Definition
The term pension expense refers to the costs associated with pension plans that are reported on the company's income statement. Expenses associated with defined contribution plans are equal to the contribution made by the company in the current period. The pension expense associated with defined benefits plans include service and interest cost, the return on the plan's assets, as well as the amortization of prior service costs and actuarial gains or losses.
Calculation
Net Pension Expense = Interest Cost + Service Cost - Expected Return on Plan Assets + Amortization of Prior Service Costs + or - Amortization of Actuarial Gains or Losses
Explanation
Companies will provide employees with a pension plan as part of a larger array of employment benefits. Pension plans are structured by companies to provide a periodic and reliable source of income when the employee reaches the plan's normal retirement age.
The FASB Statement of Financial Accounting Standards No. 87 requires firms to measure and disclose pension obligations as well as the performance and financial condition of their plans at the end of each accounting period. Pension expenses associated with defined contribution plans are simply equal to the contribution made by the company to the plan in the current accounting period.
The calculations involved in determining a company's obligation under a defined benefit plan are complex, and require the skill of an actuarial to perform. Generally, pension plan expenses would include:
Interest Costs (increases expense): The annual interest accrued on the beginning balance of the projected benefit obligation. Since the projected benefit obligation (PBO) is the present value of the retirement benefits earned by employees, the company incurs an annual expense equal to the discount rate used to determine the PBO multiplied by the starting balance of the PBO.
Service Costs (increases expense): The present value of the projected retirement benefits earned by the plan's participants in the current period.
Expected Return on Plan Assets (lowers expense): The dividends, interest, and capital gains generated by assets held in a company's pension plan.
Amortization of Prior Service Costs (increases expense): The systematic recognition of a pension expense in future periods resulting from a retroactive change to the plan's benefit formula.
Amortization of Actuarial Gains or Losses (increases or decreases expense): The increase or decrease to a company's estimate of their projected benefit obligation as a result of the periodic reevaluation of assumptions used when calculating the benefit.
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