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Overview of Financial Reporting for
Employee Benefit Plans
Presented by:
Pugh & Company, P.C.
August 10, 2010
Financial Reporting Overview
• After ERISA was enacted, the Financial
Accounting Standards Board (FASB) established
financial accounting and reporting standards for
defined benefit pension plans.
• The AICPA followed with accounting and
reporting standards for defined contribution
retirement plans and health and welfare benefit
plans.
• With the FASB Codification becoming effective,
much of the accounting guidance originally
developed by the AICPA was transferred into the
Codification.
08/2010 PUGH & COMPANY, P.C. 2
Learning Objective
Specific financial reporting issues that we will look
at include:
• Required financial statements
• Required footnote disclosures
• Required supplemental Schedules
• FAS 157
• Hard-to-value Assets
• Limited-scope Audits
• 403(b) Plans
• Plan Mergers
• Plan Terminations
• Stable Value Funds and GIC’s
• Risks and Uncertainties
08/2010 PUGH & COMPANY, P.C. 3
Required Financial Statements
• Statement of Net Assets Available for
benefits – current and prior years required
• Statement of Changes in Net Assets
Available for Benefits – current year required
• Statement of Accumulated Plan Benefits -
for DB plans only; current and prior years
required; can be disclosed in the footnotes rather
than as a separate F/S.
• Statement of Changes in Accumulated Plan
Benefits - for DB plans only; current year
required; can be disclosed in the footnotes rather
than as a separate F/S.
08/2010 PUGH & COMPANY, P.C. 4
Financial Statement Disclosures
• Plan description
• Use of estimates
• Accounting policies
• Income tax status
• Fair value measurements
• Financial instruments (concentration of
credit risk)
• Related party and party-in-interest
transactions
08/2010 PUGH & COMPANY, P.C. 5
Financial Statement Disclosures (cont.)
• Commitments
• Contingencies, risks and uncertainties
• Illegal acts and prohibited transactions
• Changes in presentation of comparative
statements
• Subsequent events
• Terminating or frozen plan
• DOL limited-scope audit
08/2010 PUGH & COMPANY, P.C. 6
Required Supplemental Schedules
• Schedule of Assets (Held at End of Year)
• Schedule of Assets (Acquired and
Disposed of Within the Year)
• Schedule of Reportable Transactions
• Schedule of Nonexempt (Prohibited)
Transactions
• Schedule of Leases in Default or Classified
as Uncollectibe
08/2010 PUGH & COMPANY, P.C. 7
FAS 157
• FAS 157 – Fair Value Determination was
effective for 2008 calendar year audits.
• DOL states that any plans with more than
5% of hard-to-value assets will hit the
radar screen in the Washington DC
offices.
08/2010 PUGH & COMPANY, P.C. 8
FAS 157
FAS 157 addresses the following:
• The fair value measurements at the reporting
date for each major category of assets or
liabilities
• The level within the fair value hierarchy each
measurement falls
• The valuation techniques used to measure fair
value and a discussion of changes in valuation
techniques, if any
• Level 3 has expanded disclosures to reconcile
beginning and ending balances
08/2010 PUGH & COMPANY, P.C. 9
FAS 157
• What Does SFAS 157 Do?
– SFAS 157 pushes for greater involvement by
the plan sponsor and the auditor in the
valuation process
– Fair value moves from being a purely custodial
concern, to a plan sponsor’s concern
– In many cases, the hierarchy will not be
certified
08/2010 PUGH & COMPANY, P.C. 10
FAS 157
• Definition of Fair Value
– The price that would be received to sell an
asset or paid to transfer a liability in an orderly
transaction between market participants at the
measurement date
• Participant
– Independent
– Knowledgeable
– Able and willing
• Market
– Principal market or
– Most advantageous market
08/2010 PUGH & COMPANY, P.C. 11
FAS 157
• Inputs
– Observable – reflect the assumptions market
participants would use based on independent
market sources
• Stock prices
• Amortized cost methods
• Price matrixes
08/2010 PUGH & COMPANY, P.C. 12
FAS 157
• Inputs…
– Unobservable – reflects the reporting entity’s
own assumptions based on best information
available
• Extrapolated data
• Proprietary models
• Analytical quotes
08/2010 PUGH & COMPANY, P.C. 13
FAS 157
• Hierarchy
– Level I
• Quoted prices for identical assets or liabilities in active
markets
– Level II
• Similar assets or liabilities in active markets
• Identical or similar assets in inactive markets
• Other directly observable inputs
– Level III
• Reporting entity’s own assumptions
• Other entity inputs that are not derived form market data
• Unobservable inputs based on the best information
available
08/2010 PUGH & COMPANY, P.C. 14
FAS 157
• What Pricing Information Do You Need?
