Definition
The term return on plan assets refers to the dividends, interest, and capital gains generated by assets held in a company's pension fund. Accounting rules require companies to differentiate between the expected and actual return on their plan's assets.
Explanation
Companies provide employees with a pension plan as part of a larger array of employment benefits. 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.
At the start of the year, companies will multiply the fair market value of the assets held in their pension funds by an estimate of the long-term rate of return on these investments. This return on plan assets reduces the company's overall pension expense. FASB rules require companies to differentiate between the following two measures:
The actual return on pension plan assets in the current accounting period; and
The difference between the actual return on pension plan assets and the expected return on the assets.
Presenting information in this way allows investors to assess the performance of the fund relative to expectations. For example, a pattern of excess returns may allow the company to reduce expenses in the future, while a series of shortfalls may indicate a need for additional company contributions.
Since SFAS No. 87 also requires companies to record pension assets at their fair market value, companies must report an unrealized gain or loss on these assets annually.
In addition to the return on plan assets, the overall level of pension funding depends on variables such as interest costs, service costs, prior service costs, changes to the plan's formula, and the plan's gains and losses.
Example
Company A's long-term rate of return on their pension plan assets was found to be 7.2%. At the start of the year, Company A had $100,000,000 in pension assets. The expected rate of return on these assets was calculated as:
= $100,000,000 x 0.072, or $7,200,000
At year end, Company A's accounting team determined the pension fund's actual return was $9,000,000, or 9.0%. Since the actual return was greater than the expected return, Company A would report an unrealized gain on plan assets of $9,000,000 - $7,200,000, or $1,800,000.
Related Terms
pension plan, defined benefit plan, defined contribution plan, pension obligation, accumulated benefit obligation, vested benefit obligation, projected benefit obligation, service cost, pension interest cost, amortization of prior service cost, actuarial gains and losses, pension expense, pension plan assets, pension funded status