Pension Interest Cost

Pension Interest Cost = Projected Benefit Obligation x Pension Discount Rate

Where:

• Projected Benefit Obligation = the obligation calculated at the beginning of the current year

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.

The company's pension benefits obligation is stated in terms of its present value. The value used to discount these future obligations is typically a relatively conservative rate such as those earned on high-quality, fixed-income investments. As each year passes, employees participating in the pension plan are one year closer to receiving their retirement benefit. Therefore, the company incurs a cost that is equal to the discount rate multiplied by the balance in the PBO at the start of the year.

Interest cost is typically the second largest component of a company's pension expense each year. The overall level of funding will also depend on variables such as the return on the fund's assets, service costs, prior service costs, changes to the plan's formula, and the plan's gains and losses.

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