MHM Executive Education Series: Employee Benefit Plan Accounting Update

November 29, 2012

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Agenda • Employee benefit plan (EBP) basics • Summary of fair value issues: fair values, NAV “practical

expedient”, “hard-to-value” level 3 • EBP Regulatory Issues:

– New service provider fee disclosure requirements at the plan level and individual participant level

– Other DOL/EBSA initiatives including proposed expanded definition of a “fiduciary”

• Areas of risk in employee benefit plans and common problems

• Auditing issues: AICPA Clarity Standards, EBP A&A Guide Overhaul

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Employee Benefit Plan (EBP) Basics

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Employee Benefit Plans (EBPs) Unique Accounting and Reporting Requirements

GAAP financial statements (“large plans”)

DOL reporting requirements

IRS supplemental schedule requirements

Regulated and Subject to Increased Scrutiny

DOL enforcement initiatives

EBPs and EBP auditors subject to DOL inspections

EBP auditors subject to peer review requirements

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Types of ERISA Plans • Health and welfare benefit plans • Defined benefit plans • Defined contribution plans:

– 401(k) – profit sharing – ESOP – 403(b)

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EBP Audit Requirements:

• The requirement for an audit is dictated by ERISA regulations and based on the number of eligible participants at the beginning of the year, usually 100. Note: The beginning of the year participant number may not be the same number as the end of the year for the previous year if the plan allows for a January entry date.

• 80/120 Rule – plans with 80-120 participants at the beginning of the plan year may file the same Form 5500 as prior year (large plan-small plan)

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Plan Audit Decision Tree

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Types of EBP audits

– Limited Scope – Full Scope

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Limited Scope

• Plan assets in custody of a “qualified institution” – Bank – Insurance company – Trust company

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Limited Scope

• Qualified institution certifies: – Accuracy of investment valuation (B/S date) – Accuracy of investment activity (P&L activity) – “Complete and accurate”

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Limited Scope

• Accountants permitted to: – Omit substantially all audit procedures on:

• Investment balances • Investment earnings/losses

– Perform audit procedures on all other areas – Disclaim an opinion on the plan’s financial

statements

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Limited Scope If the certification is incomplete or unsatisfactory, full scope

audit procedures must be extended to the investment securities.

Further inquiry may be necessary in a DOL limited scope audit when: • Cost equals fair value for investments. • Fair value for certain investments have not changed for

several years. • Description of investments on the Schedule of Assets is

inconsistent with other information and/or footnote disclosures.

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Limited Scope

• Investments not included in the certification (must be audited as a full scope audit)

• Real estate, leases, mortgages, self-directed brokerage accounts and/or participant loans are often not covered by a certification by a qualified trustee, custodian or insurance company.

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Full Scope

• No investment certification available • Client requests full scope audit to be performed • 11-K filer • Must choose full or limited scope opinion-split

reporting is not permitted

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Full Scope

• Auditor is required to perform procedures on investments by: – Confirming existence directly with holder of

assets (may have multiple custodians) – Year-end market value testing – Purchases and sales testing – Investment income testing

• Interest and dividends • Realized gains and losses • Unrealized gains and losses

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Service organizations (SOC 1, formerly SAS 70)

Outsourced service providers

Plan sponsor controls

Parties involved in handling plan transactions

Level of oversight at the plan sponsor

EBP Internal Controls

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General overview – Helps plan auditors understand and evaluate controls

at service provider organizations

– Evaluate whether substantive testing can be reduced, but not eliminated

– Often referred to as a service auditors report

– Reports on the processing of transactions performed by service organizations;

SSAE 16/SOC 1 Reports

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SSAE 16/SOC 1 Reports Limited Scope

– Auditor still has responsibility to read the SSAE 16/SOC 1 report for items such as processing of participant level transactions.

Full Scope – Auditor should obtain and read the entire SSAE 16/SOC

1 report and consider both the report and the evidence provided by the tests of operating effectiveness (Type II) and relate them to the assertions in the user organization’s financial statements.

