GASB 68: Pension Accounting for State and Local Governments
The adoption of GASB Statement No. 68, Accounting and Financial Reporting for Pensions (effective for fiscal years beginning after June 15, 2014), represented one of the most significant changes to governmental accounting in the past two decades. By requiring governments to recognize their net pension liability on the face of the balance sheet—rather than merely disclosing it in footnotes—GASB 68 transformed how bond analysts, taxpayers, and elected officials perceive government financial health. This article provides a comprehensive guide to the mechanics of GASB 68, including the determination of net pension liability, proportionate share calculations, pension expense components, and the critical role of actuarial assumptions.
GASB 68 Overview: From Implicit Obligation to Explicit Balance Sheet Recognition
Prior to GASB 68, most governmental entities recognized pension expenditures on a cash basis—recording the employer contribution required by statute or actuarial valuation each year. The underlying net pension liability (the difference between actuarial liabilities and plan assets) remained buried in footnote disclosures, invisible to casual financial statement readers. This approach masked the long-term obligations governments had implicitly accepted by promising defined-benefit pensions to employees.
GASB 68 fundamentally reoriented pension accounting toward the accrual model. The standard requires governments to:
- Recognize and measure the net pension liability on the balance sheet
- Measure pension expense using an actuarial approach that spreads gains and losses over time
- Report deferred inflows and outflows of resources related to pension activity
- Distinguish between single-employer, agent, and cost-sharing pension plans, each with different measurement and reporting requirements
The practical effect is profound. A government that previously reported a modest annual pension contribution now shows a potentially billion-dollar net pension liability on its balance sheet. This transparency has repercussions for credit ratings, borrowing costs, and electoral debate over government priorities.
Three Types of Pension Plans and Their Accounting Treatment
Single-Employer Plans
A single-employer pension plan is a defined-benefit plan that covers only the employees of one employer. Examples include pension plans for a city's fire and police departments or a county's general employees.
Measurement responsibility: The employer government is responsible for determining the net pension liability using a full actuarial valuation. The employer obtains an actuarial report prepared by an enrolled actuary, typically annually or biennially, that includes:
- The present value of future pension benefits (actuarial accrued liability)
- The fair value of plan assets
- The calculation of net pension liability
Accounting entry:
Dr. Net Pension Liability XXX
Cr. Deferred Outflow—Changes in Assumptions
or
Cr. Pension Expense (if current period) XXX
Reporting on the balance sheet: The net pension liability appears as a long-term liability (or current portion if a requirement to remeasure before year-end is met).
Agent Plans
An agent plan is a defined-benefit pension plan where the plan administrator is independent of the participating employers. The plan is funded by contributions from participating employers who share in the plan's assets and liabilities proportionately. However, unlike a cost-sharing plan, each employer is responsible for its own portion's solvency; if one employer's portion becomes underfunded, other employers are not exposed to cross-subsidization.
Common examples include:
- Statewide teacher retirement systems that are not agency plans but have multiple school districts participating
- County employee pension plans where both the county and municipalities participate
Measurement responsibility: Each participating employer measures the portion of the plan's net pension liability attributable to that employer. The plan sponsor or administrator typically provides actuarial information for each employer's proportionate share.
Accounting entry: Similar to single-employer plans, but the employer recognizes only its proportionate share:
Dr. Net Pension Liability (Employer's Share) XXX
Cr. Deferred Outflow—Changes in Assumptions XXX
Cost-Sharing Plans
A cost-sharing plan is a multiemployer defined-benefit pension plan where all participating employers contribute to and benefit from a pooled asset base. If the plan is underfunded, the burden is shared across all employers, not isolated to a single participant. Participating employers do not track their individual portions.
Examples:
- Statewide teacher retirement systems where contributions and benefits are mutualized
- County employees' retirement associations serving multiple municipalities
- State Police and Firemen's Retirement System covering multiple jurisdictions
Measurement responsibility: Under GASB 68, cost-sharing employers measure a total pension liability using the full actuarial liability of the plan, not just their proportionate share. However, the employer recognizes a "net pension liability" defined as the employer's proportionate share of the collective net pension liability.
The critical distinction: A cost-sharing employer recognizes a proportionate share of the plan's collective net pension liability, whereas a single-employer recognizes 100% of its own liability.
Accounting entry:
Dr. Net Pension Liability (Proportionate Share) XXX
Cr. Deferred Outflow—Changes in Assumptions XXX
Determining Proportionate Share in Cost-Sharing Plans
The proportionate share methodology is central to cost-sharing pension accounting. GASB 68 allows several methods to allocate the plan's collective net pension liability among participating employers:
1. Employers' Contributions Method (Most Common)
Under this approach, the employer's proportionate share equals the ratio of the employer's contributions to the plan during the measurement period to the total contributions of all employers during the same period.
Formula:
Proportionate Share = (Employer Contributions / Total Plan Contributions) ×
Collective Net Pension Liability
Example: A statewide teacher retirement system has a collective net pension liability of $50 billion. During fiscal year 20X1, total employer contributions were $5 billion. School District A contributed $25 million.
School District A's proportionate share:
($25,000,000 / $5,000,000,000) × $50,000,000,000 = $250,000,000
School District A recognizes a $250 million net pension liability on its balance sheet.
2. Employers' Payroll Method
Some plans allocate proportionate share based on the relationship of the employer's covered payroll to total covered payroll for all employers.
Formula:
Proportionate Share = (Employer Covered Payroll / Total Covered Payroll) ×
Collective Net Pension Liability
This method is less common than contributions-based allocation but may be used if the plan defines the employer's obligation by reference to payroll.
3. Actuarially Determined Method
In rare cases, an actuary may calculate each employer's separate actuarial accrued liability and allocate the collective net pension liability based on each employer's ratio of actuarial liabilities.
Method selection: The plan's actuarial valuation report typically specifies the allocation methodology. Employers using the plan should verify the method annually and ensure consistency from year to year for comparability.
Measuring the Net Pension Liability
The net pension liability is calculated as:
Net Pension Liability = Total Pension Liability − Fair Value of Plan Assets
Total Pension Liability (Actuarial Accrued Liability)
The total pension liability is the present value of all future pension benefits earned by employees to date. It reflects:
- Service cost — The cost of benefits earned in the current year
- Past service cost — The actuarial liability for benefits earned in prior years
- Interest cost — The increase in liability due to the passage of time, accrued at the discount rate
The total pension liability is calculated using:
- Actuarial valuation methods (typically the entry age normal cost method)
- Demographic assumptions (salary growth, turnover, retirement age, mortality)
- Economic assumptions (discount rate, inflation)
Fair Value of Plan Assets
The fair value of plan assets includes:
- Bonds, equities, and other investments held by the plan
- Receivables from employers and employees
- Less: payables and obligations of the plan
Plan assets are measured at fair value using market values as of the measurement date.
Discount Rate
The discount rate is critical to measuring the net pension liability. It reflects:
- For unfunded plans or plans with limited assets: The municipal bond rate (Bond Buyer 20-Bond Index) or a similar long-term municipal bond yield, representing the rate at which the government could issue long-term debt
- For well-funded plans: The expected long-term return on plan assets, reflecting the plan's asset allocation and expected investment performance
A lower discount rate increases the net pension liability; a higher rate decreases it. Changes in the discount rate assumption are the single largest driver of year-to-year pension liability volatility.
Example: A pension plan's total pension liability is $2 billion. Plan assets are $1.4 billion. The net pension liability is $600 million. If the discount rate assumption is lowered from 7.0% to 6.5%, the total pension liability might increase to $2.15 billion, pushing the net pension liability to $750 million. This $150 million increase is recorded as a change in actuarial assumptions and recognized as a deferred outflow or inflow of resources.
Pension Expense Components
GASB 68 requires governments to measure pension expense using an accrual approach that does not directly correspond to the employer contribution. Pension expense consists of:
1. Service Cost
Service cost is the actuarial present value of benefits earned by employees during the measurement period. It is measured using the same actuarial assumptions (mortality, turnover, retirement age, salary growth, discount rate) as the net pension liability.
Service cost is typically the largest component of pension expense and is recognized in the government's statement of revenues, expenses, and changes in fund balance or equivalent.
Journal entry:
Dr. Pension Expense—Service Cost XXX
Cr. Net Pension Liability XXX
2. Interest Cost
Interest cost is the increase in the total pension liability due to the passage of time. It is calculated as the total pension liability at the beginning of the measurement period multiplied by the discount rate.
Example: Total pension liability at beginning of year: $2,000,000,000 Discount rate: 7.0% Interest cost: $2,000,000,000 × 7.0% = $140,000,000
Journal entry:
Dr. Pension Expense—Interest Cost 140,000,000
Cr. Net Pension Liability 140,000,000
3. Benefit Payments and Contributions
When the plan pays benefits to retirees or receives employer contributions, the net pension liability is reduced. These are not expense items but direct reductions of the liability.
Journal entry (benefit payment):
Dr. Net Pension Liability XXX
Cr. Cash XXX
Journal entry (employer contribution):
Dr. Net Pension Liability XXX
Cr. Cash XXX
4. Earnings on Plan Investments
The difference between expected and actual earnings on plan assets is treated as a deferred inflow or outflow of resources and recognized in pension expense ratably over the expected remaining service lives of plan members.
