downs petrillo ho - macpamedia.orgmacpamedia.org/media/downloads/2011ebp/general_audit.pdfform 5500...

5/3/2011

1

Beyond the Basics –More Complex Audit Issues

Presented byKathryn Petrillo & Jennifer Downs

2

• This session will focus on the areas noted below that often challenge auditors and are commonly found by the DOL to be auditing deficiencies noted in their review of engagement files.

1. General audit file

2. Compliance testing

3. Financial statements

Agenda

5/3/2011

2

3

• Key Concepts –

– What service provider reports should be obtained?

– What time period is covered by the report(s)?

– What subservice organizations are used?

– User controls/client considerations

– Is it a Type I or Type II?

• What affect do these key concepts have on the audit?

• Use of the AQC SAS 70 Review Checklist

SAS 70 Reports

4

Full Scope Audit Procedures

A full scope audit is performed when:

• Plan administrator requests

• Investments are not held by qualified institution

• No certification or inadequate certification

• 11‐K

• Often done for ESOPs

• Must be done on any investment not covered by a valid certification even if limited scope report being issued

5/3/2011

3

5

• Need to understand internal controls related to investments and investment income

• Confirmation (existence and ownership, NOT valuation)

• Test fair value (quoted market price, audited financials of CCTs, PSAs, use of a specialist)

• Test investment income (analyticals, cut off for accruals)

• Test purchases and sales (SAS 70 when able)

Full Scope Audit Procedures

6

• What are the annual tests to be performed?– Minimum Coverage Test (Ratio Percentage or Average Benefits

Tests)– Top Heavy Test– ADP Test (Actual Deferral Percentage)– ACP Test (Actual Contribution Percentage)– Sec 402(g) Elective Deferral Limits– Sec 415(c) Annual Additions

• ADP and ACP Safe harbor• ADP and ACP testing failures ‐ can be corrected after the plan

year end by a timely distribution of excess contributions to the appropriate highly compensated participants and by forfeiture of excess unvested matching contributions.

Non-discrimination Testing

5/3/2011

4

7

The ADP & ACP Test

• The maximum permitted ADP/ACP for highly compensated employees (HCEs) for a year will be determined based on the ADP/ACP for nonhighly compensated employees (NHCEs) for the preceding year or current year (if elected by the employer).

• The rule is that the average ADP/ACP for the group of HCEs may not exceed—– 200% of the average ADP/ACP

for the group of NHCEs, if the average ADP/ACP of the NHCEs is 2% or less,

– the average ADP/ACP for the group of NHCEs plus two percentage points, if the average ADP/ACP of the NHCEs is between 2% and 8%, or

– 125% of the average ADP/ACP for the group of NHCEs if the average ADP/ACP of the NHCEs is 8% or more.

8

• Minimum Coverage Test, Top Heavy Test, Sec 415(c) Annual Additions• Were they performed and passed?

• ADP & ACP Tests• Were they performed and passed? • Refunds – accrued or PAJE?• Tie in with test of participant data• Appear reasonable?• 403(b) plans – under universal availability – only need ACP test

• Sec 402(g) Elective Deferral Limits• Was it performed and passed?• Refunds – accrued or PAJE?• 403(b) plan – alternative limit on mandatory contributions

Testing the Tests

5/3/2011

5

9

• Auditor has no responsibility to apply audit procedures to corroborate information in the Form 5500 beyond the financial information identified in the auditor’s report

• Auditor does need to read Form 5500 and all related schedules to identify any material inconsistencies with the audited financial statements

Auditor Responsibilities for 5500

10

• Can issue auditor’s report on the plan before reviewing Form 5500, but must inform client they cannot submit the audit with the Form 5500 until the auditor has reviewed it

• ERISA requires the notes to financial statements to explain any differences between the financial statement amounts and the amounts reported on Form 5500 (net assets, income, expenses, changes in net assets)


5/3/2011

6

11

Suggested items to review:• Plan name, plan number, EIN, year• Plan funding arrangement and benefit arrangement (trust, insurance, etc.)

• Schedule A present if insurance products held• Schedule SB present if defined benefit plan and contributions reconcile

• Schedule C present if direct or indirect compensation paid or attorney or accountant was terminated during the year


12

• Schedule D prepared if plan invests in PSAs, CCTs, other DFEs; amounts agree to Schedule of Assets Held; entity codes consistent with how reported in financial statements

• Schedule G present if Nonexempt Transactions identified in audit

• Schedule H items for total assets, liabilities, income, expense and changes in net assets agree to or are reconciled to the financial statements

• Schedule H Part III answers are consistent with report issued and the name and EIN of auditor are correct


5/3/2011

7

13

• Schedule H Part IV answers are consistent with audit findings and supplemental schedules are included in audit

– Schedule 4a – Delinquent Participant Contributions (new prescribed format)

– Schedule 4i ‐ Schedule of Assets (Held at End of Year)

– Schedule 4j – Schedule of Reportable Transactions (non participant directed investments)


14

• The rule for pension plans –– Under the regulation, 29 CFR § 2510.3‐102, amounts paid by a plan participant or beneficiary or withheld by an employer from a participant’s wages for contribution to a plan are plan assets on the earliest date that they can reasonably be segregated from the employer's general assets, but in no event later than the 15th business day of the month following the month in which the participant contributions are withheld or received by the employer .