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SSAE 16/SOC 1 Reports

• Types of SSAE 16/SOC 1 Reports – Type II

• Reports on controls placed in operation and tests of operating effectiveness (for a period of time, not less than 6 months)

• Differentiating factor: Includes Tests of Operating Effectiveness

• Identifies instances of non-compliance

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SSAE 16/SOC 1 Reports • Reviewing SSAE 16/SOC 1s

– Period of coverage – should cover adequate time frame in relation to audit year end

– Subservice organizations – evaluate need to include – Key control objectives – should cover all relevant

aspects of processing transactions – Test procedures – evaluate for appropriateness – Exceptions – follow up/document impact – User Control Considerations (UCCs) – determine if

your client is adequately addressing

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Summary of Fair Value Issues: Fair Value, NAV “practical expedient”,

“Hard-to-Value” level III

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PCAOB inspection findings – Fair Value PCAOB released several public documents citing fair value auditing deficiencies noted in their inspections: • Dec 6, 2011, PCAOB Staff Audit Alert No.9

http://pcaobus.org/Standards/Pages/Guidance.aspx

• Sept 29, 2010, Rule 4010 Report On Observations… Audit Risk Areas Affected by the Economic Crisis http://pcaobus.org/Inspections/Documents/4010_Report_Economic_Crisis.pdf

• 2007-9 PCAOB Staff Audit Alerts Nos. 2, 3, 4 http://pcaobus.org/Standards/Pages/Guidance.aspx

Plan Financial Statements Adoption Timeline - Fair Value Measurements

FAS 35 Plan investments valued

at fair value

FAS 157 (adopt 2008) - Apply new FV definition

- Hierarchy disclosures

ASU 2009–12 “NAV” (adopt 2009) - Use of NAV as a practical

expedient for valuation - Additional disclosures and hierarchy

ASU 2011–04 (adopt 2012) - Description of valuation processes for L3

- Unobservable inputs table (quantitative) for L3 - Public entities to disclose all

L1 and L2 transfers - Public entities to provide narrative description of sensitivity of FV to changes in unobservable

inputs (qualitative)

ASU 2010–06 (adopt 2010) - Disaggregate hierarchy disclosures by “nature

and risk” class for all FV assets and liabilities - Disclose transfers between L1 and L2

- Other new disclosures FAS 157 (adopt 2008) - Apply new FV definition - Hierarchy disclosures

FSP FAS 157–4 (adopt 2009) Disaggregate hierarchy disclosures by

“nature and risk” category for equity and debt securities

ASU 2010–06 (adopt 2011) Expanded disclosure of

L3 activity

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Divergence in Practice in Fair Value Measurement Disclosures

Common Issues/Challenges • Failure to breakout investments by category or class

• Changes to leveling as a result of errors vs. changes in observability, etc.

• When NAV used as a practical expedient, missing required additional disclosures (strategies, restrictions, unfunded commitments)

• Issues with fair value leveling - classification of debt securities

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Common Issues/Challenges • Sufficiency of information to permit a reconciliation of the

fair value disclosures presented by class to the line items in the statement of net assets

• Errors in hierarchy levels resulting from not understanding the observability of the inputs used to measure fair value or not using the guidance in ASC 820 when fair value is measured using NAV as a practical expedient

• Descriptions of the valuation techniques used and the inputs used in determining the fair values of each class of investments

Divergence in Practice in Fair Value Measurement Disclosures

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Fair Value Hierarchy by “Nature and Risk”

Level 1 Level 2 Level 3

Common Stock: •Energy •Healthcare •Consumer Goods

Open-Ended Mutual Funds: •US Large Cap Equity •International Stock •Fixed Income •Balanced

Asset-Backed Securities: •Residential Mortgage-Backed Securities •Commercial Mortgage-Backed Securities •Other Asset-Backed Securities

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The following table sets forth a summary of the Plan’s investments reported at NAV, (ASU 2009-12) (ASC 820-10-50-6A)

(a) Short-term investment fund strategies seek to invest in in high-quality, short-term securities. (b) Equity index fund strategies seek to replicate the movements of an index of a specific financial market, such as the

Standards & Poor’s (S&P) 500 Index, regardless of market conditions. (c) Venture capital funds invest in companies at their start-up phase primarily focused on the technology, telecommunications, industrial and life sciences sectors.

Fair value

Unfunded commitment

Redemption Frequency

Other redemption restrictions

Redemption notice period

STIF fund (a) $xxx immediate none

Equity index pooled separate accounts (b)

$xxx

quarterly 60 days

Venture Capital Funds (c)

$xxx $xxx,xxx Semi-annually

No redemptions in initial 3 year holding

period

120 days

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Fair Value – Financial Instruments

Some typical classifications within the hierarchy: Investment Level Traded equities Level 1 US T-Bills Level 1/2 US Treasuries Level 2 Municipal securities Level 2 US Agency securities Level 2 Private (hedge) funds Level 2/3 Private company equities Level 3 Private company debt Level 3 Funds - Net Asset Value (NAV) Level 2/3 Certificates of deposit Level 2 Mutual Funds Level 1/2

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ASU 2011-04 : Fair Value

“Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS”

• Effective for annual periods beginning after December 15, 2011

• Prospective application

• Objective to converge U.S. GAAP and IFRS in this area

• Expanded Level 3 fair value measurement disclosures!

