At best, pension expenses are only estimates. They are the management’s best guess as to what the cost will be in the future. There are three areas covered in the notes of an annual report- pensions, post-retirement benefits, and pension expenses.
- Pensions: Pensions refer to actual payments that will be made to former employees in retirement.
- Post-retirement Benefits: Post-retirement benefits pertain to insurance and health-care costs the company is responsible for in caring for their retirees.
- Pension Expenses: Pension expenses represent the amount of money management should invest to cover future pension payments at the end of the year.
The pension cost must be estimated because there are a lot of factors at play. For example, in order to determine the exact costs, the company would have to consider the average years of service of an employee at retirement, number of years an employee is expected to live after retirement, salary of employee at retirement, and the interest the invested funds are anticipated to earn.
Because this section of notes is the management’s best estimation, investors don’t pay as much attention to it as to others. However, it is still worth analyzing the fair value of the plan’s assets, the projected benefit obligation, and the difference between the two.
Revisions are often made to pension cost. When management invests more than the current year’s pension expense, it is recorded in an asset account known as Prepaid Pension Cost. When management invests less than the current year’s pension expense, it is recorded in liability account known as Accrued Pension Cost.