I was reading pension accounting according to IFRS where the net asset or liability has to be adjusted for unrecognized gain or loss. Schweser says that adjustment for loss has to be made by adding it back, but I think it should be subtracted because loss will increase pension obligation so, to undo it’s effect we need to subtract it from the benefit obligation. Can anyone kindly clarify?
Here is my understanding, but I may be wrong. I think you are looking at this the wrong way around. the net asset or liability is shown as the funded status (broken down into the plan assets and the obligation (PBO). I think the important thing here is that the funded status is plan assets - PBO (and not PBO- funded status). If this is negative its a liability, if its positive its an asset. These costs are included in PBO, which we have taken off plan assets. So essentially they are a minus in the calculation. We have taken them off. And then IFRS will adjust this by adding back the Unrecognsied costs and actuarial losses to give the pension expense shown on the Income Statement. The costs were taken off, so they get added back. Hope this helps.
chedges is correct. Say your PBO is -$100 and your plan’s fair value of assets are $50. You have no unrecognized losses or gains and therefore your funded status is 50 - 100 = -$50 Now suppose you have a loss of -$10 (from past service costs) and an actuarial gain (from an increase in mortality) of $20 that haven’t been recognized as pension expense or gain yet as they are amortized. NOTICE the PBO takes into account these losses and gains _right away_ from the following equation: Beginning PBO + service costs + interest costs ± actuarial gains (losses) ± prior service costs from plan amendments - benefits paid = PBO at end of year Therefore, your PBO is now -100-10+20 = -$90. However, you haven’t recognized the past service cost and actuarial gain yet in pension expense and income respectively (they are amortized), so you must REVERSE THESE CHANGES from the PBO as reported by IFRS. -$90 + the service cost ($10) - the actuarial gain ($20) = -$100. Now add the FV of assets -100 + 50 = -$50. This is what is reported on the BS for IFRS. Note that we arrive at the same number as the first example because effectively under IFRS, the balance sheet line item is like saying your liability (or asset) has no unrealized gains or losses. In the US GAAP standard, you are reporting the funded status, simply FV assets - PBO, in this case 50 - 90 = -$40, the offsetting entry would be a charge to shareholders equity (since pension expense is smoothed under both standards and won’t be recognized until later but the unrecognized items have been recognized here in the BS). Please verify my work. Thanks.
I am not so sure its possible to have a negative PBO? Its a future obligation therefore since your discounting back future cash flows it should be positive right? The funded status can definitely be negative if FMV of assets < PBO.
You’re right. The convention is for it to be positive, therefore PBO should be positive in all the numbers. So going back here: Beginning PBO + service costs + interest costs ± actuarial losses (gains) ± prior service costs from plan amendments - benefits paid = PBO at end of year Therefore, your PBO is now 100+10-20 = $90. Note how I switched the actuarial gains to be subtractions (they reduce the obligation) and service costs to be positive. All the answers should arrive at the same result I believe. Thanks for pointing that out.
Thanks guys, I wasn’t looking at the whole equation, it’s clear now.