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MGAC02H3 (21)
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Chapter 19

Chapter 19 Notes

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Department
Financial Accounting
Course
MGAC02H3
Professor
Daga
Semester
Fall

Description
Chapter 19 Pensions and Other Employee Future Benefits NotesIntroduction and Benefit Plan BasicsDefined Contribution Plansy a defined contribution DC plan is a postemployment benefit plan that specifies how the entitys contributions or payments into the plan are determined rather than identifying what benefits will be received by the employee or method of determining those benefits y under a defined contribution plan the amounts paid in are usually attributed to specific individuals y the contributions may be a fixed sum or they may be related to salary y no promise is made about the ultimate benefit that will be paid out to the employees y because the contribution is defined the accounting for a defined contribution plan is straightforward y the annual benefit cost ie the pension expense is simply the amount that the company is obligated to contribute to the plan y under ASPE when a DC plan is first established or when it is later amended the employer may be required to make contributions for employee services that were provided before start of the plan or its amendment which is referred to as prior or past service cost y such costs are amortized in a rational and systematic way and are added to the current service cost as part of the annual benefit expense over the period that the organization is expected to realize the economic benefits from the plan change y the cost of the plan for the period might also contain interest charges on any related discounted amounts and a reduction for interest earned on any unallocated plan surplus y under IFRS these past service costs usually fully vested amounts are generally recognized immediately in expense Defined Benefit Plans y a defined benefit DB plan is any benefit plan that is not a DC plan y it is a plan that specifies either the benefits to be received by an employee or the method of determining those benefits y the most complex type of benefit plan provides defined benefits that vest in the employee based on the employees length of service y vesting means that an employee keeps the rights to the benefit even if the employee no longer works for the entity y the objective in accounting for these plans therefore is for the expense and liability related to these plans to be recognized over accounting periods in which the related services are provided by the employees Nature of Pension Plans y a pension plan is an arrangement in which an employer provides benefits payments to employees after they retire for services that the employees provided while they were working y the company or employer is the organization that sponsors the pension plan and incurs the cost and contributes to the pension fund y the fund is the entity that receives the employer contributions and employee contributions if any administers the pension assets and makes the benefit payments to the pension recipients the retired employees y in contributory plans the employees pay part of the cost of the stated benefits or voluntarily make payments to increase their benefits y in noncontributory plans the employer bears the entire cost The Role of Actuaries y individuals who are trained in a long and rigorous certification program to assign probabilities to future events and financial effects y insurance industry employs actuaries to assess risks and to advise on setting of premiums and other aspects of insurance policies y employers rely heavily on actuaries for help in developing implementing and determining the funding of pension plans y actuaries make predictions called actuarial assumptions about mortality rates employee turnover interest and earnings rates early retirement frequency future salaries and any other factors that need to be known in order to operate a pension plan Defined Benefit Pension Plans The Employers Obligation Alternative Measures of the Obligation y one measure of the pension obligation is based only on the benefits vested to the employees y vested benefits are those that an employee is entitled to receive even if he or she provides no additional services to the company y actuaries calculate the vested benefit obligation using vested benefits only at current salary levels y another way to measure the obligation is using both vested and nonvested benefits y on this basis the deferred compensation amount is calculated on all years of employees serviceboth vested and nonvestedusing current salary levels which is called the accumulated benefit obligation y a third method calculates the deferred compensation amount using both vested and nonvested service and incorporates future salaries projected to be earned over the period to retirement which is called the projected benefit obligation y because future salaries are expected to be higher than current salaries this results in the largest measure of the pension obligation y the accrued benefit obligation ABO for accounting purposes is the present value of vested and nonvested benefits earned to the balance sheet date with the benefits measured using employees future salary levels Changes in the Accrued Benefit Obligation y the accrued obligation increases as employees provide further services and earn additional benefits and as interest is added to this outstanding discounted liability and the obligation decreases as benefit payments are made to retirees y in addition the ABO might either increase or decrease as plans are amended to change the future benefits that were promised for prior services and as the actuarial assumptions change that are used to calculate the obligation y current service cost is cost of benefits to be provided in future in exchange for services that employees provided in current period y to calculate current service cost the actuary predicts the additional benefits that must be paid under the plans benefit formula as a result of the employees current year of service and then discounts the cost of these benefits to their present value
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