Pension Basics
This type of pension plan promises employees a specific retirement benefit.
What is a defined benefit plan?
Defined benefit plans promise a fixed payout, so the company bears the risk of funding it.
This cost increases the obligation because employees worked another year.
What is service cost?
Service cost increases the obligation because employees earned additional pension benefits this year
Cash payments made by the employer to fund the pension plan increase this account.
What are pension plan assets?
When the company contributes cash to the plan, it increases the plan assets
Service cost is reported in this section of the financial statements.
What is net income (pension expense)?
Service cost is part of pension expense, which is reported in net income
Plan assets = 700,000
Defined Benefit Obligation = 500,000
What is the pension position?
This account equals pension plan assets minus the defined benefit obligation.
What is the net defined benefit asset or liability?
It’s just plan assets minus the obligation, that’s the net amount shown on the balance sheet
Interest on the pension obligation is calculated using this rate.
What is the discount rate?
The discount rate is used to calculate interest on the pension obligation over time.
Investment returns on pension assets increase this account.
What is plan assets?
When the pension investments earn returns, it increases the plan assets.
Actuarial gains and losses are recorded here.
What is OCI?
Actuarial gains and losses bypass net income and are recorded in OCI
Defined Benefit Obligation = 600,000
Discount rate = 5%
What is interest cost?
If the pension obligation is larger than the plan assets, the company reports this.
What is a pension liability?
if the obligation is bigger than the assets, the company owes more than it has, so it’s a liability
If employees are expected to live longer than previously estimated, the pension obligation will do this.
What is increase?
If people live longer, the company has to pay pensions for longer, so the obligation increases.
When benefits are paid to retirees, this happens to plan assets.
What is a decrease in plan assets?
When retirees are paid, money leaves the plan, so plan assets decrease
The difference between expected and actual returns on pension assets is recorded here.
What are remeasurements in OCI?
The difference between expected and actual returns is a remeasurement, so it goes to OCI
Plan assets = 500,000
Actual return = 20,000
Expected return = 25,000
What is the remeasurement amount recorded in OCI?
The actual return is lower than expected by $5,000, so that difference is a loss recorded in OCI
These professionals estimate pension obligations using assumptions about salary growth, mortality, and discount rates.
Who are actuaries?
Actuaries estimate the obligation using assumptions like lifespan, salary growth, and discount rates.
Payments made to retirees reduce this account.
What are plan assets?
When retirees are paid, the money comes out of the plan assets, so those decrease
The pension fund is typically managed by this independent party.
What is a trustee?
A trustee manages the pension fund separately from the company to protect employees’ benefits
Net interest on the net defined benefit liability is reported here.
What is Net income?
Net interest is part of pension expense, so it’s reported in net income.
Plan assets are $700,000, DBO is $500,000, and the discount rate is 5%. What is net interest and is it income or expense?
200,000 × 5% = 10,000