If plan assets earned $100 million but expected earnings (based on the fair value of plan assets and the discount rate assumption) were $105 million, the difference of $5 million represents a loss. This loss is recorded as:
Immediate recognition:
Dr. Deferred Outflow—Difference in Expected/Actual Earnings 5,000,000
Cr. Net Pension Liability 5,000,000
The deferred outflow is then recognized in pension expense ratably over the expected remaining service lives of plan members (typically 5–10 years).
5. Changes in Actuarial Assumptions
When the discount rate, mortality table, salary growth assumption, or other demographic assumption changes, the resulting impact on the total pension liability is recognized as a deferred inflow or outflow of resources.
Example: If the discount rate decreases and the total pension liability increases by $200 million, the entry is:
Dr. Deferred Outflow—Change in Assumptions 200,000,000
Cr. Net Pension Liability 200,000,000
This deferred outflow is recognized in pension expense over the expected remaining service lives of plan members.
6. Deferred Inflows and Outflows Recognition Schedule
GASB 68 requires governments to present a schedule of deferred inflows and outflows of resources related to pensions, with the remaining recognition periods. Typical presentation:
| Item | Balance | Years Remaining |
|---|---|---|
| Difference in expected/actual returns | $50,000,000 | 7 |
| Change in assumptions (discount rate decrease) | 200,000,000 | 8 |
| Change in proportionate share | (10,000,000) | 5 |
| Total Deferred Outflows | $240,000,000 | — |
| Deferred Inflows (gains) | (25,000,000) | 6 |
Complete Pension Expense Measurement Example
A city maintains a single-employer pension plan for its general employees. The following information is available for fiscal year 20X1:
| Item | Amount |
|---|---|
| Measurements at July 1, 20X0 | |
| Total pension liability | $850,000,000 |
| Fair value of plan assets | $425,000,000 |
| Net pension liability | $425,000,000 |
| Measurements at July 1, 20X1 | |
| Total pension liability | $920,000,000 |
| Fair value of plan assets | $460,000,000 |
| Net pension liability | $460,000,000 |
| Fiscal Year 20X1 Activity | |
| Service cost (actuarial) | $45,000,000 |
| Benefits paid to retirees | (38,000,000) |
| Employer contribution to plan | (27,000,000) |
| Expected return on assets (7.0% × $425M) | (29,750,000) |
| Actual return on assets | (32,100,000) |
| Difference (gain from higher returns) | 2,350,000 |
| Discount rate decreased; impact on TPL | 35,000,000 |
| Deferred Outflows at July 1, 20X1 | |
| Prior changes in assumptions | 120,000,000 |
| Prior differences in returns | 18,000,000 |
| Recognition of Deferred Outflows (8-year average remaining service life) | |
| Deferred outflows recognized this year | $17,250,000 |
Pension Expense Calculation:
| Component | Amount |
|---|---|
| Service cost | $45,000,000 |
| Interest cost ($850M × 7.0%) | 59,500,000 |
| Expected return on assets (deducted) | (29,750,000) |
| Recognition of deferred gains in returns | (2,350,000) |
| Recognition of deferred outflows for assumption changes | (15,000,000) |
| Total Pension Expense | $57,400,000 |
Key observation: The pension expense of $57.4 million is significantly different from the employer contribution of $27 million. The difference ($30.4 million) is the net increase in the net pension liability for the year, driven by service cost and interest exceeding contributions and investment returns.
Journal entries for fiscal year 20X1:
Dr. Pension Expense 57,400,000
Cr. Net Pension Liability 57,400,000
To record pension expense for fiscal year 20X1.
Dr. Net Pension Liability 27,000,000
Cr. Cash 27,000,000
To record employer contribution to pension plan.
Dr. Net Pension Liability 38,000,000
Cr. Cash 38,000,000
To record benefit payments from plan.
Dr. Deferred Outflow—Assumption Changes 35,000,000
Cr. Net Pension Liability 35,000,000
To record increase in TPL due to discount rate decrease.
Schedule of Changes in Net Pension Liability
Governments are required to present a Schedule of Changes in Net Pension Liability, reconciling the beginning and ending balances. A representative example:
| Item | Amount |
|---|---|
| Balance at beginning of fiscal year | $425,000,000 |
| Service cost | 45,000,000 |
| Interest cost | 59,500,000 |
| Change in assumptions | 35,000,000 |
| Difference in expected/actual returns | (2,350,000) |
| Benefit payments | (38,000,000) |
| Employer contributions | (27,000,000) |
| Change in proportionate share (if applicable) | — |
| Balance at end of fiscal year | $497,150,000 |
Note: This simplified schedule assumes a single-employer plan. Cost-sharing plans require an additional line item for "changes in proportionate share."
