Accounting for pensions involves the use of special terminology. Mastery of this terminology is essential both to an understanding of problem requirements and to the ability to respond correctly to theory questions.
There are some key points covered are as follows:
1) The difference between a defined contribution pension plan and a defined benefit pension plan and the resulting accounting and reporting differences between these two types of plans:
2) The bookkeeping entries made to record an employer's pension expense and the funding of pension cost.
3) The benefits-years-of-service approach
4) The calculation and reporting of the net pension asset/liability for employers who sponsor defined benefit pension plans
5) The five elements which, if they all exist, an employer sponsoring a defined benefit pension plan must evaluate for inclusion in its pension expense each year. These factors are
(a) service cost
(b) interest cost
(c) actual return on plan assets
(d) amortization of unrecognized prior service cost
(e) gain or loss
6) The required disclosures in the financial statements of employers who sponsor pension plans
Employer Sponsor's VS. Plan's Accounting and Reporting
a. In order to understand the accounting and reporting requirements for pension plans, you must keep in mind that there are two accounting entities involved: the employers sponsor of the plan, and the pension plan which is usually under the control of a pension trestee.
1) The employer sponsor reports Pension Cost (Pension Expense) in its income statement. In its balance sheet it usually reports a net Pension Asset/ Liability representing the difference between the Projected Benefit Obligation and Plan assets; both of the latter accounts, are under the control of the pension trustee. As discussed later, another entry may be required to accumulated other comprehensive income to report the funding status of the plan
b. A separate accounting entity, the pension plan, maintains the following accounts: Projected Benefit Obligation, Accumulated Benefit Obligation (for reporting purposes only), Vested Benefits (for reporting purposes only), and Plan Assets.The pension plan pays benefits to the retired employees
c. The diagram below shows the relationship of the entities involved in a pension plan, the accounts usually used by each, and the flow of cash.
Defined contribution pension plans
Defined contribution plans promise defined periodic contributions to a pension fund, without further commitment regarding benefit amounts at retirement
When employees make contributions to the plan in addition to employer contributions, its called a contributory plan
For defined contribution plans, the employer simply records pension expense equal to the cash contribution
Defined benefit pension plans
Defined benefit plans promise fixed retirement benefits defined by a designated formula
Uncertainties complicate determining how much to set aside each year to ensure that sufficient funds are available to provide promised benefits
A pension formula typically defines retirement pay based on the employee's (a) years of service, (b) annual compensation, and sometimes (c) age
Pension gains and losses occur when the pension obligation is lower or higher than expected
Pension gains and losses occur when the return on plan assets is higher or lower than expected
The key elements of a defined benefit pension plan are:
1. The employer's obligation to pay retirement benefits in the future
2. The plan assets set aside by the employer from which to pay the retirement benefits in the future
3. The periodic expense of having a pension plan
Components of pension expense
+ Service cost ascribed to employee service during the period
+ Interest accrued on the pension liability
- Return on the plan assets
+ Amortized portion of : Prior service cost attributed to employee service before an amendment to the
pension plan
+/- Losses or (gains) from revisions in the pension liability or from investing plan assets
= Pension expense
Accumulated benefit obligation
the accumulated benefit obligation (ABO) is an estimate of the discounted present value of the retirement benefits earned so far by employees, applying the plan's pension formula using existing compensation levels. when we look at a detailed calculation of the projected benefit obligation below, keep in mind that simply substituting the employee's existing compensation in the pension formula for her projected salary at retirement would give us the accumulated benefit obligation.
Projected benefit obligation
the pbo estimates retirement benefits by applying the pension formula using projected future compensation levels. The PBO is the most inclusive, and therefore the most conservative, measure of an employer's future payout. The PBO as of a certain date is equal to the actuarial present value of all benefits attributed by the pension benefit formula to employee services rendered prior to that date. The measurement date for benefit obligations and plan assets is generally the balance sheet date. The PBO is measured using assumptions about future as well as past and current salary levels. The PBO at the end of period equals the following:
+ Beginning PBO
+ Service cost
+ Interest cost
+ Prior service cost
- Prior service credit
- Benefits paid
+/- changes in the PBO resulting from (a)experience different from that assumed or (b) changes in assumptions
Ending PBO
No comments:
Post a Comment