Pensions
A pension plan is a contract by which an employer agrees to pay cash benefits to its employees upon their retirement. There are two types of pension plans: defined contribution and defined benefit:
The defined contribution plan is simple. Employers make a specified contribution into the plan each period. The actual benefits derived from these contributions upon retirement will depend on the investment returns on these contributions.
The defined benefit plan is a little more complicated to deal with from an accounting standpoint because, under this type of pension plan, it’s not the initial employer contribution but rather the benefit to employee at retirement that is defined. As such, companies must estimate during each period of an employee’s employment how much of a contribution must be made in order to ultimately satisfy the upcoming defined postretirement benefits.
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