Retirement Benefit Accounting

Summaries

US GAAP: old standard before 2006 Dec

Type 1: Defined Contribution Plan

-          may promise to make contribution

-          Employee assumes the shortfall risk

-          Balance Sheet: Liability

-          Income Statement: Pension Expense

Type 2: Defined Benefit Plan

-          Pay-related

-          Non-pay related

-          Employer assumes the risks

Projected Benefit Obligations (PBO)

-          Use the retirement salary for calculation

-          Need to assume the discount rate and compensation (Salary) growth rate.

-          Need to assume the life expectancy and number of year of service in the company (No need to disclose)

Accumulated Benefit Obligations (ABO)

-          Use the current salary (if calculating for the 2^nd year, use the 2^nd year’s salary) for calculations, otherwise same as PBO

Vested Benefit Obligations (VBO)

-          Same as ABO but vesting policy is taken into account

Pension Expense

= interest cost (which is previous year’s PBO x interest rate)

+ service cost (the extra one year of service the employee provided) 

- expected return on asset (need to be disclosed)

+/- Amortization of unrecognized prior service costs (change of pension plan, amortized over the expected service life of the employee so that there is no abrupt change)

+/- Amortization and Deferral of gain and loss (e.g. due to change of discount rate)

+/- Amortization of the transition of liability and asset (SFAS 87 was enacted in 1985, after which pension plan has to be put in accounting. So this is for transition)

Adjusted Pension Expense

= interest cost + service cost – real return on asset

When the discount rate is increased, generally, the pension expense will decrease (lower PBO). But when it is mature, higher discount rate may result in higher interest cost (although PBO is lower) and even make pension expense increase.