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CHAPTER 2

THEORETICAL FOUNDATION

2.1. Characteristic and Environment of Pension Fund

To perform a good analysis, the first thing to do is to recognize and understand the

entity. To understand a Pension Fund, first we should learn about the basic concepts,

laws and regulations, and the pension fund financial statement reporting.

2.1.1 Basic concept of pension fund

‘A pension plan is an arrangement whereby an employer provides benefits (payments) to

employees after they retire for services they provided while they were working.’ (Kieso,

Weygandt, and Warfield, 2002, p. 1018). From the statement above, Pension Fund can

be defined as a corporate body, which has the functions of managing and perform

program that promise post retirement benefit.

According to Tunggal (1999, p. 14) Type of a pension fund include:

b. Contributory, if employee and firm jointly give contribution to the pension fund

c. Non Contributory, if only the company that gives contribution for the pension

fund.

d. Funded Pension Plan, pension fund program that performs by deposits the fund

to a particular body which separate from the company

e. Unfunded Pension Plan, if the company itself that performs the pension payment

to the employees.

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According to the Pension Fund Law No.11 year 1992, there are two types of pension

fund in Indonesia:

1. Dana Pensiun Pemberi Kerja (DPPK)

Pension Fund that created by employer/company for the benefit of the employees.

DPPK has two types of program:

Program Pensiun Manfaat Pasti (Define Benefit Plan)

Defines the benefit that the employee will receive at the time of retirement

Program Pensiun Iuran Pasti (Define Contribution Plan)

Employer agrees to contribute to a pension plan a certain sum each period

based on a formula

2. Dana Pensiun Lembaga Keuangan

Pension Fund, which form by a bank or live insurance company that perform

define contribution plan program.

Figure 2.1 Pension Fund Types in Indonesia

Source: Tunggal 1999. p.178

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Although this thesis will only focus on defined benefit program, it is important to

distinguish the differences between the two pension plan programs. Table 2.1

summarizes the main differences between Defined Benefit Plan and Defined

Contribution Plan to provide a better understanding of Pension Fund.

Define Benefit Plan Aspect Define Contribution Plan

Pension benefit is based on the formula that has been decided on the pension fund regulation

Pension Benefit Pension fund benefit depend on the amount of the accumulated contribution from the result of investment until the participant stop working, then it will be traded with insurance company annuity

The value of contribution depends on the fund adequacy to fulfill the pension benefit liability based on the actuarial calculation

Contribution The value of employer contribution from the participants contribution has been set in the Pension Fund regulation

PSL is recognized and the funding is entirely the responsibility of the employer.

Past Service Liability

(PSL)

No PSL

Investment guidelines placed by plan sponsor

Investment Placement

Investment guidelines placed by plan sponsor and the supervisory body

Plan Sponsor held responsible Investment Risk

Participants held responsible (deduct pension benefit that will be received)

Needed since the beginning and regularly to calculate the contribution figure and fund adequacy

Actuarial calculation

Not needed

Perform by the pension fund Pension Benefit Payment

Perform by live insurance company

Continued

Relationship between

Employer and retiree

No relationship

Table 2.1 Difference between PPMP and PPIP

Source: Tunggal 1999. p.15-16

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The benefit of creating Pension Fund includes (Tunggal, 1999, p. 2):

1. To provide employees with income after retirement.

2. Provide prosperity for employees in postretirement.

3. To establish sense of security for the employees.

4. To create a conducive environment.

5. Create a harmonious relationship between employees and the company.

6. To provide motivation for employees.

7. To establish loyalty for the company.

8. Increase the productivity of the company.

9. Increase the remunerativeness of the company.

10. To create a positive image of the company in society.

11. To form an accumulated fund that funded from within the nation, this will reduce

the necessity for foreign assistant in funding the national development program.

Plan Sponsor is a person or entity that forms DPPK, or a bank or a life insurance

company that form DPLK. An entity in this extent could be in the form of a corporation,

foundation, firm, cooperative, and other form of legal entities. For an entity that does not

have the resources to create their own pension fund program, they are able to join in

other pension fund program that held by other entity.