– Quantitative information about the unobservable inputs used in level 3 fair value measurements

– Information about the sensitivity of Level 3 fair value measurements

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Expanded FV Disclosures - Issues?

Calendar 2012 Plan Financial Statements • ASU 2011-04 requires new disclosures with respect to

how fair value is determined for level 3 securities. – Private equity securities – Other non-marketable securities

• These changes may reduce the ability to rely on the limited scope certification – Will the trustee/custodian provide information and certify the required

disclosures? – If not, how will information be obtained?

Example 1: Quantifying Unobservable Inputs on Level 3 Assets (Valuation Techniques and Inputs)

(Pending Content FASB ASC 820-10-55-103)

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Example 1: Quantifying Unobservable Inputs on Level 3 Assets for a private company ESOP (Valuation Techniques and Inputs)

Description Fair Value Valuation Technique(s)

Unobservable Inputs

Rate Applied

Sponsor Company Common Stock

$92,320,000 Discounted Cash Weighted average cost of

capital

11.1%

Long-term revenue growth

rate

4.2%

Long-term pretax operating margin

10.3%

Discount for lack of marketability

17%

Market Comparable Companies

EBITDA multiple 11.3

Revenue multiple 2.0

Discount for lack of marketability

27%

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Example 2: Additional Narratives to Help Evaluate Quantitative Disclosures

For example, for RMBS, a plan might disclose the following: 1. The types of underlying loans (for example, prime loans or subprime loans) 2. Collateral 3. Guarantees or other credit enhancements 4. Seniority level of the tranches of securities 5. The year of issue 6. The weighted-average coupon rate of the underlying loans and the securities 7. The weighted-average maturity of the underlying loans and the securities 8. The geographical concentration of the underlying loans 9. Information about the credit ratings of the securities

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Example 3: Disclosure of Plan’s Process around Level 3 Assets

a. Valuation policies and procedures: 1. Description 2. Who determines the policies/procedures 3. The internal reporting procedures in place (for example: whether and, if

so, how pricing, risk management, or plan administrators discuss and assess the fair value measurements).

b. The frequency and methods for calibration, back testing and other testing procedures of pricing models.

c. The process for analyzing changes in fair value measurements from period to period.

d. How the plan determined that third-party information, such as broker quotes or pricing services, used in the fair value measurement was developed in accordance with the rule.

e. The method used to develop and substantiate the unobservable inputs used in a fair value measurement.

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Example 3: Disclosure of Entity’s Process around Level 3 Assets – Private Company ESOP

Fact Pattern: The fair value of the sponsor company common stock held by the plan is valued at fair value based upon an independent appraisal. This appraisal was based upon a combination of the market and income valuation techniques consistent with prior years. Plan management has concluded that market participants would also recognize a discount for lack of marketability. Disclosures: The valuation process involves plan management’s selection of an independent appraiser under contract for a term of 3 years with the right to cancel such contract at any time. Plan management accumulates the data for the appraiser from the audited financial statements of the Company. The appraiser prepares a preliminary report which plan management, along with the ESOP trustee, reviews in detail, discusses and approves. The results of this process are documented in minutes of the plan fiduciary.

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Example 3: Disclosure of Entity’s Process around Level 3 Assets – Private Company ESOP

Disclosures The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the plan believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in different fair value measurements at the reporting date.

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Example 4: Sensitivity Analysis for Level 3 Assets (Public only) Narrative explaining the sensitivity of the fair value measurement to changes in significant unobservable inputs and the relationship between those unobservable inputs. See example for RMBS: “The significant unobservable inputs used in the fair value measurement of the reporting entity’s residential mortgage-backed securities are prepayment rates, probability of default, and loss severity in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.”

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Fair Value - ASU 2011-4

“Nonpublic entities” are exempt from certain disclosure requirements:

– A qualitative discussion of the sensitivity of the FV to changes in unobservable inputs and the interrelationships between those inputs.

– Transfers between Levels 1 and 2 of the FV hierarchy

– Disclosures applicable to fair value measurements required for a plan when FV is disclosed but not recognized in the financial statements

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“Nonpublic entity,” as defined by the codification, is any entity that does not meet any of the following conditions:

a. Its debt or equity securities trade in a public market either on a stock exchange…

b. It is a conduit bond obligor for conduit debt securities that are traded in a public market…

c. It files with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market.

d. It is required to file or furnish financial statements with the Securities and Exchange Commission.

e. It is controlled by an entity covered by criteria (a) through (d)

Fair Value - ASU 2011-4

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Fair Value Measurements and Disclosures – Final Thoughts • Plan management is responsible for valuation of investments

and presenting the f/s in accordance with GAAP – Requires sufficient understanding of the nature of the plan’s

investments – May use outside service provider or pricing service

• Management/auditor must obtain an understanding of the plan’s process for determining – Fair value measurements – Fair value disclosures, including fair value hierarchy levels

