Some companies provide post-retirement benefits, such as health insurance, life insurance and tuition assistance to employees after they have retired. U.S. accounting rules require that the cost of these benefits must be recorded throughout the period starting with the employee’s date of hire until the date the employee is fully eligible for the benefit (attribution period). The post-retirement benefit obligation (PBO) expense is reported on the income statement throughout the employee’s attribution period and it is calculated by determining the values of six variables that make up the expense amount.
Obtain the service cost. The service cost is the portion of the expected PBO that applies to the employee’s service for the current period. The expected PBO is the present value of all future benefits expected to be paid as of the current period; it includes the present value of the future benefits that have vested as of the current period (accumulated PBO) and the present value of future benefits that have not vested. When discounting the value of future benefits to their present value, use an interest rate (discount rate) applicable to high-quality, fixed-income investments.
Obtain the interest cost on accumulated PBO. This cost is the increase in the accumulated PBO over the course of time. It is calculated by multiplying the current period’s accumulated PBO’s beginning balance by the discount rate and subtracting benefit payments.
Obtain the actual return on plan assets. Plan assets are investments made by the company that are expected to earn a return that will fund the post-retirement benefit plan’s payments. The actual return is computed by taking the current period’s beginning and ending balances of of plan assets and adjusting for contributions made and benefits paid. The actual return value will reduce PBO expense.
Obtain the amortization amount of prior service cost. This amount reflects the expense amount of the cost of benefits that have vested in a prior period.
Obtain the gains and losses on accumulated PBO. The amounts of gains and losses are related to changes in accumulated PBO due to a change in assumptions or experience related to future benefits. Amounts that are gains will reduce PBO expense, while losses will increase PBO expense.
Obtain the amortization or expense of the transition amount. This amount is the expense related to the adoption of a U.S. accounting rule (SFAS 106) that requires that post-retirement benefits be recorded (accrued) throughout the employee’s attribution period. Benefits that have vested but not have been accrued over the attribution period would be part of the transition amount. The amount can be recorded in one of two ways: expense the full transition amount in one year or expense the transition obligation over the greater of 20 years or the remaining service period of active plan participants.
Calculate the post-retirement benefit obligation expense/cost using the values from the previous six steps. Take service cost, add interest cost, subtract actual return of plan assets, add amortization of prior service cost, add gains related to accumulated PBO, subtract losses related to accumulated PBO and add the amortization of the transition amount. This total will be reported on the income statement and reflect the post-retirement benefit obligation costs for the current period.
There are similarities between accounting for post-retirement benefit obligations and accounting for pension plans; do not confuse the two.