Pension plans are one of the most popular benefits a company can offer to its employees. By helping long-term employees plan for retirement and reducing the reliance on Social Security, pension plans benefit both the employee, through the future payments after retirement, and the company, by encouraging long-term employee tenure. Because pension plans are considered employee benefits, some employees will accept lower salaries when a pension plan is included as part of the compensation package. Pension plans represent the largest institutional investors in the securities markets, and control billions of dollars in the economy. Even small, one person companies use pension plans to help their owners shelter money from taxes and defer those taxes until retirement. Because pension plans are an integral part of the business environment, accounting and auditing procedures are also an important part of the financial services department. This research examines the accounting and auditing function as it relates to pension plans.
There are two key assumptions that govern the flow of funds into a pension plan: the age of the participants at retirement, and the plan's projected rate of return on investment (the interest rate assumption). The higher the retirement age and interest rate assumptions, the lower the annual contribution needed to achieve the targeted pension benefits; conversely, the lower the retirement age and interest rate assumption, the higher the contribution to achieve the target. These assumptions, therefore, determine the contributions and thus the amount of income which is deferred from taxation.
When the pension plan is established, it is critical that these assumptions be carefully determined and their calculations documented. In 1989, the Internal Revenue Service (IRS) began an audit program designed to gain additional back taxes from pension funds whose interest rate assumptions or retirement ages the IRS f...