• Limited scope audit – Certification does not change management’s responsibilities

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EBP Regulatory Issues:

New service provider fee disclosure requirements at the plan level and individual participant level

Other DOL/EBSA initiatives including proposed

expanded definition of a “fiduciary”

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Informed Decision Making and Excessive Fees – “The Three Legged Stool”

• Disclosures by plans to participants of certain plan and investment-related information (ERISA 404)

• Disclosures to plan fiduciaries to assist in assessing reasonableness of compensation and potential conflicts of interest (ERISA 408(b)(2))

• Disclosures to public and government on electronically filed Form 5500 Annual Report including indirect compensation – Form 5500, Schedule C

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Fee & Expense Disclosures – Plan to Participant (ERISA 404)

• Effective – – Annual statements – August 1, 2012 – Quarterly statements – Nov.14, 2012

Requires fiduciaries to:

• Give workers quarterly statements of plan fees & expenses deducted from their accounts

• Give workers core information about investments available under the plan

• Use standardized methodologies when calculating and disclosing expense and return information

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Fee & Expense Disclosures – Plan to Participant (ERISA 404) (continued)

• Centerpiece – a requirement to provide investment-related advice in a format that permits workers to comparison shop among investment options

• DOL has developed a model chart for complying with this requirement

• The reg., model chart, and fact sheet may be viewed at www.dol.gov/ebsa

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408(b)(2) Disclosures

• Applies only to defined contribution and defined benefit plans

• Does not apply to: – SEP’s or SIMPLE plans – Individual IRA’s – Health and Welfare Plans – Non-ERISA 403(b) Plans – Church plans – Certain frozen 403(b) plans

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Fee & Expense Disclosures – Service Providers to Plans (ERISA 408(b)(2))

• Brings new transparency to the process of selecting and monitoring of plan service providers

• Establishes comprehensive disclosures from service providers concerning services, fees, and potential conflicts of interest

• Applies to plan contracts or arrangements for services in existence on or after 7/1/12, extended from 4/1/12, 7/16/11 and 1/1/12

• Applies to contracts ≥ $1,000

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408(b)(2) Disclosure Rules – Service Providers Covered

• Persons who provide services as an ERISA fiduciary or under the Investment Advisors Act of 1940.

• Persons who provide certain recordkeeping or brokerage services and make available investment options to be offered by the plan

• Persons who receive or may receive indirect compensation for the following services: accounting, auditing, actuarial, appraisal, banking, consulting, custodial, insurance, investment advisory (plan or participants), legal, recordkeeping, brokerage, TPA, or valuation

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Clarification of the Meaning of “Reasonable Arrangement” in 408(b)(2) Disclosure Rules

• All service agreements be in writing (no prescribed format)

• Impose new service provider disclosure obligations before or at the time the plan enters a service agreement

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408(b)(2) – Required Disclosures

• Service providers are required to disclose (before the parties enter into an agreement for services): – All services to be provided under the agreement – The compensation or fees to be received for each

service – The manner of receipt of compensation or fees – Information about conflicts of interest.

• Establishes disclosure burden on service provider – integrated with 2009 Form 5500 Schedule C Reporting

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What Happens if § 408(b)(2) Is Not Followed?

• Plan fiduciary should make a written request for the disclosure

• If service provider fails to provide disclosure within 90 days of written request, the plan fiduciary is obligated to notify the Department of Labor.

• The plan fiduciary is obligated to terminate the contract as expeditiously as possible.

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Consequences of Non Disclosure = Prohibited Transaction

• Contract or arrangement will not be “reasonable” and violates 408(b)(2)

• Responsible Plan Fiduciary violates 406(a)(1)(c) by participating in the prohibited transaction

• Service provider is a “disqualified person” under IRS prohibited transaction rules and is subject to excise taxes under Code section 4975

• Should be reported on Schedule G of Form 5500

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EBP auditor’s inquiries will most likely address:

• Which EBPs are subject to the service provider fee disclosures requirements?

• Who are the service providers from whom disclosures must be obtained?

• Whether the plan sponsor has a process to ensure all disclosures are received and reviewed timely?

• Whether participant level fee disclosures are made in a timely manner?

• More guidance is expected from the DOL.

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Other DOL/EBSA Initiatives

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Proposed Regulation—Definition of Fiduciary • The DOL proposed new regulations in October 2010 to

update and expand the definition of fiduciary for purposes of ERISA.

• The determination of who is a fiduciary under ERISA has been ascertained by applying a five-part test under DOL regulations in place for more than 30 years.

