Defined Benefit Plan

Definition

Defined benefit plan is basically a retirement related plan that is sponsored by the employer and where an employee’s benefits are determined on the basis of a formula utilizing factors like employment duration and history of salary. Managing portfolio and risking investment is completely under the entity’s control. Besides, restrictions with regard to how and when an employee can withdraw the funds without being penalized also exist for the plan.

The International Accounting Standard 19 Employee Benefits lays down the accounting related requisites for employee benefits, which typically includes short-term benefits such as salaries, wages and annual leaves, post-employment benefits like benefits after retirement, termination related benefits and other long-term benefits. As per the standard, the cost of offering employee related benefits must be recognized in the same period during which the employee earns the benefit, instead of when it is payable or paid, and also lays down how every category of employee related benefits are recognized and measured, offering detailed guide, especially regarding post-employment related benefits.

Thus, defined benefit plan is essentially a post-employment benefit related plan that includes both informal and formal practices that result in a constructive obligation to the company’s employees.

Accounting for defined benefit plans

In case of defined benefit plans, the benefit amount that is recognized in the balance sheet must be the existing value of the defined benefit obligation and is adjusted for actuarial benefits and losses that are unrecognized in addition to past services related cost that has not been recognized and minimized by the plan assets’ value that is fair.

The existing value of the defined benefit obligation must be determined utilizing the Projected Unit Credit Method. The valuations must be conducted with enough regularity in a way that the amount that is recognized in the statements is not different materially from the amounts that would be assessed at the date of balance sheet. The assumptions that are utilized for the purpose of these valuations must be mutually compatible and unbiased. The rate which is utilized for discounting estimated cash flows must be assessed by reference to market produce at the date of the balance sheet on premium quality corporate related bonds.