Pension Principles, Reporting Flashcards
What are the two types of pension plans
Defined Contribution Plan- Time value of money problem. Annual employer contribution is defined. Employee bears all the risk and performance and benefits at the end.
Defined benefit Plan: At retirement, the amount of retirement benefit is defined. You know what that benefit is going to be. Employer is liable.
Accrual accounting is used for BOTH- Recognize the liability and expense when benefits ARE EARNED!
How do you account for a defined contribution pension plan
Relatively simple and raises very few accounting issues for employers.
Employer makes a contribution into a trust fund which is administered by a third party trustee.
JOURNAL ENTRY:
Pension Expense DB
Cash CR
ENDING LIABILITY:
Sometimes there is a pay period that falls in between end of the year. You need to accrue the liability.
How do you account for a defined benefit plan?
Each employee is GUARANTEED a specified retirement income often related to his or her number of years of employment and average salary over a certain number of years.
Because they are DEFINED, this will vary as condition change including turn over, hiring more employees, raises.
Easy Defined Benefit Plan Example: An employee makes $1000 in the current year, and we agree to pay an employee $1000 for 15 years after he/she retires in 20 years. How much should you record in pension expense right now?
1) Present value of the annuity for the 15 years, $1000 payment
2) Single sum from the annuity and bring it back to today
What is the pension fund?
Company sets aside money FOR future pension obligation. This is not on the books. We give money to the third party administrator.
What is vesting?
When an employee meets certain requirements and BECOMES eligible to receive pension benefits regardless of whether or not the employee continues working for employer! (Employee has to work for a certain number of years, usually 5 to 7 years and then they have vested).
What questions are going to be asked?
- Pension expense
- Pension Liability
- Disclosures
- PBO (liability at the present time)
Information given by an actuary, which will be given on the CPA exam will include: These variables will be given in the EXAM!
- Number of years of service
- Final or highest salary attained
- Age at retirement
What are plan assets and how are the measured?
Assets set aside and given to the third party administrator
1) Fair value of the assets are set aside to pay pension benefits
2) Administrator invests the asset to get a return
IF there is an increase above the expected return IT DOES NOT IMPACT PBO! IT DOES NOT IMPACT YOUR OBLIGATION TO RETIREE!
You take money out of the plan assets and reduce the liability from that account!
The company does not make payments to retirees, it is the administrator
What TWO Amounts are important for us!?
Annual pension expense- PV cost of benefits earned during the year plus and minus adjustments
Balance sheet: Asset or Liability:
- Compare FV of the pension fund to the PBO, the difference goes on the balance sheet.
- If PBO is greater than plan assets, then you have a liability
- If your assets are greater than PBO, then you have an asset on the balance sheet.
