Question

What are the components of a pension expense?

Answer 1

Pension expense reports an employer's annual cost for maintaining an employee's pension plan. The components of a pension expense include the service cost, interest cost, expected return on plan assets, amortization of prior service cost and effect of gains and losses. These components are briefly discussed as follows:-

1) Service Cost : The primary component of pension expense is service cost. The service cost represents the present value of projected retirement benefits earned by covered employees in the current year. Service cost depends on factors such as job promotion, salary increases and early retirement as these affect the final benefit amount.

2) Interest cost : Interest cost represents the interest accumulated on the unpaid balance of the projected benefit obligation as an employee's service time increases.

3) Return on Plan Assets : The return on plan assets represents the current year's earnings on invested plan assets.

4) Amortization of prior service cost : When an employer implements or modifies a pension plan, employees usually receive credit for service prior to the change. The amortization of prior service represents the cost of providing retroactive benefits over the remaining service years of the covered employees.

5) Gains and Losses : The gains or losses components show the changes in the employer's projected benefit obligation and the market impact on plan assets. Service and interest costs always increase pension expenses. The rate of return normally decreases pension expense, but can increase it if the asset incur a loss.