– Pricing source
• Who priced the assets?
• Specific vendor or source
– Pricing type
• How did they derive the price?
• Are the prices taken from an exchange, based on
models, or broker quotes?
08/2010 PUGH & COMPANY, P.C. 15
FAS 157
– Price as-of date
• How current is the price?
• Is the price a stale price or is it still the most
current, but still lagged price (limited partnerships)?
– Inputs
• Are the inputs to the price observable or
unobservable?
• What basic assumptions were used by the vendor or
broker providing the quotes?
08/2010 PUGH & COMPANY, P.C. 16
FAS 157
• Final Level Determination
– Client needs to assist in obtaining the data
from the custodian.
– Client needs to review the data and make the
initial determination.
• The client may need your assistance in assessing
the levels of various investments
• Consider a comment in the rep letter regarding the
responsibility of the assignment of the levels
• Be careful of independence issues – auditor cannot
perform the valuation determination as our
independence would be impaired
– Auditor needs to validate and opine on the
initial determination.
08/2010 PUGH & COMPANY, P.C. 17
FAS 157
• Full Scope vs. Limited Scope
– Should the procedures differ based on the
scope of the audit?
08/2010 PUGH & COMPANY, P.C. 18
FAS 157
• Limited Scope…
– Responsibility for testing valuation disclosures
does not change between a limited and full
scope.
– If management does not have appropriate
expertise or involvement in the valuation
process, you will likely have a SAS 115
deficiency to evaluate and possibly
communicate.
08/2010 PUGH & COMPANY, P.C. 19
Hard-to-Value Assets
• Paragraph 7.69 of AAG-EBP gives an example of
a disclaimer report where the fair value of some
of the assets could not be determined.
• A footnote on that page reminds us that
historically the DOL has rejected Form 5500
filings that contain either qualified opinions,
adverse opinions, or disclaimers of opinion other
than those allowed via 29 CFR 2520.103-8 or 12.
08/2010 PUGH & COMPANY, P.C. 20
Hard-to-Value Assets
FSP FAS 157-3: Determining the Fair Value of a
Financial Asset When the Market for That
Asset Is Not Active
• Amends SFAS 157 by providing an illustrative example.
