Defined Benefit Liability formula reading, service, amount, question, official

stockjaguar

Hello all, I have a question about the DB Liability formula from the Employee Compensation reading.

the official text's formula for a DB Liability(Asset) is as follows

Defined Benefit Obligation from Balance Sheet
+ unrecognized actuarial gains (or less unrecognized losses)
– unrecognized past service cost
– value of plan assets from Balance Sheet
= Defined Benefit Liability (or if this amount is negative, DB Asset)

Intuitively, this seems backwards to me; A past service cost seems to me as something that must be paid out; it seems like it's a liability that must be expensed.

According to this formula, if I have a lot of unrecognized past service costs, my liability is decreasing, or even becoming an asset if I owe my employees a lot more than what I've funded my plan Assets with!
here's what I mean:
say my DBO is $500. I've been naughty, and not recognized my employee's services for a while, so that figure is $700. furthermore, I've only tucked away $50 into their plan assets.
According to the formula;
$500 - 700 - 50 = (-$250)
So, according to this, I would post to my balance sheet a Defined Benefit Asset of $250 (ie plan is in an overfunded position of $250).
I owe this fund a hell of a lot of money to be where I need to be relative to the benefits my employees are owed, so how is it that I have an Asset to declare?

Conversely, let's leave everything the same, but change the unrecognized past service cost to only $25.
$500 - 25 - 50 = $375
In this case, I would post a Defined Benefit Liability of $375 (Plan is underfunded by $375). wtf? I owe less money than in the other world, so why do I post a Liability in this circumstance, and an Asset in the other one?

DSquaredSlim

Leave aside the formula for a while now. Here is how my thinking goes:

The smoothening effect allows the

A. Past service cost,
B. Deferred gain / loss = (Expected - actual return),
C. Transition liability / asset

to be taken to the OCI & lets you amortize the things each year.

So your liability includes

1. Original liability +
2. Unamortized past service cost +
3. Unamortized deferred losses (gains) +
4. Unamortized transition liability (asset)

Now, if you really want to be fair to your users, IFRS would say to the makers of financial statement: "Boss, you've a helluva lot of liabilities. Take all of them and subtract it with your fair value of assets"

Instead, what IFRS telling is: "Total liability - (point 2+3+4 above) - fair value of asset".

This stuff is blowing my mind. Can anybody please explain it with the logic?

lucasg85

yeah, read my post on the 'Reading 23 Q5 - full and partial goodwill' topic. I spell out my study plan there

zephyranalyst

Thanks! Do you mind sending your notes to me? hendriar14@yahoo.com

flyinggirl

I have Stalla materials. I used it exclusively for level 1, as well as EOC questions, and that was fine.

For level 2, I find it to be overall helpful, but I don't think its well written enough that you could rely on it exclusively to pass the exam (at least I wasn't able to). Though it was generally okay, some of the readings were weak and not well explained. The pension chapter is one of those. Also, the later economics readings were not well written imo, and most of portfolio management was also written like crap. Oh, and alternative assets was pretty badly done too. As for stuff they did a good job on, I'd say they did an okay job on Intercorporate investments, Multinational Operations, Derivatives, Fixed Income, and an okay job on ethics.

The big weakness was the question bank. I found that many questions in it were wordy, too easy, but still managing to be long and tedious; kind of like if I asked you to calculate the mean of 10 numbers; not difficult to do, but takes time and is annoying.
To contrast that with actual CFA exam questions, the exam questions were quick to solve (no long tedious charts or tables to draw manually), but still had a higher degree of difficulty and even a bit of creativity on some questions.

All of this is just my opinion tho.

how is shweser?

liquidity

Schweser is not bad. It's less verbose than the CFAI text. I had a buddy who passed Level II and III with just Schweser material so I'm giving it a shot. I'll probably do EOC questions for CFAI and see if I'm missing anything from Schweser. I'm hoping to start my review in early April. As I'm going through Schweser I'm making note cards with important topics so I can do a quick refresh on the information. I've heard QBank sucks though for level II. If it's anything like Level I, I'd say Schweser sometimes focuses too much on the number crunching aspect and not enough on the theory.

