Question

How is the pension expense influenced by changes in the pension liability and plan assets?

Answer 1

Companies provide employees with a pension plan as part of a larger array of employment benefits. The FASB Statement of Financial Accounting Standards No. 87 requires firms to measure and disclose pension obligations as well as the performance and financial condition of their plans at the end of each accounting period.

At the start of the year, companies will multiply the fair market value of the assets held in their pension funds by an estimate of the long-term rate of return on these investments. This return on plan assets reduces the company's overall pension expense. FASB rules require companies to differentiate between the following two measures:

• The actual return on pension plan assets in the current accounting period; and
• The difference between the actual return on pension plan assets and the expected return on the assets.

Presenting information in this way allows investors to assess the performance of the fund relative to expectations. For example, a pattern of excess returns may allow the company to reduce expenses in the future, while a series of shortfalls may indicate a need for additional company contributions.

In other words, a pension liability is the difference between the total amount due to retirees and the actual amount of money the company has on hand to make those payments. What it's not—and this is an important distinction—is the total amount that gets paid in future pensions.

Higher pension liability would increase company's pension expenses.