Defined Contribution Plans

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International Accounting Standard 19 (IAS 19) defines defined contribution plans as “post-employment benefit plans under which an entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods”.

In defined contribution plans, an entity pays a fixed amount of contribution into a separate entity or a fund. The fund will be responsible for payments of employee benefits to the employees. The benefit of defined contribution plans for an entity is that it does not have to pay any amount over and above the fixed contribution even if the fund does not have sufficient funds to pay the employee benefits relating to employee services in the current and prior periods. The entity is under no legal or constructive obligations to pay any amount further than the fixed contribution.

Under a defined contribution plan, payment or benefits provided to the employees may simply be a distribution of total fund assets. A third party (such as an insurance company) may assume the responsibility to pay the agreed level of benefits or payments to the employees in exchange for a fixed amount of contribution. The employer will not be responsible to make up for any shortfall in the assets of the fund.

The accounting treatment of defined contribution plans includes recognition of contribution payable at the end of each period. This amount is reduced if any payment to employee is made during the period. If the payments have been made in excess of the required amounts, the excess amount is treated as prepayment. The prepayment should be recorded to the extent that the excess will lead to reduction in the future contribution amounts or refund of cash.

The amounts of contribution can be based on a formula that uses compensations to employees as the basis for calculations. Actuarial assumptions are not required and there are no actuarial gains or losses.  

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