What Is Accumulated Benefit Obligation?
Accumulated benefit obligation (ABO) is an 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.
Understanding Accumulated Benefit Obligation
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 pension liability measurement. Changes in annual ABO are mainly determined by 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. ABO and the fair value of plan assets are compared at the end of a period. If there is a shortfall in plan assets to ABO, the pension plan is "underfunded"; if plan assets exceed ABO, the pension plan is "overfunded." Underfunded plans are booked as a long-term liability on the balance sheet. Two major drivers of underfunded/overfunded status are the assumptions of discount rate and the expected long-term rate of return on plan 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.
Example of Accumulated Benefit Obligation
A financial statement note in Raytheon Company's 10-K for the fiscal year of 2016 details ABO, PBO, and plan assets amounts. ABO for domestic pension plans was $22.1 billion, compared to $17.8 billion in value of its domestic pension plans, an underfunded status of $4.3 billion. This amount was recorded as part of "Accrued retiree benefits and other long-term liabilities" on the company's balance sheet.