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Subject 1. Pension Plans PDF Download
A pension plan provides benefits to retirees for services provided during employment. A pension fund is often used as an intermediary to satisfy the employer's pension obligations. Pension fund assets need to be invested to meet the needs of the retirees.
A plan is said to be funded when the employer makes contributions to a trust. In the US, pension plans are virtually always funded because of the requirements of the ERISA, tax deductibility of the employer's contribution, and the tax-exempt status of earnings on plan investments.
Sources of pension plan funding:
- Employer contributions.
- Pension fund earnings.
- Employee contributions: If the plan is contributory, employees are either required to contribute or voluntarily contribute to the plan. If the plan is noncontributory, employees cannot make any contributions to the plan.
There are two types of pension plans, defined-benefit plans and defined-contribution plans.
Defined Contribution Plans
In a defined contribution plan, the employer agrees to contribute a certain sum each period based on a formula. This formula may consider such factors as age, length of employee service, employer's profits, and compensation level. Only the employer's contribution is defined; no promise is made regarding the ultimate benefits paid out to the employees.
- The employer deposits an agreed upon amount into an employee-directed investment fund.
- The employee generally has "ownership" of the portfolio after some vesting period.
- The plan accumulates assets, and the employee bears all risks of the pension fund performance.
- The plan makes distributions to the employee when he/she retires.
Accounting for Defined Contribution Plans
The accounting for a defined contribution plan is straightforward. The employer's responsibility is simply to make a contribution each year based on the formula established in the plan. If contribution made is less than pension expense, the employer accrues a liability. If contribution is more than pension expense, the employer accrues an asset.
- Debits pension expense for the amount of the required contribution.
- Credits cash for the amount paid.
- Credits a liability account for underpayments or debits a prepaid asset account for overpayments.
- Description of the plan, employee groups covered, basis for determining contributions, and information affecting the comparability of information for all periods presented.
- Amount of cost (pension expense) recognized during the period.
Defined Benefit Plans
Please refer to the next two subjects.
International Standards Applicable to Pension Plans
The basic principle of IAS 19, Employee Benefits, is that the cost of providing employee benefits should be recognized in the period in which the benefit is earned by the employee, rather than when it is paid or payable. Refer to page 139 of the required reading for some significant differences.
User Contributed Comments 2
|TreasureH||Pension expense is tax deductable using accrual accounting no matter funded or not?|
|davidt876||yes. it's an expense.|
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