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5/3/2012

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Beyond the Basics –More Complex Audit Issues

Presented byKathryn Petrillo & Jennifer Downs

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• This session will focus on areas 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. Various compliance areas

3. Financial statements

Agenda

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Common EBP Situations:

• Actuaries–Defined benefit plans

–Health and welfare plans

• Valuation experts–Employee Stock Ownership plans

Using the Work of a Specialist

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Cannot just get report, tic/tie the numbers and put it in the audit workpapers ‐must follow guidance in AU 336:

• Evaluate the specialist’s professional qualifications–Certification, license–Reputation–Experience with similar type of work


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• Obtain an understanding of the nature of work performed by the specialist–Objectives and scope–Methods and assumptions used and how they compare to the prior year

–Was the work done appropriate for the purpose it is being used for?

–Do the specialist’s findings support the related assertions in the financial statements?


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• Evaluate relationship to the client–Any circumstances that would impair the specialist’s ability to be objective

–Ownership or family relationships

–Looking for anything that indicates client could directly or indirectly influence the specialist


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• Test the data provided to the specialist–For DB and H&W plans, test the census data

• For DB plans, if BOY obligation is presented, be sure and test BOY census, if EOY presented, be sure to test EOY census

• Be sure plan provisions considered by actuary were correct and considered all amendments

• Confirm information with the actuary


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• Test the data provided to the specialist

–For ESOPs, test the accuracy of historical financial information


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DB Actuarial methods and assumptions:• Methods – be sure they are in conformity with FASB ASC 960 and funding method is in accordance with ERISA

• Assumptions– Mortality (updated tables being used)– Retirement (consistent with plan provisions and plan experience)

– Turnover– Interest (discount)


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ESOP valuations‐what is unusual?• No management interview / site visit performed

• Lack of transparency in valuation report– Significant input based solely on specialist’s experience or a proprietary database

– Source documents not cited

– Undocumented adjustments to client‐prepared financial information


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ESOP valuations – what is unusual?• Unreasonably high discount for lack of marketability (were put rights considered?)

• Assumptions/inputs that remain the same year‐in, year‐out

• Reliance on average public company pricing multiples with no comparability adjustments

• Disconnect between historical and prospective financial information


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ESOP valuations – practical advice• Focus on errors (is the valuation model mathematically sound?)

• Allow for differences in opinion

• Focus on unreasonable or unsupported judgments

• Perform sensitivity analysis to isolate impact of significant judgments/inputs

• Obtain written responses from specialist


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What if you think something is unreasonable?

• consider consulting another specialist

• ask for a revised/corrected valuation

• If cannot resolve, modify opinion


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• Plans must comply with certain IRS requirements in order to maintain their tax exempt status. These requirements are as follows:– Minimum Coverage Test (Ratio Percentage or Average Benefits Tests)– Minimum Participation Tests– Nondiscrimination Test– Top Heavy Test– ADP Test (Actual Deferral Percentage)– ACP Test (Actual Contribution Percentage)– Exclusive Benefit Rule– Sec 415(c) Annual Additions– Diversification of Certain Employer Security Holdings

• Sec 402(g) Elective Deferral Limits• 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 Tests – 401(k) Plans

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• Plans must comply with certain IRS requirements in order to maintain their tax exempt status. These requirements are as follows:– Minimum Coverage Test (Ratio Percentage or Average Benefits Tests)– Minimum Participation Tests– Nondiscrimination Test– ACP Test (Actual Contribution Percentage)– Exclusive Benefit Rule– Sec 415(c) Annual Additions

– Required under the universal availability rules to review annually those employees excluded due to hours to ensure they didn’t exceed the 20 hours/1,000 hour limits

• Sec 402(g) Elective Deferral Limits

A more detailed discussion of nondiscrimination testing can be found in the Guide to Nondiscrimination Testing for Code Section 403(b) Plans

Non-discrimination Tests – 403(b) Plans

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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.

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• 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?

• Sec 402(g) Elective Deferral Limits• Was it performed and passed?• Refunds – accrued or PAJE?• Mandatory contributions – excluded?

• Controlled Groups

Testing the Tests

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• AU Section 550, Other Information in Documents Containing Audited Financial Statements (SAS 118) governs auditor responsibility‐generally auditor has no responsibility for determining whether such information is properly stated

• 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

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• Should communicate with those charged with governance the auditor’s responsibility with respect to the other information, any procedures performed relating to the other information, and the results.


