What are pension accounting principles?

 

Pension accounting principles depend on the post-retirement scheme. There are two categories of post-retirement benefits:

– Defined contribution schemes.

– Defined benefit schemes.

According to IAS 19, under defined contribution plans the entity’s legal or constructive obligation is limited to the amount that it agrees to contribute to the fund. Under defined benefit plans the entity’s obligation is to provide the agreed benefits to current and former employees and actuarial risk and investment risk fall on the entity.

The accounting principes of defined contribution plans are as following:

(a)  Contributions to a defined contribution plan should be recognized as an expense in the period they are payable
(b) Any liability for unpaid contributions that are due at the end of the period should be recognized as a liability (accrued expense).
(c) Any excess contributions paid should be recognized as an asset (prepaid expense), but only to the extent that the prepayment will lead to a reduction in future payments.

The accounting principes of defined benefit schemes are much more complex and involves the following steps:

           

 1. Determining the amount of the net defined benefit liability (asset) as the amount of the  deficit or surplus which will be presented in the statement of financial position (balance  sheet). This involves to make a reliable estimate of the ultimate cost to the entity of the benefit that employees have earned in return for their service in the current and prior periods, discounting those benefits in order to determine the present value of the defined benefit obligation and the current service cost and deducting the fair value of any plan assets from the present value of the defined benefit obligation.

 2. The surplus or deficit measured in Step 1 may have to be adjusted if a net benefit asset has to   be restricted by the asset ceiling.

3. Determining the amounts to be recognized in profit or loss  (income statement) -  Current service cost, any past service cost and gain or loss on settlement, net interest on the net defined benefit liability (asset).

4. Determining the remeasurements of the net defined benefit liability (asset), to be recognized in other comprehensive income, comprising:

                 (a) Actuarial gains and losses.

                 (b) Return on plan assets.

                 (c) Any change in the effect of the asset ceiling.

The calculation of the present value of the defined benefit obligation is complex and would normally be carried out by an actuary, using actuarial assumptions and discount rates. What is the management`s expert and how does the auditor use the management`s expert work?

Plan assets may comprise of cash and cash equivalents, equity instruments, debt instruments, real estate, derivatives, investment fund, asset‑backed securities, structured debt. Plan assets held by a fund that is legally separate from the reporting entity, which exists solely to pay employee benefits.

The current service cost is the increase in the present value of the defined benefit obligation resulting from employee services during the period.

Past service cost is the change in the obligation relating to service in prior periods.

Below is an example of movement in the entity pension surplus/(deficit) disclosed in the notes to the financial statements.