Int. 2 Ch. 19: Accounting for Pensions and Postretirement Benefits

Pension Plan

arrangement whereby an employer provides benefits (payments) to retired employees for services they provided in their working years.

Funded

employer makes payments to a funding agency.

Contributory

employees bear part of the cost of the stated benefits or voluntarily contribute payments to increase their future benefits

Noncontributory

employer bears the entire cost.

Qualified Pension Plan

Plans that offer tax benefits; permit deductibility of the employer’s contributions to the pension fund and tax-free status of earnings from pension fund assets.

Defined Contribution Plan

employer agrees to contribute to a pension trust 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.

Defined Benefit Plan

outlines the benefits that employees will receive when they retire. These benefits typically are a function of an employee’s years of service and of the compensation level in the years approaching retirement.

Actuaries

individuals trained through a long and rigorous certification program to assign probabilities to future events and their financial effects.

Vested Benefit Obligation

This measure is based only on the benefits vested to the employees, at current salary levels; employee is entitled to receive even if he or she is no longer employed by the company.

Accumulated Benefit Obligation

This measure uses both vested and nonvested years of service. The company computes the deferred compensation amount on all years of employees’ service—both vested and nonvested—using current salary levels.

Projected Benefit Obligation (PBO)

This measure bases the deferred compensation amount on both vested and nonvested service using future salaries. Because future salaries are expected to be higher than current salaries, this approach results in the largest measurement of the pension obligation.

Overfunded/ Underfunded Status

difference between the fair value of the plan assets and the projected benefit obligation.

Service Cost

the expense caused by the increase in pension benefits payable (the projected benefit obligation) to employees because of their services rendered during the current year; the actuarial present value of benefits attributed by the pension benefit formula to employee service during the period.

Interest on the liability (Interest Expense)

The interest component is the interest for the period on the projected benefit obligation outstanding during the period.

Settlement Rate

Rates at which companies can effectively settle pension benefit

Actual Return on Plan Assets

The investments in stocks, bonds, and other securities generate a return in the form of dividends, interest, and changes in fair value, which increase the balance of the plan assets.

• The higher, the less the employer has to contribute over time, and, therefore, the less pension expense that it needs to report

  • Difference between fair value of plan asset at beginning of the year and at the end of the year, adjusted for contributions and benefits

Pension Worksheet

A working tool/ device to make it easier to prepare entries and the financial statements.

Pension/ Asset Liability

The difference between the projected benefit obligation and the fair value of the plan assets, which is reported on the Balance Sheet

Expected Return on Plan Assets

Expected rate of return multiplied by market-related asset value

Other Comprehensive Income (G/L)

Accumulation of asset gains and asset losses in an account

Liability Gains and Losses

Unexpected gains or losses from changes in the projected benefit obligation

Corridor Approach

Method for amortizing the account’s accumulated balance of OCI when it gets too large