Respond to the following: a. What are the two major accounting issues related to a defined benefit plan? b. Why do pension expense and pension liability recognition problems not arise with defined contribution plans?
What will be an ideal response?
ANSWER:
a. The major accounting issue that emerges in a defined benefit pension plan is that of whether or not the sponsor has an obligation to meet the projected cost of pension benefits arising from employee service to date. If so, any unfunded accumulated benefits give rise to an accounting liability that should be recognized.
A second accounting question concerns the recognition and measurement of yearly pension expense: is it simply the cash contributed to the pension fund, or is it a more complex accrual based on the yearly increase in accumulated benefits?
b. Defined contribution plans do not present difficult accounting problems because an expense is recognized for the sponsor’s contribution made in accordance with the terms of the plan. No further obligation exists because pension benefits attributable to employee service to date are restricted to the accumulation of past contributions. Accumulated benefits are fully funded by the sponsor as long as each year’s required contributions are made. An expense and liability should be accrued for the current year’s required contribution, and the liability is discharged when the contribution is made.
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