Why the benefits paid in a defined benefit plan are not (always) taken into account in total cash outflow?

In a defined benefit plan, the benefit paid to a retiree is determined based on a formula that takes into account various factors such as years of service, salary history, and other factors specified in the plan document.

 

The employer is responsible for funding the plan and ensuring that there are sufficient assets to meet the promised benefits.

 

The reason why the benefit paid in a defined benefit plan are not (aslways) taken into account in total cash outflow is because it is not a discretionary expense.

 

Unlike other expenses, such as salaries and bonuses, which can be adjusted based on the financial condition of the company, the benefit paid to a retiree under a defined benefit plan is an obligation that the employer is legally required to fulfill.

 

Therefore, the benefit paid to retirees under a defined benefit plan is treated as a non-cash expense in the cash flow statement, and as a consequence it is not included in the total cash outflow. 

Instead, the contribution made by the employer to the plan is included as a cash outflow. This contribution represents the cash that the employer actually pays into the plan to fund the promised benefits.

 

In that case, the benefit paid under defined benefit pension plan can be considered as the depreciation of the total amount due to employee i.e the total contribution made to the plan to meet the required future benefits owed to employees. 

This is the reason why for plans without funding requirements, the cash flow impact of pension or other post-employement pension benefits are this time the amount of benefits paid. 

 

Since the benefit paid are no more an obligation this is treated as cash flow expense like the payment of an any other expenses. 

 

Benefit paid in a defined benefit plan is taken into account in total cash outflow for benefit pension plans that do not have funding requirements because in these plans, the employer does not have a legal obligation to fund the plan. 

 

In other words, the employer can choose to fund the plan, but is not required to do so. 

Therefore, the benefit paid to retirees under these plans is considered a cash outflow because it represents the actual cash that the employer pays out to meet its obligation to pay benefits to retirees.

 

On the other hand, for defined benefit plans that have funding requirements, the employer is required by law to contribute to the plan and maintain a certain level of funding. 

In these plans, the contributions made by the employer to fund the plan are considered the cash outflow, not the benefit paid to retirees. 

 

This is because the contribution represents the actual cash that the employer is required to pay into the plan to meet its legal obligation to fund the plan.

 

In summary, the treatment of benefit paid in a defined benefit plan in the cash flow statement depends on whether the plan has funding requirements or not. If the plan does not have funding requirements, the benefit paid is considered a cash outflow. If the plan has funding requirements, the contribution made by the employer to the plan is considered the cash outflow, not the benefit paid to retirees.