Organizations are increasingly opting to terminate defined benefit (pension) plans in favor of more cost-effective alternatives, such as defined contribution plans. While terminating a pension plan may be strategically advantageous, the process is complex and often spans several years, requiring adherence to numerous regulatory and financial requirements. One critical aspect is the transition to the liquidation basis of accounting for the plan’s financial statements.
When does the liquidation basis of accounting begin?
Use of the liquidation basis is required once liquidation is imminent. In the case of plan termination, liquidation is imminent once an authorized party has approved the termination. For example, if the plan termination is approved in 2025, the liquidation basis does not begin until 2025. For 2024, the plan would still use an ongoing basis of accounting.
What does the liquidation basis of accounting entail?
Any administrative costs incurred to close out the plan will need to be accrued in the financial statements even if the costs are not paid until the subsequent year. This can include the costs due to an insurance company if dealing with an annuity buyout, the actuarial fee associated with determining the actuarial benefit obligation, the fee to the auditor for conducting the final audit, etc. Additionally, if the employer plans to make any contributions to ensure that the plan has sufficient funds for termination, the plan will need to record those contributions as a receivable, if not made before the plan’s current year-end. Interest income expected to be earned in liquidation should also be accrued when reporting under the liquidation basis. Note that this is not an all-inclusive list; it represents some of the common adjustments that will be needed.
What if there are changes to initial estimates for accruals?
If the company becomes aware of additional expenses that were not accrued, or changes in interest income expected to be earned, or if there are other unanticipated events that have occurred as a result of the plan termination, then the changes in the estimates would be made upon notification. For example, if there is an estimate for expenses at 12/31/24 (under liquidation) and there are additional costs that were not captured in the 12/31/24 financial statements, then the additional amount would be expensed in 2025.
Key Considerations for a Successful Transition
Given the extended timeline and potential complexity of pension plan termination, entities should proactively prepare for the transition to liquidation accounting as soon as liquidation becomes imminent. Plan management should engage both their plan auditor and ERISA counsel upon determination of termination. Maintaining accurate records and securing monthly trust statements will facilitate a smoother process and ensure compliance when preparing final financial statements.
The employee benefit plan team at Schneider Downs can assist with the accounting and auditing aspects of the plan termination.
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