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.
Under the defined benefits plan, the employee is guaranteed a certain amount of benefits/payments in the future. Because pension payments are usually made much later in the future, there is a clear time difference between when employees receive future payments and when employees actually earn those benefits. Because of this difference, companies must use the accrual basis of accounting instead of when cash changes hand.
The pensions accounting treatment for defined benefit plans requires:
Determine the fair value of the assets and liabilities of the pension plan at the end of the year
Determine the amount of pension expense for the year to be reported on the income statement
Value the net asset or liability position of the pension plan on a fair value basis
Pension expense is an expected value and when the actual value of the pension differs, those deviations are recorded through other comprehensive income (OCI) under IFRS. For Canadian private companies that adhere to ASPE, there is no such OCI account.
Pension Accounting Example
XYZ Company has a defined benefit pension plan. At the end of 2015, the fair value of the assets and liabilities in the pension amounted to $6 million. In 2016, the pension expense was $10 million and the company contributed $5 million to the pension plan. At the end of 2016, the fair value of the pension assets and liabilities was $10 million. Let’s see how pension accounting works.
This guide to pension accounting is a primer on some of the nuances of handling pensions and other benefits as an accountant. In order to help advance your career, we recommend these additional helpful CFI resources: