Pension obligations

2nd September 2021 0 By indiafreenotes

A projected benefit obligation (PBO) is an actuarial measurement of what a company will need at the present time to cover future pension liabilities. This measurement is used to determine how much must be paid into a defined benefit pension plan to satisfy all pension entitlements that have been earned by employees up to that date, adjusted for expected future salary increases.

A pension benefit obligation is the present value of retirement benefits earned by employees. The amount of this obligation is determined by an actuary, based on a number of assumptions, including the following:

  • Estimated employee mortality rates
  • Estimated future pay raises
  • Estimated interest costs
  • Estimated remaining employee service periods
  • Amortization of actuarial gains or losses
  • Amortization of prior service costs

Companies can provide employees with a number of benefits, including a salary, when they retire from work. The Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards No. 87 states that companies must measure and disclose their pension obligations, together with the performance of their plans, at the end of each accounting period. 

A projected benefit obligation (PBO) is one of three ways to calculate expenses or liabilities of traditional defined benefit pensions plans that take into account employee years of service and salary to calculate retirement benefits.

PBO assumes that the pension plan will not terminate in the foreseeable future and is adjusted to reflect expected compensation in the years ahead. As a result, it takes into account a number of factors, including the following:

  • Assumed salary rises.
  • The estimated remaining service life of employees.
  • A forecast of employee mortality rates.

Actuaries are responsible for establishing whether pension plans are underfunded. These qualified professionals, who specialize in the measurement and management of risk and uncertainty, determine the benefits needed through a present value calculation.

Actuaries are responsible for comparing the pension plan’s liabilities to its assets. In general, they provide a breakdown of the following:

  • Interest Costs: The annual interest accumulated on the unpaid balance of the PBO as an employee’s service time increases.
  • Service costs: The increase in the present value of the defined benefit obligation, resulting from current employees getting another year’s credit for their service.
  • Benefits paid: Obligations are reduced when benefits are paid out.
  • Actuarial Gains or Losses: The difference between the pension payments made by an employer and the anticipated amount. A gain occurs if the amount paid is less than expected. A loss occurs if the amount paid is higher than expected.

PBO is one of the three approaches firms use to measure and disclose pension obligations. The other measures are:

Vested benefit obligations (VBO): The portion of the accumulated benefit obligation that employees will receive, irrespective of their continued participation in the company’s pension plan.

Accumulated benefit obligations (ABO): Unlike PBO, accumulated benefit obligations (ABO) refers to the present value of retirement benefits earned by employees using current compensation levels.