pension obligation question

I don’t understand this… From CFAI book: “items that can increase a company’s pension liability in a particular period include the following: current service costs, interest expense accrued on the pension obligation, past service costs, actuarial losses, and losses on curtailments or settlements.” what is the “interest expense accrued on the pension obligation”? what’s the difference between the above and “interest income earned from the pension plan’s assets”? Who are these interests paid to, from whom? Why would it increase the company’s pension liability? Thanks!!

also…what’s “losses on curtailments or settlements”?

you have incurred an obligation because you are “storing” up costs as an liability. You need to pay someone (your employees in the future). so for that liability - you incur an extra interest expense. That is the interest expense on your obligation. For ensuring you have funds on hand - when it is due - to pay the liabilities - employer (you) set aside funds in the pension assets - which earn interest over time. That is the income portion.

Thanks cpk123. I understand it better now. Just this: If I can imagine paying off the pension liability like paying off a mortgage, and the employee (in this case similar to the bank) is charging me an interest plus the principle that I need to pay off. However, in this case, I haven’t borrowed money from anyone, and I have deposited a bunch of cash in the pension assets to pay off the “mortgage” after the employee’s service period, why should I “pay interests” to anyone? that is, my interest “expense”? I understand that there’s “interest expense” accrued on “long-term debt” or something like that, but for pension obligation, it’s an obligation, not debt, right? (CFAI also has a question of calculating debt to capital ratio with pension obligation not treated like debt…does that mean when it’s not treated like debt, there is no interest expense?) P95-96 Thanks a lot.

yeah, but the obligation is arising for someone’s time in your company. So, you are promising to compensate them for their time spent in the company in the future. That money is now growing some interest - so it has gotta be deposited there. That is the interest expense. For each year’s service to you - already done - you are promising someone a future sum of money - that is definitely an obligation for which you need to pay interest.

Good to see you back, cpk.

So the interest expenses will be received as part of the compensation by the employee in the future… (correct me if I was wrong!) Thanks and I’m feeling much better about this concept now.

New question on “lump sum payment upon retirement”: example on CFAI book P103: final year estimated salary: Euro 60,198.56 benefit: 1.5% of final salary for each year of service the book says: the lump sum payment to be paid upon retirement = final salary x benefit % x years of service = 60,198.56 x 0.015 x 5 = 4,514.89 my question is, since the value of the obligation is 60,198.56x0.015 upon retirement, why not just pay this amount, why does it need to be multiplied by 5 years? (sorry for the dumb question but I was confused by the calculations of the lump sum payment versus annual unit credit)

It’d be helpful if you posted the full question. Most of us don’t have the new CFAI books.

final year estimated salary: Euro 60,198.56 benefit: 1.5% of final salary for each year of service read it and you shall see the light!!! CANNOT HIGHLIGHT the “for each year of service” in bold…

OHHHHH I GOT IT… Now the thing is, they calculate the annual unit credit AS: Euro 60,198.56 x 1.5% / 5 years this is confusing because if it is 1.5% of final salary for “each year of service” why it is not Euro 60,198.56 x 1.5% for “annual” unit credit??

I think the book definitely makes a mistake! Here’s what the book says, same question: Annual unit credit (benefit) per service year = Value at retirement divided by Years of service = (Final year’s estimated salary x benefit %) divided by Years of service = (60,198.56 x 0.015 ) / 5 = 4514.89 / 5 = 902.98. The above calculation should be: (60,198.56 x 0.015 x 5 years) / 5 years = 4514.89 / 5 = 902.98 CP - am i right?

let me go - read the book and determine that.

I am right and the CFA “bible” is wrong… :slight_smile: (hope i don’t get into trouble saying this…)

New question: I’m a little bit confused about net funded position/status: On page 114 of CFAI book, it says “under both standards, the amount appearing in the balance sheet is a net amount”, “a related adjustment is to include the actual return on plan assets as income and the interest on the plan liability as an expense (US GAAP only as it is already included in interest expense under IFRS)” as I understand that, net funded status = DB obligation - fair value of plan assets what does the “adjustment” mean from the book? where and how do we do the adjustments? …Thanks in advance.