I am stuck with the question below. The correct answer is B “PBO”. Isn’t the PBO a part of the “Balance Sheet Asset/liability”? If the Balance Sheet Asset/Liability is sensitive, how come the PBO is less sensitive? Many thanks ahead! Which of the following measures is least sensitive to changes in pension plan actuarial assumptions? A) Total periodic pension cost. B) Projected benefit obligation (PBO). C) Balance sheet asset or liability Changing an assumption may have a small effect on the projected benefit obligation (PBO) but may have a much larger effect on the funded status (which is a net pension amount) which is the balance sheet asset or liability.
Changing the discount rate will affect the periodic pension cost and the balance sheet asset or liability, but will not affect the PBO.
Changing any other actuarial assumption will affect the PBO and, consequently, the periodic pension cost and the balance sheet asset/liability.
Thanks for the response!
Like you mentioned, “Changing any other actuarial assumption will affect the PBO and, consequently, the periodic pension cost and the balance sheet asset/liability.” Why is PBO the least sensitive to changes in pension plan actuarial assumptions?
For the first sentence you mentioned, “chaing the discount rate will NOT affect the PBO”. However, the Kaplan Notes states that “increasing the dicount rate will reduct present values; hence, PBO is lower.” Now I am confused on this concept. Do you mind explaining if I missed something here?
It may be because once the rate is set for the initial PBO and then changed, the change only affects the periodic cost on the income statement. If the asset base doesn’t reflect the change then remeasurements or actuarial losses can mitigate it, whereas the actual PBO and PBA are hard figures? Not positive.
I think the issue here is changing the rate doesn’t affect it (which relates to the above) once the PBO is already established, but when setting an initial rate (which is ideally a realistic one) to discount all the DB plan’s future values for the employees this will impact the size of the initial PBO.
My error: I was thinking of the future benefit, not the present value of the benefit.
(It’s been a long week.)
Thinking about this with a clearer head, I believe that what they meant is that the change in the PBO would be a smaller percentage change than the change in the periodic pension expense or the balance sheet asset/liability.
This is certainly true, but the question isn’t at all clear that that’s what they meant.
But I am still cusiours that why would PBO have smaller percentage change? This was the part I was confused about. Sorry If I wasnt asking clearly at first. Do you mind explaining a little more on this? Thank yoU!
Compared to the net asset/liability, the percentage change will be smaller.
Suppose that before the change, the PBO is $100 million and the value of pension assets is $80 million. If the change reduces the PBO by $10 million, then the value of the PBO has declined by 10% ($10 million / $100 million), while the value of the net pension liability has declined by 50% ($10 million / $20 million).
The change in the annual pension expense might be more or less than 10%; without knowing the specifics of the actuarial assumption it’s hard to say for sure.
Again, not a great question.
Got it! This is great to know! Thanks for all your help!!!