Key principles included in the example:
• Exit Price represents sale in an “orderly transaction”
that is not a forced liquidation or distressed sale
• In a dislocated market – not correct to automatically
conclude transaction price is determinative of FV
• Clients assumptions about FV about cash flows and risk
adjusted discount rates are acceptable when observable
inputs are not available
• Broker Quotes may be appropriate – but again – not
necessarily determinative of FV
08/2010 PUGH & COMPANY, P.C. 21
Hard-to-Value Assets
FSP FAS 157-4: Determining Fair Value When the
Volume and Level of Activity for the Asset or
Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly
• Provides additional guidance for estimating fair value when
the volume of activity has significantly decreased
• Provides guidance on indentifying when a transaction is not
orderly
• In determining an exit price, companies will need to
determine if the weight of evidence exists that a
transaction is not orderly. If the transaction is not orderly,
significant adjustments to quoted prices may be necessary
• Also provides guidance for reporting investments by level
08/2010 PUGH & COMPANY, P.C. 22
Hard-to-Value Assets
Accounting Standards Update No. 2009-12 - Fair Value
Measurements and Disclosures (Topic 820):
Investments in Certain Entities That Calculate Net
Asset per Share (or Its Equivalent)
• Permits NAV of its equivalent to be used in estimating fair
value when it’s the practical expedient
• Use of NAV permitted when:
– Alternative has attributes of an investment company
– Reports NAV or its equivalent
– Calculates NAV consistent with AICPA Investments
Companies Guide (FASB ASC 946)
08/2010 PUGH & COMPANY, P.C. 23
Hard-to-Value Assets
• ASU No. 2009-12 Disclosures
– Fair Value and description of significant investment strategies
– For investments that can not be redeemed (gets distribution
through liquidation of underlying) – the estimated period of
time they will hold the investments
– Amount of unfunded commitments
– Terms and conditions under which investor can redeem
– Circumstances under which redemption might not be allowed
– Significant restrictions on ability to redeem or sell at
measurement date
– If its probable well sell at an amount different than NAV
– disclose fair value and actions necessary to complete
the sale
– If a group of investments would otherwise meet
probable sales criteria but individual investments have
not been identified, disclose plans to sell and actions
required to complete the sale
08/2010 PUGH & COMPANY, P.C. 24
Hard-to-Value Assets
ASU No. 2009-12
• Effective for periods ending after
12/15/2009
• Early adoption permitted - without having
to adopt disclosures
08/2010 PUGH & COMPANY, P.C. 25
Practical Considerations
• Consider the assets in the plan and help
the plan administrator to consider where
the fair values are coming from, and
whether they are in compliance with FAS
157.
• Provide a copy of the “Plan Advisory for
Valuing and Reporting Plan Investments”
to plan administrators, TPA’s, trustees,
and other interested parties.
08/2010 PUGH & COMPANY, P.C. 26
Practical Considerations
• The chief accountant of EBSA has stated
that the auditors need to be sure of the
valuation of plan assets – that we cannot
hide behind certifications on limited scope
audits.
• Discuss with client representatives where
their valuations come from and what they
are based upon.
08/2010 PUGH & COMPANY, P.C. 27
Limited Scope Audits
08/2010 PUGH & COMPANY, P.C. 28
Limited Scope Audits
• Per the DOL, wording in a DOL-limited
scope certification such as “to the best of
my (or our) belief” is Not Acceptable!
• If you encounter this have the certifier
correct it.
• May have to send certifier an example of
approved wording from the reg’s.
08/2010 PUGH & COMPANY, P.C. 29
Limited Scope Audits
• When loans have not been included in the
certification, do not state in the report
that investments have been certified –
change to certain investments have been
certified.
• The footnote explaining the certification
should be clear that loans are not included
in the certification if that is the case.
08/2010 PUGH & COMPANY, P.C. 30
Limited Scope Audits
Certified Investments
• Not certified as to fair value.
• Fair value not certified as of the plan year end.
• Regulations only require certification to be based
upon the books and records of the trustee or
custodian. No mention of “fair value”.
• Regulations require investments to be reported
on Form 5500 at fair value regardless of what is
certified.
08/2010 PUGH & COMPANY, P.C. 31
Limited Scope Audits
• Determine whether the disclosures related to
investment information conform with GAAP and
comply with DOL rules and regulations.
• If certified information appears incomplete,
inaccurate, or otherwise unsatisfactory, further
inquiry may result in additional testing or
modification to opinion
• Limited scope audit may no longer be appropriate
for all or certain investments.
08/2010 PUGH & COMPANY, P.C. 32
Limited Scope Audits
• The economy has caused valuation issues with many
investments.
• Management may determine that certain investments
should not be subject to limited scope exemption.
• Investments for which the certification may not represent
fair value:
– Hedge funds
– Limited partnerships
– Venture capital funds
– Illiquid bonds
– Securities lending arrangements
– Real estate
08/2010 PUGH & COMPANY, P.C. 33
403(b) Plans
What is an ERISA covered 403(b) plan?
