Defined Benefit Plan
Contribution (Liability) is the funded defined benefit plan by the employer and these funds are invested by the employer and recognized as plan asset in balance sheet.
So at the time of payment, investment risk and actuarial risk falls on the employer which means if there is any shortfall in payment of benefits due to insufficient plan assets, employer have to contribute from his hands.
Accounting Treatment of Defined benefit Plan
Accounting for defined benefit plan have few steps to be followed.
Step 1: Determining the Deficit or Surplus
Deficit or Surplus: Fair Value of Plan Assets (-) Discounted (defined benefit obligation and Current Service Cost)
Defined benefit obligation
= Future payments to be settled resulting from employees service in Current and
Prior Periods
Current Service Cost =
Benefit obligation to be paid resulting from current period employee service
This involves using actuarial techniques and projected unit credit to make a reliable estimates
Step 2: Determining the amount of net defined benefit liability
Before going to step, we shall know the definition of asset ceiling.
Asset Ceiling:
It is
applicable when there is net defined benefit asset in the statement of
financial position i.e. the present value of defined benefit liability is less
than the fair value of plan asset at the reporting date.
Refund : Sometimes a refund
is available to an entity with an unconditional right.
Ex: The entity may have a
right to refund from the plan assets, irrespective of whether plan liabilities
are settled)
Reduction in future
contributions: Sometimes employees can leave the entity, which leads to
reduction in future contribution
Definition of Asset Ceiling: The present value of any economic benefits available in the form of
a) Refunds from the plan
b) Reductions in future contributions to the plan
In case of surplus in Step 1:
In case of deficit in Step 1:
Net defined benefit liability to be recognized in balance sheet as an increase in obligations in liabilities.
As per US GAAP, Plan deficits can also be impacted by asset ceilings if the plan has a minimum funding requirement. For example, if payments under a minimum funding requirement create a surplus, which exceeds an asset ceiling, an additional liability is recognized. Asset ceilings can therefore significantly affect the amount of any surplus or deficit that is recognized and should therefore be carefully assessed.
Step 3
Example
AB Ltd is a private
limited company and it has established a post employment funded defined benefit
plan for its employees. In accordance with the terms of the plan, the employees
will receive a pension equal to 2% of the final year salary of employee multiple
of year of services with the entity.
AB Ltd determines the cost for the year using the projected unit credit method
which also takes into account some actuarial assumptions regarding employee
turnover, mortality rates, inflation rates and discount rates, which are based
on the rate of return of high quality corporate bonds.
Following information
is available related to the defined benefit plan for the year end of 31
December 2010
·
The present value of
pension benefit in respect of employee services for the year end of 31 December
2010 is $80,000.
·
AB Ltd paid pension
benefits of $84,000 to former employees in the current year
·
The entity has
contributed an amount of $40,000 into plan asset in the year end of 31 December
2010.
·
The present value of
defined benefit liability was $6million at year ended 31 December 2009 and it
was $6.7 million at 31 December 2010.
·
The plan asset had a
fair value of $5.8 million at 31 December 2009 and the fair value of plan asset
was $6.15 million at 31 December 2010
AB Ltd had amended the
plan on 31 December 2010 and as a result employees are now entitled to an
increased pension benefit. The estimated present value of these benefits is
$250,000 at 31 December 2010.
The interest rate on high quality corporate bonds was 6% per annum 31 December
2009.
AB Ltd recognizes
re-measurement gains and losses in 'other comprehensive income (items that will
not be reclassified to profit or loss)' in accordance with IAS 19, revised
2011.
Required
Prepare the extracts
of financial statements in respect of defined benefit plan of AB Ltd for the
year end of 31 December 2010, along with the movement in Define benefit
liability and plan asset.
(Assume that the pension benefits and the contributions paid were settled at 31
December 2010).
Solution
(Working 1)
|
Statement of Profit or Loss |
31.12.2010 |
|
|
$ |
|
Current Service Cost |
(80) |
|
Past Service Cost |
(250) |
|
Net Interest: |
|
|
Interest Expense
($6,000 ×
6%)
(360) |
|
|
Interest
Income ($5,800 ×
6%)
348 |
(12) |
|
Curtailment Gain /
Loss |
- |
|
Total Charge |
(342) |
|
Other Comprehensive Income |
|
|
Re-measurements: |
|
|
Loss on Define
benefit Liability |
(94) |
|
Gain on Plan Asset |
46 |
|
|
(48) |
(Working 2)
|
Statement of Financial Position |
31.12.2010 |
|
|
$ |
|
Present Value of
Defined Benefit Liability at Reporting Date |
6,700 |
|
Fair Value of Plan
Asset at Reporting Date |
(6,150) |
|
Net Liability |
550 |
(Working 3)
|
Define Benefit Liability a/c |
31.12.2010 |
|
|
$ |
|
Balance b/ f at
31.12.2009 |
6,000 |
|
Current Service Cost |
80 |
|
Past Service Cost |
250 |
|
Interest Expense
($6,000 × 6%) |
360 |
|
Benefit Paid Out |
(84) |
|
Re-measurement Loss
(Balancing Figure) |
94 |
|
Present Value of
Defined Benefit Liability at 31.12.2010 |
6,700 |
(Working 4)
|
Plan Asset a/c |
31.12.2010 |
|
|
$ |
|
Balance b/ f at
31.12.2009 |
5,800 |
|
Contribution into
Plan Asset during the year |
40 |
|
Interest Income
($5,800 × 6%) |
348 |
|
Benefit Paid Out |
(84) |
|
Re-measurement Gain
(Balancing Figure) |
46 |
|
Fair Value of Plan
Asset at 31.12.2010 |
6,150 |
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