Defined Benefit Plan
Defined benefit plan is an employee benefit plan in which the employer commits to pay its employees a defined amount in future which is based on the employee's salary and years of service. IAS 19 Employee Benefits defines defined benefit plan simply as all employee benefit plans other than defined contribution plan.
EBP Ltd. has post-retirement benefits plan which entitles its employees to an amount equivalent to the product of its basic salary and number of years of service at the time of retirement. DCP Ltd. too has a pension plan but its agreement with the employees requires DCP to contribute an amount equal to the sum of current basic salaries of current employees to the fund.
EBP's plan is a defined benefit plan because it entitles employees to a defined amount in future (which is based on future salary). This is a defined contribution plan because the employees only receive an amount equal to their salaries today.
Net pension asset/liability
On the balance sheet the employee presents a net pension asset or a net pension liability. A net pension asset arises when the plan assets are higher than the present value of debit benefit obligation (PVDBO) (also known as projected benefit obligation) while a net pension liability arises when the PVDBO (or PBO) is higher than the plan assets.
Actuaries have calculated that project benefit obligation of EBP's pension plan is $30 million and $36 million in 2010 and 2011 respectively. At the end of 2010, EBP had plan assets of $32 million. During 2011, EBP contributed as amount of $2 million to the fund and paid out benefits of $5 million.
EBP will report a net pension asset of $2 million for the financial year 2010 ($32 million plan assets minus $30 million obligation). At the end of financial year 2011, its obligation is $36 million and its plan assets are $29 million ($32 million + 2 million (contribution) − 5 million (benefits paid out)). It will report a net pension liability of $7 million at the end of financial year 2011 (difference between plan assets of $29 million and obligation of $36 million).
A company with a defined benefit plan reports service cost, interest cost, actual return on plan assets, amortization of prior service cost, and actuarial gains and losses on its income statement. Each expense line item is classified according to its nature.
Written by Obaidullah Jan, ACA, CFAhire me at