– Generally, where there are employer
contributions, and/or
– Where the employer exercises “control” of
the plan
• Internal Revenue Code (IRC) §403(b)
plans - also known as “tax-sheltered
annuity plans” (TSA plans)
• Retirement plans often offered by schools,
hospitals, churches, charities and certain
other IRC §501(c)(3) tax exempt
organizations
08/2010 PUGH & COMPANY, P.C. 34
403(b) Plans
• Law and regulatory changes since 1986 have
slowly been eliminating any differences between
403(b) plans and 401(k) type plans – recent
changes continue that trend
• Generally excluded from the 5500/audit
requirements:
• “Governmental plans” under ERISA section 3(32)
• “Church plans” under ERISA section 3(33)
• Plans that comply with the DOL “safe harbor”
rules under DOL regulation 29 C.F.R. § 2510.3-
2(f)
08/2010 PUGH & COMPANY, P.C. 35
403(b) Plans
A 403(b) plan comprises individual
investment accounts that may include the
following types:
– Fixed and variable annuity contracts with
insurance companies
– Custodial accounts made up of mutual funds
– A retirement income account set up for church
employees
08/2010 PUGH & COMPANY, P.C. 36
403(b) Plans
IRS issued comprehensive regulations for 403(b)
plans in July 2007 effective beginning in 2009.
• Requires all plans to have written plan
documentation
– Documentation deadline was extended to
December 31, 2009
– Plan must have been operated in accordance the
requirements and any plan errors or issues
resolved by December 31, 2009
– May be a stand alone document or collection of
documents
• Could significantly change and/or increase the
administrative burden and exposure for the “plan
sponsor”
08/2010 PUGH & COMPANY, P.C. 37
403(b) Plans
Effective for 2009 Form 5500 filings, 403(b)
plans are:
– Subject to annual Form 5500 reporting
requirements similar to 401(k) plans
• Large plans (100 or more participants) are required
to file annual financial statements
• Small plans (fewer than 100 participants) are
eligible to use the short Form 5500
ERISA requires comparative statements of net
assets; therefore, 12/31/08 balances are
subject to audit.
08/2010 PUGH & COMPANY, P.C. 38
403(b) Plans
The DOL has indicated that they intend to
enforce this new audit requirement for 2009.
– Plan auditors need to educate themselves and
their clients about this change
– Careful due diligence is required to ensure
that the 403(b) plans will be auditable for
2009
– Since ERISA requires comparative statements
of Net Assets Available for Benefits (NAAB),
2008 year end balances will need to be
reflected
• 2008 NAAB may be compiled, reviewed or audited
08/2010 PUGH & COMPANY, P.C. 39
403(b) Plans
Field Assistance Bulletin (“FAB”) 2009-02
Issued July 20, 2009
Provides guidance to DOL Field Offices
Provides Enforcement Relief for Form 5500 filings
– Does NOT provide audit relief
DOL/EBSA will not reject a 403(b) plan Form 5500 filing
solely because the auditor’s report is qualified, adverse
or disclaims an opinion (other than a “limited scope”
disclaimer allowed under 29 CFR 2520.103-8) due to the
exclusion of pre-2009 annuity contracts and/or custodial
accounts meeting 4 criteria
08/2010 PUGH & COMPANY, P.C. 40
403(b) Plans
Note: Regardless of the type of opinion
issued, the auditor is still required to
complete all other audit procedures (e.g.:
contributions, distributions, etc.)
08/2010 PUGH & COMPANY, P.C. 41
403(b) Plans
All of the following conditions must be met
to qualify for the enforcement relief:
1. The contract or account was issued to a
current or former employee before
January 1, 2009;
2. The employer ceased to have any
obligation to make contributions
(including employee salary reduction
contributions) and in fact ceased making
contributions before January 1, 2009;
08/2010 PUGH & COMPANY, P.C. 42
403(b) Plans
3. All rights and benefits under the contractor
account are legally enforceable against the
insurer or custodian of the contact by the
individual owner, without any involvement
of the employer: and
4. The individual owner of the contract is fully
vested.
08/2010 PUGH & COMPANY, P.C. 43
403(b) Plans
• The FAB allows but does not require that
contracts and/or accounts be excluded
• The FAB applies to both large and small
plans
• Current or former employees with
contracts excludable under this relief are
not counted as participants
08/2010 PUGH & COMPANY, P.C. 44
403(b) Plans
• The plan sponsor will need to ensure that the four
criteria have been met in order for them to be
properly excluded
• Contracts/accounts that do NOT meet all of the four
criteria may not be excluded
• Contracts/accounts that are excludable under the FAB
may also be excluded from the comparative (2008)
financial statements included in the 2009 annual
report
• The FAB also applies to years beyond 2009
08/2010 PUGH & COMPANY, P.C. 45
403(b) Plans
• ERISA and current regulations
require the audit to be performed in
accordance with Generally Accepted
Auditing Standards (GAAS)
• The exclusion by the plan sponsor of
contracts and/or accounts that meet
the criteria of the FAB will likely
prevent the auditor from being able
to issue an unqualified opinion or a
limited scope opinion under 29 CFR
2520.103-8
08/2010 PUGH & COMPANY, P.C. 46
403(b) Plans
• Some sponsors may not find a qualified, adverse or
disclaimer of opinion acceptable
• Some vendors will not be in a position to exclude
contact or account information that meets the criteria
• DOL’s expectation is for a “good faith” effort to
comply with the ERISA annual reporting requirements
• DOL is working on additional guidance
• AICPA Joint 403(b) Plan Audit Task Force is working
on additional tools
08/2010 PUGH & COMPANY, P.C. 47
403(b) Plans
The bottom line…..
• The auditor is responsible for following GAAS
and still needs to audit whatever information
is available
• The auditor is responsible to conduct an
audit and cannot limit test work because of
a scope limitation or because the auditor is
issuing a qualified or adverse opinion
• The auditor is responsible for issuing the
appropriate opinion, which includes disclosing
the reasons for any qualifications
08/2010 PUGH & COMPANY, P.C. 48
403(b) Plans
Steps clients should take….
• Establish proper internal controls over the
plan’s financial reporting process
• Ensure that the plan has an up-to-date
written plan document
• Ensure that the plan is in compliance with
the plan’s tax exemption
• Determine what 2008 comparative
financial information the plan will need
08/2010 PUGH & COMPANY, P.C. 49
403(b) Plans
Steps clients should take….
• Understand how the DOL’s new financial
reporting and audit requirements will
affect the plan
• Establish responsibility for the plan’s
financial reporting function
• Get the plan’s books and records in
shape:
– Communicate with the service provider(s) on the
plan’s information needs
– Make sure plan participant records are complete and
accurate
08/2010 PUGH & COMPANY, P.C. 50
403(b) Plans
Opportunities for auditors….
• Prepare/review Form 5500
• Assist with data collection
• Establishing internal controls, investment
selection, fiduciary compliance
• Conduct financial statement audit
– Note: We cannot perform management
functions (data collection, internal controls,
etc) and perform the audit – one or the other
08/2010 PUGH & COMPANY, P.C. 51
Plan Mergers
• Dates are critical to determining
proper presentation in financial
statements and filing of Form 5500:
– Effective date of merger
– Date of change in legal control of assets (title
to assets)/notification to trustee of change in
title
– Date of actual asset transfer
08/2010 PUGH & COMPANY, P.C. 52
Plan Mergers
• Assets transferred in or out due to plan
mergers are shown as –
– Transfer to/from XYZ Benefit Plan in the
statement of changes in net asset
• Restatement of prior year financial
statements is not required for plan
mergers
• Liquidation basis of accounting is not
appropriate
08/2010 PUGH & COMPANY, P.C. 53
Plan Mergers
Financial Statement Disclosure
• Disclose the nature and timing of the
event in a note to the financial
statements.
• For DB and H&W plans, benefit
information disclosures in the financial
statements or footnotes should include
the effect of the combination on the
accumulated benefit obligations.
