Defined Benefit Plan Accounting

Defined Benefit Plan Accounting

Defined benefit plan is another important type of post retirement benefits. In this plan the employer guarantees an amount of pension, which is usually linked with the time of service of the employees. Company creates a fund for this purpose and makes required contribution in that fund. Some important Characteristics of defined contribution plan are listed below

a)    Pension benefits are defined.

b)   Pension benefits are linked with time of service of Employee.

c)    Entity is responsible to pay the guaranteed amount.

d)   Entity creates a fund for this purpose.

e)    Entity is responsible to contribute towards any shortage in fund.

Defined benefit Plan Contribution

In defined benefit plan the contribution are made on the recommendation of a financial expert i.e. actuary. The actuary calculation is based on number of assumption like life expectancy, age etc. The actuary cannot make 100% accurate estimates and thus there will be either a surplus of deficit situation in the fund.

In case employee obligation is more than fund investment, then it is a deficit situation. In deficit situation, the company either makes some additional contributions in the fund or does nothing believing that it is a short term phenomena.

In case employee’s obligation is less than fund investment, then it is a surpluses case. The company either stops contributions into fund or withdrawal some amount from the fund. Surplus is recognized is lower of surplus or asset ceiling.

Defined Benefit Plan Accounting Treatment

Statement of Financial position

a)    Net employees benefit is recognized as liability/asset.

b)   Net benefit is calculated Present value of benefit less fair value of planed assets.

c)    Financial statement recognizes net liability in case of deficit.

d)   Financial statement recognize net asset in case of surplus.

Profit & Loss Accounting

The following items are treated through profit & loss account.

a)    Employee current year service cost.

b)   Past Service cost.

c)    Settlement gain or loss.

d)   Net interest (income or expense).

Other Comprehensive Income Recognition

Following are recognized in other comprehensive income

a)    Actuarial gains or losses.

b)   Any change in the effect of asset ceiling (excluding the amount included in net interest of net defined benefit obligation).

Actuarial Gains

Actuarial gains results in from the following

a)    Effect of actual results and previous assumptions.

b)   Changes in actuarial assumption for future.

Accounting Steps

Step # 1

The defined benefit asset/liability shall be recognized on the face of financial statements.

Present Value of plan obligation
Less: Fair Value of plan Asset

Step # 2

Following Journal entry will record the movement of defined benefit liability/asset and contributions.

Profit & Loss
Re-Measurements
Cash Contribution
Defined benefit liability

Step # 3

Identify the profit & loss entries like current cost, past cost, interest, settlement gain and pass this amount in the above shown journal.

Step # 4

Re-measurement shall be entered as balancing figure in the journal.

Defined Benefit Plan Accounting Example

January 2015 (balance)

Fair Value of plan asset = 1000

Present Value of obligation = 2,000

Contribution = 400

Current Cost =300

Benefit paid= 100

Fair value of asset (Closing) = 900

Present Obligation (Closing) = 2100

Step # 1

Present Value of plan obligation	2100	2000
Less: Fair Value of plan Asset	900	1000
Net Plan Liability	1200	1000

Net liability has increased by 200 i.e. (1200-1000).

Step 2 & 3

Identify the amount to be charged to profit & loss account.

Current Service cost = 300

Interest 10@ 1000 = 100

Interest is calculated on the opening balance of net liability.

Journal entry

Profit & Loss	400
Re-Measurements	200
Cash Contribution		400
Defined benefit liability		200