Lower discount rate, higher remeasurement lose (IFRS), why?

CFA Level II
#1

  1. Lower discount rate ->higher higher PBO -> higher acturial loss ->higher remeasurement loss (IFRS)

  2. (IFRS) isnt remeasurement gain/loss also affected by the expected return and actual return? If the discount rate is lower -> lower expected return because the expected return= assets *dicount rate -> (expected return - actual return) lower -> lower loss?

Remeasurement loss= acturial loss + (expected return - actual return)

One increases the loss, the other one decreases, why would lower discount rate still increase the remeasurement loss?

Thanks!

#2

IFRS does not use Expected Return (ERPA). Just Actuarial Gain/Loss from changes in plan assumptions. The “Return” part of the discount rate always offsets itself on the P&L hence Net Interest Expense (what you are referreing to as Expected Return)

#3

Hi,

Obligation will always be greater than plan asset = (Plan Obligation - FVPA)

Therefore increase in obligation has to be greater than net return on Plan asset.

#4

Why is obligation always greater than plan assets?

#5

That is incorrect. It is Net Interest Income (rather than expense) if PA is greater than PO.

#6

Hi turbo989,

Thanks for your answers!

But sorry I am still confused on this.

  1. What do you mean by “Return” part of the discount rate always offsets itself on the P&L hence Net Interest Expense” ?

  2. CFA EOC question 12 from the pension chapter. (IFRS)

“the component of periodic pension cost that woule be reproted in OCI is the remeasurement component. it consists of actuarial gains and losses on the pension obligation and net return on plan assets. Here the actuarial loss was 460 and actual return was 30 lower than the return 2,730 (=39,000*0.07 and 0.07 is the discount rate) incorporated in the net interest income/expense. Therefore, the total remeasurements are 490 (460+30).”

So, the discount rate still has impact on the return (2,730) since we are adding the difference of the return to the actuarial loss this case, right?

Thank you!

#7

Hi,

I break it down like this on my index card:

IFRS ONLY

1) All Service Costs - P&L = Given to you usually

2.) Net Interest Expense(or rarely INCOME) - P&L

IFRS is basically saying you’ll earn the discount rate on your Assets, but also be billed the discount rate on the Obligation. So you only need to report the difference. You can think of it as an Expected Return, but I would not because it might confuse yourself with GAAP.

A) (PO-FVPA)*r or NPL*r** (Liabilities are greater than your Assets)**

or

B) (FVPA-PO)*r or NPA*r (Assets are greater than your Liabilities)

3.) Remeasurement - 2 Types

  1. Actuarial Gains/Losses arise from any changes in assumptions, including discount rate. It will most likely be given to you. In question 12 it is 460. Easy.

  2. Net Return. This is the Actural Return on Plan Assets (ARPA) minus the return you ALREADY ACCOUNT FOR UNDER NET INTEREST EXPENSE. You can’t double count your return on plan assets. You can’t have your cake and eat it too.

Net Return = ARPA - (FVP*r)

To answer your original question (thread title), lower Discount Rate increases the value of your OBLIGATION, so you take an acturial loss (since your NPL is reported on B/S). Higher Obligation also increases Service Costs going forward. Depending on what it does to your NPL it would also impact your Net Interest Expense (or Income) going forward.

#8

Hi tubo989,

I read your comment serveral times. Finnaly understood this concept.

Thanks a lot for your help!!!

#9

You need to remember the phrase funded status, and not just the formula incase you are given it to calculate net interest expense/income. Also helps with TPPC