08/2010 PUGH & COMPANY, P.C. 54
Plan Termination
Date of decision to terminate the plan is
critical to reporting and disclosure
• Decision made prior to the end of the plan year
– Liquidation basis of accounting applies
– Disclosure of termination in footnotes
– Accountant’s report to discuss termination
• Decision made after the end of the plan year
– Type two subsequent event
– Disclosure of termination in footnotes (subsequent
events)
08/2010 PUGH & COMPANY, P.C. 55
Plan Termination
Liquidation Basis of Accounting
• Usually little or no change to values, as
fair value is utilized to value assets.
• May impact investments carried at
contract value
– Insurance contracts
– Large blocks of stock or other assets that
cannot be readily disposed of at their quoted
market price.
08/2010 PUGH & COMPANY, P.C. 56
Plan Termination
Liquidation Basis of Accounting (cont.)
• Accumulated Benefit Obligation must
be presented on a liquidation basis
(FAS Statement No. 35 does not
apply to terminated DB plans)
– Change in interest rate
– Change in lump sum factors
– Change in vesting
– All benefits immediately payable
08/2010 PUGH & COMPANY, P.C. 57
Stable Value Funds & GIC’s
GIC – Disclosures
• DB plans report at fair value.
• FASB Staff Position No. AAGINV-1 and SOP 94-4-1 requires,
effective for annual period ending after 12/5/2006 (and
retroactively applied), fully benefit-responsive contracts to
be reported at fair value.
– For synthetic GICs, fair value is determined separately for the
portfolio of underlying investments and the wrapper.
• The following amounts shall be presented:
– Net assets reflecting all investments at fair value shall be
presented.
– The adjustment between the fair value and contract value of
all fully benefit-responsive investment contracts shall be
presented as a single line item.
• Calculated as the sum of the amounts necessary to adjust the
portion of net assets attributable to each fully benefit-responsive
investment contract from fair value to contract value.
08/2010 PUGH & COMPANY, P.C. 58
Stable Value Funds & GIC’s
GIC – Disclosures, con’t
• Disclose, in the aggregate:
– Nature of the contracts, how they operate, and
methodology for calculating the interest crediting rate,
• Key factors that could influence future average interest
crediting rates, the basis for and frequency of determining
interest crediting rates, and any minimum interest
crediting rate.
• Relationship between future interest crediting rates and
the adjustment to contract value reported on the
statement of net assets.
– Average yield earned by the plan for all fully benefit-
responsive investment contracts
– Average yield with adjustment to reflect rate credited to
participants for all fully benefit-responsive contracts
08/2010 PUGH & COMPANY, P.C. 59
Stable Value Funds & GIC’s
GIC – Disclosures, con’t
• Is reconciliation to the form 5500
necessary?
– 5500 presents GICs at fair value.
– Net assets in financials are adjustment back to
contract.
– Reconciliation is required unless client
prepares 5500 at contract (not preferred
method).
08/2010 PUGH & COMPANY, P.C. 60
Synthetic GIC - Disclosures
• In addition to GIC disclosures:
– Average yield earned by the plan
• Divide annualized earnings of all fully benefit-responsive
contracts in the plan by the fair value of all such
contracts.
• Earnings of contract differ from amounts credited to
participants (e.g., yields on underlying portfolios).
– Average yield with adjustment to reflect rate credited to
participants
• Divide annualized earnings credited to participants by the
fair value of all such contracts.
– Disclosures must be complete for each year a statement
of changes is in assets is presented.
08/2010 PUGH & COMPANY, P.C. 61
Risks and Uncertainties
• Consider whether additional language is
needed for “risks and uncertainties”
disclosures based on what the Plan is
investing in (whether related to the credit
crisis or otherwise).
08/2010 PUGH & COMPANY, P.C. 62
Risks and Uncertainties
08/2010 PUGH & COMPANY, P.C. 63
Overview of Financial Reporting for
Employee Benefit Plans
Questions?
