SFAS No. 158 no longer allows companies to report SFAS No. 87 minimum liabilty i
ID: 2543343 • Letter: S
Question
SFAS No. 158 no longer allows companies to report SFAS No. 87 minimum liabilty in the balance sheet. Instead, the amount reported in the balance sheet is measured using projected benefits rather than accumulated benefits. For the following debate, relate your arguements to appropriate accounting theory, including the conceptual framework and capital maintenance theories.
1) argue for the use of accumulated benefits for pension expense and liability purposes
2) argue for the use of projected benefits for pension expense and liability purposes
Explanation / Answer
Accumulated benefit obligation (ABO) is an approximate amount of a company's pension plan liability at a single point in time. ABO is estimated based on the assumption that the pension plan is to be terminated immediately; it does not consider any future salary increases. This differs from the projected benefit obligation (PBO), which assumes that the pension plan is ongoing, and thus accounts for future salary increases.
Accumulated benefit obligation is the present value of the amounts that a pension plan expects to pay employees during retirement based on accumulated work service and current salary levels (i.e., no future salary increases) at the time of pension liability measurement. Changes in annual ABO are mainly determined by changes in service costs, interest costs, contributions by plan participants, actuarial gains or losses, benefits paid during the year and foreign exchange gains or losses, if applicable.
ABO and PBO are similar but ABO does not provide for future salary increases. ABO and the fair value of plan assets are compared at the end of a period. If there is a shortfall in plan assets to ABO, the pension plan is "underfunded"; the if plan assets exceed ABO, the pension plan is "overfunded." Underfunded plans are booked as a long-term liability on the balance sheet. Two major drivers of underfunded/overfunded status are the assumptions of discount rate and the expected long-term rate of return on plan assets. If there is a decline in the assumed discount rate, the estimated underfunded amount will increase (or an overfunded amount will decrease), all else equal. On the other hand, if the assumed rate of return on plan assets is increased, an underfunded amount will fall (or an overfunded amount will rise), holding all other variables constant.
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