Pensions as an important financial instruments Essay

Pensions as an important financial instruments - Essay Example Center of discussion in this paper are pensions as an important financial instruments that provide economic security to employees once they retire. A pension is a fixed payment that the beneficiary receives on a monthly basis once they reach retirement age. The use of pension plans by corporations became a mainstream practice in corporate America after World War II. In the United States pension plans have become more important than ever particularly for younger people due to the fact that the social security system is not going to be able to help younger adults. The most likely outcome is that generation X will not receive a social security check 30 years from now. Defined contribution plans must be disclosed in the financial statements of an organization. The things that must be reported in the financial statements in regards to pensions include the existence of the plan, the employee groups covered, the basis for determining contributions, and any significant matters affecting comp arability from period to period. The accounting treatment for defined benefit plans is a bit more complex. It is imperative that corporations make pension contributions that are sufficient to cover the benefits that are promised by the plan. Due to the fluctuating nature of the stock market, which is an investment mechanism used by pension managers to obtain a greater return for the beneficiaries, on many occasions pension funds are underfunded. The Pension Protection Act of 2006 stipulated that all corporate pension funds must be fully funded by the year 2013. Pension fund accounting requires the use of actuarial tools to estimate the future value of pension benefits. Two benefit approaches that can be used by accountants are accumulated benefits approach and years of service approach. The difference between the two methods is that one estimates annual pension cost and liability based on existing salary levels, while the other is based on the estimated final pay at retirement. The liability for pension benefits under the accumulated benefits approach is called accumulated benefits obligation, while the liability computed under the benefits/years of service approach is called projected benefit obligation (Clark & Cathey, 2011). The proliferation of the use of pension plans occurred after World War II. The accounting profession immediately took notice of the tendency. In 1956 the Committee on Accounting Procedures released Accounting Bulleting No. 47, Accounting for Costs of Pension Plans. ARB-47 required disclosure of unfunded vested benefits on the balance sheet (Duangplov & Pence, 2007). Pension funds were considered a legal liability after the inception of APB No. 8 in 1966. APB No. 8 also discusses the different components of pension costs. The three components of pension costs are normal costs, past service costs, and prior service costs. The underfunded pension cost became a liability in the balance