Are you planning on reading the CFAI text cover-to-cover? I've heard Level II is a lot harder than Level I, but the material isn't too bad so far. It just seems like you need to make sure you dedicate enough time to learn it and repeat a dozen times before June. Any thoughts?

ninja1024

Trust me it is correct, If you treat a Asset and Liability as a minus. If you subtract at liability (minus) you actually add it, not subtract. I know it seems weird, but the point is you need to add loses and liabilites and subtract gains and liabilites.

here's the math using your formula:

Funded Status (FV plan assets- PBO) = 5798 - 5485 = 313

+/- Unrecognized deferred (gains) and losses – 59
+ unrecognized past service cost + 70
+/- unrecognized transition (assets) or liabilites – 50
= Net Pension asset(liabilites) reported on balance sheet = 274

That's just not right; you're supposed to get a net pension asset of 492, not 274


Here's the correct math. 5798-5485=313 add back 59 (unrec. actuarial losses),add back 50 (unrec. transition liability), and 70 (unrecognized past service cost)= 492

CP was trying to explain the same thing above....

Re: Defined Benefit Liability formula
Posted by: cpk123 (IP Logged)
Date: January 3, 2011 06:54AM


if you started with a sign on the DBO - it is a liability - so it has to be negative...

so -500 -725 = -1225 (a bigger liability).

CP

I guess I didn't do a good job of explaining it before. The point being as long as you add back loses and subtract gains you'll get the right answer.

BelalM

ok, that's different than what you posted initially then. It's confusing because if you have a formula that is solving for a DB Liability as a positive value, and a DB asset as a negative value (as is done in the example in the text), you have to subtract unrecognized losses:

Defined Benefit Obligation from Balance Sheet
– unrecognized actuarial losses (or plus unrecognized gains)
– unrecognized past service cost
– value of plan assets from Balance Sheet
= Defined Benefit Liability (or if this amount is negative, DB Asset)

If you're doing it the way people seem most comfortable here, which is to solve for DB asset as a positive value, then it's basically just the reverse:

Fair value of Plan Assets
+ unrecognized actuarial losses (or less gains)
+ unrecognized past service cost
+ unrecognized transition (assets) or liabilites
– Defined Benefit Obligation
= Defined Benefit Asset (negative value is a liability)

The formula you just used is basically the same as this one here, because
funded status = Fair V of plan Assets - DBO, sooo

Funded Status
+ unrecognized actuarial losses (or less gains)
+ unrecognized past service cost
+ unrecognized transition (assets) or liabilites
= Defined Benefit Asset (negative value is a liability)


Still leaves me with the same dilemma of not really understanding why having more unrecognized losses and costs increases your DB Asset tho... still hazy on that.

bdavi77962

Yeah sorry. I pulled that formula from Schweser. I'm using a combo of CFAI materials and Schweser for the exam. THey sometimes write the equations different from the CFAI, but I think it's easiers to understand sometimes.

I think in Schweser they said that you have to do the opposite mathematically because the G/L are unrealized and if you didn't do it that way the whole accounting equation (A=L + OE) would be off. Let me know if you want me to post the example verbatum from the material.

I think the way I'm going to memorize it as they way of your last post.

Funded Status
+ unrecognized actuarial losses (or less gains)
+ unrecognized past service cost
+ unrecognized transition (assets) or liabilites
= Defined Benefit Asset (negative value is a liability)

Are you using any other materials besides the stuff from CFAI??

thecfawannabe

Sorry brah, your formula just isn't right : /

again, here are the figure's we're working with for example 1:
DBO = 5485
unrec. transition liability = 50
unrec. actuarial losses = 59
unrecognised past service cost = 70
fair value of plan assets = 5798

here's the math using your formula:

Funded Status (FV plan assets- PBO) = 5798 - 5485 = 313

+/- Unrecognized deferred (gains) and losses – 59
+ unrecognized past service cost + 70
+/- unrecognized transition (assets) or liabilites – 50
= Net Pension asset(liabilites) reported on balance sheet = 274

That's just not right; you're supposed to get a net pension asset of 492, not 274