In a clean surplus environment, the change in net pension asset or liability would flow through the income statement as a pension expense. However, both U.S. GAAP and International Accounting Standards allow for a number of smoothing mechanisms when reporting pension expense. Still, the change in liabilities is a good place to start the discussion.
The pension obligation can change for a number of reasons:
- The employee’s service during the period, which increases the future liability
- Interest expense on the prior liability
- Changes in the terms of the plan
- Changes in actuarial assumptions
Furthermore, the assets in the plan can increase or decrease in value due to contributions, benefits paid and market fluctuations.
Current accounting rules require service and interest costs to be recognized immediately, while the other items can be amortized over a number of years. Furthermore, the rules allow for the return on plan assets to be estimated (the expected return) rather than used directly. All differences between the expected and actual values are also amortized.
Since there are smoothing mechanisms, the reported pension expense will not always reflect the change in the plan’s economic status and investors may wish to use the related disclosures to create a more accurate picture of the financial situation.For more information, see all articles on: Accounting, Adjusting Reported Financial Statements, Financial Statement Analysis, Fundamental Analysis See also: