What's the difference between a pension curtailment and a settlement, and how are gains/losses recognized?

Great real-world scenario — this involves BOTH a curtailment and a settlement, which are distinct events with different accounting treatments.

Definitions

Vanguard Materials Analysis:

• Closing the Detroit plant and laying off 600 → Curtailment (eliminates future service for those employees)
• Purchasing annuities for 200 retirees → Settlement (transfers obligation to insurer)

Curtailment Accounting

A curtailment triggers:

1. Immediate recognition of any prior service cost in AOCI related to the affected employees
2. A curtailment gain or loss based on the change in PBO

Suppose the PBO decreases by $25M because 600 employees will no longer accrue benefits:

• Unrecognized prior service cost related to these employees: $8M in AOCI
• Curtailment gain = $25M PBO reduction - $8M prior service cost write-off = $17M net gain

However, the rules require:

• Curtailment losses are recognized when probable
• Curtailment gains are recognized when employees terminate or the plan amendment is adopted

Settlement Accounting

When Vanguard buys $60M of annuities to settle $58M of PBO (retirees):

• Settlement loss = $60M cost - $58M PBO settled = $2M loss
• Additionally, a proportionate share of any accumulated actuarial gains/losses in AOCI related to the settled portion must be recognized immediately

If total accumulated actuarial loss in AOCI is $30M and the settlement covers 15% of total PBO:

• Proportionate AOCI recognition = 15% x $30M = $4.5M loss reclassified from AOCI to income

Combined Income Statement Impact:

Exam tip: Don't confuse the two — a curtailment changes the promise (fewer future benefits), while a settlement extinguishes the obligation. Both can happen simultaneously but require separate calculations.

For more pension accounting practice, check our CFA Level II question bank.