• The retirement plan industry and financial investment community have changed dramatically due to the rise of the 401(k) plan and the rapid growth of IRAs.

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Proposed Regulation—Definition of Fiduciary • The financial investment community, retirement plan

industry and members of Congress argued that the new definition was too ambiguous and broad.

• The EBSA announced in September 2011 that it would withdraw the proposed regulations and re-propose them to address these concerns

• The re-proposed regulations may include some special exemptions from the prohibited transaction rules where it is obvious that the participant would benefit from such exemption.

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Investment Advice • Final rule published in the Federal Register – October 25,

2011 • Designed to improve participant access to fiduciary

investment advice • Permits a fiduciary investment adviser who receives

additional fees from investment providers if certain conditions are met – Use of a computer model that is certified as unbiased by

an independent expert or – Through an adviser compensated on a “level-fee” basis,

meaning that the fees do not vary based on investments selected

• May be viewed at http://s.dol.gov/J4

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DOL/EBSA’s Current Focus on EBP Audits:

High Risk Audit Engagements

• Multi-employer Plans – Defined Benefit Pension Plans – Defined Contribution Pension Plans

• Single Employer Defined Benefit Pension Plans • Health and Welfare Plans • ESOPs • 403(b) Plans

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DOL/EBSA’s Current Focus on EBP Audits:

High Risk Audit Engagements

• The DOL is increasingly concerned about any plan with more than 5% of hard-to-value assets and these plans may be subject to further review by the DOL.

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EBSA Audit Quality Initiatives

• CPA Firm Inspection Program

• “Mini-Reviews”

• Workpaper reviews

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What does the DOL/EBSA do about deficient EBP audits?

• Inquiry letter to plan administrator

• Review of audit workpapers

• Statement of Preliminary Findings

• Rejection of plan filing

• Assessment of civil penalties

• Referral to AICPA/state regulators

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Areas of risk in employee benefit plans and common problems

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Types of Plan Errors

• Operational Errors • Plan Document Errors • Demographic Failure • Employer Eligibility Failure • Fiduciary Errors

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Operational Failures

• Failure to administer the Plan in accordance with its terms.

• Can usually be corrected using the IRS’ Employee Plans Compliance Resolution System.

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Common Operational Failures

• Eligibility (inclusion and exclusion) • Vesting (service year – hours/time, period) • Contributions (employee and employer) • Nondiscrimination Testing • Distributions (qualifications met, vesting) • Plan Loans (terms/administration, repayment)

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Plan Document Errors

• Failure to timely amend for changes in the law. • Plan provision that on its face violates Section 401(a) or

Section 403(a).

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Demographic Failure

• Failure to satisfy the requirements of Sections 401(a)(4), 401(a)(26) or 410(b).

• Failure is not an operational failure or an employer eligibility failure.

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Employer Eligibility Failure

• Adoption of a 401(k) plan by an employer that fails to meet the employer eligibility requirements to establish a Section 401(k) plan.

• Failure is not a plan document, operational or demographic failure.

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Fiduciary Errors

• Plan Investments • Plan Expenses

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Defined Contribution Plans – Common Pitfalls

• Applying new accounting principles through the Accounting Standards Updates (ASU’s)

• Fair value measurement and disclosures (Valuation of investments is incorrect)

• Untimely remittance of employee contributions • Incorrect participant data

oDOH, hours worked, compensation, etc. • Allocation of contributions and earnings (i.e. wrong %) • Incorrect vesting provision applied • Using correct definition of “Compensation” when

calculating EE and ER contributions

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• Valuation of Investments • Participant Data - test the items that actuary uses in

calculation (Gender, DOB, DOH, Wages, etc.) • Qualifications of Actuary (Document as required by SAS

73) • Assumptions used by actuary – discount rates • Incorrect calculation of benefits • Consider independent review of actuarial report • Need Form 5500, Schedule SB to agree employer

contributions

Defined Contribution Plans – Common Pitfalls

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Health & Welfare Plans – Common Pitfalls

• Accounting Challenges • Value of Assets • Qualifications of TPA and actuary • Unrecorded liabilities for TPA fees • Not as common so may be more difficult to gather

info to understand the plan basics • Application of recent legislation

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403(b) Plan Audits

• Prior to 2009, 403(b) plans had limited reporting requirements and were not subject to the audit requirement.

• Because of this, recordkeeping for these plans was lax. • The implementation of the new reporting requirements and

the audit requirement applicable to large plans has placed great challenges on sponsors of 403(b) plans.

• Due to the nature of the assets held in many 403(b) plans (i.e. individual custodial contracts or individual annuity contracts) it can be extremely difficult, if not impossible, to locate and identify all of a plan’s assets.

