Pension Expenses


Statement of Activities (Income Statement)


Government Wide Statements


What Is a Statement of Activities? (Income Statement)


If you know this stuff skip to "Pension Expense" below. This is my way of explaining what an "Income Statement" is. Revenue is a way of obtaining resources in a way you don't have to pay back.


  • Expense is a way of "using up" resources in a way that you won't get them back directly.
  • "Bottom Line" (Profit or Loss) is the difference. If your Revenue is more than your Expense you "made a profit" - or "Net Revenue". If it's less - you incurred a "Loss". (Note 1)


If you have more Revenue than Expense - the expense represents a "using up" of resources that you won't get back directly - but since you obtained more resources than you "lost" then you have replaced the resources - and then some. If you run a grocery store and sell an apple that cost you 20 cents for 35 cents, you won't get that apple back, but you can buy another apple and have 15 cents left over.


Unlike Balance Sheets that are for a specific point-in-time, usually the end of the fiscal (financial) year or quarter, Income Statements are for a PERIOD of time. Income Statements report Revenue and Expense in the period between Balance Sheets.


Pension Expense


The "Original Sin" of GASB's old rules (at least in a financial reporting sense) was that they allowed governments to report the pension expenses that created unfunded pension debt owed to their Pension Funds as they paid that debt. As I've said - that's absurd. Payments of debt eliminate debt - they don't create it.


The most powerful government financial reporting change in GASB68 is that the pension expenses that create unfunded pension debt will now be reported "roughly" as they are creating that debt - not when the debt is paid. And now that those unfunded pension expenses are to be reported that makes it possible to list those unfunded pensions as a bona fide debt. The expense must come before the debt can be reported - not after.


Calculation of Annual Pension Expense


The elements of Pension Expense


I need to repeat a part of the previous page. Each year's change in the Net Pension Liability will be reported as that year's pension expense EXCEPT the change of three variables will be spread over a number of years. The amount of these changes not yet included in pension expenses are the Deferred Inflows (or) Outflows of Pension Resources reported on Government-wide Balance Sheets. They impact reported pension expenses like this:
Deferred Outflows of Pension Resources = Amounts that will increase pension expenses in future years
Deferred Inflows of Pension Resources = Deferred Inflows of Pension Resources


This shows how many years it will take to fully include each year's Deferred pension items in reported pension expense. The current year is the first of these years. I believe these Deferrals are reasonable and necessary - see Note 2 below.


Example of Calculation of Pension Expense


Let's say County XYZ is implementing GASB68 in its 2015 audited financial statements. These are the values for the three items described above. Assume the Actuary projects the average remaining number of years for the 100 current employees is 8 years, and obviously the number of years for the 100 current retirees is zero. Therefore the average remaining years of employment are 4 years.


To make this explanation less complex assume there were no Deferred Outflows or Inflows of Pension Resources at the beginning of the year. The Net Pension Liability at the end of 2014 was $500 million and the Net Pension Liability as of the end of 2015 was $600 million - $100 million more than last year's NPL.


1) Difference Assumed v. Actual Investment Profits


The Pension Fund earned $50 million more than its assumed return and therefore Net Pension Liability was reduced by $50 million. But in calculating annual pension expense this $50 million will be "spread over" 5 years so the reduction of the current year's pension expense will be only $10 million. The other $40 million will be spread over the following 4 years and will be reported as a "Deferred Inflow of Pension Resources" on the Statement of Net Assets (because deferred inflows will REDUCE pension expenses in future years).


2) Difference Expected v. Actual Experience


Let's assume retirees are living slightly longer than was expected - generally good news. But that increases the NPL because they will get more pensions than assumed. There could be dozens of these kinds of differences in expected and actual "experience" - but the specifics of what they were doesn't affect this calculation. As stated in the assumptioins above the average remaining number of years of employment is 4 years. Therefore this $4 million increase in NPL will be added into pension expense over 4 years - $1 million this year and $3 million over the next 3 years. Since this will INCREASE pension expenses in future years $3 million will be reported as a "Deferred Outflow of Pension Resources" on the "Balance Sheet".


3) Change in Assumptions


Assume the Retirement Board lowers its projected Cost of Living Adjustment Payments to retirees in the future and the Actuary figures this immediately lowered the NPL by $8 million. Therefore the 2015 pension expense will be $2 million lower than it would have been and there will be an additional $6 million "Deferred Inflow of Pension Resources" on the Balance Sheet.


