm?

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.

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.
You need to log in first to add your comment.