Anyone looked at Q10 & 11 from the EOC of CFAI books?
According to Scwesser pg 108 (and most other online resources I have researched):
“The Return on Plan Assets has no effect on the PBO. However, the expected return on the assets reduces pensions expense” - in other words, we reduce pension expense in the I/S by the amount of the expected return on the plan assets for IFRS and GAAP.
However, in the CFAI book pg 179 we are told that it is only under GAAP that the expected return on plan assets reduce the pension expense.
Can anyone please clear this up for me? I would, of course assume, thtat the CFAI way is correct but it seems at odds with all other resources which is causing me a bit of confusion.
You sure schweser has used the word PBO? As PBO (projected benefit obligations) is the term specific to US GAAP only. Under IFRS, you actually refer the pension obligations as “PV of DBO” (present value of defined benefit obligations). So schweser could be correct here.
Gaap uses expected returning plan assets, which is different from the discount rate, while IFRS uses the discount rate, the same rate used to discount Pbo.
Yeah Schwesser says the following (apologies for just copying out a load of text):
“Expected Return on plan assets: The employer contributes assets to a separate entity (trust) to be used to satisfy the pension obligation in the future. The return on plan assets has no effect on PBO. However, the expected return on the assets reduces penson expense. Under IFRS, the expected return on plan assets is implicitly assumed to be the same as the discount rate used for computation of PBO”
This had led me to believe, along with this table on pg 110 that you reduce pension expense by the expected return under both IFRS and GAAP i.e For GAAP you reduce it by Expected Return on Assets*Assets and for IFRS you reduce it by Discount Rate*Assets (becasue discount rate=expected return):
Component US GAAP IFRS
Current Service Costs Income Statement Income Statement
PAst Service Costs OCI Income Statement
Interest Costs Income Statement Income Statement
Expected Return Income Statement Income Statement
Actuarial G/L Income statement & OCI All in OCI
I’m still not sure what I’m missing? Thanks for taking the time to come back to me anyway
Adrian, CFAI is correct. Following recent changes to pensions accounting under IFRS, expectations about how plan assets will perform (in terms of returns) are no longer relevant.
Instead, plan assets are multiplied by the discount rate (which is generally lower than what we expect the rate of return on those assets to be) and this works to reduce the overall net interest cost, which gets recognised in the Income Statement.
I agree that the effect is the same as treating this as the expected return on plan assets, where we assume the expected rate of return to be equal to the discount rate. However, that seems to be too big a simplification. Expected return on plan assets is a term reserved for true expectations about how these assets will perform, and as such it is no longer a component of the pension benefit expense under IFRS.
I suggest you take a look at the brief example on pg. 8 and 9 of the following publication by Deloitte, which shows the treatment using discount rate (revised IFRS treatment) versus expected return (old IFRS treatment). Old treatment is referred to as IAS19, revised/current treatment is called IAS19R:
It isn’t very difficult once you get your head around it, the problem is getting your head around it. Its a difficult topic. Some one please correct me if I’m wrong.
The chart you posted doesn’t paint the whole picture. First thing, GAAP will have two rates, the discount rate and the expected return of plan assets, while IFRS will only use the discount rate.
Past Service Cost ( Goes to OCI then is amortized over employees expected service life into IS)+
Actuarial Gains/Loses (Amortized from OCI using Corridor Approach)
= Income statement pension Expense
For IFRS
Service Cost+
Net Interest Cost (BEG Fund status * Discount Rate) See its just PBO * discount rate - plan assets* discount rate, this cost could be a revenue too if you have FV plan Assets>PBO +
Prior Service Cost ( realized all at once in I/S)+
= Income Statement Pension expense (actural gains and loses go to OCI and are not amortized)
Thanks very much for both of the above repsonses - they were very helpful, especially when taken together (the deloitte example is very clear).
I was not seeing that the expected return on plan assets is included in the “Net Interst Cost” under IFRS because of the assumption that expected return = discount rate. Under GAAP, since we don’t make this assumption, we calculate the interst cost as PBO*Discount rate and then subsequently subtract the Plan Assets*Expected Rate of Return.
“I agree that the effect is the same as treating this as the expected return on plan assets, where we assume the expected rate of return to be equal to the discount rate. However, that seems to be too big a simplification. Expected return on plan assets is a term reserved for true expectations about how these assets will perform, and as such it is no longer a component of the pension benefit expense under IFRS.”
It is less of a simplification to apply discount rate to a value that is in current value terms. Since it is used in IFRS to reduce the net interest cost, it is implicitly assumed to be the expected return on plan assets - as mentioned by Johnmike (and Schweser per Adrian). The link you include does imply that as well.
I think CFAI is indeed right - per new standards (but does not conflict with what is said in Schweser).