The main activity of a pension fund is to receive the contribution from the participants

and the plan sponsor, to invest the fund that collected, pay the operation and investment

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expenses and to pay the pension benefit for the member who has retired. Figure 2.2

illustrates the activity in a pension fund.

Figure 2.2 Activity of Pension Fund

Source: Sukemi and Muliawan 2005. p.11

In managing the investment, plan administrators are required to invest the wealth of the

pension fund in accordance with the investment regulation that set by the ministry of

finance. Furthermore, the plan administrator is required to follow the investment

guidelines which made by the plan sponsor and the supervisory board. Although it

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seems that the plan administrator restricted by the regulation and guidelines, they still

have the authority to decide the most profitable and secure investment. The regulation

and guidelines only give a general restriction; therefore, it gives the plan administrator

the freedom to manage their investment.

2.1.2 Laws and regulation for Pension Fund

Pension Fund in Indonesia regulated under the Pension Fund Law No.11 Year 1992.

According to the law, Pension Fund acknowledged as a legal entity that has the purpose

of managing the pension fund program. ‘The entity treated as a separate legal and

accounting entity for which a set of books maintained and financial statements are

prepared' (Kieso, Weygandt, and Warfield, 2004, p1019). The separations between the

pension fund wealth with the wealth of its plan sponsor are important to assure the safety

of the pension benefit.

Financial accounting standard regulates the accounting for pension fund for the plan

sponsor and the pension fund itself. Financial accounting standard that regulates the

pension fund financial report are:

PSAK no.18, which regulates accounting treatment and reporting for Pension

Fund

PSAK no. 24, which regulates the pension benefit cost.

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Regulations and law, which imply with the creation and analysis of pension fund

financial report, summarized in the Table 2.2

UNDANG-UNDANG

1. UU No.11 tahun 1992 tentang Dana Pensiun dan Penjelasan

PERATURAN PEMERINTAH

1. PP No. 76 tahun 1992 tentang DPPK dan Penjelasan

KEPUTUSAN MENTERI KEUANGAN

1. KMK No.343/KMK.017/1998 tentang Iuran dan Manfaat Dana Pensiun

2. KMK No. 509/KMK.06/2002 tentang Laporan Keuangan Dana Pensiun

3. KMK No.510/KMK.06/2002 tentang Pendanaan dan Solvabilitas Dana Pensiun

Pemberi Kerja

4. KMK No. 511/KMK.06/2002 tentang Investasi Dana Pensiun

5. KMK No. KEP-163/KM.10/2006 tentang Pengesahan Atas Peraturan Dana Pensiun

Dari Dana Pensiun PT Asuransi Jasa Indonesia

KEPUTUSAN DIRJEN LEMBAGA KEUANGAN

1. Keputusan Dirjen Lembaga Keuangan No.KEP.2345/LK/2003 tentang Pedoman

Penyusunan Laporan Keuangan Dana Pensiun

Table 2.2 Laws and Regulations of Pension Fund Financial Reporting

Source: Asosisasi Dana Pensiun Indonesia

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Investment has a significant role in a pension fund, mainly to increase the wealth of the

Pension Fund. Investment for the pension fund should consider several factors (Wahab,

2005, p. 29):

1. Security factor, which means relatively low risk.

2. Objectives of the investment.

3. Diversification of investment by spreading investment risk in accordance with

present regulation.

Investment of pension fund wealth should be in harmony with the characteristic of

pension fund responsibility, which is to pay pension benefit to the participants.

Government regulates types of investment which pension fund can participate and its

restriction through Finance Minister Decree Number 511/KMK.06/2002 that stated:

1. Time deposit, on call deposit, and deposit certificate, with the limitation that

placement in a single bank can not exceed 20 percent from the total pension

fund investment [Chapter 6 article (1) letter b and c, Chapter 11 article (1)]

2. Shares, bond, and other marketable securities listed in the Jakarta Stock

Exchange. Placement in a single party on those items can not exceed 20 percent

of the total pension fund investment [Chapter 6 article (1) letter d and e, Chapter

11 article (1)]

