Fact Sheet on the GASB’s New Pension Standards: Governments in Defined Contribution Pension Plans
What new requirements regarding accounting and financial reporting for pension benefits will governments that participate in defined contribution pension plans be implementing?
The Governmental Accounting Standards Board (GASB) approved Statement No. 68, Accounting and Financial Reporting for Pensions, in June 2012. Statement 68 provides guidance on how governments measure and report the long-term obligations and annual costs associated with the pension benefits they provide to their employees. The Statement is available free of charge at www.gasb.org. A separate fact sheet describes the GASB’s new pension standards and why they were issued.
What is a defined contribution pension?
Defined contribution pensions stipulate the contributions a government must make to an active employee’s account each year. A defined benefit pension plan, by contrast, specifies the benefits to be provided to the employees after the end of their employment. Governments participating in defined contribution plans are referred to here as defined contribution employers.
How should a defined contribution employer report the cost (pension expense) of the benefits it provides to its employees?
Each year, a defined contribution employer will recognize a pension expense in its accrual-based financial statements that is equal to the contributions and/or credits that the terms of the plan require in return for employee service in that year. The pension expense will be reduced by amounts forfeited from employee accounts. For example, if an employee leaves the employer before working the minimum number of years to qualify for pension benefits and the amounts previously contributed to that employee’s account by the defined contribution employer are forfeited, pension expense would be reduced by the amount of forfeitures for that year.
What liability, if any, will a defined contribution employer report related to pensions?
As under the prior standards, if the pension expense exceeds the amount the defined contribution employer pays to the pension plan, the difference will be reported as a liability in the accrual accounting-based financial statements. Differences between expense and payments in subsequent years will increase or decrease the liability (if the expense is higher or the payment is higher, respectively).
How is employer financial reporting affected if another entity is responsible for a portion of a defined contribution employer’s pension obligation?
If there are circumstances in which another entity (often governmental) is legally responsible for some or all of a defined contribution employer’s obligation to provide pension benefits and one or both of the following is true, this is called a “special funding situation”:
The amount the other entity (called a “nonemployer contributing entity”) is required to contribute is not based on events or circumstances unrelated to pensions (such as contributing a percentage of a specific revenue source)
The nonemployer contributing entity is the only entity legally required to contribute to the plan.
If a special funding situation exists, a defined contribution employer’s pension expense equals its share of the contributions and/or credits that the terms of the plan require in return for employee service in that year, plus the amount recognized as expense by the nonemployer contributing entity. The defined contribution employer also would recognize revenue in the amount of the expense recognized by the nonemployer contributing entity.
Even though another entity is paying for a portion of the pension benefits of its employees, the cost of those benefits is nonetheless the employer’s cost of providing services. This is similar to how an employer would account for state aid for a particular program: The employer does not report an expense amount net of the state aid for that program; rather, it reports the full expense and revenue in the amount of the state aid. Likewise, an employer benefiting from a special funding situation reports its full pension expense and revenue equal to the amount of expense reported by the nonemployer contributing entity.
Apart from the amounts reported in the financial statements, what other information will defined contribution employers present?
The notes to the financial statements of defined contribution employers will include:
Descriptions of the pension plan and benefits features
The contribution or crediting rates for the defined contribution employer, its employees, and nonemployer contributing entities
The amounts of pension expense and forfeitures for the year
The amount of the employer’s outstanding liability.
Why are the reporting requirements for defined contribution employers less extensive than those for governments in defined benefit pension plans?
Defined contribution employers are obligated only to pay (or credit) a certain amount to an employee’s pension plan account in return for employee service, based on the terms of the plan. The amount of benefit payment that the employees receive when retired depends primarily on contributions to their accounts and earnings on the investment of those contributions.
Employers in defined benefit plans, on the other hand, are obligated to provide a certain amount of benefit payment to employees when they retire. Determining the size of a defined benefit pension obligation for the purpose of measuring the pension liability and expense requires using actuarial methods to project future benefit payments (based on a variety of assumptions regarding factors such as salary changes, length of service, and life expectancy), discounting those future benefit payments to their value at present, and then attributing that present value to the past and future years over which it was or is expected to be earned. Consequently, the prescribed measurement process in Statement 68 is extensively described and governments are required to provide comprehensive note disclosures that identify the assumptions and methods used, describe how the pension liability changed over time and why, and measure the sufficiency of the assets in the pension plan compared with the pension liability, among other things.
When will defined contribution employers begin reporting their pensions under the new standards?
Defined contribution employers are required to put the new standards into effect beginning in fiscal years ending June 30, 2015, and later. The GASB does, however, encourage employers to implement the new standards sooner.