Past service cost definition
/What is Past Service Cost?
Past service cost is the change in the present value of defined benefit obligations caused by employee service in prior periods. This cost arises from changes in post-employment benefits or other long-term employee benefits. The change in this cost may either be positive or negative. In short, if an employer elects to either increase or decrease the benefits being paid from its retirement plan that are associated with the past service of employees, then this will trigger a change in its pension obligation.
Example of Past Service Cost
Suppose a company, Square Designs, has a defined benefit pension plan for its employees. In 2025, the company decides to amend the plan to increase the retirement benefits by 10% for all employees, including for the years they have already worked. This amendment immediately increases the present value of the pension obligations because it retroactively enhances the benefits employees have earned for their past service.
For instance, if the present value of the defined benefit obligation was $5 million before the amendment, and the increase in benefits raises this obligation by $500,000, the $500,000 represents the past service cost. This cost must be recognized immediately in the company’s financial statements, impacting the pension expense for the year.
This example illustrates how past service cost reflects the financial impact of retroactive plan amendments on a company’s pension obligations.
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FAQs
How does past service cost differ from actuarial gains and losses?
Past service cost arises from amendments to a benefit plan that change benefits attributable to employee service already rendered, reflecting a deliberate plan design decision by the employer. Actuarial gains and losses result from changes in actuarial assumptions or from differences between expected and actual experience, such as employee turnover or investment returns. Accordingly, past service cost is driven by management action, while actuarial gains and losses arise from estimation uncertainty and experience variability.