3. Direct placement on shares or debt security above one year, but not exceeding 10

years which based on Indonesian law with the regulations that placement in a

single party can not exceed 20 percent of the total pension fund investment

[Chapter 6 article (1) letter f and g, Chapter 9 article (1)]

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4. Land and building located in Indonesia with the regulations that placement in a

single party can not exceed 15 percent of the total pension fund investment

[Chapter 6 article (1) letter h, i and g Chapter 9 article (2)]

5. Shares or unit of mutual fund without any limitation of investment placement

[Chapter 6 article (1) letter k, Chapter 11]

6. Bank of Indonesia Certificate, with the limitation that placement can not exceed

20 percent of the total pension fund investment [Chapter 6 article (1) letter l]

7. Government bond, with regulation that placement can exceed 20% from the total

Pension Fund investment [Chapter 7 article (1) letter m]

2.1.3 Pension Fund Financial Statement

Under the Pension Fund Law No.11 year 1992 plan administrators are required to

submit audited financial report periodically. This regulation is supported with the

regulation about the reporting of financial statement under the Government Regulation

No. 76 year 1992, article 18 which stated that plan administrator required to report to the

minister of finance concerning:

1. Financial report and pension fund investment report which a public accounting

firm has audited.

2. Technical report that prepared by the plan administrator according to the

regulation set by the finance minister.

3. Actuary report minimum every three years and reported at least five months after

the valuation date.

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The appointment of a public accountant for the Pension Fund is the duty and privileges

of the supervisory board. Other then the duty of supervising the management of the

pension fund, supervisory board also appoints the public accountant that will conduct the

audit of the pension fund financial statement. The supervisory board assumed to have

the ability to entrust both the participants and plan sponsors importance since the board

members formed from both parties in equal numbers.

The pension fund financial statement specifically regulated under Surat Keputusan

Direktur Jenderal Lembaga Keuangan nomor KEP.2345/LK/2003. Pension fund

financial report, that either held defined benefit plan or defined contribution plan should

include:

a. Net Assets Report

Net assets report is a report, which reflects the wealth of a pension fund available

for pension benefit. Net asset report is asset minus short-term liability. Net asset

report will normally provide information about:

Investment

Current Assets Beside Investment

Operational Assets

Other assets, and

Short-term Liability

Investment in net assets presented based on fair value as regulated in the Finance

minister decree No. 76/KMK.017/1995 regarding the financial report. On the

other hand, operational assets presented based on book value.

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b. Changes in Net Asset Report

Changes in net assets report provide information regarding changes in the net

assets in the current year with previous year.

c. Balance Sheet

A Balance Sheet provides the monetary condition of the Pension Fund at a

certain time. Items that presented in the assets section of the Pension Fund

balance sheet should include:

Investment

Difference in Investment Valuation

Current Assets Beside Investment

Operational Assets

Investment item in the balance sheet presented using historical value. Investment

on land and building should relate to the accumulated depreciation. Operational

assets presented using historical value.

Items that presented in the liabilities section of the Pension Fund balance sheet

should include:

Actuarial Liabilities

Short-term Liabilities

Unearned revenues

Actuarial liability is a long-term liability for Pension Fund with Defined Benefit

Program. Because the problems associated with the pension fund involve

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complicated actuarial considerations, actuaries are engaged to assure that the

fund is appropriate. Actuaries are individuals who trained through a certification

program to assign probabilities to future events. Actuaries make actuarial

assumptions of mortality rates, employee turnover, interest rates, early retirement

frequency, and any other factors affecting pension fund

d. Income statement

Income statement is a report, which measures the profitability of a Pension Fund

over a period. The Pension Fund income statement separated income with cost

and separate investment activity with non-investment activity.

e. Cash Flow Report

Pension Fund cash flow report provides information regarding the pattern in

which cash move in and out of the Pension Fund. Cash flows repot should

include:

Cash flows from investment activity

Cash flows from operating activity

Cash flows from Financing activity

f. Note of Financial Report

Note of Financial Report Provide useful information for users of the financial

report. Items that presented in the note include:

General explanation

Explanation on the Pension program

Explanation on important accounting treatment

Explanation on investment selection

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Explanation on financing

Actuarial calculation

Calculation of tax

2.2 Theory of Financial Statement Analysis

2.2.1 Basic concept of Financial Statement Analysis

John. J. Wild defined financial statement analysis as the application of analytical tools

and techniques to general-purpose financial statements and related data to derive

estimates and inferences useful in business analysis. Furthermore, financial statement

analysis reduces reliance on hunches, guesses, and intuition for business decisions. It

decreases the uncertainty in the business analysis.

