Defined contribution or defined benefit

Learning objectives

• Distinguish a defined contribution plan from a defined benefit plan based on how risk is allocated.L1
• Justify the classification of a plan from its terms, including any constructive obligation.L2

Normative references

• IAS 19 §8Definitions: categories of benefits (short-term, i.e. expected to be settled wholly before twelve months after the end of the annual reporting period in which the service is rendered; post-employment; other long-term; termination benefits); defined contribution plan (fixed contributions paid into a separate entity, with no legal or constructive obligation to pay further contributions if the fund is insufficient) and defined benefit plan (any other plan); deficit or surplus (present value of the obligation less the fair value of plan assets), net defined benefit liability (asset) (the deficit or surplus adjusted for the effect of the asset ceiling) and asset ceiling (present value of the refunds or reductions in future contributions available); plan assets (assets held by a legally separate fund dedicated to the benefits, and qualifying insurance policies, not available to the entity's creditors); past service cost (change in the obligation for prior service resulting from a plan amendment or a curtailment, the latter being a significant reduction in the number of employees covered); settlement (a transaction that eliminates all or part of the obligations, other than benefits provided for in the plan terms and included in the actuarial assumptions).
• IAS 19 §26Post-employment benefits include, for example, retirement benefits (pensions or lump sums) and other benefits such as post-employment life insurance or medical care; the Standard applies to all such arrangements, whether or not a separate entity receives contributions and pays benefits.
• IAS 19 §27A post-employment plan is classified as a defined contribution plan or a defined benefit plan depending on its economic substance, as derived from its principal terms and conditions; in a defined contribution plan, the entity's obligation is limited to the agreed contributions and actuarial and investment risk fall, in substance, on the employee (para. 28); in a defined benefit plan, they fall on the entity (para. 30); para. 29 gives examples of obligations that go beyond the contributions.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

4 questions

• Whenever the assets of a retirement plan are held in a fund legally separate from the employer, the plan is a defined contribution plan.L1
• Lunor SA pays each year 5% of salaries into a separate fund, which pays each retiree a pension equal to 1.5% of the final salary per year of service. The rules provide that Lunor tops up the fund if its assets are not enough to pay the promised pensions (case facts). Which classification is correct?L2
• Mervaux SA pays each year to an independent insurer a fixed contribution equal to 4% of pensionable salaries, that is 96,000 for the year, for its employees' retirement. The contract imposes no obligation on Mervaux to pay more if the benefits promised to employees turn out to be insufficient, and Mervaux has no constructive obligation to that effect (case facts). Write a short justification of the classification of the plan and of the expense for the year, distinguishing rule, case facts and conclusion.L2
• Each year, Sirius SA pays an insurer a contribution equal to 5 % of salaries; the insurer then pays the retirement pensions. The contract provides that Sirius pays additional contributions if the accumulated assets are insufficient to pay the promised pensions (case facts). How is this plan classified under IAS 19?L2