Information pertaining to a company’s pension obligation can be found in three of the financial statements: the income statement, other comprehensive income, and the balance sheet.

The notes and disclosures to the financial statements also contains a lot of useful information that helps to understand what the company is responsible for paying to employees in the future.

Starting with the information presented on the income statement:

This is actually going to be the least informative of all the financial statements.

In the operating results section we will find the current periods service costs.

This is the amount that has been paid out two retired employees during the reporting period.

It will also contain some net interest income which should be small and not very significant.

The service costs or not helpful other then getting a sense of how much the service costs are going to take away from operating income in future periods. All future. So all future should be a little bit higher than the current one but not much.

The other comprehensive income statement is a little bit more helpful in determining how much the company is responsible for paying. Actuarial gains and losses will show up here. So if a company has constantly over estimated the return on assets, or under estimated future pay increases, or used inappropriate discount rates, there will be actuarial losses which subtract from retained earnings. This will give us a sense if a company is being honest about pension obligations, or if they are using unrealistic numbers to benefit current earnings.

The balance sheet is perhaps the most useful in determining what a company has promised employees.

We can go straight to the liability section because most companies will have an underfunded status. However, rarely a company may run an overfunded status, in which case the pension obligation will show up as an asset.

Under the long term liabilities we can see the pension obligation number. This will be a net number, meaning it is the present value of the obligation minus the total plan assets.

This number will also contain other post retirement benefits such as healthcare contributions etc.

For enhanced understanding we go to the notes and disclosures section of the financial statements. This will show us the assumptions the company is using to calculate the present value of its pension obligation. You can see if the discount rates and growth of income look reasonable. You could even plug in your own numbers to see what it will do to the present value of the obligation. A higher discount rate will make the present value of the obligation go down. Higher interest rates will also mean assets could grow more than the current assumed rate of growth. Of course too high of interest rates could signal and inflationary environment which would mean both bonds and stocks can decline which would cause all kinds of problems for pension plans.

As with any fundamental analysis, the analysis is subjective rather than objective. One must use judgement when assessing strength or weakness based on financial statements, but a good rule of thumb is higher obligations are obviously sign of weakness.