Chapter 19 Appendix 19A Chapter 19 Appendix 19A Example of a One-Person Plan Prepared by: Dragan Stojanovic, CA Rotman 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, years12 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 service or 2% x final salary x years of service –Discount rate = 6%

5 HTSM Corp. Example Current Service Cost – 2010 Annual 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 2010 First discount back to the retirement date of 2044, then discount back to 2010

6 HTSM Corp. Example PV $3,000 annuity to December 31, 2044 n = 12, i = 6% $3,000 x = $25, The PV on Dec. 31, 2010 of this lump sum at Dec. 31, 2044 n= 34, i = 6% $25, x = $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, % x $150,000 x 2 years = $6,000 per year of retirement PV of this annuity at Dec. 31, 2044 n = 12, i = 6% = $6,000 x = $50, PV of this lump sum on Dec. 31, 2011 n = 33, i = 6% = $50, x = $7,354

10 HTSM Corp. Example ABO Reconciliation ABO January 1, 2011$3,469 Add interest on ABO = $3,469 x 6% x 1 year 208 Add 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 = $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 = $125, $33,000 x = $276, PV of pension earned at Dec 31/14 (n=30, i=6%) $125, x = $21,896 $276, x = $48,170

15 HTSM Corp. Example ABO at Dec 31/14 after prior service recognized$48,170 ABO at Dec 31/14 before prior service recognized 21,896 Past service cost incurred$26,274

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