Defined benefits. Pensions can be significant in industrials.

Defined benefit pension will pay out an agreed amount yearly on retirement.

This is a promise made by the company, and pension plans are usually required to have assets set aside to cover these future pension liabilities.

If these assets aren't sufficient to cover the pension plan's, liabilities, the pension plan is said to be in deficit.

This needs to be shown on the sponsoring company's balance sheet and is typically treated as a debt like for valuation purposes.

Since the sponsoring company will most likely have to pay money into the pension plan to cover the deficit in the future, if the assets exceed the liabilities, the plan is in surplus.

The surplus plan is usually inaccessible by the company, so it's ignored in valuation.

There are actually two ways in which pension liabilities can be created on a company's balance sheet.

The first is an underfunded plan, which we've just explored.

The second is an unfunded plan.

For these types of plan, there is no requirement for them to be pre-funded, meaning there are no plan assets.

The obligation to make future payments can simply all be treated as a deficit.

Most post-retirement medical plans are like this, and some countries allow pension funds to run like this, most notably Germany because defined benefits. Pensions are more common in industrials and can be so significant to valuation.

Understanding them is important in this sector.