FSA: pension: unrecognized actuarial gain/loss

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hw0799's picture

in IFRS b/s, what this item refer to? Thanks

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pepp's picture

hw0799 Wrote:
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> in IFRS b/s, what this item refer to? Thanks

Can someone pls explain, what is unrecognized actuarial gain/loss, and unrecognized prior service cost.

Why would one subtract these two items from DB obligation to determine overfunded/underfunded status. I thought since you’ve not recognized these losses, you’d want to add these losses to your obligation (liability).

It appears everything I do in FRA has an opposite sign in book. Someone pls pls help.

Dreary's picture

Here is my take on this. Unrecognized actuarial gains/losses as well as unrecognized prior service costs/benefits are adjustments to the DBO due to various reasons, e.g., changing average emploee life, loss/gain on actual assets, salary increase rate, you name it. However, when these numbers are assessed they are not expnsed immediately as that would make the DBO volatile, same reason why we capitalize costs instead of expensing them.

So, you take these losses/gains and book them in a small account under equity, and just leave them there. Don’t amortize them yet. Just pile them up there. When they exceed 10% of your beginning DBO or your beginning plan assets value, then any excess above 10% gets amortized and that that’s what goes on your pension expense.

IFRS says if you really want to show the status of your pension plan, don’t hide those gains/losses in equity, get them out of there. You then add/subtract them to/from funded status.

perimel's picture

Question:

I still cannot understand whether actuarial gains / losses increase or decrease the DBO.

Actuarial gains —> increase DBO?

Actuarial losses —> decrease DBO?

This seems counterintuitive.

Can someone elaborate on this?

Dreary's picture

DBO is a liability. If there is a gain, that reduces the liability.

pepp's picture

Dreary Wrote:
——————————————————-
> DBO is a liability. If there is a gain, that
> reduces the liability.

Exactly. So why are actuarial gains added to the DBO? Shouldnt it be subtracted?

Robert A's picture

Maybe I can help.

The PBO gets the full hit of the item, whether it be an actuarial gain, a prior service cost, or whatever. What you’re confused about is the contra-account.

So for example, if we’re talking about prior service cost, the PBO is credited for 100% of the liability in year 1. It doesn’t matter if this is GAAP or IFRS.

However, since we’re not expensing the prior service cost once, the deferred expense (a debit) has to go somewhere on the balance sheet. With GAAP, it hits equity (as a reduction). With IFRS, it gets netted up against the PBO and the plan assets.

Does this clarify things a bit?

- RA

supersunny138's picture

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There are certain events that affect PBO and Assets:

These are>

(1) Deffered Gains and Losses
which has further 2 parts

(a) Changes in acturial assumptions affecting PBO
(b) Difference between actual and expected return on PA (As only Expected return goes to pension expense, you will have to take care of actual return)

You Net (a) and (b)

Now you compare this “NET” amount to either Opening balance of PBO or PA and if this “NET” amount exceeds 10% of PBO or PA, you can amortize it over the remaining life of the employee. (This 10% limit is called corridor method)

You have the choice to amortize only the EXCESS amount over PBO/PA or you can amortize the whole amount.

(2) Prior Service Adjustments
(3) Transition Assets / Liability
(There is no corridor method for 2 & 3 so they are simply amortized by the remaining life)
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Under US GAAP these elements are in Balance Sheet and Amortized over time
Under IFRS these are kept Off Balance Sheet and Amortized over time

Hope it made sense, Please correct me if you find any mistake

Dreary's picture

pepp Wrote:
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> > DBO is a liability. If there is a gain, that
> > reduces the liability.
>
>
> Exactly. So why are actuarial gains added to the
> DBO? Shouldnt it be subtracted?

Think in terms of plus and minus, it helps. Ignore the accounting entries, unless you are very comfortable with that kind of terminology. Liability is a negative number because it reduces your assets. If you get a gain, it’s a positive number, so when you add it to liability, liability shrinks. DBO = -$1200. Gain = +$100. DBO = -$1200 + $100 = -$1100.

If there was a PSC of $100, it’s a cost so it has a negative sign. Add it to your liability, and liability increases, i.e., gets worse.

As another example, cash is a positive account. You have +$500. If you spend $100 to buy something, you treat that as minus 100. Add it to your cash: Cash = +$500 + (-$100) = +$400.

ov25's picture

Let me try….
GAAP requires that ’ events’ be expensed immediately. So (economic) funded status; however ifrs misses these events on it’s b/s so bring them on ‘smoothly’

With that said, the PSC, one of such events, needs to be undone to reconcile for ifrs. It is therefore u see that losses and liabilities are added and gains/ assets subtracted(unrecognized ones)

I need to know if I am wrong

Robert A's picture

Not quite.

