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Pension Schemes Essay

628 words - 3 pages

Pension is a type of post-employment benefits given to the employees. Defined Benefit (DB) and Defined Contribution (DC) pension schemes are two different forms of pensions which are adopted by the companies. A DC pension scheme is the one in which contributions are made into the pension plan by the employer. These plans are then invested through a financial intermediary. Employee and employer both can contribute into the plan. However, there is no other obligation of the employer other than making contributions into the plan. The future benefit to the employee depends on the performance of the funds. Therefore, the risk regarding the future benefit is born by the employee not the employer. The reporting in DC scheme is simple as employer only makes contributions with no future liability hence contributions are expensed in income statement. Only a current liability can occur in balance sheet if unpaid ...view middle of the document...

The reporting in DB scheme is quite complex as the future liability is due but the amount is uncertain. Therefore, in order to estimate the pension liability certain assumptions are made which may include average retirement age, average life expectancy after retirement, etc. Both IFRS and US.GAAP measure the pension obligation as the present value of future benefits for services provided to date. There are many other complexities like what discount rate to use for discounting. There can be vesting periods (certain criteria to be met by employee to be eligible for pension). Therefore, there can be estimation of the probability that some employees will not meet the vesting requirements. Based on this information current service cost (increase in the pension obligation due to increase in length of service in the current period) and present value of pension obligation is calculated. These estimates change over time and therefore, changes occur in the pension liability. If changes increase the pension liability, the increase is called the actuarial loss and if pension liability is decreased then it is referred to as actuarial gain (CFA, 2013).
There are some differences under IFRS and US.GAAP reporting of pension liability. Actuarial gains/losses are recognized in OCI under IFRS however under US. GAAP they can be recognized in P/L or in OCI then subsequent amortization to P/L using corridor and faster recognition method. Net return on Plan assets are treated in same way in both standards as actuarial gains/losses however, expected return is used to calculate return on plan assets under US.GAAP where interest rate (yield of high quality corporate bond) is used under IFRS.
Currently due to many complexities involved under DB schemes certain companies are reluctant to use DB schemes and they are now shifting towards DC scheme. A recent example is the case of Boeing Company which is switching to DC scheme to “curb the unsustainable growth” in the pension liability (BBC, 2014). Many large US companies also shifted to DC to reduce costs including General Motors in 2012.

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