Interest cost is one of the five components of pension expense. In simple terms, interest cost is going to be calculated by multiplying the discount rate used to compute the service cost by the beginning balance of the projected benefit obligation (PBO).
Interest cost will increase pension cost, similar to service cost.
The interest cost component is the increase in the PBO due to the passage of time (FASB ASC 715-30-35-8 and 9). The interest cost is calculated by applying the discount rate to the PBO at the beginning of the accounting period. Both the PBO and the assumed discount rate are provided by actuaries. The discount rate used to compute the PBO at the end of the period is the discount rate on high quality corporate bonds (i.e. Aa rated or higher) at the end of the period. No adjustment is made to the rate to reflect cat an average rate over some period of time.
If the general level of interest rates rises or declines, the assumed discount rate is changed at each year-end to reflect the rate in effect at that date. Changes in the discount rate during the year give rise to gains (when the rates increase) or losses (when the rates decline). (FASB ASC 715-30-35-43-45)« Back to Glossary Index