Introduction
Generally, every organization has the obligation of ensuring that its employees are provided with a source of income when they are retired or when they are no longer in a stable condition to continue working. This benefit has been ensured through implementation of the pension plan. However in this article, the pension plan understanding is developed and brought out in such a way that it is not befuddled with the severance pay. This article develops the understanding of the retirement plan as the pension issued once an individual has retired. Tracing the retirement plans to the origin, these arrangements have mainly been prepared by the insurance companies, employers, government, and various other organizations. In the United States, what has mainly been referred to as the retirement plan has been understood as the pension schemes in Ireland and United Kingdom. Specifically, this article critically looks at the various aspects of the pension plans as related to employee compensation. These pension plans not only represents the US funding larger part but also largely represents the main type of pension plans adopted by the local and state governments.
Pension plans as utilized by firms
Basically, Hann and colleagues (2007) perceive the pension plan as not only important for the employers but it can also be the best available tax shelters. The contributions can be deducted thereby making these deductions to be transferred to the worker. Hann adds that implementation of the security act of the Employee Retirement Income has been enhanced through the effort of the Employee Benefit Security Administration (EBSA). The first provision of the EBSA provides a cover to various benefits plans of the employees in the private sector. The voluntary establishment and maintenance of such plans is mainly accredited to the effort of the employer, the employee organization or through a joint or more than one organization of employer.
As a category of the employee benefit plan, the retirement plans are perceived to be founded and maintained with an aim of providing retirement earning. These plans are also established with an aim of ensuring that the employees’ income is deferred until the time when the agreement allows for revocation of the agreement. In addition, the welfare plans are also another type of employee benefit plan that is founded and upheld with an aim of ensuring that death benefits, disability benefits, health benefits, vacation benefits, prepaid legal benefits, training benefits, apprenticeship, and day care benefits are provided.
The two categories of pension plans
Hann et al. (2007) have detailed two categories of pension plans which are defined benefit pension plans and defined contribution benefit plans. As it has traditionally been understood, the defined benefit has mainly been perceived to be the plan clearly formulated by well established goals as opposed to being stack to the investment returns. For instance, in the United States, the pension benefit legislation clearly give the specifics of the benefit plan. In the United States context, the defined benefit plan is perceived incorporate any pension plan that has not been incorporated in the definition of the pension plan. In the defined benefit pension plan, the benefit is devised by a formula incorporating the payment of the employee, the employment years and the retirement age among various other factors. For instance learning from the Dollar Times Service, the design is developed in such a way that a specific amount is provided on monthly basis for the period that the employee remains in a particular company. Therefore, a plan that offers $100 on monthly basis for every year of service has a likelihood of awarding the retiree with a monthly benefit of $3,000 as long as the employee has made contribution for a period of more than 30 years (Hann et al., 2007).
The contributions in the defined contribution scheme are channeled to every member’s individual account. After making these contributions, they are invested in various profitable ventures. The returns from these investments are then credited to the account of every individual. Once these members have retired, their accounts are used in providing the retirements benefits, at times via an annuity purchase through which regular income is later provided. With this benefit, the prominence of the defined contributions has widely spread to the global level in the recent years. At the current moment, this type of plan is perceived to be a dominant plan in various countries’ private sectors. For example, in the United States the defined benefits plans membership has been rapidly reducing based on the fact that an increasing number of people perceive the pension contributions as a high expenditure that can avoided through dissolution of the defined benefit plans as opposed to offering a defined contribution plan.
The accumulated benefit obligation
The accumulated benefit obligation is perceived to be an approximation that is employed when measuring the liability of the pension plan. The estimation of this obligation is solely based on the supposition that there has to be an immediate termination of the pension plan without considering any increases in the future salaries. In the explanation detailed by Hann et al. (2007), evaluation of the pension accounting in any company can be a significant analysis piece for the investors. Therefore the pension accounting is an aspect that can ensure the aggressiveness of a company in various ways, such as the rate of discounting employed for the obligations of future pensions. Hann et al. (2007) has highlighted the difference of accumulated benefit obligation from the projected benefit obligation which is mainly based on the understanding of the pension plan as a continuous arrangement. Therefore based on this assumption held in the projected benefits obligations, the future salary accounting continually increases.
Detailing the significant difference existing between the accumulated benefit obligation and the projected benefit obligation (PBO), Stewart, and Yermo (2008) perceives the latter as the amount of commitment that will be required by the company in order to ensure the future of its employees is covered. In the various companies, the actuary is usually incorporated for the PBO calculation based on the fact that the pensions may be characterized with complexities. The PBO considers the period of time that the employee remains employed and any future obligations changes that are to impact the pensions of the employee. Through incorporation of the financial statement analysis, the accountant can possibly work backwards in the PBO calculation.
When the PBO is being calculated, the initial stage involves determining the status of the funded pension plan on the balance sheet of the company. The funded status has a possibility of being noncurrent asset, a noncurrent liability, or current liability. Alternatively, the funded status can also possibly adopt the three forms based on the fact that the funded status will be reported by the accountant as per the plan. For instance, consider a pension plan of a company that has a funded status of noncurrent asset totaling $700 and the funded status of the non-current liability totaling to $500. In such an instance, the funded status will total to $200.
The funded status
According to Hann et al. (2007), the funded status is perceived to be the retirement plan assets fair value minus the expected liability (benefit obligation). Before this equation is formulated, the underfunded pension plans have to be recorded as a liability on the balance sheet of a company because of the accounting rules that have been designed at smoothening the effect of the interest rates changes and the returns of the volatile market on the liabilities and assets of the retirement plan. By the year 2005, the standard financial accounting standards (SFAS) study was approximated to be unfunded by $243 with the funding of the postretirement plan being approximated at $770 million. Interestingly after the SFAS 158 was adopted one year later, the underfunding reduced to a new level of $116 with the postretirement and pension plans experiencing a registering a reduction to a new level of $659.