Pension expense under GAAP and IFRS is the same. Items that cover more than one period are amortized over time under both methods.

What’s different is the balance sheet presentation. Under GAAP, the unamortized portion is stuffed into stockholders’ equity. With IFRS, it’s netted against the liability or asset.

ov25 Wrote:
——————————————————-
> Let me try….
> GAAP requires that ’ events’ be expensed
> immediately.

- RA

ov25's picture

Thanks Robert.

This is much clearer.

pepp's picture

Thanks, I think I follow you guys and I don’t have a disagreement with the above. Dreary, I follow your sign terminology too. We are saying the same thing, I assumed liability as positive number and subtracted the gains (again a positive number) - ie. you end up with lower liability.

However, my question is something totally different.

a) What is an unrecognized past service cost? - Book says that its a cost that should have occurred in the past, but we didn’t recognize it so lets do it now. So effectively unrecognized past service cost is now added to your total PBO.
b) What is unrecognized actuarial losses? books says that due to change in some of actuarial assumptions we’ve increased our PBO liability.

Now go to pg #200. You’ll notice that in solution to 1st problem, they’ve taken PBO = 5485
and instead of increasing the PBO liability by unrecognized actuarial losses & past service costs, they’ve reduced PBO by that much. <——— THIS IS THE PART I NEED HELP WITH UNDERSTANDING.

ssr123456's picture

I will take a crack at this since I am actually studying it now.

A) Let’s say your employer promise to pay you $60K per year now instead of their original promise to pay $50K, but this new $10K add’l benefit doesn’t kick in until 2015 (i.e. they tell you there’s a vesting period). What’s happened is the employer has changed the existing DB plan that’s already in place. Companies can “smooth” that $10K add’l amount over the vesting period. If the vesting period is 5 years, then after year 1, you’d have $8K of unrecognized past service cost.

B) This is another “smoothing” type deal. Actuarial assumptions can be related to things like the assumed plan return or the discount rate. If the plan had originally assumed that it would earn a 20% return, it was putting in less cash than another plan that had assumed an 8% return (since it assumed it could make up the unfunded difference over the long-term via market appreciation of its assets). Suddenly, they change their assumption and now only think they can earn a 15% return on their plan assets instead of 20%. That the dollar amount of that difference associated with 5% now becomes a loss and can also be smoothed over a period of time (see readings on Corridor Method and Faster Recognition Method). At any point during the “smoothing” period, there will be a portion of that 5% loss that’s unrecognized.

I’m not sure about what book you’re referring to regarding page 200.

pepp's picture

ssr123456 Wrote:

>
> I’m not sure about what book you’re referring to
> regarding page 200.

Take a guess which book I am referring to. CFAI FRA Book 2. pg #200.

Also no one is contesting smoothing etc. Question is, if at present your employer has a liability of 50k showing on his B/S. if your employer promises you 60K today, his liability has gone up by 10k. so his B/S should show 50K+10K = 60k. Not 50K-10K (unrecognized costs) = 40k.

pepp's picture

By the way what is corridor method?

pepp's picture

I’VE HAD AN EUREKA MOMENT. Just figured out why unrecognized actuarial losses need to be added back to DBO.

The reason is that unrecognized actuarial losses are those losses which have still not hit the I/S. where as “projected” DBO includes all your obligations. so to figure out the funded/underfunded status as of today, you must exclude those expenses which are not part of DBO until a later date.

ssr123456's picture

From my notecard:

Corridor method - if net cumulative act. gain/loss > 10% of the DBO or 10% of the fair value of plan assets, amortize the amount above the 10% threshold over the expected average remaining working lives of people in the plan.

Faster recognition method - same criteria, but recognized over a shorter time period.

As for the book, there’s a million damn CFAI, Schweser, etc. books we have to study not to mention practice tests and I’m not going to look through all of them to figure out where your problem is.

The $10K is an additional expense on the prior service costs (you already recognized the $50). $10K can now be smoothed over the vesting period of 5 years. In year 1, you recognized $10K/5 yrs = $2K. Year 1: Expense = $2K, unrecognized past service cost = $8K. Year 2, you expense another $2K; expense = $2K, unrecognized past service cost = $6K.

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