ACCOUNTING FOR PENSIONS:

Introduction:

Pension funds are normally set up to provide pension benefits to employees who have retired. The
pension funds receive contributions mainly from employers and employees and the contributions
are invested. Pension benefits are paid out of the contributions and investment income received.

Final Accounts:

As pension funds are set up for a specific purpose, and not for trading, we do not prepare the
normal trading profit and loss account or the balance sheet. The presentations for the final accounts
are as per the requirements of IAS 26 whereby instead of a trading profit and loss account we have
the statement of changes in net assets. We also prepare the statement of net assets in the place of
a balance sheet.

Defined Contribution Plan:

Defined contribution plan is a pension plan where the contribution that the employer agrees to
make to a pension trust is defined by a formula.

Income Statement:
Pension Expense - pension expense is recorded each period for the amount that the employer is
obligated to contribution to the pension trust.

Balance Sheet:

Prepaid / Accrued Pension Cost--a prepaid asset or an accrued liability is recorded for the
difference between the amount contributed to the pension trust and the pension expense.

Illustration:
A corporation provides a defined contribution pension plan for its employees; during year 1 the
corporation had a required contribution of Ksh.50,000 under the plan and made a contribution
Ksh.50,000 to the pension trust; during year 2 the corporation had a required contribution of
Ksh.50,000 under the plan and made a contribution of Ksh.55, 000 to the pension trust; during
year 3 the corporation had a required contribution of Ksh.50,000 under the plan and made a
contribution of Ksh.40,000 to the pension trust.
Year 1:
Pension Expense 50,000
Cash 50,000

Year 2:
Pension Expense 50,000
Prepaid / Accrued Pension Cost 5,000
Cash 55,000

Year 3:
Pension Expense 50,000
Cash 40,000
Prepaid / Accrued Pension Cost 10,000

Disclosure:
Description of the plan, including employee groups covered.
The basis for determining contributions
The nature and effects of significant matters affecting comparability.

Defined Benefit Plan

A defined benefit plan is a pension plan where the benefits that the employee will receive at the
time of retirement are defined by a formula

Accounting
Income Statement
Pension Expense - pension expense is recorded each period for an amount equal to service cost
increased by interest on the projected benefit obligation decreased by the expected return on plan
assets increased by amortization of any unrecognized prior service cost increased or decreased by
the amortization of any unrecognized gain or loss

a) Service Cost - Service cost is the actuarial present value of benefits attributed by the
pension formula to employee service during the current period.

b) Interest on the Projected Benefit Obligation - Interest on the projected benefit obligation is
the interest for the period, computed using the settlement rate, on the projected obligation
outstanding during the current period.

Projected Benefit Obligation - the projected benefit obligation is the actuarial present
value of both vested and non vested benefits accrued to date based on all years of service
performed by employees and the employees' future salary levels

Settlement Rate - the settlement rate is the discount rate at which pension benefits could
be effectively settled using annuity contracts or high-quality fixed income investments
 c) Expected Return on Plan Asset - the expected return on plan assets is the expected rate of
return multiplied by the fair value of the plan assets or a market-related asset value of the
plan assets
Market-related Asset Value - the market-related asset value of the plan assets is a
calculated value that recognizes changes in the fair value of the plan assets in a systematic
and rational manner over not more than 5 years.

d) Amortization of Unrecognized Prior Service Cost

Amortization of unrecognized prior service cost is the allocation of prior service cost over
the periods which will benefit from the prior service cost.

Prior Service Cost - prior service cost is the increase in the projected benefit obligation at
the date of adoption or amendment of a plan from retroactive benefits given to employees
for years of service provided before the date of adoption or amendment of the plan.

Allocation - the retroactive benefits should be allocated to the service period of those
employees who are expected to receive benefits under the plan.

A) Years of Service Method:

the portion of the prior service cost allocated to the current period is calculated by multiplying the
prior service cost by a fraction the numerator of which is the number of service-years worked each
period by all of the participating employees and the denominator of which is the total number of
service-years to be worked by all of the participating employees.

Illustration:

A corporation has a prior service cost of Ksh. 10,000, the corporation has 5 employees. Two of
the employees are age 60 and 3 of the employees are age 55; retirement age is 65.
Service-years = 2 x 5 + 3 x 10 = 40

Years 1 to 5:
Amortization = 5 / 40 x 10,000 = 1,250

Years 6 to 10:
Amortization = 3 / 40 x 10,000 = 750

B) Straight-line Method.
The portion of the prior service cost allocated to the current period is calculated by dividing the
prior service cost by the average remaining service life of all of the participating employees, which
is computed by dividing the total number of service-years to be worked by all of the participating
employees by the number of participating employees.

