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Level I CFA: Non-current (Long-Term) Liabilities-Lecture 5 - YouTube
Channel: IFT
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pensions and other post-employment
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benefits
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pensions and other post-employment
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benefits give rise to non-current
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liabilities reported by many companies
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the question you might be wondering here
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is what is the link between pension and
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liability
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the point here is that we are talking
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about
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non-current liabilities if i am a
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company and i have lots of employees
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and i have promised certain benefits to
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my employees
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that is a obligation on me the company
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and obviously if it is an obligation i
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need to
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record that obligation one of the most
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significant post employment benefits is
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pension
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and a typical pension would be where a
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company says to its employees that when
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you retire
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then a certain percentage of your income
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will be paid to you
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as pension for the rest of your life or
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for x number of years
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whatever the terms might be they will be
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defined in the contract between the
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employee and the company but
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these are obligations that the company
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has
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and therefore needs to show it as a
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liability
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we will focus on pension with pensions
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you need to recognize that there are two
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broad
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categories you can either have a defined
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contribution plan or a
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defined benefit plan in a defined
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contribution plan the
[84]
company contributes an agreed upon
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amount to the plan so agreed upon
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essentially is where the defined is
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coming in
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from a accounting standpoint this is
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easy for the company why because
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whatever the agreed upon amount is that
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is contributed every period and that
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amount is shown as
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a expense on the cash flow side
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that is shown as a operating outflow
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because essentially
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this is a compensation it's like a
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just like salary is a compensation a
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pension
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contribution or a defined contribution
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is also considered
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operating cash flow sometimes
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if the payment is not made in a given
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period it's made in the next period
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there might be a short term
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liability but by and large whatever the
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contribution is
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needs to be shown as a expense for the
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period accounting wise very simple and
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essentially the risk is transferred to
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the employee over here because the
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company is saying that i'm going to pay
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this much
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into your plan and then if the plan does
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well that's good for the employee
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if the plan does badly it's bad for the
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employee so
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the company is washing its hands off the
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risk and just as a general point
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these plans are becoming much more
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popular worldwide
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relative to defined benefit in a defined
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benefit plan the company makes promises
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of a future benefit so the company is
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saying that when you retire
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we will look at your salary and give you
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a certain percentage of that salary
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that's just one example of a future
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benefit
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so the company is promising a benefit
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and here
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we don't know or the company doesn't
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know what that benefit will be because
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we don't know
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what that final salary will be we don't
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know how long that person will
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live for after retirement so you have
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these people called actuaries who
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make lots of assumptions and they come
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up
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with numbers we don't need to go into
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the details but
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simplistically assumptions are made and
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based on those assumptions the company
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calculates uh
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obligation so that is called a pension
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obligation
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it is essentially the present value of
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the future payments that the company
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expects to make okay that's called a
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pension obligation
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now how does a company meet
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those obligations what most companies do
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is set up a pension fund
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this pension fund is also called the
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plan
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assets companies put money into this
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fund and then the pension liabilities or
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obligations
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are paid from this fund
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as you might imagine the accounting for
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defined benefits is very difficult
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and from an analyst perspective when you
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look at
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balance sheets and income statements you
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need to be able to interpret
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what companies are doing and
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in this segment we will just very
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briefly cover the most important points
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and as i've said before
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this will be covered in detail at level
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two an important concept is that of
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funded status
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as i just said plan assets these
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represent
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the the fund that the company creates
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in order to meet the future obligation
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the value of that fund let's say
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is 100 now that fund might consist of
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stocks
[300]
bonds other investments but it will have
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a certain value today
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that value is the value of the plan
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assets
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then you have the defined benefit
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obligation
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this is the present value of what the
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company believes
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all its obligations will be
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let's say that the present value of
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those obligations is 110.
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and obviously this 110 is based on
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several
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assumptions this is giving you a
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negative number
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it is saying that the obligations are
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more
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than the plan asset
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so what we have here is a net pension
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liability
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why because the liability or the
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obligation is more than the asset
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so you have what's called the
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underfunded plan
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or you have a net pension liability
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most companies that have pension plans
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are in this situation
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if the plan assets are greater than the
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obligation then you say you have a over
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funded plan or you have a net
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pension asset now
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this is a asset or a liability so
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it is reported on your balance sheet
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dates
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let's say you have a pension liability
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that is
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the liability is 10 at the start of the
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period
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end of the period the liability goes up
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when the liability increases
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is that expense yes it is
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increase in liability is a expense
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now that expense or that increase in
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liability
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needs to be shown either on the
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income statement as a loss or
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expense or in oci
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remember when we were discussing oci one
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of the components had something to do
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with pension
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now this is a fairly complicated area
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which we will discuss
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in level two but when your pension
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obligation increases
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then some part is shown
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in the income statement some part is
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shown in
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oci and i really don't think you need to
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know the details
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right now just recognize the high level
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picture
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the pension expense under ifrs has three
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components
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employee service costs net interest
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expense or
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income and re-measurements very briefly
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if a company has
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a pension plan then
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most of those pension plans have
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something to do with how long people
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work and people sort of earn their
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pension
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benefits based on their work
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how much time they spent with the
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company so the change
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in the pension amount based on people
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working
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that is called the employee service cost
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the
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interest expense is a pension obligation
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at the start of a period multiplied by a
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rate
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and if you think about it how is
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interest expense calculated it is the
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liability at the start of a period
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multiplied by a rate
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if pension obligation is a liability
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and you multiply that by a rate you will
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get a certain
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expense and re-measurements i will skip
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you really don't need to know that
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at this stage under us cap you don't
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have three components you have
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five components so notice that i'm
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skipping over
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a lot of details here because i know
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that
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you will have to worry about them at
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level two
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here you just need to know the basics
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and let's see if you can do
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this example what we have here is a
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pension obligation is equal to
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hundred the clan
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assets are equal to 90.