Actuarial Assumptions: The Critical Drivers
The actuarial assumptions underlying pension liability calculations are the most judgmental and volatile inputs to GASB 68 accounting. Three assumptions warrant particular attention:
1. Discount Rate (Assumed Long-Term Return)
The discount rate is the lynchpin of pension accounting. It reflects the expected long-term return on plan assets. Common assumptions:
- 7.0% to 7.5% for well-diversified public sector pension plans
- 5.0% to 6.0% for plans with limited growth assets or recent experience of lower returns
- 4.0% to 4.5% (municipal bond rate) for severely underfunded plans
Impact of 0.5% change: A $1 billion total pension liability changes by approximately 5–7% per 0.5% change in the discount rate, depending on the plan's maturity. A shift from 7.0% to 6.5% increases the liability by ~$50–70 million.
2. Mortality Assumptions
Mortality assumptions reflect the expected lifetime of plan members. The actuary selects from standard mortality tables published by the Society of Actuaries (SOA) or tailors assumptions to plan experience.
Common tables:
- RP-2014 Mortality Table (now aging to RP-2020)
- SOA Pub-2010 Mortality Table (specifically for public employees)
Impact of changes: If mortality assumptions improve (people live longer), the total pension liability increases because the plan must pay benefits for more years. Conversely, if assumptions improve (because plan members' actual life expectancy decreases relative to assumptions), the liability decreases.
3. Salary Growth
Salary growth assumptions reflect expected increases in covered payroll, driven by merit increases, cost-of-living adjustments, and promotions. Typical assumptions:
- 2.5% to 3.0% annual salary growth for general employees
- 2.0% to 2.5% for public safety (fire, police)
Impact: Higher salary growth assumptions increase the actuarial accrued liability because future retirement benefits are calculated on estimated final salaries.
Actuarial Valuation Methods: Entry Age Normal Cost Method
The entry age normal cost method is the predominant actuarial method for calculating the actuarial accrued liability and service cost. The method conceptually assumes:
- The plan was established at the valuation date.
- Each participant entered the plan at the "entry age" (the earliest age at which they could have been covered by the plan).
- Normal cost is the annual contribution necessary to fully fund benefits if such contributions had been made continuously from entry age.
- The actuarial accrued liability represents the present value of all benefits attributed to service to date.
Calculation of service cost: Service cost is the entry age normal cost attributable to the current year. For a participant with salary of $60,000 and entry age normal cost rate of 12% of salary, the current year service cost is $7,200.
Calculation of total pension liability: The total pension liability equals the sum of actuarial accrued liabilities for all participants, calculated as the present value of all benefits earned to date under the entry age normal method.
GASB 82 Update: Payroll Measurement
GASB Statement No. 82, Pension Obligations (effective for fiscal years beginning after June 15, 2019), refined GASB 68 by specifying that payroll used to calculate the proportionate share of cost-sharing plans is the payroll for which contributions are made to the plan, not total payroll for all purposes.
This clarification prevents governments from using payroll not subject to pension contributions (such as certain temporary or administrative payroll) in calculating proportionate share, ensuring consistency with the employer's pension obligation.
Common Pitfalls and Best Practices
Pitfall 1: Confusing pension expense with pension contribution. The employer contribution and pension expense rarely match. A government may contribute $50 million while recognizing $75 million in pension expense.
Remedy: Establish clear reconciliation schedules. Use separate accounts for "Pension Contribution" and "Pension Expense."
Pitfall 2: Failing to recognize deferred inflows and outflows. Some finance teams focus on the change in net pension liability but neglect to track and systematically recognize deferred gains and losses over time.
Remedy: Maintain a comprehensive deferred inflows/outflows schedule with remaining recognition periods. Perform monthly or quarterly calculations of current-year recognition.
Pitfall 3: Misunderstanding the impact of discount rate changes. A 0.5% change in the discount rate is not merely an accounting adjustment; it reflects updated expectations about plan asset returns and significantly impacts the liability.
Remedy: Monitor discount rate assumptions annually. When assumptions change, communicate to leadership and the public the reasoning and financial impact.
Pitfall 4: Misclassifying deferred amounts. Inflows (gains) and outflows (losses) require careful tracking to ensure recognition in the correct period and statement of net position.
Remedy: Use a deferred amounts ledger with individual tracking by source and remaining recognition period.
Conclusion
GASB 68 has made pension liabilities transparent on government balance sheets, creating both accountability and scrutiny. Governments must maintain rigorous processes for:
- Actuarial valuation oversight — Reviewing and validating actuarial assumptions annually
- Proportionate share calculation — For cost-sharing plans, verifying contribution and payroll metrics
- Deferred amount tracking — Systematically recognizing gains, losses, and assumption changes
- Expense measurement — Distinguishing pension expense from employer contributions and ensuring accurate recognition
With disciplined processes and clear communication, governments can use GASB 68 as a tool to align pension funding strategies with long-term financial capacity.
AI Disclosure: This article was prepared with AI-assisted research by DWU Consulting. It is provided for informational purposes only and does not constitute legal, financial, or investment advice. All data should be independently verified before use in any official capacity.