Components of a Company’s Defined Pension Costs

The periodic pension cost of a company’s defined benefit plan is the change in the net pension liability or asset adjusted for the employer’s contributions.

The following make up a company’s defined pension costs:

1. Service Costs

Current service cost refers to the present value of benefits during the current period based on salary growth levels. A past service cost is a change in the amount of pension obligation relating to prior periods due to changes in plan amendments or plan curtailment.

IFRS Recognition

The company recognizes service costs in profit and loss.

GAAP Recognition

The company recognizes current service costs in profit and loss. However, it recognizes past service costs in OCI and amortizes the subsequent costs to profit and loss over the years of service.

2. Net Interest Income/Expense

The net interest expense is the financial cost of deferring benefits related to the plan.

The net interest income is the financial income from prepaying amounts related to the plan.

IFRS Recognition

Under IFRS, the company recognizes this component in P&L as:

$$ \text{Net interest income /expense = Net pension liability or net pension asset × Discount rate} $$

GAAP Recognition

The company records the interest expense on pension obligation in P&L and recognizes the expected return on plan assets in the P&L as an amount given by:

$$ \text{Net interest income/expense = Plan assets × Expected return} $$

3. Remeasurement

Remeasurement includes:

• Actuarial gains and losses.
• The actual return on plan assets and the amount included in the net interest expense/income calculation differ.

$$ \text{Actuarial gains and losses = Changes in a company’s pension an obligation arising from changes in actuarial assumptions} $$

$$ \text{Difference in the expected and actual return on assets = Actual return – (Plan assets × Expected return)} $$

IFRS Recognition

A company recognizes remeasurement in OCI.

$$ \text{Net return on the plan assets = Actual return – (Plan assets × Interest rate)} $$

$$ \text{Actuarial gains and losses = Changes in the company’s pension obligation arising from changes in actuarial assumptions} $$

GAAP Recognition

Under GAAP, the company reports remeasurements in P&L. Additionally, it can amortize the subsequent costs to P&L using the corridor approach.

Question

A hypothetical company ABC has a DB plan. Which component of ABC’s periodic pension cost is most likely to be shown in OCI rather than P&L?

1. Remeasurements.
2. Net interest (income expense).
3. Service cost.

Solution

The correct answer is A.

A company recognizes remeasurements in OCI rather than P&L under IFRS.

Reading 12: Employment Compensation: Post-Employment and Share-Based

LOS 12 (c) Describe the components of a company’s defined benefit pension costs.