Pension Accounting Terminology

Pension Terminology Definitions & Discussion

The author is asked to define a number of terms relative to pension accounting and its associated terminology and definitions. The terms the author asked to define, in order, are service cost, interest cost, actual return on planned assets, amortization of unrecognized gains/losses and amortization of the transition amount.

Service cost is the present value, from an actuarial standpoint, of the projected benefits that can be associated with an employees' tenure at a pension-using employer during the current year. This is very similar to normal cost. Interest cost is the increase in projected benefit obligation (PBO) associated with the lapse of time as the year goes on. Generally speaking, the interest cost is gained by multiplying the discount rate by the PBO applicable at the beginning of the year.

Actual return on plan assets is what it sounds like. It is the "actual" results that are gained after an initial projection is given as to what the results will be, known as expected return on assets. Amortization of unrecognized gains or losses is a gradual and deliberate recognition of actuarial gains/losses. Actuarial gains/losses are those that are projected to pass but that have not actually "hit" a company's financial statements. In other words, if actuarial calculations say a loss will occur, it would be amortized for the purposes of a pension even if the financial statements (e.g. income statement, balance sheet) of a firm have not yet become official. In a similar fashion, transaction obligation or asset (otherwise known as amortization of the transition amount) is the phased recognition on the income statement of the disparity between the plan's status from a funding point-of-view and the accrued/prepaid cost of the company's balance sheet as it is known at that point.

Minimum Liability Provision

Basically, it is a situation, vis-a-vis a pension, when the mandatory outlays of the pension's benefit structure are clearly outstripped by the assets that are on hand at that given time. For example, if a pension plan has mandatory outlays of $50 million but only has $40 million in actual assets at that time, then the minimum pension liability would kick in.

No such or similar provision would be in play if the opposite were to occur. As a related example, if the mandatory benefits are $50 million and the assets on hand are $60 million, no additional mandatory outlay is required. The pension plan is simply running a surplus and this has no bearing on the eventual benefits played except to say that the pension plan is not going to run out of money.

When the condition in the first paragraph comes to pass, an accrual for that difference between mandatory and actual benefits available is keyed. This is keyed as an additional liability.