Post Employment Benefits: Defined
Benefit Plan
Introduction
A defined benefit (DB) plan is a type of employer-sponsored retirement plan that promises a specific
and predetermined benefit to employees upon retirement. The benefit amount is typically based on a
formula that considers factors such as the employee's salary history, years of service with the
company, and age at retirement. Unlike defined contribution plans, where retirement benefits depend
on the amount of contributions and investment performance, DB plans guarantee a specific benefit
amount regardless of investment returns.
Accounting for Defined Benefit Plan
Accounting for defined benefit plans is complex because actuarial assumptions are required to
measure the obligation and the expense and there is a possibility of actuarial gains and losses.
Moreover, the obligations are measured on a discounted basis because they may be settled many years
after the employees render the related service.
REQUIRED CONTRIBUTION ≠
EXPENSE
Here are the following steps to follow:
Step 1: Determine the Present Value of Defined Benefit Obligation
Step 2: Determined the Fair Value of plan assets
Step 3: Determine the Deficit or Surplus
Step 4: Determine the Net Defined Liability or Asset
Step 5: Determine the Defined Benefit Cost
Component of Define Benefit Cost
Service Cost:
Current Service Cost
the increase in the present value of the defined benefit obligation resulting from employee service in
the current period.
Illustration:
Past Service Cost
the change in the present value of defined benefit obligation for employee service in prior periods,
resulting from a plan amendment (the introduction or withdrawal of , or changes to, a defined benefit
plan) or a curtailment ( a significant reduction by the entity in the number of employees covered by a
plan)
Illustration:
Gain or Loss on Settlement
It arises when the amount of settlement is not equal to the carrying value of obligation distinguished.
Net Interest Expense
Interest Expense
Computed by multiplying the beginning balance of PV of DBO by the discount rate.
Interest Income = Beginning PV of Defined benefit Obligation x discount rate
Interest Income
Computed by multiplying the beginning balance of FVPA by the discount rate.
Interest Income = Beginning FV of plan asset x discount rate
Interest Expense on the effect of Asset Ceiling
Computed by multiplying the beginning effect of the asset ceiling by the discount rate.
Interest Income = Beginning effect of the asset ceiling x discount rate
Discount rate to be used is based HIGH QUALITY CORPORATE BONDS or ON
GOVERNMENT BOND in the absence thereof.
Remeasurements on net defined benefit liability or asset
Remeasurement on PV of DBO
Actuarial gains and losses - are changes in the present value of the defined benefit obligation resulting
from experience adjustments and the effect of changes in actuarial assumptions. Experience
adjustments are adjustments from the differences between the previous actuarial assumptions and
what has actually occurred. Actuarial assumptions are the entity’s best estimate of the variables that
will determine the ultimate cost of providing postemployment benefits. Actuarial assumptions
comprise of demographic and financial assumptions
Remeasurement on FVPA
Return on plan assets – the components of return on plan assets include the following:
1. interest, dividends and other revenue derived from the plan assets.
2. realized and unrealized gains or losses on the plan assets.
Change in Effect of Asset Ceiling
ASSET CEILING is the present value of any economic benefits available in the form of refunds from
the plan or reduction in future contributions to the plan.
The ASSET CEILING is a limit on the recognition of any surplus in the plan's
assets in the employer's financial statements. It ensures that the surplus is not
over-recognized, particularly if there are restrictions on the ability of the
employer to access the surplus.
Illustration:
Step 1: Determine the Present Value of Defined Benefit Obligation
PV of DBO
Debit Credit
Actuarial Gain xxx PV of DBO, Beg . xxx
Benefits Paid xxx Current Service Cost xxx
CA of DBO settled in advance xxx Past Service Cost xxx
Interest Expense xxx
Actuarial Loss xxx
PV of DBO, End. xxx
Step 2: Determined the Fair Value of plan assets
FVPA
Debit Credit
FVPA, beg. xxx Benefits paid xxx
Contribution to the plan xxx Settlement price of DBO settled in xxx
advance
Actual Return xxx
FVPA, end. xxx
Step 3: Determine the Deficit or Surplus
Scenario
If FVPA > PV of DBO Surplus
If FVPA < PV of DBO Deficit
Step 4: Determine the Net Defined Liability or Asset
Net Defined Liability Deficit
Net Defined Asset Lower of the Surplus and Asset Ceiling
Step 5: Determine the Defined Benefit Cost
Component Presentation
Service Cost
Profit or Loss
Net Interest
Remeasurements Other Comprehensive Income
Sample Problem:
The following information pertains to Hephaestus Corp.’s defined benefit plan for the year 2022:
Defined benefit obligation, January 1, 2022 P 2,200,000
Fair value of plan assets, January 1, 2022 1,400,000
Actual return on plan assets 90,000
Settlement price of additional DBO settled 200,000
Present value of additional DBO settled 250,000
Defined benefit obligation, December 31, 2022 2,070,000
Current service cost 800,000
Discount rate 10%
Benefits paid to retirees (at scheduled retirement) 700,000
Contribution made during the year 650,000
Past service cost 300,000
Requirements:
a. Ending balance of PV of DBO.
b. Ending balance of FVPA.
c. How much is the surplus or deficit on December 31,2022
d. How much is the net define benefit liability or asset?
e. How much is the define benefit cost?
Current Service Cost
the increase in the present value of the defined benefit obligation resulting from employee service in
the current period.
Projected Unit Credit Method
The projected unit credit method is a required to be used as actuarial valuation method for calculating
the present value of defined benefit pension obligations and determining related costs, including the
current service cost. This method is based on attributing a portion of the total expected benefit to each
period of service, reflecting the employees' accumulated benefit entitlements as they work.
Projected Credit Unit Method sees each period of service as giving rise to an
additional unit of benefit entitlement and measures each unit separately to build
up the final obligation.
Sample Problem:
CJ Ent. Co provide a lump-sum retirement benefit to employees equal to 8% of final salary for each
year of service. The following are the information regarding a certain employee named John:
Employee: John
Age: 35
Expected retirement age: 65
Current salary: P60,000 per year
Discount rate: 5% per annum
Expected salary growth rate starting nex: 3% per annum
Requirement:
a. Compute for the expected ultimate cost of a defined benefit of John.
b. How much is the current service cost in year 1 to year 5 expectedly.
c. How much is the balance of PV of DBO at the end of year 1-year 5.
