Defined Contribution Plan
Defined contribution plan is an employee benefit plan in which the employer undertakes to contribute a specific amount each period to the fund. Since the employer is responsible only for his contributions and nothing else, he does not bear the risks related to the plan rather those risks are borne by employees. The contributions made by the employer are based on the current number of employees and their current salary levels.
Accounting for a defined contribution plan
Accounting for defined contribution plan is straight forward. The employer records pension expense equal to the contributions which it is required to make to the plan in accordance with the fund characteristics. The pension plan has no further accounting complications for the employer because the contributions are managed by a trust representing the employees and the employer shares no gain or loss on those funds.
Company DCP has a defined contribution plan. According to employment contracts it has entered into with its 100 employee it is required to contribute an amount one average monthly salary per employee to the plan. Average salary for the financial year ended 31 December 2012 is $60,000.
The yearly contribution which DCP should record as pension expense amounts to $6,000,000 ($60,000 multiplied by 100). The contributions are collected by a trust which represents employees and manages the contributions received for DCP on their behalf. Any future increase in salary level, decrease in mortality rate, increase in expected inflation and expected return and prevailing market return, etc. has no impact on the company's expense and liability related to the plan.
Written by Obaidullah Jan, ACA, CFA and last modified on