What Pension Information Should Be Disclosed on Financial Statements?
Pension plans consist of two types of plans: defined benefit and defined contribution. A defined benefit plan specifies the employee benefits to be paid at retirement. In a defined contribution plan, the contributions made by the employer or sponsor company are specified, along with the way the contributions should be allocated to employees. Accounting and disclosure of pension information consists of the pension expense reported on the sponsor’s income statement; plan asset, liability and/or other comprehensive income (OCI) accounts reported on the balance sheet; as well as footnote disclosures.
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Net Pension Expense
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The net pension expense consists of six items: current service cost; interest cost; expected return on plan assets; amortization of prior service cost; gain or loss amortization due to plan asset or benefit assumption changes; and amortization of existing net obligation or net asset.
The current service cost, interest cost, amortization of prior service cost, loss amortization and amortization of existing net obligation increase the expense amount.
The expected return on plan assets, gain amortization and amortization of existing net asset reduce the expense.
The total net pension expense is reported as a line item on the income statement, and the components that make up the expense are detailed in the pension plan’s footnote disclosures.
Pension Plan Asset or Liability
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When the fair value of plan assets are greater than the plan’s benefit obligation, the pension is considered "overfunded" and a plan asset should be recorded. The pension plan asset is always reported as a noncurrent asset on the balance sheet.
When the plan’s benefit obligation is greater than the plan assets, the pension is underfunded and a plan liability should be recorded. The amount of the liability reported on the balance sheet can be current, noncurrent or both.
Any excess benefit obligation that is payable within the next 12 months is a current liability. Amounts payable in a future period would be categorized as noncurrent.
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Accumulated Other Comprehensive Income
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Pension gains or losses, prior service costs and net assets or obligations are reported in accumulated OCI (an equity account on the balance sheet) when they are incurred. Pension losses, prior service costs and net obligations increase pension expense when recognized for tax purposes; this decrease in future taxable income results in a deferred tax benefit recorded in accumulated OCI. Pension gains and net assets will decrease pension expense when recognized for tax purposes; this increase in future taxable income results in a deferred tax expense recorded in OCI. The deferred benefit or expense is amortized over time through net pension expense.
Pension Plan Footnote Disclosures
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There are various required pension plan disclosures listed in the footnotes to the financial statements. Some of the disclosures include reconciliations of beginning and ending balances of the plan’s benefit obligation and the fair value of the plan assets, that is, the funding status of the plan along with a list of plan assets and the impact of adjustments affecting OCI.
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References
- “Financial: CPA Exam Review”; DeVry/Becker Educational Development Corp.; 2009
- American Academy of Actuaries; Fundamentals of Current Pension Funding and Accounting for Private Sector Pension Plans; July 2004
