Ch 20 Flashcards
What are the 2 divisions for pension accounting
1 accounting for employer
2 accounting for the pension fund
Pension plan
Arrangement where employer provides benefits (payments)
To retired employees for services they provided in their
Working years
Pension fund/plan
1 Entity that receives contributions from employer,
2 administersThe pension assets
3 makes benefit payments to retired employees
When is a pension plan funded?
When employer makes payments to funding agency
Contributory pension plans
Employees bear part of cost of stated benefits or
Voluntarily make payments to increase their benefits
Non contributory pension plans
Employer bears entire cost
Qualified pension plans
Offer tax benefits
What are the tax benefits of qualified pension plans? 2
1 deductibility of employer’s contributions
2 tax free status of earnings from pension fund assets
What should a pension fund be considered in terms of an entity
As a separate legal and accounting entity
What are the 2 most common types of pension plans?
1 defined contribution plans
2 defined benefit plans
Defined contribution plan
Example of this kind of plan?
Employer agrees to contribute to a pension trust a certain
Sum, each period based on a formula
Ex. 401k plan
Defined contribution plan: what 4 possible factors are considered in the formula for contribution
1 age
2 length of employee service
3 employer’s profits
4 compensation level
What is the only thing defined in the defined contribution plan?
The amount of the employer’s contribution
What factors do the size of the pension benefits depend on? 3
1 amounts contributed
2 income accumulated in trust
3 treatment of forfeitures of funds caused by early
termination of employees
Independent 3rd party trustee
Assumes ownership of the pension assets and is
accountable for their investment and distribution
Defined benefit plan
Outlines benefits employees will receive when they retire
Defined benefit plan: how are benefits determined
As function of employee’s years of service and
compensation level in years approaching retirement
Who are the beneficiaries of the defined benefit trust?
2) who are the beneficiaries of the defined contribution trust?
Defined benefit trust: employers are beneficiaries
Defined contribution trust: employees are beneficiaries
What is the primary purpose of the defined benefit plan?
Safeguard and invest assets do there will be enough
To pay the employer’s obligation to employees
In form the defined benefit trust is a…
Separate entity
In substance, the defined trust assets and liabilities…
What does this mean?
Belong to the employer
As long as the plan continues, no matter what happens in
The trust, the employer is responsible for payment of employee
Benefits
Actuaries
Individuals trained through rigorous certification program
assign probabilities to future events and their financial effects
What do actuaries do relating to pension plans?
Companies hire actuaries to ensure pension plan is
appropriate for the employee group covered
Pension obligation
Deferred compensation obligation employer has to
employees under terms of pension plan
Vested benefits
Those employee is entitled to receive even if rendering
No additional services to company
What do companies use to compute vested benefit obligation?
Vested benefits at current salary levels
Or on years of service
Accumulated benefit obligation
Measures vested and no vested benefits based on years
Of service
Projected benefit obligation
Pension obligation for vested and nonvested benefits using
Future salaries
Method preferred by FASB
How is the projected benefit obligation measured?
Using present value of vested and no vested benefits accrued
To date based on future salary
How is overfunded or underfunded status measured on a pension plan?
Difference btw fair value of plan assets and projected
benefit Plan
How do companies account for pension cost?
On an accrual basis
Service cost AKA projected benefit obligation
Expense caused by increase in pension benefits payable
To employees b/c of their services rendered during the year
How do actuaries compute service cost?
Present value of new benefits earned by employees during
Year
Interest on liability
Interest expense accrues each year on projected benefit
Just as it does on discounted debt
Settlement rate
Interest rate (on liability) computed by actuary
Actual return on plan assets
Company adjusts annual pension expense for interest and
Dividends that accumulate within fund
As well as increases and decreases in fair value of assets
Amortization of prior service cost
Allocation of prior service cost to pension expense in
Future to remaining service year employees
5 components of pension expense
1 service cost for year 2 amortization of prior service cost 3 interest on liability 4 actual return on plan assets 5 gain or loss
Interest on liability: discounted basis
Company defers paying liability until maturity
Settlement rates
Discount rate that reflects rates at which companies
effectively settle pension benefits
How do companies determine settlement rates?
Look at rates of return on high quality fixed income
investments currently available
Equation for actual return on plan assets
Actual return =
(plan assets ending balance - plan assets beginning balance)
- (contributions - benefits paid)
