The projected benefit obligation (PBO) is the present value of the expected future payments to employees from a pension plan for the services they have rendered to date. PBO reflects the impact of expected future salaries, inflation, discount rate, and a number of other factors.
Projected benefit obligation (PBO) is a term used primarily in US GAAP. In IFRS, it is called present value of defined benefit obligation (PVDBO).
PBO is estimated by actuaries by applying complex statistical modeling techniques.
Projected benefit obligation (PBO) at the start of a year is reconciled with the PBO at the end of the year as follows:
| Opening projected benefit obligation | XXX |
| Service cost | XXX |
| Interest cost | XXX |
| Contributions made | (XXX) |
| Actuarial gains | (XXX) |
| Actuarial losses | XXX |
| Closing projected benefit obligation | XXX |
Projected benefit obligation is compared with fair value of plan assets to find out a pension fund's funded status.
The projected benefit obligation is unwinded each period by recognizing interest cost on the obligation which increases both the PBO balance and the pension expense. Interest cost equals the product of opening PBO and the discount rate.
OBP Ltd. had a PBO of $400 million as at 1 January 20X1. Their actuaries estimated that the company's employees earned benefits worth a present value of $20 million as a result of the services they provided during the financial year ended 31 December 20X1. The interest rate is 8% and the company contributes an amount of $30 million to the fund. The fresh actuarial estimate of PBO as at 31 December 20X1 is of $415 million. Reconcile the opening PBO with closing PBO.
The opening projected benefit obligation is $400 million. The service cost represents the present value of benefits earned during the current year and it equals $20 million. Interest expense equals the product of opening PBO and interest rate and in this case it equals $32 million. Since the closing PBO is $435 million, the actuarial gains should equal $7 million (=$415 million + $30 million − $400 million − $20 million − $32 million).
The closing PBO reconciles with opening PBO as follows:
| USD in million | |
| Opening projected benefit obligation | 400 |
| Service cost | 20 |
| Interest cost | 32 |
| Contributions made | (30) |
| Actuarial gains | (7) |
| Actuarial losses | - |
| Closing projected benefit obligation | 415 |
Projected benefit obligation differs from the accumulated benefit obligation (ABO) in that the ABO is based on current service rendered and compensation level while PBO forecasts future compensation level, expected service duration, etc. even though both measure obligation arising from services rendered to date.
Relationship between PBO and ABO can be given as follows:
Projected Benefit Obligation = Accumulated Benefit Obligation + Progression of Salaries
by Obaidullah Jan, ACA, CFA and last modified on Nov 7, 2020