Defined Benefit Scheme - Terms

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Defined Benefit Scheme - Terms

Defined benefit plan

As we said in the intro - this is “A post-employment benefit that creates a constructive obligation to the enterprise’s employees”.

  • The SFP shows the pension fund as it stands at the year end in terms of the present value of the obligation less FV of assets.

    Let’s dig a little deeper to make some sense out of this.

  • The idea is that the company puts money into the fund, the fund spends that money on assets. 

    The assets make an EXPECTED return. The company hopes this return will pay off the employees future pensions when they leave the company.

  • Of course, the fund will not always exactly match the pension liability. Therefore there will either be a surplus or deficit on the SFP.

Let’s look at some terms before we put it all together:

  1. Actuarial gains/losses

    These occur due to differences between previous estimates and what actually occurred.

    These are recognised in the OCI.

  2. Past service cost

    Dr Income statement
    Cr Pension Liability

    This is a change in the pension plan resulting in a higher pension obligation for employee service in prior periods.

    They should be recognised immediately if already vested or not.

  3. Plan curtailments or settlements

    Curtailments are reductions in benefits or the number of employees covered by the pension.

    Any gain/loss is recognised when the curtailment occurs.

    Eg. An amendment which improves benefits for pensioners

    DEBIT Profit or loss X
    CREDIT Present value of defined benefit obligation X

  4. Current service cost

    Increase in pension liability due to benefits earned by employee service in the period.

    Dr Income statement
    Cr Pension Liability

  5. Interest cost

    The unwinding on the discount of the pension liability.

    Dr Interest
    Cr Pension Liability

  6. Expected return on plan assets

    This is the Interest, dividends and other revenue from the pension assets and is now to be based on the return from AA-rated corporate bonds.

    This means companies cannot set expected returns according to the assets actually held by the plan; it could encourage them to invest in more secure vehicles than is currently the case, seeing as the potential higher return will no longer be reflected in the accounts.

    The reason behind this is to improve transparency and consistency.

    Dr Pension Asset
    Cr Interest received

    The Interest cost and EROA are netted off against each other. They use the same discount rate. 

    So if a fund has more assets than liabilities (a surplus) - it will have net interest received.

    If a fund has more liabilities than assets (a deficit) - it will have net interest paid.

  7. Contributions to Pension fund

    This is simply the money that the company puts in to the fund - so the fund can buy assets to generate an expected return.

    Dr Pension Asset
    Cr Cash

  8. Benefits paid

    These are the actual pensions paid out to former employees. 

    Paying the pensions means we reduce the liability, but we use the pension fund to do it, so we reduce the pension asset also.

    Dr Pension Liability
    Cr Pension Asset

Other Long-term Benefits (eg Profit shares, bonuses)

A simplified application of the model described above for other long-term employee benefits:

All past service cost is recognised immediately.

Termination Benefits (e.g. Redundancy)

Amount payable only recognised when committed to either:

  1. Terminating the employment of employees before the normal retirement date; or

  2. Providing benefits in order to encourage voluntary redundancy.

    “Demonstrably committed” means a detailed formal plan without realistic possibility of withdrawal. 

    Discount down if payable in more than a year.

Equity Compensation Benefits

No recognition for stock options issued to employees as compensation. 

Nor does it require disclosure of the fair values of stock options or other share-based payment.

IAS 19 ‘Asset Ceiling’

This stops gains being shown just because Past service costs (unvested) have been deferred.

It may be that there are net assets but not all can be recovered through refunds / contributing less in the future.

In such cases, deferral of past service cost may not result in a refund to the entity or a reduction in future contributions to the pension fund, so a gain is prohibited in these circumstances.

So, any asset recognised in the balance sheet should be the lower of:

  • the net total calculated; and

  • the net total of:

    (i) past service costs not recognised as an expense; and

    (ii) the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan. 

    An asset may arise where a defined benefit plan has been overfunded or in certain cases where actuarial gains are recognised.

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