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Accumulated Benefit Obligation – Definition

Accumulated Benefit Obligation Definition

An Accumulated Benefit Obligation (ABO) is an estimate of the present value of retirement benefits or pensions that an employee is entitled to when current compensation levels are used. ABO is used when a retirement or pension plan is to be terminated or when an employee stops working for the organization.

The accumulated benefit obligation is estimated solely on the current compensation levels without taking into account any future increase that might likely occur. When used for a company, ABO is the amount of pension (retirement) plan liability of the company at a certain time.

A Little More on What is an Accumulated Benefit Obligation

An employee who is under a pension scheme and is about to retire or terminate their appointment with a company is entitled to the accumulated benefit obligation (ABO). ABO is the present value of benefits paid to employees, it is estimated based on pension obligation and current compensation level at the time.

ABO is also determined by interest expenses, cost of services and other factors prevalent in the company as at the time of estimation. ABO however does not account for future increases, the value of ABO and planned asset is compared at the time of valuation. In cases where the ABO does not accurately finance the planned asset or if the planned assets exceed the ABO, the pension plan can be re-selected.

Example of the Accumulated Benefit Obligation

An accumulated Benefit Obligation (ABO) measures the liability of a company’s pension plan, with the belief that the plan will terminate immediately. ABO is one of the ways to calculate pension plan liabilities in a company, VBO and PCO are other measures. An example of ABO is seen in a company whose financial report for the year 2016 gives a total amount of $22.1 billion of domestic pension plans. If the total domestic pension program is $ 17.8 billion, the difference is $ 4.3 billion which is estimated as long-term liabilities and part of accumulated pension.

References for Accumulated Benefit Obligation

Academic Research on Accumulated Benefit Obligation

The liabilities and risks of state-sponsored pension plans, Novy-Marx, R., & Rauh, J. D. (2009). Journal of Economic Perspectives, 23(4), 191-210.

Relative measurement errors among alternative pension asset and liability measures, Barth, M. E. (1991). Accounting Review, 433-463.

Discounting state and local pension liabilities, Brown, J. R., & Wilcox, D. W. (2009). American Economic Review, 99(2), 538-42.

Valuation implications of reliability differences: the case of nonpension postretirement obligations, Byeonghee (Ben) Choi, Collins, D. W., & Johnson, W. B. (1997). Accounting Review, 351-383.

Guaranteeing defined contribution pensions: the option to buy back a defined benefit promise, Lachance, M. E., Mitchell, O. S., & Smetters, K. (2003). Journal of Risk and Insurance, 70(1), 1-16.

The effect of pension accounting on corporate pension asset allocation, Amir, E., Guan, Y., & Oswald, D. (2010). Review of accounting studies, 15(2), 345-366.

Did pension plan accounting contribute to a stock market bubble?, Coronado, J. L., & Sharpe, S. A. (2003). Brookings Papers on Economic Activity, 2003(1), 323-371.

Pension funds and financial innovation, Bodie, Z. (1989). National Bureau of Economic Research.

The impact of pension freezes on firm value, Rubin, J. (2007). Wharton Research Scholars Journal, 39.

 

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