Limited Time Offer: Save 10% on all 2021 and 2022 Premium Study Packages with promo code: BLOG10    Select your Premium Package »

Presentation of Defined Benefit Pension Plans

Presentation of Defined Benefit Pension Plans

Under a defined contribution plan, a company contributes a defined amount, i.e., pension expense into the plan.

Under a defined-benefit plan, a company commits to pay future benefits to employees during their retirement.

Presentation and Disclosure Related to DC and DB Pension Plans

Under a defined-benefit plan, a company reports either a net pension asset or a net pension liability.

A company’s balance sheet will reflect a net pension asset if the fair value of the pension fund’s assets is higher than the present value of the estimated pension obligation. Conversely, a company’s balance sheet will reflect a net pension liability if the present value of the estimated pension obligation is higher than the fair value of the pension fund’s assets.

In each period, the change in net pension asset or liability is recognized either in profit or loss. Alternatively, the change in net pension asset or liability is recognized in other comprehensive income.

Under IFRS, the change in net pension asset or liability has three general components: (i) employees’ service costs (which is recognized as pension expense in profit and loss); (ii) net interest expense or income accrued on the beginning net pension asset or liability (which is also recognized as pension expense in profit and loss); and (iii) remeasurements (which is recognized in other comprehensive income).

Under US GAAP, the change in net pension asset or liability in each period has five components: (i) employees’ service costs for the period; (ii) interest expense accrued on the beginning pension obligation; (iii) expected return on plan assets, which reduces the amount of expense recognized; (iv) past services costs; and (v) actuarial gains and losses. The first three components are recognized in profit and loss in the period when they are incurred, while the latter two components are recognized in other comprehensive income and then amortized into profit and loss (as pension expense) over time.

The pension expense related to production employees is added to inventory and expensed through the cost of sales. For those employees who are not directly involved in the production process, the pension expense is included with salaries and other administrative expenses. Pension expense is therefore not directly reported on the income statement. Instead, extensive disclosures are included in the notes to the financial statements.

Question 1

Company XYZ has a defined benefit pension plan. If at the reporting date, the company’s pension obligation is $5 million and pension assets are $7.5 million, the balance sheet reporting would most resemble:

  1. $2.5 million is shown as a net pension asset.
  2. $2.5 million is shown as a net pension obligation.
  3. $7.5 million is shown as an asset, and $5 million is shown as a liability.

Solution

The correct answer is A.

The difference between the pension assets ($7.5 million) and the pension liabilities ($5 million) is reported on the balance sheet as a net pension asset ($2.5 million).

Question 2

A company paying a fixed amount of money to finance its employees’ pension plan is considered to have:

  1. A defined benefit pension plan.
  2. A fixed contribution pension plan.
  3. A defined contribution pension plan.

Solution

The correct answer is C.

A company paying a fixed amount of money to finance its pension plan is considered to have a defined contribution pension plan. A defined benefit pension plan would require the company to pay a variable amount of money depending on the company’s estimates which change from year to year. There is no such thing as a fixed contribution pension plan.

Featured Study with Us
CFA® Exam and FRM® Exam Prep Platform offered by AnalystPrep

Study Platform

Learn with Us

    Subscribe to our newsletter and keep up with the latest and greatest tips for success
    Online Tutoring
    Our videos feature professional educators presenting in-depth explanations of all topics introduced in the curriculum.

    Video Lessons



    Sergio Torrico
    Sergio Torrico
    2021-07-23
    Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
    diana
    diana
    2021-07-17
    So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
    Kriti Dhawan
    Kriti Dhawan
    2021-07-16
    A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
    nikhil kumar
    nikhil kumar
    2021-06-28
    Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
    Marwan
    Marwan
    2021-06-22
    Great support throughout the course by the team, did not feel neglected
    Benjamin anonymous
    Benjamin anonymous
    2021-05-10
    I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
    Daniel Glyn
    Daniel Glyn
    2021-03-24
    I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
    michael walshe
    michael walshe
    2021-03-18
    Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.