Question

Respond to the following in a minimum of 175 words:

Discuss the role that pension funds play in company pension plans. What benefits accrue to companies who elect to use pension funds? How does the use of a pension fund change the accounting that must be done with respect to employee pension amounts?

Answer 1

Question: Pension Fund roles, benefits, treatment.

Solution:

The role that pension funds play in company pension plans.

A pension plan is a retirement plan that requires an employer to make contributions to a pool of funds set aside for a worker's future benefit. The pool of funds is invested on the employee's behalf, and the earnings on the investments generate income to the worker upon retirement.

Benefits accrue to companies who elect to use pension funds.

Pension funds can be more or less segregated or not legally separated from the balance sheet of the plan sponsor. The plan sponsor taking the form of either a special-purpose legal entity (a pension entity) or a separate account managed by financial institutions on behalf of the plan members or in the form of a reserve, the sponsor can use pension assets (reserve) to fund its business.

The use of a pension fund changes the accounting that must be done with respect to employee pension amounts.

The employer promises to pay a pension to the employee in retirement. The size of the payment is typically related to the number of years of service and the salary of the employee during the years of service.

This promise immediately creates an obligation for the company that needs to be recognized on the balance sheet as a liability. The liability after considering the following

i. Present Value of the defined benefit obligations at the balance sheet
                                  (minus)
ii. Any past service cost not yet recognized
                                  (minus)
iii. Fair Value at the balance sheet date of the plan assets (if any) out of which the obligations are to be settled directly

The unfunded scheme would be simpler, as there would be no pension assets on the balance sheet (take out insurance against company bankruptcy). For a funded scheme, there is both a pension asset and a pension liability on the balance sheet.

The difference between actual and expected return on assets and the impact of changes in actuarial assumptions are referred to as actuarial gains and losses.