One of the most important jobs for management or investor at the end of a financial

period is to analyze the company financial statement. Financial statement analysis

separates the financial statement into pieces of smaller information units and finds the

relationship between them. Any significant relationship or any relationship between the

information will provide new information’s needed in making an important decision

accurately. Information that gathers from those relationships will add another vision

from different perspective and will give more depth rather the conventional financial

report. The purpose of financial statement analysis is to convert raw data originated from

the report and translate to information that is more useful.

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Financial statement analysis maximizes the information that relatively small into wider

and more accurate information. The result of the financial statement analysis will reduce

the inconsistency of a report. Results of the analysis will make the information far more

reliable, thus will increase the reliability of the information that will make a more

accurate decision.

2.2.2 Users of Pension Fund Financial Statement

There are several parties that affected by the financial condition of the Pension Fund.

Users of Pension Fund financial statement include (Tunggal, 1999, p. 118):

Plan Sponsor will need the information regarding the financial condition of the

Pension Fund especially about the wealth and liabilities of the Pension Fund.

Plan sponsor of Pension Fund with defined benefit program considers the

position of the wealth and liabilities of the fund to be very important. The reason

is that it is the responsibility of the plan sponsor to covers the liabilities of the

Pension Fund.

Participants needed information on how the plan administrator manages the

Pension Fund. This is important to participants since the pension benefit that

will have received is depended on how the wealth managed.

The Plan administrator needed the financial report to fulfill their responsibility

for the management of the pension fund.

Government needed the financial report for observation of the management of

the Pension Fund. The government also uses the financial report to calculate tax.

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2.2.3 Objectives of Pension Fund Financial Statement Analysis

In general financial statement analysis is prepared to help investors and creditors

understand the financial history of a company and use that knowledge to predict the

future cash flows and price appreciation. John J. Wild in his book “Financial Statement

Analysis” Eight Edition stated:

‘The foundation of a reliable analysis is an understanding of its objectives. This

understanding leads to efficiency of effort, effectiveness in application, and

relevance in focus. Most analyses face constrains on availability of information.

Decisions must be made using incomplete or inadequate information. One goal

of financial statement analysis is reducing uncertainty through a rigorous and

sound evaluation.’

The objectives of financial statement analysis according to Bernstein in 1983 (Cited in

Harahap, p.197)

1. Screening:

Analysis perform with the objectives of understand the situation and condition

of a company through the financial statement without directly went to the field.

2. Understanding:

Understand the company, financial condition, and company profits

3. Forecasting:

Analysis use to predict the financial condition in the future

4. Diagnosis:

Analysis intended to see the possibility of problems in the management,

operational, financing or other problems in the company.

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5. Evaluation

Analysis was intended to evaluate the achievement of management in managing

the company.

Specific analysis objectives will reduce unnecessary analysis. With the present of

specific and explicit analysis objectives, plan administrator would be able to choose the

right technique that needed to fulfill the objective. Plan administrator could also leave

behind unnecessary analysis method by adjust to the objective stated earlier. A specific

analysis objective will increase the efficiency and affectivity of financial statement

process. Without unnecessary and overloading analysis method, analysis process will

save time, energy, and cost. The result of the analysis will become more focus and make

the process of decision-making become easier.

Pension Fund financial statement cannot be separated from the principles and standard

of financial accounting in general. Financial report that followed the general standard

should be able to analyze with analysis techniques that used in the common financial

statement with several adjustment.

Before deciding the objectives of the analysis, it is important to consider the function

and duty the party who will perform the analysis. As an example, the plan administrator

has the duty of safeguard the liquidity of the pension fund then one of the objectives of

the analysis is to determine the level of liquidity of the pension fund.

