when calculating econ pens expense, why do employer contributions deduct from the plan asset value? because they are using plan assets to pay workers pensions? I interpreted this as the employer putting assets into the plan, hence INCREASING plan assets. Same equation, how do benefits paid add to the plan asset value? Wouldn’t the plan assets DECREASE if I am using the plan assets to pay out benefits to retirees? Thanks, Andrew
try not to look at it in terms of mechanics, but as what makes up the change in the PBO and FVA. In other words what are the acutal components that would reconcile Beg. PBO to end PBO. Then when you make your adjustments think about how this effects what is left in the number that you calculated as the change in either the PBO or FVA. Change in the PBO + Benefits paid - Acutal Reutrns = Economic Pension expense. Why? --because you now have an *adjusted change* that removed the effects of the ‘smoothers’ embedded in the original change. These smoothers are usually the result of acturial assumptions, and not actual cash. Likewise, Change in Plan Assets - Employer Contributions + Benefits Paid gives you an adjusted change in the change in plan assets that represents economic expense rather than accrual expense more accurately.
Thanks Andrew. I get it that change in PBO + Benefits paid - Actual Returns= econ pens exp. I seem to see conflicting examples though in the books…this one has change in PBO less actual return on assets, with no mention of benefits paid. Back to my question, aren’t benefits paid an outflow which would decrease plan assets? And contributions by the company are an inflow which increase plan assets? -CFAI book, first EOC, Kensington problem, #2, you can just say “assets went up 673, obligation went up 115, but contributions of 693 is an additional cost of 20 (over the 673 asset increase), so take the oblig of 115 and add 20 and you have your 135 econ pens exp”. Since I (as the company) actually paid out more in contributions than the return on assets, then that is a cost to me. -Then on the EOC- Aero Euro problem, #20, I get that the PBO goes up 1,084, then we have assets go up 866, THEN WHY DO YOU DEDUCT CONTRIBUTIONS, THEN WHY DO BENEFITS PAID INCREASE PLAN ASSETS? Thanks for your help, Andrew
Look man, I won’t spell it out for you. And I mean this with all respect due. I have to be a retaker this year even though I studied balls last year b/c I just didn’t understand this stuff well enough I guess so I have to try again. You gotta do your time too. But I’m telling if you’ll just look at the components that make the pension liability and pension asset that reconcile the beginning to end values, then you’ll see what I said above will make perfect sense. You just have to do that and then perhaps stare and struggle with it for a bit and should become clear. Good luck to you -A
think of the plan assets as an investment portfolio. economic gain is when the portfolio goes up. if the employer puts in money, it’s not really the same as the portfolio appreciating in value. that’s the difference.
Thanks Palantir, makes sense now, contributions shouldn’t really “count” towards the increase in asset (investment portfolio) value. And then benefits paid increase the portfolio because why? Really appreciate it, Andrew
I think you have it wrong… contributions increase assets benefits paid decrease the assets
Ok, first isolate the “real” change in the investment portfolio (Plan Assets), that means, that you have to take out the plan contributions which artificially increase the portfolio and take out distributions, which artificially decrease the portfolio. That gives you a picture of what is really happening to their pension assets. Hope that helps.
Palantir, thanks i think that makes sense, CP would you agree?
that part only makes sense when you are trying to calculate the economic pension expense. when you are looking at the move from beginning Plan Assets to Ending Plan assets for an accounting period => Contributions INCREASE Plan assets, Distributions decrease Plan assets.
Right, contributions “increase” assets and distributions “decrease” assets, but for economic expense you have to take those effects out.
Thanks guys- pretty sure this is clicking now. Contributions physically increase plan assets as the company puts money into the plan, while distributions physically decrease assets as they are paid out of the plan to retirees, but they are not a “REAL” change in the investment portfolio so exclude these changes to get the TRUE ECONOMIC PENSION EXPENSE Really appreciate it, Andrew