Accumulated Benefit Obligation
Understanding an accumulated benefit obligation and other pension plans, such as projected benefit obligations, is critical to running your company.3 min read
If you are an employer, understanding an accumulated benefit obligation and other pension plans, such as projected benefit obligations, is critical to running your company.
Companies that provide their employees with pensions and other benefits are required to be transparent about their plans and need to keep up with current laws. The FASB of Statement of Financial Accounting Standards No. 87 requires companies to reveal any pension obligations. In addition, companies are required to state the pension financial and performance conditions within each accounting time period. There are three pension formulations: vested, accumulated, and projected benefits.
What are Accumulated Benefit Obligations?
Not all pensions are the same. Some are limited and others ongoing. An accumulated benefit obligation (ABO) is a limited pension. An ABO measures approximate liabilities of a pension plan based on assumptions that pensions will be terminated without future salary increases. ABOs are current values of benefits that are vested and non-vested based on current salaries. Values of future earnings are not considered. While an employee will continue to work and will probably receive several pay increases during employment, this means an accumulated benefit obligation is lower than a pension obligation that takes into account future earnings.
How Changes in ABO Are Determined
Annual ABO charges are determined by service cost changes, interest costs, plan participant contributions, actuarial losses or gains, yearly benefits, and even foreign exchange gains or losses, if these are part of the plan calculation. Any shortfalls in ABO plan assets are “underfunded,” while the plan assets exceeding ABO are “overfunded.” Underfunded plans are long-term liabilities on a balance sheet.
Major Causes of Underfunding and Overfunding
The primary drivers of underfunded and overfunded statuses are suppositions of discount rate and anticipated long-term plan asset rates of return. If a diminution in the assumed discount rate occurs, the estimated underfunded amount will become greater or overfunded amounts will decrease. If the assumptive return rate on assets become greater, any underfunded amounts will decrease or an overfunded amount will rise to hold all other quantities constant.
Different Pension Obligations
The ABO is one of three methods to calculate costs or liabilities associated with pensions. Other measures are vested benefit obligations (VBO) and projected benefit obligations (PBO). The ABO calculates how much money the company needs to pay currently retired employees for their pension benefits. In contrast, the PBO assumes the pension is ongoing and will have forthcoming salary increases. ABOs do not take into account employees that continue to accumulate salary and will have future salaries, making ABOs smaller than PBO pension plans.
Difference between ABOs and PBOs
The value of an employee's compensation is different between an ABO and a PBO. With an ABO, the employee's present-day compensation is the benchmark for the pension. A PBO, however, uses the employee's calculated payment at retirement. ABOs do not take into account upcoming salary increases for employees in contrast to PBOs that are more flexible in future calculations. Additionally, a PBO calculates the benefits earned by current employees and takes into account salaries and time working for the company.
SFAS 158 Pension Requirements and ABO
A Statement of Financial Accounting Standards is a statement from the Financial Accounting Standards Board providing guidance on a specific accounting topic. On Sept. 29, 2006, the board issued Statement No. 15 regarding ABO transparency and understandability. Before the board released SFAS 158, an employer's funded status for a defined benefit or retiree medical plan —essentially the difference between plan assets and obligations — was not completely reported on balance sheets. Now, funded statuses need to be reported on balance sheets.
Under previous rules, plan sponsors were required to adjust balance sheets to include pension liability at least as great as unfunded ABOs. However, this requirement was triggered when pension assets were less than ABOs. If assets exceeded ABOs, no adjustment was required. Now both liabilities and assets must be documented. This applies to public and private companies as well as nongovernmental not-for-profit organizations.
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