I don’t get the reason why expected return, rather than actual return is used in the calculation of pension plan expect. What’s the concept and rationale here? For that matter, I do not understand why the return of the trust would affect expense at all. Shouldn’t current expense be the service and interest costs (plus any actuarial gains/losses and amort items)? Why does expected return come into play if the discount rate is already factored into interest cost?
I answered my second question, but I don’t quite understand the first one.
actual return keeps varying - depending on the portfolio of assets that the DB Plan sponsor sets up. The difference between the expected and the actual shows up in the difference between the “Reported expense” on the income statement and the “Economic Pension Expense” used to make corrections to the statements.
but why? what’s the rationale for using ER instead of actual return in expense?
expected return is an estimate, actual return is what the actual performance would be. if the actual return would be used - period after period there would be high volatility in the net income - which is not good. however - based on the expectations - which can be same period after period - your net income would not have as much fluctuations.
CP’s right. Although there may be fluctuations from period to period, in the long run the actual and expected return is expected to be fairly close. Due to the fluctuations in the returns from the pension fund, the total net income of the company from period to period may not be a good reflection of their primary operation (meaning the company income may be heavily effected my the income from pension fund). So to avoid this abberation, they use the expected return (the smoothed return)… at least this is my understanding of it.