Financial Accounting: In an Economic Context

PENSIONS

A pension is a sum of money paid to a retired or disabled employee, the amount of which is usually determined by the employees' years of service. For most large companies, pension plans are an important part of the employees' compensation packages, and they are part of almost all negotiated wage settlements. Pension plans are backed by contractual agreements with the employees and are subject to federal regulation.

Most pension plans are structured so that an employer periodically makes cash payments to a pension fund, which is a legal entity distinct from the sponsoring company. The cash, securities, and other income-earning investments that make up the fund are usually managed by someone outside the company, and the assets in the pension fund do not appear on the company's balance sheet. The employer's cash contributions plus the income generated through the fund's management (i.e., dividends, interest, capital appreciation) provide the cash that is distributed to employees upon retirement. The terms of the pension plan determine the amounts to which individual employees are entitled (benefits).

There are two primary types of pension plans: a defined contribution plan and a defined benefit plan.

Defined Contribution Plan

Under a defined contribution plan an employer agrees only to make a series of contributions of a specified amount to the pension fund. These periodic cash payments are often based on employee wages or salaries, and each employee's percentage interest ...