Chapter Chapter 1919

Appendix 19AAppendix 19AExample of a One-Person PlanExample of a One-Person Plan

Prepared by:

Dragan Stojanovic, CARotman School of Management, University of Toronto

2

HTSM Corp. Example

• Lee Sung:– Age 30– Employment date January 1, 2010– Starting salary $37,500– Expected to work for 35 years– Retirement date December 31, 2044 (Age 65)– Expected annual salary increase of 4% (approx.)– Expected salary at retirement $150,000– Life expectancy at December 31, 2044 is 12 years

3

HTSM Corp. Example

Period of Employment

Jan 1, 2010

Dec 31, 2044

Dec 31, 2056

35 years 12 years

Retirement Period

4

HTSM Corp. Example

• The Pension Plan– Defined benefit plan– Annual pension benefits on retirement

• 2% of salary at retirement for each year of serviceor

• 2% x final salary x years of service– Discount rate = 6%

5

HTSM Corp. Example

• Current Service Cost – 2010Annual benefit on retirement earned in 2010:2% x $150,000 x 1 year of service= $3,000

• This annuity must be discounted to determine the cost in 2010First discount back to the retirement date of 2044, then discount back to 2010

6

HTSM Corp. Example

• PV $3,000 annuity to December 31, 2044n = 12, i = 6%$3,000 x 8.38384= $25,151.52

• The PV on Dec. 31, 2010 of this lump sum at Dec. 31, 2044 n= 34, i = 6%$25,151.52 x .13791= $3,469

7

HTSM Corp. Example

• Current service cost is then calculated in same manner for each year with n adjusted accordingly

• For 2011, the current service cost = $3,677 (n now = 33)

8

HTSM Corp. Example

• Accrued Benefit Obligation (ABO)• At December 31, 2010 (first year) ABO will

equal the current service cost• At December 31, 2011 (now two years of

service) the ABO is calculated as

9

HTSM Corp. Example

• Pension benefit earned to Dec. 31, 20112% x $150,000 x 2 years= $6,000 per year of retirement

• PV of this annuity at Dec. 31, 2044n = 12, i = 6%= $6,000 x 8.38384 = $50,303.04

• PV of this lump sum on Dec. 31, 2011n = 33, i = 6%= $50,303.04 x .14619 = $7,354

10

HTSM Corp. Example

• ABO ReconciliationABO January 1, 2011 $3,469Add interest on ABO = $3,469 x 6% x 1 year 208Add 2011 current service cost 3,677

ABO, December 31, 2011 $7,354

11

HTSM Corp. Example

• The process as illustrated would continue for each year of Lee Sung’s employment

• Current service cost is calculated using the two step PV process (adjusting n accordingly)

• ABO is calculated each year• So what happens at retirement?

12

HTSM Corp. Example

• At December 31, 2044 (at retirement)assuming all initial assumptions remain in effect

• ABO on retirement will be:Pension benefit earned =2% x $150,000 x 35 years= $105,000 per year of retirement

• PV of the pension annuity, and ABO at Dec. 31, 2044 is= $105,000 x 8.38384= $880,303

13

HTSM Corp. Example• Past Service Cost:

– If Lee Sung had previously worked for six years for another of HTSM subsidiary companies but was not a pension participant

– He may be given credit for the prior years worked

• There is a cost to HTSM when these past service credits are granted

• The ABO is calculated both before and after the past service entitlement– The difference will be the cost of the past

service obligation

14

HTSM Corp. Example

Before credit for prior service

After credit for prior service

Pension benefit earned to Dec 31/14

2% x $150,000 x 5 years

= $3,000 x 5

= $15,000 per year

2% x $150,000 x 11 years

= $3,000 x 11

= $33,000 per year

PV of pension earned at Dec 31/44 (n=12, i=6%)

$15,000 x 8.38384

= $125,757.60

$33,000 x 8.38384

= $276,666.72

PV of pension earned at Dec 31/14 (n=30, i=6%)

$125,757.60 x .17411

= $21,896

$276,666.72 x .17411

= $48,170

15

HTSM Corp. Example

ABO at Dec 31/14 after prior service recognized $48,170ABO at Dec 31/14 before prior service recognized 21,896

Past service cost incurred $26,274

16

Copyright © 2010 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.

COPYRIGHT