Interpretation of Pension Plan Note Disclosures Including Cash flow Related Information

Interpretation of Pension Plan Note Disclosures Including Cash flow Related Information

Pension plan disclosures are used to further analyze a company’s pension and other post-employment benefits. The following are the different components of the disclosures, apart from assumptions that we discussed in detail in the previous LOS: Explain and calculate how adjusting for items of pension and other post-employment benefits that are reported in the notes to the financial statements affects financial statements and ratios.

1. Net Pension Liability (or Asset)

The amount disclosed in the balance sheet is the net amount under both IFRS and US GAAP.

Analysts can adjust a company’s net assets and liabilities for the gross amount to reflect the underlying economic liabilities and assets.

2. Total Periodic Costs

The total periodic cost is the change in the net pension liability or assets, excluding the effect of the employer’s periodic contribution to the plan.

$$ \text{Periodic pension cost = Ending funded status – Employer contribution – Beginning funded status} $$

Cash payment to a retiree does not impact the net pension liability or asset since it reduces plan assets and obligations in an equal amount.

3. Periodic Pension Costs Recognized in P&L vs. OCI

$$\small{\begin{array}{l|l} \textbf{IFRS P&L} &\textbf{US GAAP P&L}\\ \hline{\text{Includes both current and past service costs}} & {\text{Includes only current service costs and}\\ \text{any amortization of past service costs}}\\ \hline{\text{Incorporates return on plan assets equal to the}\\ \text{discount rate used in estimating the pension obligation}} & {\text{Incorporates expected}\\ \text{return on plan assets}}\\ \hline{\text{Does not permit amortization of}\\ \text{amounts from OCI to P\&L}} & {\text{May show the impact of}\\ \text{amortizing actuarial gains/losses}\\ \text{recognized in the previous periods}}\\  \end{array}}$$

An analyst could adjust reported amounts of P&L to achieve comparability across companies. Alternatively, the analyst can use comprehensive income (net income from P&L plus OCI) as the basis for comparison.

4. Classification of the Periodic Pension Costs Recognized in P&L

Adjusting the amounts of periodic costs is vital for the analyst to make accurate comparisons across companies. For instance, to better reflect a company’s operating performance, the analyst can adjust the operating income as follows:

$$ \text{Adjusted operating income = Operating income + Full amount of pension costs reported in the P&L – Total of service costs and settlements and curtailments} $$

Refer to the previous LOS for more explanation on this.

5. Cash Flow Information

Cash flow impact is the amount of contributions that a company makes to fund the plan or for plans without funding requirements.

The regulations of the countries in which the plan operates determine the cash flow impact. However, companies may choose to contribute in excess of the regulation’s requirements.

A reduction in pension obligation occurs when a sponsoring company’s periodic contributions to a plan exceed the total pension costs of the period.

A contribution that is less than the total pension cost of the period can be seen as a source of financing.

An analyst may choose to adjust cash flows where the amounts of benefit obligations are material.

Example: Adjusting Cash Flow

The information below is based on ABC Ltd.’s 2018 annual report.

$$\begin{array}{l|r} \text{Total pension costs} & £237\\ \hline\text{Company’s contribution} & £300\\ \hline\text{Cash flows inflow from operating activities} & £5,600\\ \hline\text{Cash outflow from financing activities} & £1,200\\ \hline \text{Tax Rate} & 30\%\\  \end{array}$$

Using the above information, we determine how the company’s 2018 contribution to the pension plan compares with the total pension cost for the year.

The amount by which the company’s contribution exceeds total pension cost (pre-tax) \(= \text{Company’s contribution} – \text{Total pension costs}\)
\(=£300 – £237 = £63\)

And the amount by which the company’s contribution exceeds total pension cost (After-tax) \(= £63 × (1-0.30) = £44\).

Cash from operating and financing activities can be adjusted to illustrate that the difference between the company’s contributions and the total pension costs is similar to a form of borrowing.

In 2018, ABC Ltd. contributed £63 (£44 after-tax) more than the 2018 total pension cost.

If the excess contribution is interpreted as similar to the repayment of borrowing rather than as operating cash flow, the company’s cash outflow from financing activities will increase by £44 (£1,200 to £1,244). Similarly, the cash inflow from operations would increase by £44 (from £5,600 to £5,644).


Melon Plc is a hypothetical company that offers its employees a defined benefit pension plan, and it complies with IFRS. Note that the figures provided are hypothetical.

$$ \textbf{Melon PLC Defined Benefit Pension Plan in 2018 (£ millions)} $$

$$\small{\begin{array}{l|r}  \textbf{Periodic benefit cost} &\\ \hline\text{Service cost} & 300\\ \hline\text{Net interest (income) expense} & 250\\ \hline\text{Remeasurement} & -20\\ \hline\text{Periodic pension cost} & 530\\ \hline\textbf{Change in benefit obligations} &{}\\ \hline\text{Benefit obligations at the start of the year} & 30,000\\ \hline\text{Service cost} & 300\\ \hline\text{Interest cost} & 2,000\\ \hline\text{Benefits paid} & -1,500\\ \hline\text{Actuarial gain or loss} & 0\\ \hline\text{Benefit obligations at the end of the year} & 30,800\\ \hline\textbf{Change in plan assets} & {}\\ \hline\text{The fair value of assets at the start of the year} & 24,000\\ \hline\text{Actual return on plan assets} & 1,400\\ \hline\text{Employer contributions} & 1,000\\ \hline\text{Benefits paid} & -1,500\\ \hline\text{The fair value of assets at the end of the year} & 24,900\\ \hline\text{Beginning of the year funded status} & 6,000\\ \hline\text{End of year funded status} & 5,900\\  \end{array}}$$

Melon Plc wants to adjust its financial statements of cash flows to reclassify the company’s excess contribution. Assuming that there is no income tax, the adjustment that is most likely involves reclassifying £470 million as an outflow related to:

A. Operating activities rather than financing activities.

B. Investing activities rather than operating activities.

C. Financing activities rather than operating activities.


The correct answer is C.

The amount by which Melon’s contribution exceeds the total pension cost (pre-tax) \(= \text{Company’s contribution} – \text{Total pension costs}\)
\(= £1,000 – £530 = £470\)

The £470 difference between these two numbers can be viewed as a reduction of the overall pension obligation. To adjust the statement of cash flows to reflect this view, an analyst would reclassify the £470 million as an outflow related to financing activities rather than operating activities.

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

LOS 12 (f) Interpret pension plan note disclosures including cash flow related information.

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