CFA Level I Exam · Topics in Long-Term Liabilities and Equity

Pensions and Defined Benefit Plans for CFA Level I

Updated 7 October 2026 · Fact-checked

A defined contribution plan fixes what the employer pays in, and the employee bears the investment risk. A defined benefit plan promises a future benefit, and the employer bears the risk. Funded status equals plan assets minus the projected benefit obligation. IFRS pension cost is service cost plus net interest, with remeasurements in OCI.

Understand Pensions and Defined Benefit Plans

A pension plan is a promise to pay employees after they retire. The two main designs split risk differently.

In a defined contribution (DC) plan, the employer pays a set amount into an account for each employee. The employee's retirement income depends on how those investments perform. The employer's expense is simply the contribution for the period. There is no pension obligation on the employer's balance sheet beyond any unpaid contribution.

In a defined benefit (DB) plan, the employer promises a specific benefit, often based on salary and years of service. The employer must fund it and carries the investment and longevity risk. This is where the accounting gets harder. The projected benefit obligation (PBO) is the present value of benefits earned so far, using projected future salaries. IFRS calls it the defined benefit obligation. Plan assets are held in a separate fund and measured at fair value. Funded status = fair value of plan assets − PBO. A negative figure is a net pension liability. A positive figure is a net pension asset. Both IFRS and US GAAP put the funded status on the balance sheet. IFRS limits a net asset to the asset ceiling.

The PBO grows each year from current service cost (benefits earned this year), interest cost (discount rate × beginning PBO), past service cost from plan amendments, and actuarial losses. Benefits paid reduce it. Plan assets grow with the actual return and employer contributions, and fall with benefits paid.

IFRS and US GAAP differ in what reaches profit or loss. Under IFRS, profit or loss gets service cost (current and past) and net interest (discount rate × net pension liability or asset). Remeasurements go to other comprehensive income (OCI) and are never reclassified to profit or loss. Remeasurements are actuarial gains and losses, plus the actual return on plan assets minus the interest income on plan assets. Under US GAAP, profit or loss gets service cost, interest cost, the expected return on plan assets, and amortization of prior service cost and of actuarial gains and losses. Differences between actual and expected return, and actuarial gains and losses, go to OCI first and are amortized into profit or loss later.

Assumptions matter. A higher discount rate lowers the PBO and the service cost. Under US GAAP, a higher expected return on assets lowers pension expense, so analysts watch it as an earnings-management lever. Under IFRS, the expected return is not used in expense, because assets earn the discount rate.

Key formulas to remember

Funded status: Funded status = Fair value of plan assets − PBO; Negative means a net pension liability. Positive means a net asset, subject to the asset ceiling under IFRS.
Ending PBO: Ending PBO = Beginning PBO + Current service cost + Interest cost + Past service cost + Actuarial losses (− gains) − Benefits paid; Interest cost = discount rate × beginning PBO.
Ending plan assets: Ending assets = Beginning assets + Actual return + Employer contributions − Benefits paid; Employee contributions, if any, are also added.
IFRS pension cost in profit or loss: Service cost (current + past) + Net interest expense; Net interest = discount rate × beginning net pension liability (or minus the same for a net asset).
IFRS remeasurements (OCI): Actuarial gains/losses + (Actual return on assets − Discount rate × beginning plan assets); Stays in OCI and is not recycled to profit or loss.
US GAAP periodic pension cost: Service cost + Interest cost − Expected return on plan assets + Amortization of prior service cost + Amortization of actuarial losses (− gains); Expected return = expected rate × beginning plan assets. Actual-minus-expected return goes to OCI first.
DC plan expense: Expense = Employer contribution for the period; No PBO or plan assets on the employer's books.

How to solve Pensions and Defined Benefit Plans questions

Use this order for any pension question. It works for a calculation or a conceptual item.

1Identify the plan type. If it is DC, expense equals the contribution and you are done.
2Identify the reporting framework: IFRS or US GAAP. If the question does not say US GAAP, assume IFRS.
3Compute the beginning funded status (assets − PBO) and note whether it is a net liability or a net asset.
4Sort each item into its bucket: profit or loss, OCI, or balance-sheet-only movements such as contributions and benefits paid.
5Under IFRS, compute service cost plus discount rate × beginning net liability. Under US GAAP, compute service cost + interest cost − expected return + amortizations.
6If asked about the balance sheet, roll the PBO and plan assets forward with the formulas and subtract to get ending funded status.
7If asked about assumptions, trace the direction: discount rate affects PBO and interest. Expected return affects US GAAP expense only.
8Check the sign and the label, since cost versus income and liability versus asset are common traps.

Quickest way: Bucket-and-multiply shortcut

When to use it: Use it for single-answer pension expense questions where you have about 90 seconds.

