IFRS vs. US GAAP Treatment of Net Pension Asset / Liability

Of the following, where will the primary difference in financial statements concerning pension plans between US GAAP and IFRS be found?

No. In both cases, the net pension asset or liability will be shown on the balance sheet in the same fashion.

No. In both cases, the net pension asset or liability will be shown on the balance sheet in the same fashion.

Right! Since IFRS does not amortize actuarial gains and losses and the difference between expected and actual returns on plan assets, other comprehensive income related to pensions could reflect a significant difference than under US GAAP accounting.

Pension assets are generally kept in a trust separate from the company’s financial statements. Therefore, you will not see the pension’s assets or liabilities on the company’s financial statements. Ideally, pension assets should equal the present value of the projected pension benefits, called the __pension obligation__. If the pension assets equal the pension obligation, the only impact on the company's financial statements will be the annual pension expense on the income statement. Such is rarely the case.

How do you think the financial statements of the company are affected if the pension assets do not equal the pension obligation?

No. There will be an impact to the company’s financial statements beyond simply a footnote, due to a difference between the pension assets in trust and the pension obligation.

Very good! A difference between the pension assets and the pension obligation represents either an obligation of or future benefit to the company. If the assets are short, the company has an obligation to make up the shortage, so the difference will be a __net pension liability__ on the balance sheet. Conversely, if the assets exceed the pension obligation, the company will enjoy a reduced pension contribution in the future, and the difference will be a __net pension asset__ on the balance sheet.

No. There will be an impact to the company’s financial statements due to a difference between the pension assets in trust and the pension obligation.

The pension obligation changes during the year for five reasons. Three of the factors will impact the pension obligation, and pension costs, every year. First, service costs are added equaling the present value of the pension benefits earned by employees during the year. Second, interest costs are added equaling the pension obligation times the interest rate used to determine the pension obligation. Third, the expected returns on plan assets are subtracted. The final two factors may or may not impact pension expense each year. Prior service costs are added. Prior service costs equal the present value of the future benefits because of any retroactive changes to the terms of the pension plan during the year. Actuarial gains and losses are changes in the present value of the future benefits due to changes in the assumptions about those benefits.

Why do you think service costs are added to current pension expense at their present value rather than the expected total benefits to be paid?

Correct! Pension assets are accumulated while an employee is working. Until benefits are paid, the assets are invested and earn returns. If everything works out correctly, the assets will grow to an amount sufficient to pay the benefits. And, since the pension obligation is recomputed every year, they are adjusted so that it eventually works out correctly.

No. Costs are, well, costs. A company cannot simply record lower costs just because it wants to.

No. While it is true that future benefits are estimated, that is not the reason that the present value of service costs is added to pension expense.

While prior service costs and actuarial gains and losses affect a company’s net pension asset/liability position, US GAAP requires that only service costs, interest costs, and expected return on plan assets be recorded in pension expense each period. US GAAP allows companies to amortize, or smooth, prior service costs and actuarial gains and losses because they are the most volatile. Instead of recording these two components as expenses as they occur, they are recorded in other comprehensive income. Prior service costs are amortized over the remaining estimated service lives (working lives) of the employees affected by the change in the plan. Actuarial gains and losses are also amortized over time.

In summary: [[summary]]

The accounting for pensions under IFRS is similar to the accounting for pensions under US GAAP. Under US GAAP, prior service costs are recorded to other comprehensive income and amortized over the remaining service life of the employees impacted by the plan change. Under IFRS, prior service costs are included with service costs and recorded as part of pension expense in the period of the plan’s change. Prior service costs cannot be amortized under IFRS. Under IFRS, actuarial gains and losses and the difference between the expected return on plan assets and the actual return on plan assets are called __remeasurements__. Remeasurements are recognized in other comprehensive income but are not amortized to expense over time.

Balance sheet assets

Balance sheet liabilities

Balance sheet equity

The company must disclose the difference only in a footnote in its financial statements

The company must show the difference as a pension asset or liability on its balance sheet

There will be no impact since the accounting is all reflected on the financial statements of the pension trust

Because the benefits to be paid is based only on an estimate

To lower the costs to encourage companies to offer pension plans

The benefits will not be paid until the future, allowing the assets time to earn returns

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