What is important in pension accounting?

For a start:

While pension accounting is complicated, an understanding of a few basic concepts can help answer the important questions regarding the company’s pension balances and the required disclosures to provide useful information to all users of financial statements.

This textbook explains key concepts underlying the company’s pension liability and pension expense, how they are calculated, and what factors influence the amounts reported in the consolidated financial statements.

Parties involved in a pension plan

A pension plan is funded by an employer, and/or an employee, during an employee’s working years. Pension payments are later made to retired employees from the pension plan.

The assets of a pension plan are, many times, held in a pension fund, but can also be insured at a third party insurance company. A pension fund is typically established as a more or less independent entity (common law: legal trust, civil law: foundation) that receives contributions from its sponsors (employer and employee), invests the contributions, and makes benefit payments from its pool of invested assets to retired employees.

A pension plan is usually an arrangement in which an employer provides benefits to retired employees in exchange for their years of service. The employer is usually the organization that decides to create, or sponsor, a pension plan, although labor unions and/or employees also sponsor them.

A pension plan sponsor incurs costs when it contributes to a pension fund. In some plans, working employees (also known as “active” members of the pension plan) may also make contributions to the pension fund. They may do so as plan members or, in some cases, they act as plan co-sponsors alongside the employer. It is also possible that employees make additional contributions to repair shortfalls from changing jobs or in order to gain additional pension benefits.

A pension fund is a separate legal and accounting entity that maintains its own accounting records and prepares its own financial statements. It is beyond the scope of this report to discuss the process for maintaining pension-fund records and preparing financial statements; instead, this textbook addresses pension accounting and reporting by an employer acting as a plan sponsor.

The three organizations typically involved in a pension plan and the flow of cash among them are:

Continue reading: What kind of company pension plans are there?

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