• Many EBP auditors were in the difficult position of having to disclaim opinions on incomplete financial statements.

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403(b) Plan Audits - A Second Year Look

What auditors found… • More plan assets!

– Accounts and contracts not reported in prior year but should have been included

• Plan elected to exclude accounts and contracts this year but included them last year

• Accounts and contracts excluded last year but no longer met the exclusion test this year (e.g., participant transfers)

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What auditors found, continued… • Commingling of assets (e.g., ee and er plans) • “Safe harbor” plans merged into ERISA plans • Vendors certified accounts and contracts last year but would

not certify this year • Misunderstanding of excluded accounts and contracts (i.e.,

auditor did not know to disclaim) • Predecessor auditor issued “clean” limited scope report last

year; successor auditor issued disclaimer report this year

403(b) Plan Audits - A Second Year Look

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ESOPs

An ESOP is a unique form of defined contribution plan. Under the prohibited transaction statutory exemptions, an ESOP has the ability to borrow money and to concentrate plan investments in qualifying employer securities. Frequently these securities are not publicly traded.

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ESOPs

• DOL Focus on ESOPS • Need to appropriately evaluate and review the valuation

report prepared by a qualified appraisal firm • Release of stock valuation report

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Example 1: Quantifying Unobservable Inputs on Level 3 Assets for a Private Company ESOP (Valuation Techniques and Inputs)

Description Fair Value Valuation Technique(s)

Unobservable Inputs

Rate Applied

Sponsor Company Common Stock

$92,320,000 Discounted Cash Weighted average cost of

capital

11.1%

Long-term revenue growth

rate

4.2%

Long-term pretax operating margin

10.3%

Discount for lack of marketability

17%

Market Comparable Companies

EBITDA multiple 11.3

Revenue multiple 2.0

Discount for lack of marketability

27%

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ASU 2011-04 Fair Value – Expanded Level III Investment Disclosures in 2012 • Plan administrator in conjunction with fiduciary, valuation

advisor and attorney need to start now in thinking about how to draft these footnotes

• Consideration must be given to the fact that this is public information, i.e. all 5500s including the audited financial

statements are PUBLICLY accessible on the DOL’s EFAST2 website: http://www.efast.dol.gov/portal/app/disseminate?execution=e1s1

• GAAP departure is possible, but Form 5500 requires disclosure of a GAAP departure

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ASU 2011-04 – Other Implications for Auditors • Limited scope audit

– Trustee certifies accuracy of financial statements – Auditor does not have to audit any investments

information CERTIFIED – Avoids the issue of the auditor having to agree that

valuation is reasonable • What about the new footnotes?

– Can or will the trustee certify to the footnote information?

– If not, does the auditor have to audit the footnote information? If so, will full scope procedures be required on the company stock?

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Economic Considerations and Trends • Terminating defined benefit plans • Managed portfolios

– Becoming more popular with smaller plans • Privacy, security and fraud issues • Hardship withdrawals • Other

– Credit rating downgrades – New/emerging investment products

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Auditing Issues: AICPA Clarity Standards

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Convergence Considerations

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Convergence with ISAs

• Harmonize, not adopt • Most audits performed internationally are of nonpublic

entities — therefore, ASB and IAASB have a similar focus

• Avoid unnecessary differences with PCAOB • ASB standards — more use of “should” than in ISAs, but

fewer than in existing SASs

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Changes to Existing Standards • Primary difference relates to group audit standard

– More specific as to what group engagement partner is responsible for

• Additional quality control (QC) guidance – QC responsibilities for the audit more specifically

described – Overall QC function remains “firm” responsibility, but

responsibilities are engagement partner’s and engagement team’s

• Some changes in audit report to more clearly describe management’s responsibility – New format to use report headings

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Examples of Impact of Selected Standards—Auditor Reports Exposure Drafts

Examples of Effect of Selected Standards—Auditor Reports

Opinion (Basis for qualified, adverse, or disclaimer)

Emphasis of matter • Matters appropriately

presented or disclosed Other matter • To understand audit matters

Headings and subheadings

Other auditor reporting responsibilities

Management’s responsibilities

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No substantive changes to requirements • Audit documentation • Auditor’s communication with those charged with

governance • Risk assessment standards • External confirmations • Analytical procedures • Audit sampling • Auditing accounting estimates • Written representations • Subsequent events • Consideration of omitted procedures after the report

release date

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Changes to be Alert to

• AU-C 240—Consideration of Fraud in a Financial Statement Audit

• AU-C 250—Consideration of Laws and Regulations in an Audit of Financial Statements

• AU-C 500—Audit Evidence • AU-C 550—Related Parties • AU-C 580—Written Representations • AU-C 620—Using the Work of an Auditor’s Specialist