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so do we have a net asset or a net
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liability we have a net liability
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equal to 10. so under both u.s gaap and
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ifrs
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on the balance sheet we will show a net
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pension liability of
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10 and then in the footnotes and
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disclosures there will be lots of detail
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about where this 10
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comes from okay coming close to the
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end of this reading evaluating solvency
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now all these ratios should look
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familiar what is solvency
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it is the ability of a company to meet
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long-term obligations that's what we've
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been talking about over here long-term
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debt long-term
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obligations long-term liabilities how do
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you
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evaluate whether a company will be able
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to meet those obligations
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you look at two kinds of ratios solvency
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ratios and coverage ratios and you've
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seen these before
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debt to assets debt to capital so all
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these ratios are given here you've seen
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them before
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just memorize these ratios and recognize
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that
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high is bad in the sense that
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a high debt to asset ratio means that
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you have a lot of debt relative to your
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assets and these ratios as we've
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discussed before
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need to be looked at in the context of
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the industry
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of that particular company and then
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coverage ratios
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interest coverage is ebit divided by
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interest payments
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here you actually would want a high
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ratio
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because so here high is good
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why because you want a high operating
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income relative to
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interest payments earlier we had seen
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this expression
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ebit plus lease payments divided by
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interest payments
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plus lease payments and i sort of went
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over it very fast
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now this concept should make sense
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because you have studied leases
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what is the concept if you even take
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this ratio over here
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the top one what what is ebit it's your
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earnings before interest so you are
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looking at how much
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money is a company generating before
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making any interest payments
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and then you have to divide by interest
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payments so it is saying how much money
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is a company making
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relative to interest payments if you
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think about lease payments
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are lease payments and obligation just
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the way interest payments are an
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obligation
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they are but is
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the lease payment included in your
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operating expense
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it is all right so
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what you want to see is how much money
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are you making
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without counting that lease payment
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without counting the lease payment you
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then add
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back the lease payment to your operating
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income
[715]
and then you divide by your obligation
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what's your obligation it is the
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interest payments plus the
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lease payments so conceptually both
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these ratios are very similar you use
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this
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ratio when you have a lot of lease
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payments
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all right that brings us to the end of
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this reading i'll just
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summarize the main points we talked
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about
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bonds with bonds what are the most
[744]
important points you need to recognize
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what to do when a bond is issued you can
[749]
either have a power bond a discount bond
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or
[751]
a premium bond the relationship between
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the coupon rate
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and the effective interest rate is
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critical
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if the coupon rate is high relative to
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the
[765]
effective interest rate then you have a
[769]
a premium bond because what is happening
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here is the investor is getting
[774]
more money relative to the effective
[776]
interest rate so he's willing to pay
[778]
more for the bond if this is less than
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then we'll have a
[782]
discount bond amortization refers to the
[785]
process where we
[786]
bring the value of the bond down to
[790]
par value and you need to understand
[792]
what's happening with the interest
[793]
expense
[794]
and you need to understand how the
[797]
coupon payments are being
[799]
categorized then we talked about leases
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you need to understand that there is a
[805]
lessee perspective and a lesser
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perspective
[808]
the lessee is the entity that is using
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the machine
[811]
you should learn the advantages of
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leasing and this is more from the
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perspective of operating leases
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and then the accounting for operating
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leases and finance leases
[821]
understand those tables that i presented
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pensions i don't think is overly
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important
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at level one but just know the basics i
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think the most important point is the
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concept of the funded
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status or whether a company has a net
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pension liability or net pension assets
[841]
these are shown as a single line item on
[843]
the balance sheet
[844]
and then the details are given in the
[846]
footnotes
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and then solvency you need to know the
[850]
ratios you see the ratios here and
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you've seen the ratios in
[853]
earlier readings
[857]
go over the curriculum summary do the
[861]
learning objectives just see the
[863]
learning objectives and make sure that
[864]
you can say something sensible about
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each one of them
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examples in this particular reading i
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think are fairly difficult
[872]
if you have time you can go through the
[875]
examples
[876]
but if you don't have time then
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definitely do
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all the practice problems in the
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curriculum
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the exam type questions
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and then do practice questions from
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other sources as well
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you
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