Pension

This one’s gonna be super short!!!

Big picture first —

if I had studied this for the CPA, this stuff lives under an accounting standard called “Employee Benefits,” and there are a bunch of things a company hands out to its employees as benefits. The ones we care about:

1. Short-term employee benefits (monthly salary, paid leave, that kind of thing) / 2. Post-employment benefits (what you get when you retire) / 3. Termination benefits (a little extra for being let go) / 4. Other long-term employee benefits (everything else)

So those are the categories, and what we’re looking at today is post-employment benefits.

Good news though — post-employment benefits is part of the CFA Level 2 curriculum (it’s one of the 5 main themes in Level 2 FRA^^), so here the plan seems to be just to introduce it so you’re not blindsided later, and that’s it.

So let’s start with: what even is a Pension system? heh heh heh

I work for a company.

In exchange, the company pays me.

We Employees provide labor, and what do we get as Benefits in return?

First, monthly salary and performance bonuses — and since there’s basically zero interesting accounting happening with salary or bonuses, there’s also nothing worth putting on an exam.

But aside from salary, one of the things you get is a Benefit paid out at retirement.

The retirement benefit is basically the company going “thanks for sticking around all this time, here’s some money.”

Let’s say someone works for 5 years and then leaves, and they’re handed 10 million won for those 5 years of service.

Now — if you just SLAP!!! that whole 10 million won onto the I/S (income statement) as an expense in one go, that

violates the matching principle of revenues and expenses.

Meaning: that 10 million won should be expensed bit by bit during the years the employee is actually working,

so it gets matched against the revenue those employees are generating each year.

Which translates to: “as each year passes, the retirement benefit owed to the employee also has to be expensed little by little.”

So year by year, the company makes entries like this:

Something gets booked as a liability while also being expensed,

and then when the employee actually leaves, you knock that liability off and offset it against the Cash going out. Right?

This setup isn’t called a Pension system — it’s called a “Retirement Allowance System (internal reserve system).”

(The company I work for right now runs a retirement allowance system, and apparently when you resign, you get paid out as average salary of the last 3 months × years of service. lol

I literally went over to the management support team and asked about this while I was studying this part. lol lol (There was a whole scene, everyone asking if I was switching jobs… seriously, don’t just ask about stuff like this. lol))

Now, the retirement allowance system has one big problem.

What problem? Let’s do the extreme case: suppose the company suddenly goes bankrupt.

The creditors, who have a claim as Liability holders, come in and grab their share.

Then the shareholders, who have a residual claim, grab what’s left.

And after paying out everyone in that order… there’s nothing left for the employees.

(Apparently that’s what actually happens abroad, but in Korea, under labor law, 3 months of wages and 3 years of retirement pay get priority over even secured creditors… it’s this really powerful protection for Korean workers’ rights, and apparently foreigners look at it and go “whoa, that’s extremely strict…” heh heh)

So the thing built to patch this problem is the Pension system,

and simply put: you stash the money somewhere completely independent — outside the company — where creditors can’t touch it.

That is,

The plan assets (assets held outside the company) are usually parked with a financial company (banks, securities firms, more banks) etc.,

and the money just sits there.

So what entries does the company actually make?

Cash gets handed over to the financial company and moves into the plan assets account,

and since this creates a present obligation on our side, it also creates a liability.

But — as mentioned in the intro section — for something to be recognized as an asset,

Future Economic Benefit must be Probable / AND it has to be under the company’s control.

And wait — if the company can just control this money, does it still mean anything as a Pension?

Obviously the company has to be kept from messing with it.

So!!!! The plan asset is not an asset!!!!!

It gets recorded like this, as a deduction from the liability.

OK OK OK OK OK OK OK OK so now, that financial company we’ve signed with has money steadily piling up

right about now, right?!?!

Raise your hand if you want to just leave it sitting there~~~~~~~

I mean — the longer it just sits, the more of a loss it is, right?!?!?! lol

So naturally you’d want to invest this in financial assets, put it somewhere……

but whatever investment vehicle you use, to get a return, you have to eat the corresponding risk… (crying)

Who eats that risk…….??

Is it our company that put the money in,

is it each employee who’ll collect the money later,

or is it the financial company????

Whoever bears the investment risk is exactly what splits the retirement pension system into its types! heh heh heh heh

Out of these, the DC type (Defined Contribution pension plan) is super simple.

Because we’re studying the accounting from our own company’s point of view,

and our company’s obligation is completely done the moment it plops the cash over.

Whether there’s a loss or a gain after that, whatever — it all just gets paid out to the employee when they leave~ heh heh

The problem is the DB type (Defined Benefit pension plan)……

The company is on the hook for the investing, and the amount the company owes the employee is fixed…. heh

And the company also doesn’t know when the employee is going to retire. lol lol And has to estimate all of this on top…..

Ridiculously, absurdly, stupidly complicated — and apparently all this complicated stuff gets covered in glorious detail in CFA Level 2. heh heh

Is it really OK to just fly past it with a photo like this???? lol lol lol

See you all at Lv2 for it! heh heh heh heh heh

Phew~

(There’s that moment where your brain briefly short-circuits and you’re like, wait — which one was it, DC or DB?!?! You can work it out from first principles: “OK what’s being Defined — the Contribution, or the Benefit…” and then think about who bears the investment risk… but I just memorized it like this instead)

DB is the bad guys that make my head explode!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

(Random sudden apology to DB Group (the Korean conglomerate). (crying)(crying)(crying) But what am I supposed to do…. the first thing that pops into my head when I hear “DB” is DB…. sorry~)

I actually studied the intermediate accounting that CPA candidates study, as a hobby,

and honestly, I’d already gotten a teeeensy~~~ taste of this part. lol lol

But looking at intermediate accounting as a whole, it wasn’t actually a huge wall.

The accounting stuff that really felt like a wall to me was… not this, but actually………..

the revenue recognition section….. probably??? lol lol

Anyway — want a little sample of defined benefit pension accounting? lol lol

Exciting, right?!?!?!?! lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol

lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol lol

Heh heh — see you again next week! heh heh heh heh heh

Originally written in Korean on my Naver blog (2021-08). Translated to English for gdpark.blog.