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. § 2510.32(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 benefitresponsive 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?