The pension note disclosure for Deutsche Lufthansa AG for the

The pension note disclosure for Deutsche Lufthansa AG for the year ended December 31, 2008, is provided in the chapter.

Instructions

Using the information from this disclosure, answer the following questions.

(a) If Lufthansa could adopt the immediate recognition approach, determine what the amounts recognized as the accrued benefit liability would be for the years ended December 31, 2007, and 2008. Reconcile this balance with the balance recognized under the deferral and amortization approach. (Assume that the asset benefit obligation would be the same under the projected benefit approach and the actuarial funding approach.) Calculate the expense under the immediate recognition approach for 2008. Show a reconciliation of the opening and closing balances of the deficit balance under the immediate recognition approach for 2008.

(b) Given the information in part (a), discuss the impact of the different reporting approaches on the statement of financial position and the profit or loss statement for the 2008 fiscal year end.

Explain what has caused the major differences in both approaches. Which method do you

believe most faithfully represents the pension plans in the financial reports for the company?

What is the cash flow required for the company in 2008 and how does this relate to the statement presentation?

(c) Review the assumptions that Lufthansa has used for the discount rate and expected return on the plan assets. How does the company determine the expected rate of return on the plan assets? Comment on the trends over the past few years, and whether you believe these are fair and reasonable assumptions.

Lufthansa

(a)  All numbers are in millions of Euros.

Based on the information provided, the accrued benefit liability that is reported on the statement of financial position should be equal to the funded status at the year end.  Given this, the accrued benefit obligation at December 31, 2008 and 2007 should be determined as follows:

Pension provision	2008	2007
Accrued obligation liability	7,754	7,619
Fair value of plan assets	4,921	5,228
Deficit	2,833	2,391
Allocated to plans as follows:
Plans in a deficit	2,833	2,436
Plans in a surplus	0	-45
Reconciliation to current provision
Balance reported as per Lufthansa report	2,400	2,261
Deduct the actuarial losses not yet recognized	466	40
Add the unrealized asset surpluses not yet recognized	-33
Asset ceiling test		-110
Revised balance	2,833	2,391

Determination of the expense under immediate recognition approach

Current service expense for 2008	305
Interest effect of projected benefit obligation	386
Actual return on plan assets (effective loss on plan assets as per notes) (see note1)	725
Past service costs arising during the year (fully expensed in the year of recognition) (see note 2)	(12)
Plan cuts /settlements	(4)
Actuarial gains arising in 2008 for benefit obligations	(450)
Other – adjustment on obligation	9
Total expense	959

(1) In the reconciliation of plan assets, the company has reported projected return on assets of €281M and an actuarial gain/loss arising in current year of -€1006M.  The net of these two amounts is €725M, which is the actual loss for the year as reported in the notes.

(2) The past service costs were fully recognized in the current year, since there were no unamortized amounts for past services showing in the reconciliation of the funded status to the reported amounts.

Proof

Deficit - Balance – Jan 1, 2008	2,391
Add current expense	959
Less contributions to plan	-338
Net exchange adjustments (112 – 103)	9
Net pension payments for pensions not funded (241 – 53)	(188)
Deficit – Balance Dec 31, 2008	2,833

(b) As can be seen from the above analysis, the impacts on the financial statements are as follows under both approaches: (all in million of Euros)

	Amount of liability showing on statement of financial position	Amount of expenses showing on profit or loss statement
Defer-and-amortize approach	2,400	419
Immediate recognition approach	2,833	959
Difference	433	540
Cash flow funding required – employer contributions		338

The immediate recognition approach would have reported a liability that was €433 million higher than under the defer-and-amortize approach.  On the expenses, the immediate recognition would also have reported an expense that was €540 higher than the defer-and-amortize approach.  There are two primary reasons for this.  The first reason is the actual return on the plan assets was a loss of €725 million, when an expected return had been a gain of €281million.  Under the immediate recognition method, this entire loss would be recorded in 2008, whereas under the alternative approach, the full loss could be deferred and only recognized (if ever) as determined under the corridor approach.  The second reason is that the actuarial gain on the obligation was fully recognized in 2008, but was deferred under the defer-and-amortize approach.  Again, this gain would only be recognized when required (if ever) under the corridor approach.  Under both alternatives, there is no deferral of past service costs, which were all fully recognized in 2008 as they arose.

For cash flow requirements, the expense reported under the defer-and-amortize approach more closely relates to the amount of funding required by the employer.

The immediate recognition approach certainly more faithfully represents the accrued benefit liability at December 31, 2008, since it equals the actual funded status of the plan.  On the other hand, the profit or loss is made more volatile with the changes that were required in this balance.  Given a focus on the statement of financial position, I believe that the immediate recognition method more faithfully represents the status of the company’s pension plan. However, for the knowledgeable user, since all of the information is provided in the notes, they can easily make any adjustments to the balances they wish in their analysis.  Given this, we could conclude that the information is faithfully represented.

(c) Based on the note disclosure, Lufthansa has used the following ranges of rates for assumptions for its pension plan accounting:

	2008	2007	2006
Discount rates for obligation	3.9% – 6.7%	3.4% – 6.0%	4.5 – 6.0%
Expected return rates on plan assets	3.5% to 8.3%	3.75% to 8.0%	5.2% to 8.25%

For the expected return on the plan assets, the company has determined equity investment returns based on historical rates, inflation rates, expected dividends and projections for growth.  For bond returns and cash balances, the current market rates of returns have been used.

Although the ranges for the discount rates appear large, given the current economic conditions, these are likely reasonable amounts.  It is interesting that the low end of the ranges for the amounts used in 2008 were lower than 2006.  This may change in 2009.  The expected return on the plan assets also is a large range. It is also interesting to note that the low end of the range has moved much lower in 2008 from 2006, indicating the lower expectations in the market. But again given the mix of the assets, and the long term expectations, these are within reasonable ranges.