Under the new pension accounting and disclosure rules of Financial Accounting Standards Board Statement No. 87, four components of total pension expense must be separately disclosed. Service cost (Component 1) represents the increase during the year in the discounted present value of the pension benefits ultimately payable; it is attributable to employees having worked an additional year. Interest cost (Component 2), which arises from the passage of time, increases pension expense. Return on plan assets (Component 3) reduces pension expense.
Actual experience may differ from the assumptions used to compute pension expense and return on plan assets. Component 4, net amortization and deferral, is designed to capture such variances, but it allows for considerable smoothing of their effects on the balance sheet. Gains or losses resulting from differences between expected and actual returns, for example, may be deferred. And in the event that cumulative deferred amounts continue to grow, corrections can be spread out over future years.
Because of the smoothing allowed, balance sheets prepared under FAS 87 will not reflect the real economic status of pension plans. Companies must therefore provide a footnote disclosure that reconciles the real economic status of the pension plan to the balance sheet amounts.
