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Welcome back,
in our final lesson in this module we're going to look at individual plans.
Sometimes a plan isn't part of a broad plan that includes a lot of employees.
It may be written to be just a small group of employees, two or three people, or
even an individual employee usually a member of senior management.
Now when we do that, the individual arrangements that are not
part of the plan are accounted for individually.
Now, why do we account for them individually?
Well, actually exemptions are really based on a loss of large numbers, and
when you're trying to apply those to an individual it really doesn't work as well.
Also you don't really need to do that,
it's easier to make the individual calculations for one person.
So the difference is that the present value are those future amounts
that are attributable to past service are accrued immediately,
so one thing is you are not going to have any deferral for
past service costs, or prior service costs in this case.
It's going to be not have that deferred recognition feature that you find
in a defined benefit plan, which is really part of actuarial science.
So as a result, these are not as complicated.
The present value of retirement benefits would be accrued on a systematic and
rational manner over the period from the day to the contract that
you start the contract until the period where the employee is fully eligible for
pension benefits.
The gains and loses will be recognized immediately.
So estimates will be based on the life expectancy of each individual concerned.
And it will be based usually on the most recent mortality tables available or
the estimated cost of an annuity contract.
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At the end of the period, the aggregated amount accrued then
should equal the then present value of the expected benefits to the employee.
But don't forget to include any beneficiaries if they're covered and
covered dependents that in exchange for the employee's service to that date.
So, let's look at the quick example of this.
So, an entity enters into a contract with a 55 year-old employee who
has worked 5 years for the entity.
Do you reward them for good service?
The contract states that in exchange for past and future services,
the entity will pay an annual pension of $20,000 to the employee,
commencing immediately on employee's retirement.
Now, the actuarial present value of a lifetime annuity of $20,000 that begins
at the employee's expected retirement date, would be accrued as of the date of
the contract is entered into because if the employee is fully eligible for
the pension benefit at that date.
So if the contracts states, we're going to pay you a bunch of
benefit of $20,000, it's fully vested today.
That's a past service request.
We're going to fully accrued that benefit today.
Now, well be a present value benefit.
You're going to look at based on the estimate retirement date of the employee.
So lets tweak that scenario a little bit.
What if future services actually required?
What if the contract stipulates that the employee must work an additional five
years to qualify for the $20,000 annuity?
Well then, the benefit would be accrued in a systematic and
rational manner over the next five years.
So what if those, the first 20,000 is vested but if they work an additional
five years, they will get $20,000 more for a total benefit of $40,000.
Well then that benefit attributable to the past service would be accrued immediately,
and the additional benefit would be accrued, again, in a systematic and
rational manner over the next five years.
So this is a little bit less complicated accounting, but of course there'll be
more volatility involved in this, as you have a smaller pool of employees,
maybe just a pool of one, and your assumptions don't really apply.
But you are going to have immediate recognition for
any changes to the plan upon initiation of the plan.
You're going to accrued the amounts that you expect to be
the present value of the future benefits at the retirement date, thank you.
John HeppClinical Assistant Professor of Accountancy
