A theme that runs through the entire topic of pension accounting is that of the projected benefit obligation (PBO). The PBO is the present value of the future benefits expected to be paid to employees based on their employment to date and taking into consideration expected increases in salaries that would affect their benefits.
This measurement is based upon actuarial assumptions of employee turnover, life expectancy, and interest rates.
The PBO is increased and decreased by several items, thus leading to the following relationship:
PBO, beginning year
+ Service cost
+ Interest cost
− Benefits paid
± Changes in actuarial assumptions
= PBO, year-end
+ Service cost
+ Interest cost
− Benefits paid
± Changes in actuarial assumptions
= PBO, year-end
Service costs and interest costs will be defined later on.
Company A had a beginning PBO of $100,000, service cost and interest cost were $10,000 and $9,000 respectively, changes in assumptions were −$4,000, and the ending PBO is $95,000. Using the above formula, benefits paid would be $20,000, determined as follows:
$100,000 + $10,000 + $9,000 − X − $4,000 = $95,000
X = $20,000