Pension Expense Flashcards
What is a Defined Contribution Plan?
When the employer sets aside specific amounts during the time of service, and the retired employee receives whatever sum these contributions and earnings produce.
(401k) - Straight-Forward; payments are made to the Plan and expensed immediately.
What is a Defined Benefit Plan?
When the employer guarantees certain benefits to be paid to retired employees, and is responsible for setting aside sufficient amounts to fulfill these promises
Actuaries are required to determine the services required to be paid in the future
Vested Benefit Obligation (VBO)
What is owed if an employee is terminated immediately. The actuarial PV of vested benefits
Accumulated Benefit Obligation (ABO)
The present value of future retirement payments attributed by the pension benefit formula to employee services rendered prior to that date - based on current salaries.
Projected Benefit Obligation (PBO)
What is owed for service to date if the employee continues in employment until normal age and receives periodic adjustments to pay for increased experience and general inflation based on “future wage rates”.
This is the most useful in determining pension expense since it represents the most realistic estimate of pension costs
Formula to Calculate Pension Expense
\+ Service Cost \+/- Prior Service Cost Amortization \+ Interest Cost - Actual Return on Plan Assets \+ Deferred Gain (- Loss) - Excess Amortization of Deferred Gain (+ Loss) \+/- Amortization of Existing New Obligation or Net Asset ------------------ Pension Expense
“A-SPIDER”
What is Service Cost and Prior Service Cost?
Service Cost - increase in PBO for 1 year
Prior Service Cost - Cost associated with service years before Plan was implemented
PSC = Beginning PSC / Avg Service Life
How to calculate interest cost associated with pension expense:
Interest cost is the change in PBO resulting from passage of time
= Beginning PBO x Discount Rate (settlement rate)
How to calculate Actual Return on Plan Assets:
= Ending PA - Beginning PA - Contribution Made + Benefits Paid
OR
= Beginning FV of Plan Assets x Plan Return
How to calculate the Deferred Gain (unrecognized pension gain):
Portion of the Investment income that is believed to be the results of short-term variations from the long-run expected return on investments.
To avoid having pension expense vary widely from year to year, the excess of actual return over avg-rtns are deferred.
=Return on PA - Beginning PA x Expected Rate of Return
Excess Amortization of Deferred prior pension Gain (or loss) Amortization:
Needed when the Deferred Gains or Losses get too large
To limit the risk of an actuary incorrectly estimating too low a rate, any deferred amounts exceeding 10% of the higher of beginning PBO or beginning Plan Assets must be amortized
((Beg. Deferred Amt - (10% x Beg PBO or PA) ) / Avg Srv Life
if PBO > FV of Plan Assets then amortization of net obligation will increase or decrease pension expense?
INCREASE
if PBO < FV of Plan Assets then amortization of net obligation will increase or decrease pension expens
DECREASE
What is considered to be the “Funded Status” of Pension Plans?
The difference between the ending PBO and the ending FV of the Plan Assets
When is the Plan Over-funded and where is the Obligation recorded on the F/S when this occurs?
When the funding (payment) is more than the expense
Noncurrent Asset is recorded (Prepaid Pension Cost)
