Pension provisions – a pillar of company pension provision
Pension provisions are a complex issue. That’s why many companies don’t even bother to do it. Are there Information on pension provisions to discuss at least the basics. Serious management errors can thus be avoided. Both profit and cash flow are affected.
An exact calculation is essential, especially for companies that have to submit a balance sheet. Do the provisions also have an effect on the equity ratio as well as on solvency and the financing options for investments.
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What are pension provisions?
On January 1, 2018, a new era began for small and medium-sized businesses (SMEs). The one introduced at that time Company Pension Strengthening Act should make company pension schemes interesting for companies of this size.
To the Employer attractiveness When looking for executives, a company pension scheme can be a plus to retain top talent in a company. One way of doing this is by granting pension commitments. The current equivalent of the future payment obligation is entered in the balance sheet as a pension provision.
Design options
As a rule, there are two options for structuring these pension commitments.
Defined contribution pension commitment
With this variant, the employer pays the money directly with the wages or salaries to a separate account. The employee decides how this has to be done. Both bond funds and share purchases are possible. Employers and employees bear the risk of Performancebecause the employer must at least provide a minimum guarantee for the assets. The money is invested in the company’s business assets.
This type of payout does not appear in the commercial balance sheet if the investment has been pledged in favor of the authorized employee.
Defined benefit pension commitment
Here, the employer makes certain, mandatory pension commitments to the employee for a later fixed benefit. He invests the money and alone decides on the form of investment. The company therefore has to bear the risk of the investment’s performance entirely itself. As an entrepreneur, it is advisable to seek the advice of an expert.
This form of pension provisions affects the Company balance sheet out. The agreed benefits must be provided when the employee has reached retirement age. The pension provisions influence the annual balance sheet and thus the company value. However, there is also the option of offsetting against saved assets.
Effects on profit, interest and cash flow
Defined benefit pension provisions are future payments and can only be calculated under certain assumptions. These can change, an exact prediction is not possible.
Mortality and wage trends are subject to relatively little fluctuations. Through the rapid decline in interest rates In the last few years, interest rates on many forms of investment have fallen dramatically. This increases the cash value. This denotes the value that future obligations have at the present time.
Effects of interest rate developments
Due to the new regulation of interest rates in Germany, the resulting difference had to be taken as Increase in pension provisions get booked. In the past, this resulted in a reduction in equity for many companies. Often the resulting equity ratio could not be compensated by higher profits, so that solvency was impaired.
Effects of the changed pension provisions on profit
The changed interest rate gives the pension provisions a different value. They have a direct effect on the income statement, as they cause changes in the service cost and the interest component. The Service cost is posted under personnel costs. This increases the pension provisions. And this does have an impact on the profit. In times of interest rate cuts, this is reduced within the relevant accounting period.
Interest is to be declared as an expense
Since the pension provisions are not paid out immediately, interest must be paid on them at the end of the year. In the end, the provisions are nothing more than a Creditthe employee to the Companies granted.
The accruing interest thus represents an expense. Pension provisions are to be compared as liabilities with loans and bonds and must therefore be declared meticulously in the balance sheet.
Effects on cash flow
The moment the provisions are paid out, they are debited as concrete payments the cash flow. Longer terms are therefore more advantageous, as the outflow of liquid funds can be delayed.
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