Question

What is a pension plan? According to U.S. GAAP, how should pension plans be accounted for? What are the components of a current year's pension plan expense? Discuss each of these components. Why are pension plans problematic to account for?

Answer 1

Pension

In addition to salaries, many companies offer other benefits to their employees such as pension plans, health insurance, stock option benefits, fitness memberships, or life insurance plans. There are very specific requirements around pension accounting, which will be outlined in this article.

For regular benefits, the accounting is relatively simple – the employer records an expense for the amount of the benefits employees earn in a year.

However, the accounting treatment becomes more complicated when employees earn the rights to the benefits NOW but receive those benefits later, in the FUTURE. A clear example of such a benefit is the pension.

The income statement / profit and loss account is made up as follows:

Service cost / new pensions accrued	Always in operating costs
+ Interest cost	Under US GAAP always in operating costs but under IFRS may be in operating or financial costs
– Expected return on assets	Under US GAAP always in operating costs but under IFRS may be in operating or financial costs
+ Actuarial loss net of experience gain on plan assets	Under IFRS not expensed. Under US GAAP either expensed in full or amortized over time
Net pension expense

To calculate a pension expense, the employer must report the service and interest cost, expected return on plan assets, amortization of prior service cost and effects of gains and losses.

The real cost of pensions can't be measured in cash flow terms: how much is being paid out this year, as opposed to the contributions being put in. ... That is because pensions are a debt which must be paid. The problem is that low bond yields have forced up the present value of future benefits and widened deficits