# PBO formula

Hello,

In the book, I am reading the PBO formula to be

Current service cost +

past service cost +

interest cost +

changes in actuarial assumptions (including true up for actual return on planned assets over the expected return)

-benefits paid

Shouldn’t this formula also include the amount of the expected return itself (not just the adjustment between the expected return and the actual return?)

Thanks,

Why would an expectation of return on plan assets decrease or increase the benefit obligation?

Also, I’m not certain this is accurate: “changes in actuarial assumptions (including true up for actual return on planned assets over the expected return)”

My understanding of actuarial assumptions has to do with actuarily stuff… how long people live, how long they will be retired, etc.

Where, exactly, did you see this formula?

Neither expected return on plan assets nor actual return on plan assets has any effect on PBO.

Saw it in Kaplan, accounting section

I just looked through my VitalSource copy of Kaplan’s 2018 Level II Study Guide. Nowhere did I see expected return or actual return in a PBO calculation.

Where, exactly, did you see this formula?

Doesn’t change in actuarial assumptions include the true up from expected return on planned assets to actual return on planned assets?

Or that is just included in the total periodic pension cost?

No.

No.

Actual return on pension assets is part of (i.e., reduces) total periodic pension cost.

Expected return on pension assets is part of (i.e., reduces) pension expense.

The difference between the actual return on plan assets and the expected return on plan assets goes into Retained Earnings as part of OCI.

Is it safe to say that the planned assets/PBO and total periodic pension cost calculation would be the same between GAAP and IFRS?

From what I read the difference between GAAP and IFRS lie within the allocation of the pension cost between the I/S and the OCI.

First, just to be clear: it’s _ plan _ assets, not planned assets; i.e., it’s the assets that belong to the pension plan.

Second, yes:

• Costs are costs, irrespective of the accounting rules
• Assets are assets, irrespective of the accounting rules
• Liabilities are liabilities, irrespective of the accounting rules

Third, yes: the differences between US GAAP and IFRS lie in how the pension cost is split between pension expense and OCI:

• US GAAP
• Past service cost goes to OCI, and is amortized over the average service life of the affected employees
• Actuarial gains/losses usually go to OCI (they can go to the income statement if you want), and are amortized, usually using the corridor method
• Expected return on plan assets less actual return on plan assets usually goes to OCI (they can to to the income statement if you want), and are amortized, usually using the corridor method
• IFRS
• Past service cost goes to the income statement
• Actuarial gains/losses go to OCI; they are not amortized
• “Expected” return on plan assets less actual return on plan assets goes to OCI; it is not amortized

Ok sounds good. Also, how come level of compensation growth does not affect actuarlial assumptions related to the PBO, it only affects current service cost for employees on the plan.

CFA text has great examples on the actual PBO calculations and how changing certain factors change the calculations. After you go through that, it will be easier to see why certain things change PBO such as service cost, compensation, growth, interest, discount rate, etc.

Estimated rate of compensation growth is an actuarial assumption. Whether or not it affects the PBO depends on how the pension payments are calculated. If the pension payments depend on the employee’s final year salary (which is common), then it will affect the PBO, because a change in the estimated rate of growth will change the estimate of final year’s salary.

So I am reading one question that claims an increase in compensation growth would increase both current service cost and net interest cost (under IFRS) because an increase in the compensation expense will increase the per period current service cost (which would increase the PBO in the next period). As such, with the increase in the PBO in the next period, we should expect net interest cost to increase as well.

Does this analysis make sense? I am trying to replay it in my head.

It does.

Suppose that the company calculates (with the current formula, which is based on ending salary) that it needs \$250,000 when an employee retires to fund their pension payments, and that they expect the employee to work for them for 25 years before retirement. Therefore, the employee earns \$10,000 in future value each year they work. The service cost is the present value of that \$10,000.

If the company increases their estimated compensation growth rate, then their estimate of ending salary will increase, which will increase that \$250,000. If it becomes, say, \$300,000 (20% more than the original), then the employee will earn \$12,000 in future value each year (20% more than the original), and each year’s service cost will be 20% more than the original. The interest cost is the discount rate times the beginning PBO, so when this year’s service cost increases, next year’s beginning PBO increases, so next year’s interest cost increases.

9I am reading a question in a mock that says if he increase the compensation projection in the next period the current service cost and net interest cost in the next period would increase.

I understand how the current service cost in the next period would increase, but not sure how the net interest cost would increase? Since the net interest cost is based off the beginning PBO (which would not have taken into account the increase in compensation project that was to start in the period of the beginning PBO).

s2000 answered it in his example above

but u probably posted before you read that response.

bcos net service cost increases - PBO increases.