Financial statements of defined benefit pension plans
In this post we look over the different areas of the financial statements that are affected by a defined benefit pension plan.
Statement of Financial Position
Both the pension assets and pension liabilities will be recorded in the statement of financial position.
Pension assets
Pension assets are the assets that will be invested to provide the eventual pension for the retired employees.
Hopefully these assets will provide enough of a return to pay out when the employees reach retirement.
Pension liabilities
There’ll also be a pension liability, which is the present value of the payments we expect to make to the retired employees.
We’ll calculate how much we expect to owe the employees at retirement, and discount it back to their present value.
These pension assets and liabilities will net out to one line on the statement of financial position, either a net pension asset, or net pension liability.
Keep in mind this is one of the rare times the international accounting standards allow these sorts of things to be netted off, normally an individual line item for each is needed.
Calculating the net deficit or surplus
The net deficit or surplus of the pension plan is the difference between:
- Plan’s assets
- PV (present value) of future obligations
The plan’s assets are measured at fair value, which is the market value of any investments it may hold.
The future obligations of the pension plan are the amounts the plan will have to pay its members when they retire.
Because the future obligations are long term, they are discounted back to give a present day value.
Asset or liability?
If the plan’s assets are worth more than the future obligations, there may be an asset in the SOFP of the employer.
This will depend if the employer is entitled to receive any surplus, in some cases the money may go to the employees or the pension plan manager.
If there’s a deficit, so the assets are worth less than the present value of future obligations, this will be recorded as a long term liability in the SOFP.