Topic: Accounting
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Fundamentals of Pension Accounting and Funding
Pension Accounting - the annual pension expense calculation and disclosure of a pension plan's assets and liabilities in a company's financial statement. The Financial Accounting Standards Board (FASB) governs pension accounting under generally accepted accounting principles (GAAP) in the U.S.
Pension Funding - the cash contributions that are made to the pension plan. Pension funding is governed by laws described in the Internal Revenue Code (IRC), which determine the annual minimum required contribution and the annual maximum tax-deductible contribution.
Pension plan formulas are generally designed to tie the participants' benefits at retirement to their compensation and/or service with the employer. Each employer chooses how to reflect compensation and service based on their individual business needs and the needs of their workforce. Pensions are a form of deferred compensation . Participants trade compensation today for future pensions tomorrow. Both the pension funding rules and pension accounting rules require that the cost of that deferred compensation be recognized as it is earned.
Both pension funding and accounting require assumptions to be made about the future. These assumptions are called actuarial assumptions and they, along with current plan participant data and the benefit formula described in the pension plan, are used to project future benefits. For pension funding, the law gives the plan's actuary responsibility for the selection of actuarial assumptions. For pension accounting, the plan sponsor selects the actuarial assumptions, with guidance from the actuary. Actuarial assumptions for pension accounting are also generally reviewed by and approved by the company's external auditors in their general auditing of a company's financial statements.
Source: www.actuary.org
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