Timeliness of Deposits

5/3/2011

8

15

• Failure to remit or untimely remittance of participant contributions constitutes a prohibited transaction under ERISA Section 406, regardless of materiality.

• Participant contributions include loan repayments.

• Delinquent contributions should be reported on line 4a, Part III of Schedule H of the 5500.

• Judgment is needed on level of testing.

Timeliness of Deposits (cont’d)

16

• In addition, EBSA officials have stated that a prohibited transaction would occur if the employer normally remits the participant contributions to the plan within five days of being withheld (demonstrating the time the contributions can be reasonably segregated), but one time during the year remits the contributions 15 days after being withheld. The 15 day maximum period for remittance is not a safe harbor for large plans. In other words, plan sponsors (and auditors) should not assume contributions are in compliance with the regulations so long as they are remitted prior to the 15 day limit. The defining characteristic is the earliest date on which contributions can reasonably be segregated from the employer’s general assets.

Timeliness of Deposits (cont’d)

5/3/2011

9

17

• Necessary if contribution or benefits are based on compensation or hours worked

• Consider relying on test of payroll done as part of corporate audit

• Consider reducing (NOT ELIMINATING) certain aspects of payroll testing if you can rely on SAS 70 of third party service organization

Payroll Testing

18

• What steps are involved in payroll testing?

– Select sample of transactions during plan year

– Trace pay rate to authorization

– Trace hours worked to approved timecards/timesheets

– Recalculate gross pay

– Trace gross pay to payroll journal

Payroll Testing

5/3/2011

10

19

• Frequent compliance error noted in audits

• Read the plan document thoroughly to determine full definition– Compensation base could be different for deferrals, match, profit sharing

• Discuss with payroll personnel and review payroll reports to ensure system is capturing proper compensation when calculating withholding

Definition of Compensation

20

• Be sure you are using actual payroll reports or have tested accuracy of extraction from payroll system

• Misapplication could result in significant receivable to plan due to required correction methods (ex. 50% of missed deferrals plus 100% of missed match)

• Problems often arise with turnover in payroll personnel, changes in payroll systems mid‐year, amendments to plan document that don’t get changed in operation

Definition of Compensation

5/3/2011

11

21

• For selected accounts, recompute the allocation of the following items to the individual account based on the allocation procedures specified in the plan document. Investigate and document any significant differences.

• (1) The employer contribution,

• (2) Plan income,

• (3) Realized and unrealized investment gains or

losses,

• (4) Expenses,

• (5) If applicable, forfeitures.

Income Allocation Testing

22

Decision to terminate plan could affect:

• Report issued

• Footnote disclosures

• Audit procedures

Terminating Plans/Going Concern

5/3/2011

12

23

Decision to terminate plan before year end:

• Report issued includes an explanatory paragraph:

As further discussed in Note X to the financialstatements, the Board of Directors of ABC Company,the Plan’s sponsor, voted on May 10, 2010 to terminatethe Plan. In accordance with accounting principlesgenerally accepted in the United States of America, thePlan has changed its basis of accounting from theongoing plan basis used in presenting the 2009financial statements to the liquidation basis used inpresenting the 2010 financial statements.


24

Decision to terminate plan before year end:

• Financial statements are presented on liquidation basis

– Assets recorded at price they can be sold

– Liabilities recorded at the estimated settlement amounts

– Usually no significant impact on plans as assets are already at fair value, but consider insurance contracts reported at contract value


5/3/2011

13

25

Decision to terminate plan after year end:

• Typically disclosed as subsequent event

• If plan sponsor intends to terminate the plan within 12 months of the date of the financial statements, the auditor should include an explanatory paragraph in his or her report that discloses that fact


26

• Example language (PPC suggested):

The accompanying financial statements have been prepared assuming that the Plan will continue as a going concern. As discussed in Note X to the financial statements, the Board of Directors of ABC Company, the Plan’s sponsor, voted in May 2011 to terminate the Plan, which indicates that the Plan is not a going concern. The financial statements do not include any adjustments that might be necessary upon termination.


5/3/2011

14

27

• Audit procedures likely increase

– Get authorization for termination for relevantdisclosure in report/footnotes

– Volume of benefit payments may change andincrease number of transactions tested

– Participants become 100% vested

– Consider partial termination


28

• Can occur if approximately 20% or more of plan participants are terminated by the plan sponsor as a result of an action, such as a termination of a division.

