Reading 18 EOC Q14

[ayousaf]

2009 expected return: 6.06%
2007 expected return: 6.79%
Compared to 2009, if the company had used the same expected long-term rate of return on plan assets as 2007, its year end 2009 pension obligation under US GAAP would most likely have been:
a) lower
b) higher
c) the same
The answer is C. However, I don’t understand why the return on plan assets would not change the pension obligation.
Under US GAAP periodic pension cost = current service cost + amortization (past service cost + actuarial gains/losses) + interest expense on plan liability - expected return on plan assets
The above equation (which I think is right) explicitly includes expected return on plan assets, so why would a lower rate of return have no impact on the pension obligation?

 

[S2000magician]

Ending pension obligation = Beginning pension obligation + Service cost + Interest cost ± Actuarial gains/losses ± Past service cost − benefits paid
Nowhere in that equation do you see expected return on plan assets.

 

[ayousaf]

S2000magician wrote:
Ending pension obligation = Beginning pension obligation + Service cost + Interest cost ± Actuarial gains/losses ± Past service cost − benefits paid
Nowhere in that equation do you see expected return on plan assets.

Isn’t the interest cost = interest expense on pension liability - expected return on plan assets?

 

[S2000magician]

ayousaf wrote:

S2000magician wrote:
Ending pension obligation = Beginning pension obligation + Service cost + Interest cost ± Actuarial gains/losses ± Past service cost − benefits paid
Nowhere in that equation do you see expected return on plan assets.

Isn’t the interest cost = interest expense on pension liability - expected return on plan assets?

No.
In computing pension expense (on the income statement), you add interest cost on the pension liability and subtract expected return on plan assets, but that hasn’t anything to do with the pension obligation (on the balance sheet).

 

[ayousaf]

Thanks for your help so far, but I’m still a little bit confused. When the pension expense has been calculated isn’t that just the debit to the P&L and the same amount is credited to the balance sheet, i.e.
Dr Pension expense $1m
Cr Pension obligation $1m
And the employer contributions are just Cr Bank, Dr Pension obligation. I don’t see how only specific parts of the pension expense can be reported on the balance sheet?
Specifically, if the (interest expense on pension liability - return on plan assets) is reported on the P&L, where is the other side of this journal (if it isn’t going to the plan liability on the BS)?

 

[S2000magician]

The actual return goes to plan assets and the difference between the expected return and the actual return goes to OCI where it gets amortized through the income statement. None of it goes to the pension liability.