Pension Expense

Pension expense is the amount reported in the income statement related to a company's pension plan.

Pension expense under defined contribution plan

Under the defined contribution plan, the periodic contribution which the company is required to pay is expensed out on accrual basis.

Example

CPE Ltd. has a defined contribution plan which required the company to contribute $20 million to the fund each year. In the financial year 2011, the company pay $25 million while in financial year 2012, it paid $15 million.

The company will recognize a pension expense of $20 million each in 2011 and 2012. The first year payment will result in $5 prepayment of contribution which will expire in 2012.

Pension expense under defined benefit plan

The pension expense under the defined benefit plan is made up as follows:

  1. Service cost
  2. Interest cost
  3. Expected return on plan assets
  4. Amortization of prior service cost
  5. Amortization of actuarial gains and losses

Amortization of actuarial gain and a positive expected return on plan assets result in a decrease in pension expense.

Service cost represents the portion of projected benefit obligation (PBO) earned by the employees in the current year.

Interest cost represents the increase in projected benefit obligation (PBO) on account of unwinding of discount. It equals the product of opening defined benefit obligation (PBO) multiplied by the interest rate.

Expected return on plan assets is the return which is expected to be earned by the plan assets over the next period.

Amortization of prior service cost represents the additional service cost resulting from changes to plan structure, which is expensed in the current period.

Amortization of actuarial gains and losses represent the amount of actuarial gains or loss that are written off in the current period.

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork