Chapter 20 Class Notes

Chapter 20 Class Notes - Chapter 20 ACCOUNTING FOR PENSIONS...

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Chapter 20 ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITS Accounting for pension costs is somewhat complicated because of the variety of social concepts, legal considerations, actuarial techniques, income tax regulations, and varying business philosophies that affect the development and maintenance of pension plans. This chapter relates these issues to the recommended accounting treatment for the costs associated with pension plans. Nature of Pension Plans A pension plan is an arrangement whereby an employer provides benefits (payments) to employees after they retire for services they provided while they were working. In the accounting for a pension plan, consideration must be given to accounting for the employer (this will be our focus) and accounting for the pension plan itself. A pension plan is said to be funded when the employer sets funds aside for future pension benefits my making payments to a funding agency that is responsible for accumulating the assets of the pension fund and for making payments to the recipients as the benefits come due. In an insured plan, the funding agency is an insurance company; in a trust fund plan, the funding agency is a trustee. Pension plans can be contributory or noncontributory. In a contributory plan, the employees bear part of the cost of the stated benefits or voluntarily make payments to increase their benefits. If the plan is noncontributory, the employer bears the entire cost. Because the problems associated with pension plans involve complicated actuarial considerations, actuaries are employed to ensure that the plan is appropriate for all employee groups covered. Actuaries make predictions (actuarial assumptions) of mortality rates, employee turnover, interest and earnings rates, early retirement frequency, future salaries, and other factors necessary to operate a pension plan. Thus, accounting for defined benefit pension plans is highly reliant upon information and measurements provided by actuaries. In summary, pension plans are: Contributory: employees voluntarily make payments to increase their benefits Noncontributory: employer bears the entire cost A pension fund should be a separate legal and accounting entity Types of Pension Plans The most common types of pension arrangements are defined-contribution plans and defined-benefit plans . In a defined-contribution plan, the employer contributes a certain sum each period based on a formula. The formula might consider such factors as age, length of service, employer’s profits, and an employee’s compensation level. The accounting for a defined-contribution plan is straightforward. The employer’s 1
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responsibility is simply to make a contribution each year based on the formula established in the plan. Thus, the employer’s annual cost is the amount it is obligated to contribute to the pension trust. If the contribution is made in full each year no pension asset or liability is reported on the balance sheet. A
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This note was uploaded on 12/09/2011 for the course ACC 371 taught by Professor Proscott during the Spring '11 term at S. Alabama.

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Chapter 20 Class Notes - Chapter 20 ACCOUNTING FOR PENSIONS...

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