What Is Accumulated Benefit Obligation (ABO)?
Accumulated benefit obligation (ABO) is the approximate amount of a company's pension plan liability at a single point in time. ABO is estimated based on the assumption that the pension plan is to be terminated immediately; it does not consider any future salary increases. This differs from the projected benefit obligation (PBO), which assumes that the pension plan is ongoing, and thus accounts for future salary increases.
- Accumulated benefit obligation (ABO) is the approximate amount of a company's pension plan liability at a single point in time.
- The assumption for the accumulated benefit obligation (ABO) is that the pension plan will be terminated immediately, meaning that there will be no more future salary increases.
- Accumulated benefit obligation (ABO) is equal to the present value of the future amount that a pension plan expects to pay an individual during their retirement.
- Companies are required to measure and report their pension liabilities and the performance of their pension plan by the Financial Accounting Standards Board's Statement No. 87.
- If the accumulated benefit obligation (ABO) is above the pension plan's assets, then the plan is underfunded. If the ABO is below the pension plan's assets, then the plan is overfunded.
- Underfunded or overfunded status can be affected by the discount rate used as well as the expected rate of return on the plan's invested assets.
Understanding Accumulated Benefit Obligation (ABO)
At the end of each accounting period, the Financial Accounting Standards Board requires companies to file FASB Statement No. 87, which quantifies and discloses pension liabilities in addition to the financial position and performance of their pension plans. There are three ways to measure this: accumulated benefit obligation (ABO), projected benefit obligation (PBO), and vested benefit obligation (VBO).
Accumulated benefit obligation is the present value of the amounts that a pension plan expects to pay employees during retirement based on accumulated work service and current salary levels (i.e., no future salary increases) at the time of the pension liability measurement.
Changes in annual ABO are mainly a result of changes in service costs, interest costs, contributions by plan participants, actuarial gains or losses, benefits paid during the year, and foreign exchange gains or losses, if applicable.
ABO and PBO are similar, but ABO does not provide for future salary increases whereas PBO does. As a result, PBO is a more accurate measure of a company's pension liability to its employees, because it assumes salary increases over time, hence, an increase in liabilities that it must be prepared to payout.
When comparing the ABO to the value of the plan's assets, the plan's assets can either be overfunded or underfunded. If ABO is higher than the plan's assets, then there is a shortfall and the pension plan is underfunded. If the plan's assets exceed ABO, then the pension plan is overfunded.
Accumulated Benefit Obligation (ABO) Calculation Factors
Underfunded plans are booked as a long-term liability on the balance sheet of a company. As ABO is a present value calculation, there are two major drivers that determine if a plan is underfunded or overfunded. The two assumptions are the discount rate used in the present value calculation and the expected long-term rate of return on the plan's assets.
If there is a decline in the assumed discount rate, the estimated underfunded amount will increase (or an overfunded amount will decrease), all else equal. On the other hand, if the assumed rate of return on plan assets is increased, an underfunded amount will fall (or an overfunded amount will rise), holding all other variables constant.
Real World Example
A financial statement note in Raytheon Company's 10-K for the fiscal year of 2016 details ABO, PBO, and plan asset amounts. ABO for domestic pension plans was $22.1 billion, meaning that the company had a liability to pay its employees a pension amount of $22.1 billion. The current value of the pension plan was $17.8 billion.
As the liability amount of $22.1 billion was higher than the plan's assets of $17.8 billion, the plan was underfunded by $4.3 billion. This amount was recorded as part of "Accrued retiree benefits and other long-term liabilities" on the company's balance sheet.