• Can accumulate over one or more plan years and still be classified as a partial termination

• Calculation = # of affected employees eligible for plan benefits/sum of all eligible employees and those employees who became eligible during the year

• Results in 100% vesting for affected participants

Partial Termination

5/3/2011

15

29

• In September 2010, the FASB issued ASU 2010‐25, Reporting Loans to Participants by Defined Contribution Pension Plans. The guidance in ASU 2010‐25 indicated that participant loans should be classified as notes receivable from participants in the financial statements of a defined contribution pension plan, measured at the outstanding principal amount plus accrued, but unpaid interest. ASU 2010‐25 is effective for fiscal years ending after December 15, 2010. Early adoption is permitted.

• However, they are still classified as investments on Schedule H of Form 5500

Participant Loans

30

• Included in ‘Investments at fair value’ on the statement of net assets available for benefits

• Interest income is reflected in investment income section on statement of changes in net assets

• Labeled as ‘Loans receivable’ in description of plan note

Participant Loans (cont’d)

Before ASU 2010‐25 Under ASU 2010‐25

• Shown as ‘Notes receivable from participants’ on the statement of net assets available for benefits

• Interest income is reflected separately below the investment income section

• Labeled as ‘Notes receivable from participants’ in description of plan note

5/3/2011

16

31

Participant Loans (cont’d)

• Description of valuation method included in ‘Investment Valuation and Income Recognition’ in Summary of Accounting Policies note

• Included in ‘Investment Valuation’ footnote as level 3 investment

• Included in investments on the Schedule of Assets (Held at End of Year)

Before ASU 2010‐25 Under ASU 2010‐25

• Description of valuation method separately stated in ‘Notes receivable from participants’ note in Summary of Accounting Policies note

• Not included in ‘Investment Valuation’ footnote

• Included below investments on the Schedule of Assets (Held at End of Year)

32

• FASB ASC 820 Fair Value Measurements originally became effective for years beginning after November 15, 2007 and has been updated several times

• Required for all assets and liabilities measured at fair value

Fair Value Disclosures

5/3/2011

17

33

• Standard disclosures:

– Fair value

– Level within the hierarchy

– Transfers between levels 1 and 2 (effective periods beginning after 12/15/09) and reasons

– Rollforward of level 3

– Description of valuation techniques, inputs and changes therein


34

• Disclosure for debt and equity securities should be by major security type (effective periods ending after June 15, 2009)

• Based on nature and risks of the security

• Equities– Consider industry sector

• Mutual funds/PSAs– Consider enrollment package information provided to participants

– Consider morningstar classifications


5/3/2011

18

35

• Contracts under which payments to the insurance company are held in an undivided fund for investment until they are used to pay benefits or to buy annuities for plan participants who retire or terminate employment with vested benefits.– Deposit administration (DA) contracts.– Immediate participation guarantee (IPG) contracts.– Guaranteed investment contracts (GIC).– Synthetic GICs.– Individual (separate) separate accounts.– Pooled separate accounts.

Investment Contract with an Insurance Company

36

• A common or collective trust (CCT) may be used to invest some or all of a plan’s assets. A plan generally acquires investment units, referred to as units of participation, representing an undivided interest in the underlying assets of the trust. The purchase or redemption price of the units is determined periodically by the trustee, based on current market values of the underlying assets in the funds.

• Stable Value Funds

Common or Collective Trusts

5/3/2011

19

37

• FASB ASC 962 and 965 (formerly SOP 94‐4, Reporting of Investment Contracts Held by Health and Welfare Benefit Plans and Defined Contribution Pension Plans). FASB ASC 962 and 965 (formerly Statement of Position No. 94‐4) provide the accounting standards for certain investment contracts held by health and welfare plans and defined contribution retirement plans.

• Investment contracts with insurance or other companies, specifically GICs, and CCTs must be reported at fair value for conformity with GAAP.

Reporting

38

• Planning –– For insurance contracts, obtain a copy of all contracts (and any

amendments) and review for provisions (i.e. required deposits, limits on distribution amounts, limits on fund transfers, guaranteed interest rate(s), termination clauses)

– Obtain (if available) the insurance company financial statements and financial statements for the contract or the financial statements for the CCT.

• Investment audit procedures –– Is the contract/CCT covered by a certification?– Is the contract or investments in the CCT, fully benefit‐responsive

(FASB ASC 962‐325‐50‐3)?– Is the contract/CCT valued at fair value or contract value?– If contract value, what is adjustment needed to bring it to fair value?

