Accounting Defined benefit plan
International Accounting Standard (IAS 19) explains accounting for employee benefits. An employee benefit refers to all kinds of payments given by a company in exchange services offered by employees or payment for employment payment. According to IAS 19 entities are required to recognize:
- All liabilities after employees have offered services in exchange for benefits paid to employees in the future.
- Cost when the company consumes the economic benefit that arises as a result of the services offered by employees to compensate for the employee benefit.
The employees’ benefits are classified into a defined contribution plan and defined benefits plan. The defined contribution plan specifies the amount of money contributed to the pension plan. According to this plan investment risk is incurred by the employees.
The defined benefit plan specifies the amount of money received by the employees in payment of services rendered and benefits are paid during retirement. According to IAS 19 the employer suffers the investment risk.
Discuss the reasons why companies face increasing costs in relation to their defined benefit schemes
Companies today face an increase in cost related to their defined benefit scheme as a result of an increase in service cost. Service cost refers to the actuarial present value of the benefited associated with the service during the present reporting period. Services cost includes the level of future compensation to the employees based on the befit payment for the services offered. Second, the defined benefit schemes increase is a result of the interest cost for the future benefit obligation. Interest cost is more of a financial item as compared to cost associated with employee compensation.
main reasons for growing costs and deficits in defined benefit schemes
Life expectancy
Life expectancy determines the cost and deficit of defined benefit scheme. The life expectancy of the defined benefit scheme refers to the length of time that the employee will receive his or her periodic retirement benefits. It is hand to know the payout option selected by the employees since their benefit status change with time. High life expectance means that an employee will receive more retirement benefits. As a result of this in the country where the life expectancy is high employees will be required to pay high defined benefit schemes as compared to employees with low life expectancy.
The interest rates of high-grade corporate or government bonds
The interest rate is another factor that affects the cost of define benefit schemes. The lower the discounting rate of the scheme, the higher the value of the scheme and hence the increase in the amount of contribution made. Most of the amount contribute are invested in government bonds and hence if the interest rate is low it means that the amount accrued by the company is low hence employees will be required to pay more so as to receive substantial retirement benefits.
Shocks in the stock market
Shock in the stock market affect the return on investment and hence increase the risk associated with the investment.