Dear all, Can someone explain to me the paragraph about defined benefit liability on page 90 of reading 22 Employee Comppensation ( CFA text ) : IFRS (IAS 19) require companies to report a defined benefit liability on their balance sheet eual to the net total of the following amounts: the present value of the defined benefit obligation at the balance sheet date plus any unrecognized actuarial gains (less any actuarial losses) minus any any past service cost not yet recognized… I thought that the unrecognized actuarial losses and past service cost should increase the liability as you can see in the practice problem of the same reading on page 132 and therefore we should add them to the defined benefit liability. I am really confusing and will appreciate any help. Thank you.
Okay, for IFRS, before deducting PBO from Plan Assets we need to adjust PBO like this: But before that, know this: PBO already has ALL sorts of unrecognized Gains/Losses already into it. Now the adjustments: 1. Adjusting PBO figure for Unrecognized Losses: Since Unrecognized losses are already in the PBO, and these losses have INCREASED PBO, to nullify their effect we need to REDUCE these Losses from PBO. 2. Adjusting PBO figure for Unrecognized Gains: Since Unrecognized Gains are already in PBO and these gains have REDUCED PBO, we need to ADD them back to nullify their affect. So, Reduce any Unrecognized Losses and add back any Unrecognized Gains to PBO. Now, after adjusting PBO in such manner, we can reduce this adjusted PBO from Plan Asset value to get Net figure to be reported on B/S. Hope it helps.
Thank you rus1bus, you really help me out ! So I suppose that the minus sign of unrecognized past service cost in the first problem of EOC in reading 22 means that it is actually an unrecognized past service cost reduction (gain). I have another question, could you or anyone please answer? All else equal, the increase in discount rate assumption will : A) increase future pension expense and cause a higher benefit obligation B) decrease future pension expense and cause a lower benefit obligation C) may increase or decrease future pension expense and cause a lower benefit obligation Thank you,
I’m going to go with C here. I hope I’m right. As benefit obligations are present values, an increase in the discount rate should make this smaller. As the interest expense is the expense associated with the change in the benefit obligation due to the passage of time, this should also decrease future pension expense. However, if the plan is mature an increase in the discount rate will increase pension expense, because your benefit obligation won’t benefit from being discounted for a long period.
When you increase discount rate, then the PV of future obligations (i.e. PBO) will decrease for sure, so A is out as it says ‘higher benefit obligation’. Now, choice is between B and C, based on Pension Expense. 2 of the components of Pension Expense are ‘Current Service Cost’ and ‘Interest Cost’. With increase in Discount Rate, Currenct Service Cost would decrease, but Interest Cost would increase. If the plan is old and mature (i.e. average employee population is old), Interest Cost would be on a high existing PBO and thus, may exceed Current Service Cost. If this is the case, then overall effect on Pension Expense could be dominated by Interest Cost and hence Pension Expense could Increase. So, the correct answer should be C, as with increase in Discount Rate, Interest costs would increase and current service cost would decrease. And depending on which one has a higher effect, would determine whether Pension Expense would increase or decrease.
Thank you soddy1979 and rus1bus for your explaination. Yes, C is the correct one.