How do you calculate the funded status of a defined benefit pension, and what hits the income statement vs. OCI?

Question

AcadiFi · Accepted Answer

Pension accounting is one of the densest topics in CFA Level II, but once you see the framework, it becomes very systematic. Let me break it down.

## The Funded Status

**Funded Status = Fair Value of Plan Assets − Projected Benefit Obligation (PBO)**

- If plan assets > PBO: **overfunded** (net pension asset on balance sheet)
- If PBO > plan assets: **underfunded** (net pension liability on balance sheet)

## What Goes Where

| Component | Income Statement | OCI |
|---|---|---|
| Service cost (current) | Yes | No |
| Net interest cost/income | Yes | No |
| Past service cost | Yes (IFRS: immediately) | No |
| Remeasurements (actuarial gains/losses) | No | Yes (IFRS) |
| Actual vs. expected return difference | No | Yes |

**Under IFRS**, the income statement includes:
1. **Current service cost** — the present value of benefits earned by employees this period
2. **Net interest** = Opening net pension liability (or asset) x Discount rate

Everything else — actuarial gains and losses from assumption changes, and the difference between actual and expected return on plan assets — goes to **OCI** and is never recycled to the income statement.

## Worked Example

**Brightwell Manufacturing** has the following pension data at year-start:
- PBO: $240 million
- Plan assets (fair value): $210 million
- Discount rate: 5.0%
- Current service cost: $18 million
- Employer contributions during the year: $15 million
- Benefits paid to retirees: $12 million
- Actual return on plan assets: $14.7 million
- Actuarial loss from revised mortality assumptions: $6 million (increases PBO)

**Step 1 — Net interest cost:**
- Interest cost on PBO: $240M x 5.0% = **$12.0M**
- Expected return on plan assets: $210M x 5.0% = **$10.5M**
- Net interest cost = $12.0M - $10.5M = **$1.5M**

**Step 2 — Income statement pension expense:**
- Service cost: $18.0M + Net interest: $1.5M = **$19.5M**

**Step 3 — OCI charges:**
- Actuarial loss (mortality assumption): **$6.0M** (debit OCI)
- Return difference: Actual $14.7M - Expected $10.5M = **$4.2M** gain (credit OCI)
- Net OCI impact: $6.0M loss - $4.2M gain = **$1.8M net loss in OCI**

**Step 4 — Ending funded status:**
- Ending PBO: $240 + $12 (interest) + $18 (service) + $6 (actuarial loss) - $12 (benefits paid) = **$264M**
- Ending plan assets: $210 + $10.5 (expected return) + $4.2 (excess return) + $15 (contributions) - $12 (benefits) = **$227.7M**
- Funded status: $227.7 - $264.0 = **($36.3M)** underfunded

## Key Exam Tip

Under US GAAP, actuarial gains/losses can be amortized from OCI back into the income statement using the corridor approach. Under IFRS, they stay in OCI permanently. The CFA exam loves testing this GAAP vs. IFRS difference.

For detailed pension accounting drills and more worked examples, check out AcadiFi's CFA Level II Financial Reporting module.

How do you calculate the funded status of a defined benefit pension, and what hits the income statement vs. OCI?

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