What is an actuarial gain or loss?
Actuarial gain or loss refers to an increase or decrease in the projections used to measure the obligations of a company’s defined benefit pension plan. The actuarial assumptions of a pension plan are directly affected by the discount rate used to calculate the present value of the benefits and the expected rate of return on plan assets. Financial Accounting Standards Board (FASB) SFAS 158 requires that the state of pension fund financing be included in the plan sponsor’s balance sheet. This means that there are periodic updates to pension obligations, fund performance and the financial health of the plan. Depending on plan participation rates, market performance and other factors, the pension plan may experience an actuarial gain or loss in its projected benefit obligation.
Although these accounting rules require that retirement assets and liabilities be valued at the market price on the balance sheet of an entity, they allow actuarial gains and losses, or changes in actuarial assumptions, to be amortized through profit or loss. overall in equity rather than going directly to profit. declaration.
Key points to remember
- Actuarial gains and losses are created when the assumptions underlying a company’s projected benefit obligations change.
- Accounting rules oblige companies to disclose both retirement obligations (liabilities) and the assets intended to cover them. This shows investors the overall health of the pension fund.
- All defined benefit pension plans will experience periodic actuarial gains or losses as the key demographic assumptions or key economic assumptions making up the model are updated.
Understanding the actuarial gain or loss
Actuarial gains and losses are better understood in the context of global pension accounting. Unless otherwise specified, this definition deals with accounting for pension plans under United States generally accepted accounting principles (GAAP). Although US GAAP and International Financial Reporting Standards (IFRS) prescribe similar principles for measuring retirement benefit obligations, there are key differences in the way the two standards present the cost of pensions in the income statement, in particular the treatment of actuarial gains and losses.
The funded status represents the net assets or liabilities linked to a company’s defined benefit plans and corresponds to the difference between the value of the plan assets and the plan’s obligation for projected benefits (PBO). The valuation of plan assets, which are the investments set aside to finance plan benefits, requires judgment but does not involve the use of actuarial estimates. However, PBO measurement requires the use of actuarial estimates, and it is these actuarial estimates that give rise to actuarial differences.
There are two main types of assumptions: economic assumptions that model how market forces affect the plan, and demographic assumptions that model how participants’ behavior should affect benefits paid. Key economic assumptions include the interest rate used to discount future cash outflows, the expected rate of return on plan assets, and expected salary increases. Key demographic assumptions include life expectancy, expected length of service, and expected retirement age.
Actuarial gains and losses create volatility in earnings
From one period to another, a change in an actuarial assumption, in particular the discount rate, can lead to a significant increase or decrease in PBO. If recorded in the income statement, these adjustments potentially distort the comparability of financial results. Consequently, under US GAAP, these adjustments are recorded in other comprehensive income in equity and are amortized to the income statement over time. Under IFRS, these adjustments are recognized in other comprehensive income but are not amortized in the income statement.
Footnotes contain useful information on actuarial assumptions
Accounting rules require detailed information on pension assets and liabilities, including activity from one period to another in the accounts and the main assumptions used to measure the funding status. This information helps users of the financial statements understand how a company’s pension plans affect the financial position and results of operations compared to previous periods and to other companies.