Illustration
A corporation has a prior service cost of Ksh.10, 000. The corporation has 5 employees--2 of the
employees are age 60 and 3 of the employees are age 55; retirement age is 65.
 Service-years = 2 x 5 + 3 x 10 = 40
Average Remaining Service Life = 40 / 5 =
8

Years 1 to 8:
Amortization = 10,000 / 8 = 1,250

Amortization of Unrecognized Gain or Loss.

Amortization of unrecognized gain or loss is the allocation of unrecognized gain or loss over the
remaining service-years of all of the participating employees.

Unrecognized Gain or Loss.

Unrecognized gain or loss consists of the increase or decrease in the projected benefit obligation
that arises from changes in the actuarial assumptions and the difference between the actual and the
expected return on the plan assets.

Allocation
The excess of the unrecognized gain or loss over 10% of the larger of the projected benefit
obligation or the market-related value of the plan assets on the first day of the period should be
allocated over the remaining service-years of all of the participating employees using either the
years of service method or the straight-line method.

Balance Sheet:

Prepaid / Accrued Pension Cost:

A prepaid asset or an accrued liability is recorded each period for the difference between the
amount contributed to the pension trust and the pension expense.

Additional Pension Liability:

an additional pension liability is recorded each period for the excess, if any, of the accumulated
benefit obligation over the fair value of the plan assets reduced by any accrued pension cost or
increase by any prepaid pension cost with the offset being to an intangible asset to the extent of
any unrecognized prior service cost and to a contra stockholders' equity account for the excess of
the additional pension liability over the intangible asset.

Accumulated Benefit Obligation:

The accumulated benefit obligation is the actuarial present value of both vested and non-vested
benefits accrued to date based on all years of service performed by employees and the employees'
current salary levels.

FORMAT FOR FINAL ACCOUNTS:

STATEMENT OF CHANGES IN NET ASSETS

ABC Pension Fund

Statement of Changes in Net assets
 For the year ended 31 December

Ksh. ‘000’ Ksh. ‘000’

Contributions Received:
- From employers: Normal X
- From employers: Additional X
X
- From employees: Normal X
- From employees: Additional voluntary X
X
Transfers in:
- Group transfers in from other schemes X
- Individual transfers from other schemes X
X
Investment income:
- Income from fixed investment securities X
- Dividends from equities X
- Income from unit trusts X
- Net rents from properties X
- Interest on cash deposits X
- Share of profit/loss of trading subsidiary and joint X
venture
X
Other income:
- Claims on term insurance policies X
- Sundry income X
X
X
Benefits payable:
- Pensions (X)
- Commutation of pensions and lump sum retirement (X)
benefits
- Death benefits (X)
- Payments to and on a/c of leavers:
- Refund of contributions (X)
- Group transfers out to other schemes (X)
- Individual transfers to other schemes (X)
_(X)
X
Profit on disposal of investments X
Losses on disposal of investments (X)
X
Changes in values of investments X
X
Payments:
- Premiums on term insurance policies (X)
- Other payments (X)
- Admin. Expenses (X)
(X)
X
Taxation on income (X)
Net change for the year X

STATEMENT OF NET ASSETS

ABC Pension fund
Statement of Net assets as at 31December
Ksh. ‘000’ Ksh. ‘000’
Investment Assets
- Fixed interest securities: Government X
: Other X
X
- Equity investments X
- Unit trust investments X
- Property: Freehold X
: Leasehold X
X

- Cash deposits X
- Trading subsidiary cost & joint ventures X
- Insurance policies X
- Other investments X
- Debtors on investment transactions X
- Creditors for investment transactions (X)
X
X
Fixed Assets
- All assets held primarily for reasons other
than investment potential X
X
Long term borrowings
(Normally to enhance fund’s returns) (X)
X
Current Assets
Contributions due from employer X
Other current assets X
X
Current liabilities
Unpaid benefits (X)
Other current liabilities (X)
(X)
 X
Net Assets XX

Accumulated fund as at beginning of year X

Net new money invested as per revenue a/c
(including changes in market value of interests) X
Accumulated fund as at year end XX

Illustration:
The following is the trial balance of Civil Servants Pension Fund as at 31 March 2005:

Ksh.000 Ksh.000
Accumulated fund as at 1 April 2004 3,245
Land and buildings in the Central business district 2,000
Pensions 390
Income from fixed return securities 580
11% Treasury Stock 400
Freehold Property (Developed with rental income housing units) 2,200
Employers normal contribution 980
Employees additional voluntary contributions 200
Administration expenses 150
Claims received on tem insurance policies 21
Premiums paid on term insurance policies 49
Term insurance policies 400
Employers additional contributions 25
Employers normal contributions 300
Unpaid benefits 30
Group transfers in from other schemes 75
Individual transfers out to other schemes 5
Debtors on investment transactions 16
Commutation of pensions and lump sum retirement benefits 15
Dividends received from equity investments 400
20,000 ordinary shares in Flamingo Airways 200
Individual transfers in from other schemes 14
Income from unit trusts 70
Rental income from property 45
Group transfers out to other schemes 40
Cash and demand deposits 35
Tax paid on fund income 460
Ksh..250, 000 loan stock in KVM 200
Death benefits paid 15
Creditors for investment transactions 22
Refund of contributions 28
Investment in unit trusts 350
Loan from HFCK to develop Property 1,000
Contributions due within 30 days 56
 Shares in Moyalematt Ltd 2.00 2
7,009 7,009

