Question

Question 26 8 pts

Explain the difference between a defined benefit pension plan and a defined contribution pension plan. Also explain why the accounting for the two types of plans is so different. Hint: you do not need to explain the details of pension accounting.

Answer 1

In defined Benefit Pension Plan the employer contributes to the pension either through lumpsum or annual payments to the pension plan and promises to pay certain amount to the employee on his retirement, in this plan the obligation of contribution is with the employer in case of any shortfall whereas in defined contribution plan the employer contributes a fix amount to the pension and the other part may be contributed by the employee of there is shortfall in the plan. In the defined contribution pension plan the liability of the employer is only to the extend of cash contribution any shortfall is borne by the employee.

The accounting for these two plans are different because of the differences in obligation and contributions. In one case once the cash contribution is paid the liability is over while in contribution defined pension plan the employer needs to keep a check on the liability part because any shortfall needs to be contributed by the employer and hence there is difference in accounting.