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Implementation Timeline • Clarity project will greatly affect audits of periods ending

on or after December 15, 2012. • Summary of differences between clarified SASs and

existing SASs can be found at: http://www.aicpa.org/interestareas/frc/auditattest/downlo

adabledocuments/clarity/clarity_sas_summary_of_differences.pdf

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Auditing Issues: AICPA Employee Benefit Plan

Audit and Accounting Guide Overhaul

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EBP Guide Overhaul Project • Guide last issued over 20 years ago • Has not been revised or amended other than for

conforming changes • Significant changes have occurred

– Types of retirement plans offered – Plan administration – Types of investments – Numerous changes to the rules and regulations by

the DOL, IRS and PBGC • ERISA GAAP vs. GAAP GAAP

– Divergence in practice – Lack of consistency

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EBP Guide Overhaul Project • Accounting chapters include:

– Defined contribution retirement plans – Defined benefit pension plans – Health and welfare plans – Investments – Illustrative financial statements

• Guide will include the clarified auditing standards • Chapters containing auditing guidance will be reviewed

and cleared by the ASB • Guide expected to be released after in January 2013

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What’s New – All Plan Types Added FinREC recommendations for:

– Dividends and Distributions – reinvested • Dividends should be considered investment

income and shown separately from changes in fair value

• Capital gain distributions should be considered either investment income and shown separately from changes in fair value or included as part of the net change in fair value

– Cash Balances • Interest bearing cash should be shown as an

investment • Since no cash flow statement is required there is

no need to classify short term investments as cash equivalents

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What’s New – All Plan Types, cont’d Added FinREC recommendations for:

– Separate disclosure of employer contributions relating to the correction of operational defects or other nonrecurring items

– Additional disclosures • Benefits paid • Other income • Other employer contributions • Expense offset arrangements

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What’s New – All Plan Types, cont’d

• Additional disclosures and discussion – Transfers of assets to of from other plans – Frozen or merged plans—enhanced discussion – Full or partial terminations

• Employee Stock Ownership Plans – How a leveraged ESOP plan works – ESOP financial statements for leveraged ESOPs

• Income tax expense and plan tax status

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What’s New – Defined Contribution Plans • Added FinREC recommendations for:

– Excess contributions/corrective contributions • Should be netted against contributions received in the

statement of changes with additional footnote disclosure

• Include refund or payment as a payable to participant – Contributions receivable

• Additional guidance added to include the factors that should be reviewed in determining whether a receivable should be recognized and the relationship between employer and employees as compared to a DB plan

– Participant loans classified as a note receivable with additional disclosures for valuation, interest income, etc.

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What’s New – Defined Contribution Plans, cont’d • Added FinREC recommendations for:

– Forfeitures • Added more discuss about forfeitures and use of

forfeitures with required disclosures – Rollover Contributions

• Significant rollovers should be shown as a separate line item on the statement of changes in net assets available for benefits

• Discussion as to when a rollover is really a plan transfer

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What’s New – Defined Benefit Plans

• Added FinREC recommendations for – Contributions receivable

• ERISA minimum required contribution be recorded as a contribution receivable and any excess amounts would be considered a non recognized subsequent event unless there was evidence of a formal commitment

– Funding waivers • Expanded guidance on funding waivers and recommended

that a receivable be recorded for the minimum contribution that is not received and consider whether an allowance for uncollectible amounts is necessary

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What’s New – Health & Welfare Plans • Added FinREC recommendations for:

– Contributions receivable • A receivable should be recorded equal to the

liability for claims IBNR if there is a legal obligation by the employer as of the date of the financial statements to fund the specific amount. (Generally does not exist in single employer plans)

– Postretirement medical benefit obligations—Claims IBNR

• Disclosure of where retiree IBNR is calculated to ensure that obligation is properly reported, not double counted or omitted entirely. Consider disclosing where it is recorded

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What’s New – Health & Welfare Plans, cont’d • Added FinREC recommendations for:

– Trust arrangements • Added guidance that all transactions of the

plan whether or not paid out of the trust need to be accounting for in the plan

– Reporting entity and the combination of plans • Added guidance for how to account for a plan

when multiple plans are wrapped into one plan for regulatory filing requirements

– Other receivables – rebates from service providers and other subsidies

• Added criteria on when a plan should record a receivable

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What’s New – Health & Welfare Plans, cont’d • Added FinREC recommendations for:

– Stop-loss arrangements • Capturing all activity associated with the plan

is most meaningful • Stop-loss premiums generally should be

recorded as an expense of the plan • Refunds recorded as reduction of benefits paid • Recognized that this issue is complicated

