FAR · Select balance sheet accounts · 6 practice questions
Projected Benefit Obligation (PBO) Rollforward
Service cost and interest increase PBO; benefits paid and actuarial gains reduce it. Below: a worked rollforward shows each component's sign and calculates interest from beginning PBO.
Try one first
Hint
Use the PBO rollforward: begin with opening PBO, add items that increase the obligation, and subtract items that reduce it.
Answer B. Ending PBO starts with beginning PBO and adds service cost and interest cost. It also includes the $30,000 increase from the plan amendment, subtracts benefits paid, and subtracts the actuarial gain because a gain reduces the obligation. The computation is $1,200,000 + $90,000 + $72,000 + $30,000 - $110,000 - $40,000 = $1,242,000.
Why not A: This comes from treating the plan amendment increase as a reduction. When a plan amendment grants additional prior service benefits, it increases the projected benefit obligation.
Why not C: This comes from adding the actuarial gain instead of subtracting it. An actuarial gain reduces the obligation, while an actuarial loss increases it.
Why not D: This comes from omitting the $30,000 amendment effect from the rollforward. An amendment that increases promised benefits must be included in ending PBO.
Worked example
Cedar Co. begins Year 1 with a $2,500,000 PBO and a 4% discount rate. Service cost is $150,000. An amendment adds $75,000 to the obligation. An actuarial gain is $25,000, and benefits paid are $200,000. No other changes occur. What is ending PBO?
| 1 | Calculate interest cost$2,500,000 × 4% | $100,000 |
| 2 | Add service cost to beginning PBO$2,500,000 + $150,000 | $2,650,000 |
| 3 | Add interest cost$2,650,000 + $100,000 | $2,750,000 |
| 4 | Add the full amendment increase$2,750,000 + $75,000 | $2,825,000 |
| 5 | Subtract the actuarial gain$2,825,000 - $25,000 | $2,800,000 |
| 6 | Subtract benefits paid$2,800,000 - $200,000 | $2,600,000 |
Cedar reports an ending projected benefit obligation of $2,600,000.
Check: Additions are $325,000 and reductions are $225,000, so PBO rises by $100,000 to $2,600,000.
Key points
- Service cost comes from current-year employee service; interest cost comes from time passing on the opening obligation.
- Include the full amendment effect immediately. Do not amortize or prorate the PBO change.
- A lower discount rate raises the present value of benefits, creating an actuarial loss.
- For a missing component, write the full rollforward first, then solve for the unknown.
How the exam traps you
- Applying the discount rate to ending PBO or beginning PBO plus service cost. Apply the rate to beginning PBO only.
- Adding an actuarial gain to the obligation. A gain reduces the liability; a loss increases it.
- Subtracting employee contributions from PBO. Contributions fund plan assets. They do not reduce PBO.
Question 2
Hint
First decide whether the new assumption makes the projected benefit obligation larger or smaller, then identify where that remeasurement goes first.
Answer B. Increasing the assumed salary growth rate raises expected future benefit payments when benefits are based on final pay. That increases the projected benefit obligation and creates an actuarial loss. The loss is recorded in other comprehensive income when it arises, so the pension-related net loss in AOCI increases at year-end.
Why not A: This mistake delays recognition until amortization. Assumption changes are first recorded in OCI, and only later may part of the accumulated amount be amortized into pension expense.
Why not C: This comes from treating a higher salary growth assumption as if it reduced the obligation. In a final-pay plan, higher expected salaries increase the projected benefit obligation, so the change produces a loss rather than a gain.
Why not D: This applies the corridor as if it were a recognition test. The corridor affects whether accumulated gains and losses are amortized to expense, not whether the actuarial loss enters AOCI initially.
Question 3
Hint
Compare how PBO and ABO treat future compensation assumptions for salary-based pension formulas.
Answer C. The PBO is measured using assumptions about future compensation levels when benefits depend on pay at or near retirement. Increasing assumed salary growth increases those projected future benefits and therefore the PBO. The ABO generally measures benefits based on service to date using current compensation levels, so it is not directly increased by future salary progression.
Why not A: This results from excluding future raises from all obligation measures. That is true for the ABO but not for the PBO, which reflects expected future compensation when the formula is salary based.
Why not B: This results from assuming both measures use projected compensation. Only the PBO captures future salary growth for a pay-related formula; the ABO remains based on current compensation.
Why not D: This results from treating the accumulated measure as if it incorporated future pay growth. Under U.S. GAAP, the accumulated benefit obligation generally uses current compensation levels, while the PBO incorporates future salary assumptions.
Question 4
Hint
Start with beginning projected benefit obligation times the old rate, then compare it with the new rate.
Answer C. Interest cost equals the beginning projected benefit obligation multiplied by the discount rate. The change raises interest cost from $40,000 at 5% to $48,000 at 6%, so net periodic pension cost increases by $8,000 when no other component changes.
Why not A: This answer uses the new total interest cost instead of the change in pension expense. The question asks how much expense changes, so only the $8,000 increase matters.
Why not B: This answer both uses the full 6% interest cost and applies the wrong direction. The revised rate produces $48,000 of interest cost, which is $8,000 higher, not lower.
Why not D: This answer reverses the effect of the discount rate on interest cost. A higher discount rate increases the interest cost applied to the projected benefit obligation.
Question 5
Hint
Keep the obligation measurement separate from the funding of the plan.
Answer A. Employee contributions do not affect the projected benefit obligation. Whether contributions were required or remitted, they relate to funding the plan and plan assets, not to measuring the actuarial obligation.
Why not B: This comes from subtracting only the amount remitted to the trustee. That fails because remittances increase plan assets, not the PBO.
Why not C: This comes from subtracting the full required employee contribution from the PBO. That fails because required employee contributions do not reduce the actuarially measured obligation.
Why not D: This comes from adding the required employee contribution to the PBO. That fails because employee contributions are not an additional employer benefit obligation.
Question 6
Hint
Ask which assumption change makes the present value of promised pension benefits larger.
Answer D. A lower discount rate raises the present value of future pension payments. When a change in actuarial assumptions increases the projected benefit obligation, that increase is an actuarial loss.
Why not A: This answer comes from confusing mortality direction. Shorter expected benefit payment periods mean fewer projected payments, which decreases the obligation instead of increasing it.
Why not B: This answer comes from assuming any salary assumption change increases the obligation. For a final-salary plan, lowering expected salary growth reduces projected benefits and therefore reduces the projected benefit obligation.
Why not C: This answer comes from reversing the discount rate effect. A higher discount rate lowers the present value of future benefits, so it creates an actuarial gain rather than a loss that increases the obligation.
Common questions
Why is pension interest cost based on beginning PBO?
Interest cost measures the increase from time passing on the obligation already outstanding at year-start. Current-year service cost and year-end remeasurement are separate rollforward components.
Does an actuarial gain increase or decrease PBO?
An actuarial gain decreases PBO. An assumption change that increases PBO creates an actuarial loss.
Does a plan amendment increase PBO immediately?
An amendment granting additional prior-service benefits immediately increases PBO by its full actuarial effect. Amortization into pension expense does not spread out the PBO increase.
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