• Balance sheet presentation

Auditing Contracts and CCTs

5/3/2011

20

39

According to FASB ASC 962‐325‐20 (formerly SOP 94‐4) an investment contract is considered fully benefit‐responsive if it meets all of the following conditions:

a. The contract is entered into directly between the plan and the issuer and the plan is not allowed to assign or sell the contract or the proceeds from the contract to another party without the issuer’s consent.

b. Either the issuer of the contract has a financial obligation to repay the principal and interest credited to participants in the plan, or participants in the plan are provided prospective interest crediting rate adjustments on a designated pool of investments (either held by the plan or the issuer of the contract) through which a financially responsible third party provides assurance that adjustments to the interest crediting rate will not result in a rate less than zero. In the latter case, the third party generally provides the assurance through a contract referred to as a “wrapper.” If a situation occurs, such as a significant decline in the creditworthiness of the issuer or provider of the wrapper, and it becomes no longer probable that full contract value will be realized for a particular investment contract, that contract would no longer be considered fully benefit‐responsive.

Fully Benefit-Responsive

40

According to FASB ASC 962‐325‐20 (formerly SOP 94‐4) an investment contract is considered fully benefit‐responsive if it meets all of the following conditions:

c. The contract must require all participant‐initiated transactions with the plan (such as withdrawals, loans, or transfers allowed by the plan) to be made at contract value, without limitations, conditions, or restrictions.

d. It must be probable that an event would not occur that would limit the plan’s ability to conduct transactions with the issuer at contract value and that would also restrict the plan’s ability to conduct transactions with plan participants at contract value. Such events may include the plan’s premature termination of the contracts, layoffs, termination of the plan, plant closings, bankruptcy, mergers, or early retirement incentives.

e. The plan must allow participants to have reasonable access to their funds. For example, if plan participants are allowed access at contract value to all or a portion of account balances only upon termination of their participation in the plan, this would not be considered reasonable access and the contract would not be considered fully benefit‐responsive.

Fully Benefit-Responsive(cont’d)

5/3/2011

21

41

Disclosed at FV per GAAP

Netted with Investments (at fair value) ‐> agrees to Form 5500

Extracted from PPC

42

Disclosure –• Is the following information disclosed in the aggregate for fully benefit‐responsive investment contracts:

(FASB ASC 962‐325‐50‐3) (formerly SOP 94‐4, Paras. 15a–15e)

– A description of the nature of the contracts, how they operate, and how the interest crediting rate is calculated. This disclosure should include key factors that could influence future average interest crediting rates, the basis for and frequency of determining interest crediting rate resets, and the minimum interest crediting rate, if any, included in the contract. The disclosure should also explain the relationship between future interest crediting rates and the amount reported on the statement of net assets representing the adjustment from fair value to contract value.

– For each period for which a statement of net assets is presented, the average yield earned by the plan for all fully benefit‐responsive investment contracts.

– For each period for which a statement of net assets is presented, the average yield earned by the plan for all fully benefit‐responsive investment contracts with an adjustment to reflect the actual interest rate credited to plan participants.

– A description of the events, if any, that limit the plan’s ability to execute transactions at contract value with the issuer (e.g., premature termination of the contracts by the plan, plant closings, layoffs, plan termination, bankruptcy, mergers, and early retirement incentives), including a statement about whether those events are probable to occur.

– A description of the events and circumstances that would permit issuers to terminate the contracts and settle at amounts that differ from contract value.

Disclosures for Contracts and CCTs

5/3/2011

22

43

Disclosure –• Are provisions of insurance contracts included as plan assets that

could cause an impairment of the asset value upon liquidation or other occurrence (for example, surrender charges and market value adjustments) disclosed?

• Is there appropriate disclosure of characteristics of insurance contracts that restrict the use of assets, for example, disclosure of: (AEBP, Para. 7.50c)– Termination clauses (such as a market value determination

adjustment) in an insurance contract?– The plan’s intention to dispose of or terminate an insurance contract,

if the plan has indicated such an intention?– An event that has affected the contract issuer that requires disclosure

or caused plan management to report the investment in the insurance contract at less than contract value?

Disclosures for Contracts and CCTs (cont’d)

44

• For investment contracts issued by troubled insurance companies and other financial institutions, such as ones that have been taken over by state insurance or other regulators, the accounting or disclosure requirements of FASB ASC 450 (formerly SFAS No. 5, Accounting for Contingencies) and FASB ASC 275 (formerly SOP 94‐6, Disclosure of Certain Significant Risks and Uncertainties) may apply. Another valuation consideration is whether the insurance company can continue to provide the return specified in a GIC and whether interest should continue to be accrued on such contracts. The auditor should make further considerations in determining the fair value of investment contracts issued by troubled insurance companies.

Troubled Insurance Companies

downs petrillo ho - macpamedia.orgmacpamedia.org/media/downloads/2011ebp/general_audit.pdfform 5500...

Documents