Pensions and Financial Reporting

Abstract

This note serves a wide audience. At Darden, it is used in two elective courses: Financial Reporting and Analysis and Financial Statement Analysis and Corporate Valuation, as well as in the open executive education program, Financial Management for Non-Financial Managers. It will also be used in the EMBA and Global EMBA programs. Depending on the type of pension plan offered, accounting for pensions can present one of the more difficult and challenging financial reporting issues that companies encounter. This note outlines the differences between defined benefit and defined contribution pension plans. It is written for students, managers and executives who have an interest in the topic but have limited accounting and financial reporting backgrounds. It covers the two major types of pension plans and the accounting and financial reporting challenges they present. It also includes an explanation of how corporate pension plans affect financial statements and the footnotes. It also mentions public pension plans. It includes an example from an actual corporate annual report. Pensions are a major global issue for corporations, countries, states and cities. Excerpt UVA-C-2340 Feb. 7, 2013 PENSIONS AND FINANCIAL REPORTING Since the 1940s, U.S. corporations have been providing some type of pension benefits for their employees, primarily as a means of attracting and retaining desired personnel. Depending on the type of pension plan offered, accounting for pensions can present one of the more difficult and challenging financial reporting issues that companies encounter. The reason for this is that the traditional type of pension plan offered to employees can result in benefits that are earned over a 40- to 50-year period, which creates a promised payout period of 20 years or more. As a consequence, pension accounting can be heavily dependent on estimates, judgments, and discounting assumptions. This traditional type of plan is known as a defined benefit pension plan. Before describing this pension plan, however, we will first describe a much simpler type of plan known as a defined contribution (DC) pension plan. Defined Contribution Plans DCs are the simplest and most straightforward corporate pension plans. These plans promise a specific monetary contribution to an employee's pension account. The employee usually has an opportunity to influence where the contributed funds are invested and, in return, bears the responsibility for the investment risk. For example, a plan might promise to contribute 8% of an employee's salary to an investment account for the employee's benefit. Typically, these plans (e.g., 401(k) plans) have the employer matching employee contributions to approved investments. Upon retirement, there is often an opportunity to cash out with a lump-sum payment or to select an annuity where a payment is made to the retiree over some specified period of time. The accounting for (DC) plans is also simple and straightforward. In each accounting period, the promised contributions are reported as an expense, and a payment is made to the employee's account or trust. After that, the employer has no further responsibility or obligation. . . .