Write the framework (IFRS or US GAAP) at the top of your scratch paper.
IFRS: cost = service cost + past service cost + rate × (beginning PBO − beginning assets). Ignore actual return, since it goes to OCI.
US GAAP: cost = service cost + rate × PBO − expected rate × assets + prior service amortization.
Only two multiplications are needed, so no TVM keys are required. On the BA II Plus or HP 12C, just use the multiply and add functions.
Look at the three options. Remove the one that omits a component and the one that adds the expected return instead of subtracting it.

Common mistakes in Pensions and Defined Benefit Plans

Using the expected or actual return on assets to compute IFRS pension expense.
US GAAP uses the expected return, and candidates carry that habit over.
Fix: Under IFRS, assets earn the discount rate in net interest. The gap between actual return and that interest goes to OCI.
Putting IFRS remeasurements through profit or loss later.
US GAAP amortizes OCI amounts into profit or loss, so candidates assume IFRS does too.
Fix: Under IFRS, remeasurements stay in OCI and are never reclassified to profit or loss. They may be transferred within equity.
Adding employer contributions and benefits paid to pension expense.
They change the funded status, so they seem like costs.
Fix: Contributions and benefits paid move the PBO and assets only. They are not expenses.
Treating a DC plan like a DB plan and looking for a PBO.
Both are called pension plans.
Fix: For DC, expense equals the employer's contribution and the employee bears the investment risk.
Applying the discount rate to the PBO instead of the net liability under IFRS.
Candidates remember interest cost on the PBO from US GAAP.
Fix: IFRS net interest is discount rate × (PBO − plan assets). Interest cost on the PBO is only for US GAAP and the PBO roll-forward.
Getting the direction wrong on assumptions, such as saying a higher discount rate raises the PBO.
Candidates forget that the PBO is a present value.
Fix: A higher discount rate lowers the PBO and service cost. A higher expected return lowers US GAAP expense.

Worked examples

Example 1

Under IFRS, a plan has a beginning PBO of $500 million and beginning plan assets of $450 million. The discount rate is 6%. Current service cost is $40 million and past service cost from an amendment is $10 million. The actual return on plan assets was $30 million. What pension cost is recognized in profit or loss? A) $43 million B) $53 million C) $80 million

Show the solution

Beginning net pension liability = 500 − 450 = $50 million.
Net interest expense = 6% × 50 = $3 million.
Profit or loss cost = current service 40 + past service 10 + net interest 3 = $53 million.
The actual return only affects OCI. Interest income on assets is 6% × 450 = $27 million, so the remeasurement gain is 30 − 27 = $3 million in OCI.
Option A omits past service cost. Option C uses interest cost on the full PBO of $30 million (40 + 10 + 30).

Answer: B) $53 million

Example 2

Under US GAAP, a plan has a beginning PBO of $500 million, beginning plan assets of $450 million, a discount rate of 6% and an expected return on assets of 8%. Current service cost is $40 million and amortization of prior service cost is $5 million. There are no actuarial amortizations. What is periodic pension cost in profit or loss? A) $34 million B) $39 million C) $75 million

Show the solution

Interest cost = 6% × 500 = $30 million.
Expected return on assets = 8% × 450 = $36 million.
Periodic cost = service cost 40 + interest cost 30 − expected return 36 + amortization of prior service cost 5 = $39 million.
Option A leaves out the prior service cost amortization. Option C leaves out the expected return.

Answer: B) $39 million

Exam tips

Always check whether the stem says US GAAP. If not, use IFRS rules.
Memorize the IFRS split: service cost and net interest to profit or loss, remeasurements to OCI.
With three options, one usually omits a component and another mishandles the sign of expected return. Eliminate those first.
For analyst-adjustment questions, think about what the assumption does. A high expected return under US GAAP flatters earnings and is a quality-of-earnings flag.
Funded status questions only need assets minus PBO. Do not add anything else, such as OCI balances.

Practice questions from Topics in Long-Term Liabilities and Equity

Pensions and Defined Benefit Plans in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Pensions and Defined Benefit Plans: frequently asked questions

What is the difference between a defined benefit and a defined contribution plan?

In a DC plan the employer pays a fixed contribution and the employee bears the investment risk. In a DB plan the employer promises a specific benefit and bears the risk of funding it. DB plans create a pension obligation and plan assets that must be reported.

How is pension expense different under IFRS and US GAAP?

IFRS puts service cost and net interest in profit or loss, and sends remeasurements to OCI permanently. US GAAP puts service cost, interest cost, expected return on assets and amortizations in profit or loss. US GAAP amortizes OCI amounts into profit or loss over time.

How do I calculate the funded status of a pension plan?

Subtract the projected benefit obligation from the fair value of plan assets. A negative result is a net pension liability and a positive result is a net asset. IFRS limits a net asset to the asset ceiling.

Why do the discount rate and expected return matter to analysts?

A higher discount rate lowers the PBO and current service cost. Under US GAAP, a higher expected return reduces pension expense and raises reported earnings. Analysts therefore compare these assumptions across firms and check them against the actual returns.