In the SFAS 158, the employees are specifically required to ensure that their obligation connected to the defined pension is recognized. In the financial position statement, the company has to recognize the underfunded or overfunded status of the postretirement plan defined benefit, measured as the variation between the plan assets fair value and obligation benefits. In addition, there has to be a coincidence between the measurement date when the funding status is determined and the date when the financial position statement was prepared by the employer.
Reporting the postretirement benefits in accounting statements
This reporting is perceived to recognize the plan funding status in the financial position statement. In addition, various components have to be disclosed by the employer. For each period when there is presentation of the income statement, actuarial loss, or gain or the prior cost of service or credit have to be recognized in other inclusive earning. Every time of presenting a financial position, the net actuarial gain and loss amount, the previous credit and costs have to be included in the other inclusive earnings. In addition, there has to be presentation of the average actuarial loss or gain that have been accumulated in other inclusive earnings that are recognized as the net periodic benefit cost component over subsequent fiscal year.
When the postretirement plan funding status is reported in the financial position statement, Novy-Marx (2008) cites elimination of certain disclosures. The existing disclosures of reconciling the plan funded status to the recognized amount in the employers’ financial position statement are eliminated. Based on the fact that the financial statement conforms to the plan measurement date, Novy-Marx (2008) emphasizes on the need for reporting the plan measurement date.
Actuary duty in the pension plan
Hanna et al. (2007) perceives the actuary as a highly trained statistician. This individual is endowed with the expertise to evaluate the various categories of risks. According to an estimate provided by Hanna and colleagues, more than half of the actuaries are mainly absorbed by the insurance industries and are mostly involved in various major roles when it comes to establishing the insurance policies, conditions and terms. In addition, the actuaries embark on the career of managing the pension funds. In this approach, these individuals forecast the payouts in the future in addition to establishment of the existing investment policies and contributions. In addition, Hanna highlights the important role played by the actuary when it comes to designing and implementation of the procedures and policies that can result in risk mitigation in various operation aspects.
Detailing the important aspect of actuary in the pension plans, Hanna has detailed the comprehensive information that also covers on the valuation of the actuary. In the valuation report, there are specific information and disclosures that need to be provided when necessary. From this explanation, Hanna upholds the importance of the actuary being able to disclose the long term trends of costing that are expected to result from the continuous utilization of the existing methods and assumptions. In addition, the actuary has to be able to disclose any facts based on the fact that failure to divulge will automatically result in incomplete comprehension of the results of valuation. Hanna also upholds the importance of the actuary disclosing all the important happenings that takes place after the date of valuation that would affect the results valuation.
Legal issues
Stewart and Yermo, (2008) upholds the importance of good governance when it comes to effective system of private pension. Through this approach, the investment performance is likely to be benefited coupled with enhancing other security benefits. However although there has been industry and regulatory initiatives, there are still various weaknesses that have been perceived to persist. These weaknesses persists when it comes to the policy making process. For instance, Stewart and Yermo (2008) highlight the challenge that is basically based on absence of government arrangements for the defined styles of pension contributions. To address this challenge, one course of action involves incorporation of the management committees, enhanced fiduciary responsibility for the pertinent parties or even increased roles for the authorities involved in pension supervision. Overcoming this challenge may also require pension industry consolidation in some nations in order to ensure that the economy of scale is achieved. This achievement would in turn allow the pension funds to have more resources being dedicated to the internal governance strengthening (Ambachtsheer, Capelle & Lum, 2006).
The approach incorporated in investing and supervision of the registered pension plans assets is important when it comes to ensuring the success of the pension plans. When the pension assets are regulated and supervised, two goals are achieved: firstly, the security and safety of these assets is assured and in addition, an environment is created in which the management of the assets can obtain the best returns at a risk level that is acceptable. This approach should be based on the understanding that in most of the countries, the pension funds represents the major source of capital.
Conclusion
This article has comprehensively evaluated the various aspects of pension plans as related to employee compensation. From the explanation detailed in this analysis it is hence apparent that in various retirement, health and aging issues, the main issue pertains ensuring that the pension plan is a future security. From the perspective adopted in the funded statuses results, economic consequences may accompany the postretirement plans. Therefore there is a high likelihood of the underfunded plans firms experiencing a cost increase as a result of lenders behavioral changes. Therefore, only time can tell whether the funding statuses reporting will affect the employee and the capital costs, particularly when the companies have underfunded plans. However with a comprehensive pension plan, it is apparent that the future risks are likely to be significantly reduced as a result of certainty of continued sustenance even when an employee ceases from the employment.
References
Ambachtsheer, K., Capelle, R. & Lum, H. (2006). The Pension Fund Governance Today:
Strengths, Weaknesses and Opportunities for Improvement. Financial Analyst Journal.
Hann, R., Lu, Y. & Subramanyam, K. (2007). Uniformity vs. flexibility: evidence from pricing
of the pension obligation. The Accounting Review 82 (1): 107-137. 33
Novy-Marx, R. & Joshua D. (2008). The intergenerational transfer of public pension promises.
National Bureau of Economic Research Working Paper 14343.
Stewart, F. & Yermo, J. (2008). Pension Funds Governance: Challenges and Potential
Solutions”, OECD Working Papers on Insurance and Private Pensions. No. 18, OECD
Publishing.