Calculation of Pension Expense


The Net Pension Liability went up $100 million. Two numbers were SUBTRACTED - $10 million of $50 million actual investment profits above what was assumed and $2 million of the $8 million reduction in NPL the Actuary figures will result from lowering the assumed COLA payments to retirees in the future. Also - $1 million of the $4 million increase in NPL caused by retirees living longer was ADDED.


The result is $89 million of pension expenses that will be included in County XYZ's 2015 audited Statement of Activities (the "Income Statement" in government-wide statements). Incidentally - these values will appear in the County's Government-Wide Balance Sheet (Statement of Net Assets):


  • $600 million Net Pension Liability
  • Deferred Outflow of Pension Resources of $3 million (the difference caused by retirees living longer) that will increase pension expense $1 million in each of the next 3 years
  • Deferred Inflow of Pension Benefits of $46 million
    • $40 million in investment profits that will reduce pension expense $10 million in each of the next 4 years
    • $6 million reduction in NPL caused by lowering the assumption about future COLA payments that will reduce pension expense by $2 million in each of the next 3 years

Pension Expense Not Reported Separately in Income Statement


Unfortunately the format of the Government-Wide Statement of Activities (or) Statement of Changes in Net Position (the "Income Statement") doesn't provide a place to report annual Pension Expense. Total Expenses are reported - but not the individual components. However, it is disclosed in a footnote in the audited financial statements.



NOTE 1: Many people believe that because a government doesn't exist to "make a profit" then it doesn't need to earn more revenue than its expenses. This is a huge falacy. What happens if a County spends every dime of its local tax revenue on its expenses every year - and a bad recession hits that guts its tax collections? What happens is it's forced to lay off a whole bunch of people and maybe cut salaries of those that are left. And - assuming the County was operating efficiently (which of course may or may not be the case) then the County is going to have to cut services - perhaps drastically. But when a bad recession hits the need for all kinds of services for people in need is going to increase - not decrease. And wouldn't it be nice if a county had built up reserves to do things like repave roads - so it had a bunch of money it could spend to do that when local contractors and their employees didn't have enough work - could offer lower costs to the County - and help move money into the local economy during a recession?


Just like everyone else - counties should build up "reserves" in the good times so they can go through the inevitable bad times without having to slash staff and services. CAnd - it should slowly build up reserves so that it can replace Capital Assets like sewer pipes and roads decades after they were built but cost way - way more than they did originally. To do that - in the good times it must make "a profit" - although it isn't called that in government financial reports.


NOTE 2: These "Deferrals" are "Reasonable" and "Necessary". Many expenses happen the year they can be calculated. But some don't. A common example is "Depreciation" - say - of machinery. If a machine costs $10,000 and it's going to provide 5 years of service before it's junked, it's rational to report the expense of the purchase of that machine is $2000 a year in each of those 5 years. In fact it would distort the Income Statement and Balance Sheet if it weren't "expensed" that way. If the cost of $10,000 were "expensed" in the first year then there would be no value of that machine reported in the Balance Sheet, a $10,000 expense in the first year it's used, and no expense in the following 4 years. But that's very inaccurate way of reporting the value and expense of that machine.


The nature of some kinds of expenses make it proper to spread their expenses over a number of years because that's what is really happening financially. As stated on the previous page one of GASB's principles that underlies this aspect of GASB68 is the pension "transaction" is spread over an employees entire period of employment with a particular government. Part of the reason for this is that a very important aspect of pension finance is that today's values are ESTIMATES - and these estimates are ALWAYS WRONG. (See Actuarial Valuations are Estimates & They Are ALWAYS WRONG on the "Pension Fund Success - or Failure" page in the Pension Basics" section)


We can be absolutely certain that the assumed rate of investment profits will turn out to not what it should have been. Indeed all the assumptions about life spans, amounts of future pension payments, when employees will retire - all those estimates will turn out to not have been correct. And so adjustments to those assumptions must be made over time to keep things on track. (It's too bad that hasn't been done accurately over the past 2 decades - but that's another story - see the "Actuary Failure" section.)


But if one year we figure actual results were significantly different than we projected, or we make major changes in our assumptions it would seriously distort the nature of the pension expense if we included the entire change in the year we figure that out or make that assumption change. It makes more sense to spread those changes across the remaining average years of service for both active employees and retirees. That accomplishes two things:


  • It makes sure that the full pension expense for current employees and past employees are reported by the time they retire on average (assuming our assumptions and calculations are reasonbable approximations of reality - huge assumption!). This helps assure we are performing our "intergenerational duty" by not forcing the next generation to pay our past living expenses as well as theirs.
  • It prevents huge - chaotic year-to-year changes in expenses that would so confuse people that the "usability" of financial reports would be seriously damaged.