Have you ever wonder how companies figure out how much they owe people in pensions? There’s a number they use called Accumulated Benefit Obligation, or ABO for short.
Put simply, it’s what a company would have to pay if they shut the pension plan down today.
It only looks at what you’ve already earned, using your current salary, with no guessing about future raises or promotions
ABO is used in pension accounting to give companies a concrete figure of what it would owe employees if its pension plan were shut down today. That said, this number doesn’t depend on projections, nor assumptions about future raises. Rather, it solely focuses on commitments based on work already done.
Many champion it as an effective way to measure pension liabilities. However, it should be noted that others dismiss this and say it does not fully reflect reality — given that some employees will earn more as time goes on.
Regardless, ABO is widely used in financial reporting and is a key metric for understanding pension obligations.
How ABO is Calculated
ABO is simple: it measures the value of pension benefits employees have earned so far, using their current salaries. So, if a company closed its pension plan immediately, this is the amount it would need to pay.
Both vested and non-vested benefits are included. Vested benefits are locked in, meaning employees get them no matter what. Non-vested benefits might require an employee to stay longer to qualify, but they are still counted because they represent compensation for past work.
The limitation of ABO is that it does not account for salary increases. If someone is due for a raise next year, it does not matter, as ABO only looks at current numbers.
This is why ABO usually ends up lower than another approach, called projected benefit obligation (PBO).
How is PBO different?
Unlike ABO, PBO tries to estimate future costs by factoring in salary growth. Whether that is a strength or a weakness depends on how you look at it.
ABO vs. PBO: A Side-by-Side Comparison
Let’s look at how these two important approaches differ:
ABO
- Uses current salaries
- Only includes benefits earned so far
- Does not assume future pay increases
- Typically shows a lower liability
PBO
- Accounts for expected salary increases
- Estimates future pension obligations
- Provides a broader, but more uncertain, view
- Usually results in a higher liability
Some argue that ABO is more reliable because it does not fluctuate with salary projections. Others believe it underestimates the real cost of pensions, since wages tend to rise over time.
Why Companies Track ABO
ABO is not just a theoretical number. It has real financial consequences.
If a company runs into financial trouble or considers restructuring its pension plan, ABO helps determine what would be owed immediately. That can influence business decisions, especially when cash flow is tight.
Investors and analysts also look at ABO. If a company’s pension plan is underfunded, that can be a red flag. If plan assets exceed ABO, it signals financial stability. Either way, these figures play a role in how a company is perceived.