Question

Your employer gave you an option between a defined contribution pension plan and a defined benefit pension plan. Recall what each plan offers and choose the plan that works best for you. Support your response with facts about each plan. Also, consider the accounting method your employer uses to report these expenditures. How does this method compare to an Endowment fund? Identify any similarities and differences between pension plan reporting and endowment fund reporting.

Answer 1

A defined contribution (DC) plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis.

Whereas in defined benefit pension plan is a type of pension plan in which an employer/sponsor promises a specified pension payment, lump-sum on retirement that is predetermined by a formula based on the employee's earnings history, tenure of service and age

Since in defined contribution plans, future benefits fluctuate on the basis of investment earnings, but in defined benefit plan an employee is entitled to a pre-determined lump-sum, therefore as a rational employee I will opt for the defined benefit plan because it is better to get a fixed amount at the time of retirement rather than being always uncertain about you actual retirement income. Also, if one has a fair idea of what he is going to get at the time of retirement he can plan his spending and also make invest plans accordingly to save any hassle later on.

Accounting treatment for defined contribution plan is a simple journal entry in the books of employer which is:    

DR Pension Expense,

CR Cash

(Being contribution made to the employees’ pension)

But in defined benefit pension plan the pensions accounting treatment for defined benefit plans requires:

To determine the fair value of the assets and liabilities of the pension plan at the end of the year

To determine the amount of pension expense for the year to be reported on the income statement

The net asset or liability position of the pension plan on a fair value basis

Pension expense is an expected value and when the actual value of the pension differs, those deviations are recorded through other comprehensive income (OCI) under IFRS, which is a complex procedure.

Accounting method for endowment fund is also complex and difficult to calculate because an endowment fund is an investment fund established by a foundation that makes consistent withdrawals from accumulated fund. Usually, the more endowments an organization has, the more stable and established it is. Accounting for endowments can be difficult because each endowment may have its own contract and compliance issues.

Differences are: -

Since endowment accounting can be complex and endowment types vary, nonprofits should disclose additional information regarding their endowments. GAAP requires nonprofits to disclose specific endowment fund information in their annual financial statement notes. Nonprofits should detail the balance of unrestricted and permanently restricted endowments and note the types of endowments they hold. They also must explain the nonprofit spending and investing policy for the endowment, as well as the board's understanding of the laws governing the endowments. Whereas pension plan reporting involves preparation of a Statement specifically applies to pension plans that administer benefits through trusts that meet all three of the following criteria:

Contributions from employers (and by other governments and entities on behalf of the employers) are irrevocable.

Assets in the trust are dedicated to providing pension benefits to the plan members.

Assets in the trust are protected from the creditors of the employers (and other contributing governments and entities), the plan administrator, and the plan members (for defined benefit pensions).

Similarities include: -

Both endowment fund reporting and pension plan reporting involves accumulation of funds at regular interval basis.

Both endowment fund reporting and pension plan reporting works on accrual basis for reporting.