For example, a pension plan fund had a net pension asset of $9.312 billion before considering any valuation allowance.
As with any recorded asset (think of accounts receivable, or a building), a pension asset signals that the sponsor can benefit from the asset in the future. However, unlike other types of assets, a sponsor does not own the plan assets in a pension plan. This unique accounting situation requires a sponsor to consider whether and when it can benefit from the surplus assets in a pension plan.
Before a sponsor can record a pension asset on its statement of financial position, the sponsor must first consider the “limit on the carrying amount of an accrued benefit asset,” or, put more simply, the “pension asset ceiling”. This ceiling is a test imposed in IAS 19.64 on net defined benefit asset balances.
Pension asset ceiling and Valuation allowance
The pension asset ceiling is an annual calculation that requires a sponsor to record a valuation allowance for any excess of the pension asset over the sponsor’s “expected future benefit.” In determining the valuation allowance, IAS 19 requires net unamortized actuarial losses to be subtracted from the pension asset.
A sponsor’s expected future benefit is an estimated dollar amount representing the benefit a sponsor expects to realize from a pension asset. IAS 19 requires a sponsor to calculate its expected future benefit as the sum of:
- the present value of the sponsor’s expected future service cost for the current group of active employees less the present value of required employee contributions and minimum required employer contributions regardless of any plan surplus; plus
- the amount of plan surplus that can be withdrawn in accordance with the existing plan and any applicable laws and regulations.
In simpler terms, the above formula restricts a sponsor to only two possible sources from which to expect future benefits from a pension asset: (1) reductions in future required contributions to the plan, and/or (2) withdrawals of surplus funds from the plan trust.
A further restriction on the expected future benefits is that the sponsor must be currently entitled to benefit from reduced contributions or a surplus withdrawal. In accounting, the sponsor is not entitled to benefit from either source without the required approval of employees (as a joint sponsor), a regulator and/or a court of law.
Once the expected future benefit is determined, the sponsor compares this amount to the pension asset. If the sponsor’s expected future benefit is greater than the pension asset, the full amount of the pension asset is recorded on the sponsor’s statement of financial position.
On the other hand, if the sponsor’s expected future benefit is less than the pension asset, a valuation allowance is required. A valuation allowance simply reduces the pension asset on the statement of financial position to set it equal to the expected future benefit (this is the asset ceiling). Valuation allowances can increase or decrease in future years, depending on the updated balance of the pension asset and changes in the sponsor’s expected future benefits from the two sources. All changes in valuation allowances are recorded in pension expense.