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It is important to consider the main activity of the Pension Fund as explain in Figure 2.2

when set up the objective of financial statement analysis. The three main activities in the

Pension Fund are collecting plan contribution from the plan sponsor and the participants,

invest or redeem investment and to receive the result of the investment, and payment of

pension benefit.

No. General Objectives No. Specific Objectives

1. To determine the compliance of the Pension Fund toward existing regulation and law in reporting/presentation the financial statement and the management of the Pension Fund wealth.

1.A To determine the compliance of Financial statement presentation with existing regulation

1.B To determine the compliance of Pension Fund wealth management toward existing regulation

2. To determine the investment efficiency and financial management

2.A Determine the rate of return from Pension Fund investment

2.B Compare the actuarial assumption with the realization

2.C To determine result generated from assets

2.D To value cash flows from investment activity

3 To determine the financial safety of Pension Fund

3.A To determine the fund adequacy

3.B To determine the compliance of contribution collection

3.C To determine the trend from the financial activity

4. To determine the ability of Pension Fund in fulfill the obligation toward the plan participant

4.A To determine the compliance of plan administrator to fulfill the obligation of pension benefit payment

Table 2.3 Objectives of pension fund financial statement analysis

Source: Sukemi and Muliawan 2005. p.50-51

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2.2.4 Limitation of Financial Statement Analysis

The financial statement analysis techniques are useful for providing insights into the

financial position and performance. Nevertheless, there are certain limitations that

should consider. According to Hogget, Edwards, and Medlin (2003, p.1024-1025) those

limitations include:

1. Financial analysis performed on historical data mainly to forecasting future

performance. The historical relationships may not continue because of changes in

the general state of the economy, the business environment in which the entity

must operate, or internal factors such as change in management or changes in the

policies established by management.

2. The measurement base used in calculating the analytical measures is historical

cost. Failure to adjust for inflation or changes in fair values may result in some

ratios providing misleading information on a trend basis and in any comparison

between entities.

3. Year-end data may not be typical of the entity’s position for the year. Knowing

that certain ratios calculated at year-end, management may attempt to improve a

ratio by entering certain types of transactions near the end of the year.

4. Sometimes the information contained in the general-purposed reports may be

subject to modifications, supplementations and qualifications expressed in

accompanying documents such as directors’ reports and auditors’ report. Any

analysis and interpretation should take into consideration such matters.

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5. Entities may not be comparable because of factors such as the use of different

accounting methods, size, and the diversification of product lines, data may not

provide meaningful comparison.

2.3 Analysis method of Pension Fund Financial Statement

Analyzing a financial statement conducted by understanding the condition of a company

through accounting by the media of financial report. Steps that often perform in the

financial statement analysis are calculating ratios and indexes, comparing recent

financial statement with previous financial statement, and analyzing relationship and

identify problems in financial statement.

In analyzing Pension fund financial statement, tools that will be used includes:

1. Comparative financial statement analysis

2. Common-size financial statement analysis

3. Ratio analysis

4. Cash flow analysis

5. Compliance Analysis.

6. Investment Performance Analysis.

2.3.1 Comparative Financial Statement analysis

According to Wild, Subramanyam, and Halsey (2004, p.24-25) Individuals conduct

comparative financial statement analysis by reviewing consecutive balance sheets,

income statements, or statement of cash flow from period to period. The most important

26

information often revealed from comparative financial statement analysis is trend. A

comparison of statements over several periods can reveal the direction, speed, and extent

of a trend. Comparative financial statement analysis also referred to as horizontal

analysis given the left-right analysis of account balances.

This method used by using the figures in the financial statement and compares it with

other financial statement. The comparison conducted by comparing the financial

statement with (Harahap, 2006, p.217):

1. Comparing between financial years, for example financial statement of 2005

compared with financial statement of 2006.

2. Comparison of one financial year by comparing the elements of financial

statement

3. Compare the financial statement with the best company in the industry.

4. Compare the financial statement with the industry standard.

5. Compare the financial statement with the budget of the company.

2.3.2 Common-size Financial Statement analysis

Common-size financial statement analysis or also known as vertical analysis is an

analysis method that presenting financial statement in the form of percentage. Normally

the percentage connected with important figure in the financial statement, for example

total asset figure in the balance sheet.

