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Deferred Compensation Accounting
Overview of Deferred Compensation Accounting
When you expect to pay an employee for deferred compensation, accrue for the present value of future benefits. You should incorporate into this calculation an estimate of the life expectancy of the recipient, which is based on either mortality tables or on the estimated cost of an annuity contract.
Example of Deferred Compensation Accounting
Nocturnal Widget Company creates a deferred compensation contract for its employees, under which they become fully eligible for benefits ten years after entering into the contract. A provision of the contract states that, if an employee becomes disabled prior to the ten-year vesting date, then the contract will pay benefits at once.
The structure of this plan indicates that employees are rendering services for ten years that earn the contractual benefits, so Nocturnal should accrue the obligation over the ten-year period.
The cost of the contract to Nocturnal is $10,000 per employee. An employee becomes disabled after two years. Since Nocturnal had only accrued $2,000 through the disability date, it should immediately accrue the remaining $8,000 cost associated with the contract for that employee.
Another employee is expected to retire before reaching the end of the ten-year vesting period. In this case, Nocturnal does not have to accrue any obligation, since there is no expectation of payment to the employee.
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