The key issues and different types of pension provision

Published:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

According to Alexander, the pension benefits are regarded as the most essential long-term employee benefits. And the purpose of a pension "is to grant people some money when they are retired". (Ch21, P494) The amount of pension paid per year depends on the earnings of the employee whilst in work. Pension schemes can take a variety of different forms, I have listed three major different categories below:

1.State pensions (adopted mainly in the south of Europe)

After receiving a retirement benefit which is already included in the employment contract, the employees are also entitled an individual state pension from the pension savings plans. Because the organisation's obligation is to pay the contributions when they are due, the accounting problems do not usually occur for entities. Moreover, IAS19 pays less attention on the state pension schemes due to the separation of it from employment contracts.

2&3. Defined contribution plans & Defined benefit plans (adopted in countries like the UK, the US)

Defined contribution plans

In a defined contribution plan, a fixed amount of money is contributed regularly by the employer to a pension account. This enables the employees to receive the benefits at retirement together with the interest from contribution invested under their names. However in such situation, the employees will have to undertake the risk by their own. The defined contribution plans can be administrated either by the company or by a bank and once the contribution has been paid, the company has no future payment obligation. Use of this plan could lead to a much more straightforward view for the finance pattern and the employer's responsibility, it is therefore preferable by the employers.

Defined benefit plans

IAS19 classified that all plans other than defined contribution plans are the defined benefit plans which provide benefits according to pay and years of service. They are benefits promised in advance and a certain amount of return will be provided to employees when they retire. These plans are based on the plan's benefit formula that is also defined in advance. Three types of formula are generally used to determine an employee's pension.

The final pay plan: a percentage of your final earnings from employment. (E.g. 10% of your final salary)

The final average pay plan: a percentage of your last 3 or 5 years average earning. (E.g. 10% of your average earnings over last 3 years)

The career average pay plan: your annual pension benefit is a fixed percentage of your annual earnings. (E.g. 10 % of your average salary)

Above two plans (2&3) can be grouped into Company pension plans. A company pension plan is an agreement between an employer and its employees, in the contrast to the defined contribution promise, it often draws most of attention from IAS19 for having a significant impact on a company's financial situation. Moreover, when employers choose either one of Company Pension Plans, they can consider whether to set up the organisation and funding as a single-employer plan or multi-employer plans. As for these benefits plans, the terms of the contract with the third party (insurance company) must specify the type of risks and responsibilities are transferred to it, because this is vital on deciding if a defined contribution or defined benefit type should be applied.

Benefits to employee and the corporation

Application of IAS19 for the defined benefits pension plans would offer a number of advantages to the employees.

With regard to pension rights, once the employees have earned their rights by providing services for the company for more than certain years, they will be benefit from the plans whether they stay further with the organisation or not. In some other cases, if the employee benefits are vested which means they are not restricted by years of services.

The type of pension plans determines that how these benefits can be accounted for in the financial statement.

Key Issues

The actuarial difficulties and uncertainties arise with this scheme. Under IAS 19, the balance sheet preparation process needs actuarial assumptions to measure the legal obligation and the expenses of the organisation. Whereas both decisions of assumptions and the valuation method have major effect on the contribution rate calculated at each valuation. The main problem is that there are always differences (actuarial gains or losses) between the assumptions and what will be occurring in reality underlying more complexity for the recognition and measurement in accounting.

IAS 19 opted the projected unit credit method to determine and calculate the pension cost and liability. Projected unit credit technique takes into account the accrued or earned pension and as well as the expected future salary levels.

As far as the present value of the defined benefit obligation is concerned, it is the key for the valuation of a possible pension liability.

A net pension obligation is required to appear on the balance sheet.

Under IAS 19, a number of problems have arisen in the recognition of the pension costs and liabilities. With regard to the costs, they include

Cost: The amounts to be funded each year relating to the benefit formula mentioned earlier are defined as the current service cost. However an entity should calculate the benefit on a straight line basis rather than using the plan formula if an employee's service in later years will lead to an increase in benefit. In addition, the interest accrual (depending on the discount rate) is also included in the total pension cost. Thus both of the current service cost and interest cost should be reported on the Profit & Loss Account.

Likewise some other factors also affect the total pension cost, such as when the amounts to be funded are involved in the investment. The realised return on plan asset can lead to a lower or higher total pension cost based on whether the investments are successful (higher realised return will reduce the pension cost and verse vice). On the other hand, if another party will contribute such expenditures included in the obligation, the amount should be recognised and taken out from the total cost.

Another element which has impact on the total cost is actuarial gains or losses. These can be differences between assumptions and reality on returns as mentioned earlier or changes in assumptions themselves. As for the 2nd possibility, it indicates the trend of future amounts to be funded. If the new assumption is higher than the old one, there will be a loss since the difference needed is not funded yet. The opposite situation will enable the firm a refund.

All those factors provided above will increase the volatility on the income statement. Consequently the IASB has opted the corridor approach which allows us to only recognise the gains and losses outside the 10% of the present value of the obligation or 10% of the fair value of any plan assets at that date. This approach helps in a long term offset gains and losses against each other.

ISSUE: As IAS 19 required, an entity should disclose each element of actuarial assumption in absolute terms in the financial statement rather than just a margin between different percentages or other variables. Hence, the preparers and auditors might have to increase the disclosures in the notes. Carsten Zieke identified that typical investors will not want any actuarial investment assumptions, but any changes in fair value in the income statement. He also argued that simply close the defined benefit plans may not be a solution.

Short-term fluctuations influence the measurements of both assets which are held for the long term and uncertain liabilities.

'By adopting this method, the amounts to be funded at the start of a career of a person are lower than if one would finance the promised benefit under a projected valuation method, which takes into account from the start the whole expected service period.' An entity's obligation whereby reduces.

Under defined benefit plans, the organisation will have to be committed to the actuarial and investment risks. (obligation / liability increased)

Paragraph 54 stipulates that the amount to be recognised as a defined benefit liability should be the net total of the following amounts:

The present value of the defined benefit obligation at the balance sheet date (see para.64)

Plus any actuarial gains (less any actuarial losses) not recognised because of the treatment set out in paras 92-93 and

Minus any past service cost not yet recognised (see para.96)

Minus the fair value at the balance sheet date of plan assets (if any) out of which the obligations are to be settled directly (see paras 102-104)

Accounting for the plan

Writing Services

Essay Writing
Service

Find out how the very best essay writing service can help you accomplish more and achieve higher marks today.

Assignment Writing Service

From complicated assignments to tricky tasks, our experts can tackle virtually any question thrown at them.

Dissertation Writing Service

A dissertation (also known as a thesis or research project) is probably the most important piece of work for any student! From full dissertations to individual chapters, we’re on hand to support you.

Coursework Writing Service

Our expert qualified writers can help you get your coursework right first time, every time.

Dissertation Proposal Service

The first step to completing a dissertation is to create a proposal that talks about what you wish to do. Our experts can design suitable methodologies - perfect to help you get started with a dissertation.

Report Writing
Service

Reports for any audience. Perfectly structured, professionally written, and tailored to suit your exact requirements.

Essay Skeleton Answer Service

If you’re just looking for some help to get started on an essay, our outline service provides you with a perfect essay plan.

Marking & Proofreading Service

Not sure if your work is hitting the mark? Struggling to get feedback from your lecturer? Our premium marking service was created just for you - get the feedback you deserve now.

Exam Revision
Service

Exams can be one of the most stressful experiences you’ll ever have! Revision is key, and we’re here to help. With custom created revision notes and exam answers, you’ll never feel underprepared again.