Reporting Paper

MEMO

To: CEO

From: Controller

Re: Acquired Segments

It is common for a company to offer some form of retirement plan for its employees. There are two broad types of pensions -- defined contribution plans and defined benefit plans.

In a defined contribution plan the employer agrees to contribute to a pension trust a certain amount each period based on a formula. This formula may consider such factors as age, length of employee service, employer’s profits, and compensation level. (Kieso & Weygandt). After a minimum vesting period, the funds become the property of the employee for their benefit once they enter retirement. The employee will receive the full benefit of the funds and the investment returns, usually withdrawing them gradually after retirement.

For the employer, defined contribution plans offer an important desirable feature: the employer's obligation is known and fixed. Risk is transferred to the employee. Further, the employer ordinarily gets a tax deduction for its contribution, even though the employee does not recognize that contribution as taxable income until amounts are withdrawn from the pension many years later.

Another aspect of defined benefit plans is that the accounting is straight-forward. The company merely expenses the required periodic contribution as incurred. Thus the company expenses the retirement plan payment and no further accounting on the corporate books is necessitated. The pension assets and obligations are effectively transferred to a separate pension trust, greatly simplifying the recordkeeping of the employer.

With the defined benefit plans the employer's promise becomes more elaborate, and its cost far more uncertain. The amount of pension benefits to be received in the future is defined by the terms of the plan. For example, the company may agree to make annual pension payments equal to 2% (for each year of service) times the average annual salary during the last three years of employment. So, a...