Accounting for defined-benefit pension plans involves complicated mathematical considerations. As a result, organizations enlist the help of actuaries, who are trained to assign probabilities to future events and quantify their financial effects.
Actuaries help ensure that sponsors have established appropriate funding levels to meet future obligations, and they assist in reporting on pension plans. Employers rely heavily on actuaries for assistance in developing, implementing, and administering pension plans.
Actuaries make predictions, called actuarial assumptions, on factors such as mortality rates, employee turnover, interest rates, early retirement frequency, future salaries, and any other factors necessary to account for a pension plan.
The plan sponsor is responsible to select appropriate actuarial assumptions, often with guidance from the actuary because pension benefits are paid far into the future.
Actuarial assumptions influence the value of the estimated liability at a point in time but do not determine the ultimate cost of the benefits, which will only be known when the benefits have been fully paid. The need to make assumptions in pension accounting is unavoidable, given that no one can know the future.
Using these assumptions together with current employee data and the plan benefit formula, actuaries compute the various pension measures that affect a sponsor’s financial statements, such as the pension obligation and annual pension expense.
In summary, accounting for defined-benefit pension plans relies heavily on the measurements and judgments provided by professional actuaries.