Cotter Corp. reports the following information (in hundreds of thousands of dollars) to you about its defined benefit pension plan for 2011:

Cotter Corp. reports the following information (in hundreds of thousands of dollars) to you about its defined benefit pension plan for 2011:

Actual return on plan assets ………………………………   11

Current service cost ……………………………………..  21

Benefits paid to retirees …………………………………   8

Interest cost ……………………………………………..    9

Contributions from employer …………………………… 20

Opening balance, accrued benefit obligation (ABO) …… 92

Cost of plan amendment in year …………………………   13

Opening balance, fund assets ……………………………   100

Provide a continuity schedule for the ABO for the year.

Accrued benefit obligation, opening balance          $92

Interest cost                                          9 

Current service cost                                  21

Benefits paid to retirees                                    (8    )

Past cost of plan amendment in year                   13

Accrued benefit obligation, ending balance          $127

Unsure Corp. has recently decided to implement a pension plan for its employees; however, it is unsure if it would like to structure the pension as a defined contribution plan or a defined benefit plan. As requested by management, prepare a short memo outlining the nature of both plans, along with the accounting treatment of each plan.

A Defined Contribution Plan (DC)

A defined contribution (DC) plan is a post-employment benefit plan that specifies how the entity’s contributions or payments into the plan are determined, rather than identifying what benefits will be received by the employee or the method of determining those benefits.

For a DC pension plan, the amounts that are contributed are usually turned over to an independent third party or trustee who acts on behalf of the beneficiaries (the participating employees). The trustee assumes ownership of the pension assets and is responsible for their investment and distribution. The trust is separate and distinct from the employer.

The ultimate risk and reward of the DC pension rests with the employees as the employer’s involvement is essentially limited to making the annual contribution each year.

Therefore, the accounting for a DC pension is relatively straight-forward.  The employer’s obligation is dictated by the amounts to be contributed.  Therefore, a liability is reported on the employer’s balance sheet only if the required contributions have not been made in full, and an asset is reported if more than the required amount has been contributed.

The annual benefit cost (i.e., the pension expense) is simply the amount that the company is obligated to contribute to the plan.

A Defined Benefit (DB) Plan

A defined benefit (DB) plan is any benefit plan that is not a defined contribution plan. It is a plan that specifies either the benefits to be received by an employee or the method of determining those benefits.

Similar to a DC plan, for a DB pension plan, the amounts that are contributed are usually turned over to an independent third party or trustee who acts on behalf of the beneficiaries.

The ultimate risk and reward of the DB pension rests with the employer since the employer must guarantee that a set retirement benefit will be paid to the employees. The benefits typically are a function of an employee’s years of service and compensation level in the years approaching retirement.

To ensure that appropriate resources are available to pay the benefits at retirement, there is usually a requirement that funds be set aside during the service life of the employees.

Therefore, accounting for a DB is much more complex.  The pension cost and accrued benefit obligation depends on many factors such as employee turnover, mortality, length of service, and compensation levels, as well as investment returns that are earned on pension assets, inflation, and other economic conditions over long periods of time.

Because the cost to the company is affected by a wide range of uncertain future variables, it is not easy to measure the pension cost and liability that have to be recognized each period as employees provide services to earn their pension entitlement.

This is not intended to be a comprehensive discussion of all issues associated with the DB, but rather, to highlight some of the key differences between a DB and DC pension.