Page 38 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

LOS 15.b: Explain and calculate measures of a defined READING 15: EMPLOYEE COMPENSATION: POST-EMPLOYMENT AND SHARE BASED
benefit pension obligation (i.e., present value of the defined
benefit obligation and projected benefit obligation) and net
pension liability (or asset). MODULE 15.2: DEFINED BENEFIT PLANS—BALANCE SHEET

Projected benefit obligation (PBO) [known as present value of defined benefit obligation (PVDBO) under IFRS] is the actuarial present
value (at an assumed discount rate) of all future pension benefits earned to date, based on expected future salary increases.

Measures the value of the obligation, assuming firm is going concern and that the employees will continue to work for the firm until they retire.

From one period to the next, the benefit obligation changes as a result of current service cost, interest cost, past (prior) service cost, changes
in actuarial assumptions, and benefits paid to employees.

Current service cost is the present value of benefits earned by the employees during the current period. It includes an estimate of
compensation growth (future salary increases) if the pension benefits are based on future compensation. In rare cases, the pension plan may
have a provision for employees to share in the service cost. Current service cost in that case would only represent the employer’s share of
the cost. Employee contributions would be added to both beginning PBO and beginning plan assets in PBO and FV plan asset reconciliation
respectively.

Interest cost is the increase in the obligation due to the passage of time. Benefit obligations are discounted obligations; thus, interest
accrues on the obligation each period. Interest cost = the pension obligation at the beginning of the period multiplied by the discount rate.

Past (prior) service costs are retroactive benefits awarded to employees when a plan is initiated or amended. Under IFRS, past service
costs are expensed immediately. Under U.S. GAAP, past service costs are amortized over the average service life of employees.

Changes in actuarial assumptions are the gains and losses that result from changes in variables such as mortality, employee turnover,
retirement age, and the discount rate. An actuarial gain will decrease the benefit obligation and an actuarial loss will increase the obligation.

Benefits paid reduce the PBO.
Consider the following example of calculating the PBO.