Measurement uncertainty

Measurement uncertainty – Uncertainty that arises when the result of applying a measurement basis is imprecise and can be determined only with a range.

Measurement uncertainty arises when a measure cannot be determined directly by observing prices in an active market and must instead be estimated.

The level of measurement uncertainty associated with a particular measurement basis may affect whether information provided by that measurement basis provides a faithful representation of an entity’s financial position and financial performance. A high level of measurement uncertainty does not necessarily prevent the use of a measurement basis that provides relevant information.

However, in some cases the level of measurement uncertainty is so high that information provided by a measurement basis might not provide … Read more

Retirement Benefit Plans

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Retirement Benefit PlansRetirement Benefit Plans – The objective of IAS 26 is to specify measurement and disclosure principles for the reports of retirement benefit plans. All plans should include in their reports a statement of changes in net assets available for benefits, a summary of significant accounting policies and a description of the plan and the effect of any changes in the plan during the period.

Retirement benefit plans are normally described as either defined contribution plans or defined benefit plans, each having their own distinctive characteristics. Occasionally plans exist that contain characteristics of both. Such hybrid plans are considered to be defined benefit plans for the purposes of IAS 26.

For defined contribution plans, the objective of reporting Read more

Defined Contribution Pension Plans

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Defined Contribution Pension PlansDefined Contribution Pension Plans – In a defined contribution (DC) pension plan, workers accrue funds in individual accounts administered by the plan sponsor. The contributions of employees are typically deducted directly from their pay and frequently some portion of these contributions is matched by the employer. Since contributions to DC plans are generally a fixed percentage of earnings, DC assets build at a fairly steady rate over time (abstracting from the time-pattern of investment returns) – avoiding the backloading of accrued benefits that is a hallmark of DB plans.

So in contrast to a defined benefit (DB) plan, it is the contributions rather than the benefit that is fixed in a DC pension plan; the retirement Read more

Defined Benefit Pension Plans

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In traditional defined benefit pension plans, workers accrue a promise of a regular monthly payment from the date of their retirement until their death, or, in some cases, until the death Defined Benefit Pension Plansof their spouse. The promised life annuity (deferred) is commonly based on a formula linked to an employee’s wages or salary and years of tenure at the sponsoring firm. Defined Benefit Pension Plans

In a typical DB plan the member earns a unit of pension, usually expressed as a percentage of nominal earnings, for each year of credited service/participation. The DB pension may be indexed to inflation but in a number of countries such as the U.S. and Canada, this is uncommon in private sector pensions. Read more

What is a correct discount rate in pension calculations?

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What is a correct discount rate in pension calculations – Some background information on the discussion on pension plans and discount rates. Choosing the correct discount rate in calculation pension liabilities is not an easy task and a task that brings public responsibility.

Interest rates in the European area are close to zero because the ECB holds its benchmark refinancing rate at zero since March 2016, see table below:

What is a correct discount rate in pension calculations

Low-interest rates play a critical role in calculating pension plan obligations. Specifically, the interest rates on high-quality corporate bonds are used to determine the plan’s expected risk-free return in the future – a metric known as the “discount rate”. If the discount rate decreases, a pension plan needs Read more

Sponsor Accounting for a Pension Asset

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Sponsor Accounting for a Pension Asset – A pension asset arises when total contributions by the sponsor of a defined-benefit plan (plus interest income) are greater than all pension expense since the plan’s inception. Sponsor Accounting for a Pension Asset

For example, a pension plan fund had a net pension asset of $9.312 billion before considering any valuation allowance.

As with any recorded asset (think of accounts receivable, or a building), a pension Sponsor Accounting for a Pension Assetasset signals that the sponsor can benefit from the asset in the future. However, unlike other types of assets, a sponsor does not own the plan assets in a pension plan. This unique accounting situation requires a sponsor to consider whether and when … Read more

Determining annual pension expense

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Determining annual pension expense – In general terms, pension expense reported in the statement of profit or loss is driven by how much the pension liability increased during the year, net of returns on the plan’s assets. Normally, a pension liability increases as employees earn additional future benefits from an additional year of service, and as they get closer to collecting retirement benefits. These factors also increase the pension expense in the statement of profit or loss.

Plan assets increase with returns that the plan earns on its investments, reducing the pension expense reported in the statement of profit or loss.

The company’s annual pension expense consists of the following components:

Determining annual pension expense

(- cost, + income)

31/12×1

31/12×0

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Components of a company’s pension liability

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Components of a company’s pension liability – A company’s defined-benefit pension plans have three basic components:

    • accrued-benefit obligations, or the future liabilities created by employees’ service;
    • plan assets, used to pay pension benefits; and
    • unamortized actuarial gains and losses.

Setting aside unamortized actuarial gains and losses, when plan assets are less than the accrued benefit obligation, a net pension liability is recorded on the statement of financial position. A net pension liability is the estimate of the amount needed to pay for pension benefits that have been earned by current and past employees, less the pool of assets set aside in a separate legal entity to eventually pay for the benefits.

A net pension asset arises … Read more

Impact of the Discount Rate on Pension obligations

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Impact of the Discount Rate on Pension obligations – In order to understand how the discount rate impacts the company’s pension obligations, it is useful to first understand the finance concepts of time value of money and present value. Note that the discount rate is the most important (and most difficult to assess) assumption in calculating pension obligations.

Time Value of Money Impact of the Discount Rate on Pension obligations

The concept of time value of money is best explained in a simple way: a dollar today is worth more than a dollar in the future.

Imagine receiving $1,000 today and putting it in a simple bank savings account. That Impact of the Discount Rate on Pension obligations$1,000 will eventually grow over the years … Read more

Key assumptions in a Pension plan

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Key assumptions in a Pension plan – There are two types of pension assumptions that a sponsor makes with input from their actuaries:

  • Economic assumptions describe how market forces affect the amount of expected future benefits to be paid to plan recipients.
  • Demographic assumptions describe the impact of plan-participant behaviours on the timing and probabilities of benefits being paid to them.

In (consolidated) financial statements the following key actuarial assumptions that the company/ sponsor used to estimate its portion of benefit obligation and pension expense under the pension plan.

The economic assumptions relate to:

  • discount rate;
  • expected rate of return on plan assets; Key assumptions in a Pension plan
  • salary escalation rate; and Key assumptions in
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