Funded Status

In pension accounting, funded status refers to the extent to which the plan's liabilities are covered by plan assets. It equals the net liability or net asset of the pension plan, which in turn equals the fair value of total plan assets minus the projected defined benefit obligation.

Determination of funded status

Funded status is determined by comparing fair value of plan assets with pension liability.

Funded status = Fair value of plan assets − Projected defined benefit obligation

Plan assets are the investments of the pension fund. These may include investment in the company's stock, other stocks listed on any stock exchange, exchange-traded funds, bonds, real estate, etc.

Projected defined benefit obligation (also known as present value of defined benefit plan) is the present value of expected pension payments which the employees are entitled to receive based on the service they have accumulated to date.

Presentation on balance sheet

Under US GAAP, when the fair value of plan assets exceeds the projected defined benefit obligation, a net pension asset equal to the excess of fair value of plan assets over the projected benefit obligation is reported on the balance sheet.

On the other hand, if the projected defined benefit obligation exceeds the fair value of plan assets, a net liability equal to the excess of defined benefit obligation over the fair value of plan assets is reported on the balance sheet.

Example

FS Ltd. has a defined benefit pension plan. As at 31 December 20X1, its plan assets had a book value of $140 million and fair value of $160 million. The PBO at the time was $150 million. During the year, the company contributed an amount of $20 million to the fund, the fund paid out $15 million while the return on plan assets was $10 million. Service costs were $30 million, interest cost amounted to $12 million while actuarial gains were $3 million.

Solution

As at 31 December 20X1, the funded status was $10 million (calculated as $160 of fair value of plan assets minus $150 million of projected defined benefit obligation) and it would be reported as an asset on the balance sheet.

After one year, i.e. as at 31 December 20X2, new fair value of plan assets is:

USD in Millions
Opening fair value of plan assets160
Contributions received20
Benefits paid(15)
Actual return on plan assets10
Closing fair value of plan assets175

The projected defined benefit obligation as at 31 December 20X2 will equal $180 million as calculated below:

USD in Millions
Opening PBO150
Service cost35
Interest cost12
Benefits paid(15)
Actuarial gain(2)
Closing PBO180

Funded status as at 31 December 20X2 would be -$5 million which represents a net pension liability of $5 million to be reported on the balance sheet.

by Obaidullah Jan, ACA, CFA and last modified on

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