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etween the previous actuarial assumptions and what has actually happened.
Past service cost. The increased present value of a defined benefit obligation for employee service in previous periods that has arisen because of the
introduction of changes to the benefits payable to employees. Past service costs may be positive or negative depending on whether the benefits are improved or
reduced.
DEFINED CONTRIBUTION PLANS AND DEFINED BENEFIT PLANS—CLASSIFICATION
In defined contribution plans, an entity pays a fixed contribution into a separate entity (fund) and will have no legal or constructive obligation to pay further
contributions if the fund does not have sufficient assets to pay employee benefits relating to employee service in the current and prior periods. An entity should
recognize contributions to a defined contribution plan where an employee has rendered service in exchange for those contributions.
All other postemployment benefit plans are classified as defined benefit plans. Defined benefit plans can be unfunded, partly funded, or wholly funded.
DEFINED BENEFIT PLANS
IAS 19 requires an entity to account not only for its legal obligation to defined benefit plans but also for any constructive obligation that arises.
In accounting for defined benefit plans, an entity should determine the present value of any defined benefit obligation and the fair value of any plan assets with such
regularity that the amount shown in the financial statements does not differ materially from the amounts that would be determined at the end of the reporting period.
Defined benefit plans should use the projected unit credit method to measure their obligations and costs.
DEFINED CONTRIBUTION PLANS
Under a defined contribution plan, payments or benefits provided to employees may be simply a distribution of total fund assets or a third party—for example, an
insurance entity—may assume the obligation to provide the agreed level of payments or benefits to the employees. The employer is not required to make up any
shortfall in the fund’s assets.
CONTRASTING DEFINED BENEFIT AND DEFINED CONTRIBUTION
Under the defined benefits scheme, the benefits payable to the employees are not based solely on the amount of the contributions, as in a defined contribution
scheme; rather, they are determined by the terms of the defined benefit plan.
This means that the risks remain with the employer, and the employer’s obligation is to provide the agreed amount of benefits to current and former employees. The
benefits normally are based on such factors as age, length of service, and compensation.
The employer retains the investment and actual risks of the plan. The accounting for defined benefit plans is more complex than defined contributions plans.
Facts
CASE STUDY 2
According to the pension plan of an entity, the employees and entity contribute 5% of the employee’s salary to the plan, and the employee is guaranteed a
return of the contributions plus 3% a year by the employer.
Required
What classification would be given to the above pension scheme?
Solution
It is a defined benefit plan, as the employer has guaranteed a fixed rate of return and therefore carries the risk.
ACCOUNTING FOR DEFINED CONTRIBUTION SCHEMES