Crash Course in Accounting and Financial Statement Analysis, Second Edition

Defined Benefit Plan

The plan allows employers and/or employees to make annual contributions:

• Unlike the defined contribution plan, which has fixed annual contributions but no guaranteed return upon retirement, contributions under the defined benefit plan vary based on numerous assumptions about investment returns of the defined benefit pension plan. Companies have the task of determining how much they need to fund a plan each period in order to satisfy a defined obligation upon an employee’s retirement.

• Unlike the defined contribution plan, by which the amount of retirement benefits depends on accumulated contributions and their investment returns, retirement benefits under the defined benefit plan are fixed and are based on individual employees’ salary history and years of service for the company.

• Contributions to the defined benefit pension plan are protected by the Pension Benefit Guarantee Corporation (PBGC), a U.S. federal agency.

In the Real World: Estimating Annual Contributions Annual contributions on the behalf of employers are determined based on the amount required to fund the company’s pension liabilities stemming from current-year employees. However, the exact amount of these pension liabilities cannot be determined until current employees retire. Accordingly, companies hire actuarial firms, whose expertise lies in estimating the amount of pension liabilities. To arrive at the estimated amount of pension liabilities, actuaries use many assumptions, including: Expected ...