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2.3.3 Ratio Analysis

Ratio analysis is among the most popular tools in the financial statement analysis.

Analysis of ratio can reveal important relations between components that make up the

ratio. According to the management of the pension fund ratios analysis that normally

used in analyzing Pension Fund financial statement, include:

1. Return on Investment (ROI) is the ratio of money gained or lost on an investment

relative to the amount of money invested from the pension fund. ROI computed

as

ROI = Total income from investment /Average of Total Investment

Total income from investment figures found in the income statement or from the

changes of net assets report. Average of total investment calculated from the

balance of total investment at the beginning of the year plus the balance of total

investment at the end of the year and divided by two.

2. ROA is the ratio that shows the performance of the pension fund asset in

generating income. ROA computed as:

Total income from investment came from the income statement or the changes in

net assets report. Average of net assets calculated from the balance of net asset at

ROA = Total income from investment / Average of Net asset

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the beginning of the year plus the balance of net asset at the end of the year and

divided by two.

3. Solvability ratios refer to the ability of a corporation to meet its long-term fixed

expenses and to accomplish long-term expansion and growth. Based on the

finance minister decree no 510/KMK.06/2002 Solvability ratio computed as:

Net asset figures retrieved from the net assets report. Solvability liability

calculated by the actuary and reported in the actuary report.

4. Fund Adequacy Ratio shows the ability of a company to fulfill its obligation with

the assumption that the pension fund is going-concern. Based on the finance

minister decree no 510/KMK.06/2002 Fund Adequacy Ratio computed as:

Fund Adequacy Ratio = Net Assets / Actuarial obligation

Net assets figure retrieve from the net assets report or from the changes in net

assets report. Actuarial obligation figure retrieve from the balance sheet or from

the actuarial report.

According to the finance minister decree no 510/KMK.06/2002 there are three quality of

funding

Solvability Ratio = Net Assets / Solvability Liability

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First rank: The wealth of Pension Fund exceeds both actuarial obligation and

solvability obligation.

Second rank: The wealth of Pension Fund is less then the actuarial obligation and

exceed the solvability obligation

Third rank: The wealth of pension fund for funding is less than the solvability

obligation.

2.3.4 Cash-Flow Analysis

The statement of cash flows provides information on cash inflows and outflows for a

period. To predict cash flows in the future analyst could use the historical cash flow.

Cash flow reporting distinguishes the sources and uses of cash flows into operating,

investing, and financing activities. Financing activities includes of contribution

collection and pension benefit payment.

In evaluating sources and uses of cash, the analyst should focus on question like (Wild,

Subramanyan, and Halsey, 2004 p.395):

Are asset replacements financed from internal or external funds?

What are the financing sources of expansion and business acquisitions?

Is the company dependent on external financing?

What are the company’s investing demands and opportunities?

What are the requirements and types of financing?

Are managerial policies (such as dividends) highly sensitive to cash

flow?

30

Efficiency can be measure by calculating cash flow return on investment and cash flow

return on investment revenue. The higher that these ratios the higher the efficiency of

cash usage in investment portfolio.

Cash Flow Return on Investment = Cash Flow from Investing Activity / Total Investment

Cash Flow Return on Investment Revenue = Cash Flow from Investing Activity / Income from Investment

2.3.5 Measuring the Investment Performance of Pension Fund

Aside from the common analysis method, it is very important to analyze the investment

performance of the pension fund. The fiduciary responsibilities of pension plan

sponsors, administrators, managers, trustees, and other mandate that they periodically

evaluate the investment performance of the fund’s asset pool. Investment performance

measurement provides information on managing pension fund (Logue and Rader, 1998,

p.159):

How well a fund is doing in meeting its investment goals?

Investment performance measurement helping meet the goals of the pension plan

or whether it hurting.

Performance measurement offers insights into the general competence of an

investment manager and establishes whether the manager is following the

investment policy and guidelines provided by the sponsor.

31

Performance measurement offers information as to whether the investment

manager’s behavior is consistent with the investment philosophy that the

manager portrays as guiding decisions: that is, is the manager following the

investment strategy she said she would follow.