– Claims Processor • Accounting for liabilities should be on the same

basis as for obligations

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What’s New – Health & Welfare Plans, cont’d Added FinREC recommendations for: – COBRA postemployment obligations

• COBRA should be treated as a postemployment obligation and should include IBNR

• Includes COBRA subsidy information and how to account for such subsidy

– FSAs, HRAs and HSAs • FSAs and HRAs--Amounts available to participants

at year end be included in the plans financial statements

• HSAs—disclosure that the arrangement exists but that the associated activity be excluded from the plans fiancial statements as the plan is not obligated to pay benefits

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What’s New – Health & Welfare Plans, cont’d

Added FinREC recommendations for: – Added two new appendices

• The annual health care process • Examples of health and welfare arrangements

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What’s New – Investments

• Added FinREC recommendations for: – Master Trust Arrangements

• Fees and expenses specific to the plan should be recorded in the plan’s financials statements

• Allocated fees and expenses should be included in the master trust financial statements

• Contributions and distributions should be reported in the plan’s financial statements and should be reported in the master trust financial statements as a transfer in or a transfer out

• Presentation of all master trust activity in the footnotes to the financial statements not just investments and income

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What’s New – Investments, cont’d

• Added FinREC recommendations for: – Master Trust Arrangements

• Disclosure of the plan’s percentage interest in each investment type where the plan has a specific interest and not an undivided interest

• For undivided interests disclosure of those investments that are greater than 5% of the master trust

• For specific interests disclosure of those investments that are greater than 5% of the plan’s investments

• Master trust disclosures are not relevant for a H&W plan with a 401(h) account but should be considered

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Auditing Topics

Audit areas being enhanced – Risk assessment considerations – Payroll – Receipt of benefit payments – Allocations to individual participants – Investment and Investment income – Claims – Distributions and census data – Other

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Speaker Biography

Hal leads MHM’s Employee Benefit Plan Audit Practice. With over 25 years of diverse experience with employee benefit plan accounting, auditing and compliance issues, he is also a member of the firm’s Professional Standards Group as subject matter expert on EBP plan audits, as well as Business Combinations and Leasing. As the National Practice Leader for EBP Audits, Hal is responsible for providing internal training on the subject, along with providing technical support to engagement teams, serving as engagement quality reviewer and developing resource tools for our EBP audit professionals.

Hal Hunt, CPA

Shareholder

Mayer Hoffman McCann P.C.

913.234.1012

hhunt@cbiz.com

108

Speaker Biography

Mike has 15 years of public accounting experience with financial and service based companies, including the engineering and construction industry. He is a member of MHM's Professional Standards Group, providing accounting knowledge leadership in the areas of derivative financial instruments, share-based compensation, fair value, leasing, revenue recognition and others. Mike's experience includes over 14 years with a Big Four firm where he was responsible for client service for large and small SEC filers and non-public entities, audit/accounting technical expertise and training instruction and delivery.

Mike Loritz, CPA

Shareholder

Mayer Hoffman McCann P.C.

913.234.1226

mloritz@cbiz.com

109

Speaker Biography

Based in the Boca Raton office, Chris serves as the local Attest Practice Leader and the East region Employee Benefit Plan Audits leader. He has in-charge responsibilities for audit engagements including Employee benefit plan, not-for-profit, manufacturing, real estate development and construction, wholesale distribution and general business clients. In his leadership roles, Chris helps set firm-wide policy and teaches EBP audit practices at local offices and national training conferences.

Chris Wittig, CPA

Shareholder

Mayer Hoffman McCann P.C.

561.922.5128

swittig@cbiz.com

110

Speaker Biography

Linda leads the Employee Benefit Plan Audit segment for MHM’s Memphis office. She is the main contact for benefit plan audit engagements and is responsible for overall coordination and efficient utilization of firm resources. Linda has more than 25 years of experience with international and local accounting firms and employee benefit administration for Fortune 500 companies. She frequently conducts seminars and webinars on plan audits as well as plan administration issues and fiduciary responsibilities.

Linda Lauer, CPA, CEBS

Shareholder

Mayer Hoffman McCann P.C.

901.685.5575

llauer@cbiz.com

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Speaker Biography

Tony is based in our Phoenix office and joined the organization in June 2002. He has approximately 15 years of experience with national and international public accounting firms and serves as the Western Region EBP Audit Leader for MHM and is a member of the MHM ERISA Task Force. Through these roles, Tony participates in designing and implementing MHM's audit approach as well as ensuring audit quality for approximately 650 ERISA audit clients firm wide.

Anthony Hakes, CPA

Shareholder

Mayer Hoffman McCann P.C.

602.650.6225

ahakes@cbiz.com

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Questions?