Notes:
The fund owned 12,000 shares in Moyalematt, which were initially purchased for Ksh.14, 000.
These have been disposed of during the year. The only entries made in the books were in a debtor
account and investment account since the shares are yet to be paid for. The trustees felt the need
to reflect the following market prices in the financial statements:
Loan stock in KVM – Market price index – 84.00
Shares in Flamingo Airways Ksh. 9.75 per share.

Required:

(a) Statement of changes in net assets for the year to 31 October 2005.
(b) Statement of net assets as at 31 October 2005.

Note: This should be in compliance with IAS 26 – Accounting and reporting of retirement benefit
plans.
Solution:
Civil Servants Pension Fund
Statement of Changes in Net Assets
for the year to 31 October 2005
Ksh. ‘000’ Ksh. ‘000’
Contributions received:
From employees: Normal 980
From employers: Additional 25
1005
From employees: Normal 300
From employers: Additional voluntary 200 500

Transfers in:
Group transfers in from other schemes 75
Individual transfers in from other
Schemes 14 89

Investment income:
Income from fixed interest securities 580
Dividends from equities 400
Income from unit trusts 70
Rents from properties 45 1095

Other income: Claim on term insurance policies 21

2710
Benefits payable:
Pensions (390)
Commutation of pensions and lump sum
Retirement benefits (15)
Death benefits (15)
Payments to and on a/c of leavers:
Refund of contributions (28)
Group transfers out to other schemes (40)
Individual transfers out to other schemes (5)
(493)
2217
Profit on investment disposals 2
Changes in market values of investments:
Loan stock in KVM 10
Shares in Flamingo Airways (5)

Payments: Premiums on term insurance policies (49)

: Admin expenses (150)
(199)
2025
Taxation on income (460)
Net change for the year 1565

Civil Servants Pension Fund

Statement of Net Assets
As at 31 October 2005

Ksh. ‘000’ Ksh. ‘000’

Investment Assets
Fixed interest securities: 11% Stock 400
: KVM loan stock 210
610
Equity investments: Flamingo Airways shares 195
Unit trust investments 350
Property: Freehold 2200
Cash and demand deposits 35
Insurance policies 400
Debtors on investment transactions 16
Creditors for investment transactions (22)
(6)
3784

Fixed Assets:
Leasehold property in Nairobi CBD 2000
5784
Long term borrowings
HFCK Loan (1000)
4784
Current Assets:
Contributions due within 30 days 56
Current Liabilities:
Unpaid benefits (30)
26
Net Assets 4810

Accumulated Fund at 1 Nov.2000 3245

Net new money invested per revenue a/c
including changes in market value of
investments 1565
Accumulated Fund at 31 October 2001 4810

Exercise 1:
The following trial balance was extracted from the accounting records of the XYZ Retirement
Benefits Scheme for the year ended 30 September 2000.

KShs. ‘000’ KShs. ‘000’

Accumulated fund as at 1 October 1999 461,560
 Accrued expensed 240
Administrative expenses 2,840
Cash and demand deposits 23,460
Change in market value of investments 22,640
Commutation and lump sum retirement 4,820
benefits 4,940
Contributions due within 30 days 36,480
Employer normal contributions 3,150
Individual transfers in from other schemes 1,860
Individual transfers out to other schemes 47,400
Investment income 132,320
Immovable property 263,605
Kenya Government securities 18,240
Members’ nominal contributions 4,560
Members’ additional voluntary 7,640
contributions 87,835
Pensions 320
Quoted equity investments 19,990
Unpaid benefits 571,950 571,950
Unquoted equity investments

Required:
The statement of Changes in Net Assets (the Fund Account) for the year ended 30 September 2000
and a statement of Net Assets as at 30 September 2000, in accordance with International
Accounting Standard 26 (Accounting and reporting by Retired Benefit Plans)

Hints:
The XYZ Retirement Benefits Scheme’s accounting policies state that the reconciliation of the
accumulated fund for the year is included in Statement of Net Assets and administrative expenses
are included as the final item in the Statement of Charges in Net Assets. In all other respects, the
format used is in conformity with that laid down in the Retirement Benefits Regulations in
Retirement Benefits Act.