Accounting for Post-Retirement Benefit Expenses

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  • 0:04 Post-Retirement…
  • 0:56 Post-Retirement…
  • 1:55 Defined Benefit…
  • 4:41 Accounting
  • 6:01 Lesson Summary
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Lesson Transcript
Instructor: Shelumiel Ryan Abapo

Shelu is a Certified Public Accountant, SAP Business One Consultant, University Professor handling Taxation, Financial Accounting, Cost Accounting and Basic Accounting

In this lesson, you will learn the two types of post-employment benefit plans that employers might set up for their workers. You'll also see the accounting treatment of the two types of retirement plans and the different components of the post-retirement benefit expense to be recognized.

Post-Retirement Benefits Overview

Imagine owning a business and employing several workers. Once hired, you would be accountable to pay these workers for their services.

All forms of consideration given to employees for their services are employee benefits. They include post-employment benefits, short-term and long-term benefits, as well as termination benefits. Post-employment benefits are also known as post-retirement benefits. They refer to the compensation received by your workers at the end of their employment, except if due to termination.

Post-retirement employment benefits might include pensions and lump sum payments upon employees' retirement. They might also cover post-employment life insurance and post-retirement medical care.

Post-Retirement Benefit Expense

Formal or informal, giving post-retirement benefits to your workers costs you money. Post-retirement benefit expense refers to the cost of pension recognizable for the period. There are several components in computing for post-retirement benefit expense, but they depend on the type of plan established by your company. These plans can either be a defined contribution plan or a defined benefit plan.

A defined contribution plan calls for fixed contributions. You and your employees contribute into a separate fund. Your contribution to the retirement fund will be the post-retirement benefit expense.

A defined benefit plan aims to provide agreed benefits to your employees. It guarantees that your workers will receive a specific amount of benefits. They depend on the salary upon retirement and the corresponding years in service. As such, the defined benefit expense is comprised of several components.

Defined Benefit Expense Components

Some components of defined benefit expense include the following:

Service cost is the amount you need to set aside for the current period. This amount will match the retirement benefits that have accrued to your employees. Service costs are determined by computing the present value of the retirement benefits earned by your employees. Factors that you have to consider are the number of workers and any planned increases in compensation.

Interest cost is the net interest arising from your employee's retirement plan. It refers to the difference between the interest on your benefit obligation and the interest income on the plan assets.

Plan assets are those held by a long-term fund that are available to pay only employee benefits. In fact, plan assets are not available to your creditors even in bankruptcy. The return on plan assets refers to interest, dividend, and other income derived from them. It also includes any realized and unrealized gains and losses on your plan assets.

Amortization of prior service cost refers to the gradual recognition of pension expense to be incurred in the future as a result of changes made to the defined benefit plan formula. To illustrate, say your company has amended the employees' pension plan. The policy change has increased your company's projected benefit obligation by $100,000. Based on your company's data, the average time until retirement for this group of employees is 10 years. Accounting standards require your company to amortize the pension cost of $100,000 over 10 years. This thereby increases your pension expense by $100,000 or $10,000 per year for the next 10 years.

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