Employers use a discount rate to compute the actuarial present value of benefits, pension ex- pense, and the obligation of the employer under the pension plan. The choice of the discount rate can have a great effect on measures of pension cost and benefit obligations. Assumptions regard- ing discount rates must be made carefully in order to ensure that differences in pension plans are properly reflected in the annual reports of companies sponsoring such plans. Identify factors employers should consider when choosing the discount rate to be used in ac- counting for pension plans of the enterprise.

 

Answer:

Assumed discount rates are used in measurements of the projected, accumulated and vested bene- fit obligations and the service and interest cost components of net periodic pension cost. The as- sumed discount rate should reflect the rate at which pension obligations could be settled if suffi- cient funds were invested at that rate. Actuarial present value considers not only the time value of money, but also factors that affect the probability of payment, such as life expectancy, turnover, and disability. An estimate of the discount rate should include consideration of the rates implicit in the current prices of annuity contracts that could be used to effect settlement of the obligation. Information on available annuity rates currently published by the Pension Benefit Guaranty Corporation represents one source of rates on annuity contracts. Employers also should look at rates of return on high-quality fixed-income investments currently available and expected to be available during the period to maturity of the pension benefits. Consideration also should be giv- en to the average age of employees. The discount rate for a plan covering mainly retirees might reflect a portfolio of investments with shorter maturities than those of a plan covering a younger workforce. In this regard, it should be noted that a relatively small change in the discount rate can have a rather dramatic effect on pension liabilities.