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• 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)


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Suggested items to review:• Plan name, plan number, EIN, year, type of plan• 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


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• 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


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• Schedule H Part IV answers are consistent with audit findings and supplemental schedules are included with audited financial statements– Schedule 4a – Delinquent Participant Contributions

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

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


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• 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

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• 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)

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• 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)

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• Eligibility requirements

• Eligibility errors

• Auto enrollment

• Hours of service requirement

• Rehired employees

Compliance Issues - Eligibility

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• 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 SOC‐1 of third party service organization

Payroll Testing

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• 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

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• 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

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• 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 plus lost earnings)

• 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

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• 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

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Vesting issues:• Be sure you have current vesting schedule as well as any prior vesting schedules that may still be relevant

• Be sure you test appropriately using either elapsed time or hours of service method, and obtain evidence of hours if HOS method is used

• Mergers create unique problems – be sure TPA is tracking properly if different vesting schedules apply

• Understand how/when TPAs remove unvested funds from participant accounts

• Look out for proper treatment of breaks in service

Distribution Issues

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• Testing of hardship distributions generally include:– Making sure hardship distributions are permitted by plan document

– Reviewing the request and any related documentation and seeing if it meets the plan provisions and tax requirements for a hardship

– Ensuring the distribution came only from amounts allowed by plan provisions to be withdrawn for this purpose (i.e. elective deferrals, other sources specified)

– Ensuring contributions are suspended for these individuals after the hardship

Distribution Issues

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• Questions that arise:

– What constitutes a hardship?

– What documentation must be provided?

– Is the employee’s certification of the need enough?

– How much is permitted to be withdrawn?

– How much tax needs to be withheld?

Distribution Issues

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• What constitutes a hardship?

– Immediate and heavy financial need

• 6 “safe harbor” reasons in regulations

• General rules provide for facts and circumstances interpretation

– No other resources available to meet the need

Distribution Issues

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• What documentation must be provided? Can an employee just certify the need without providing support?– Should be specified in the plan document‐IRS guidance says “The determination of the existence of an immediate and heavy financial need and of the amount necessary to meet the need must be made in accordance with nondiscriminatory and objective standards set forth in the plan.”

– In absence of plan document specific guidance, plan sponsor can set procedures. At a minimum, signed documentation indicating the purpose should be obtained.

Distribution Issues

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• What documentation must be provided? Can an employee just certify the need without providing support?

– Can rely on certification as to lack of availability of other sources as long as the employer has no actual knowledge that the employee’s need can be relieved by other sources

Distribution Issues

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• How much can be withdrawn? How much tax must be withheld?

– Amount of distribution cannot be more than is required to meet the need (plus taxes/penalties incurred as a result of taking distribution)

– Tax withholding on hardship withdrawals is voluntary – the participant can specify the amount (as these amounts cannot be rolled over) – usually defaults to 10% withholding

Distribution Issues

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• Things to watch for:

– Interest rates – reasonable? Tied to prime?

– # of loans permitted

– Balance exceed $50,000?

– Are principal residence loans erroneously approved for extended amortization period?

– Loans taken before hardship withdrawals?

Compliance Issues – Loans

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Decision to terminate plan could affect:

• Report issued

• Footnote disclosures

• Audit procedures

Terminating Plans/Going Concern

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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, 2011 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 2010financial statements to the liquidation basis used inpresenting the 2011 financial statements.


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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


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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


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• 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 2012 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.


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• 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


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• 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

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• AU Section 558 Required Supplementary Information– Applies with respect to information that adesignated standard setter requires to accompanyan entity’s basic financial statements

– Supplemental schedules are required by ERISAand DOL, not a designated standard setter

– SAS 120 therefore does not apply to thesupplemental schedules attached to plan’saudited financial statements

SAS 120

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• AU Section 551 Supplementary Information in Relation to the Financial Statements as a Whole

– Applies when engaged to report on whether SI isfairly stated, in all material respects, in relation tothe financial statements as a whole

– Would apply in full scope audit

– Does not apply in limited scope audit

SAS 119

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Changes from prior full scope opinion – unqualified – per AICPA EBP Audit Guide:

Our audits were performed conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental schedules of [identify title of schedules and period covered] are presented for the purpose of additional analysis and are not a required part of the basic financial statements but are supplementary information required by the Department of Labor's Rules and Regulations for Reporting and Disclosure under the Employee Retirement Income Security Act of 1974. Such information These supplemental schedules are is the responsibility of the Plan's management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has The supplemental schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information are is fairly stated in all material respects in relation to the basic financial statements as a whole.

SAS 119

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• AU Section 550 Other Information in Documents Containing Audited Financial Statements

– Applies when audited financial statements areincluded with documents such as annual reportsissued to owners, governments and non‐profitorganizations or other documents to which theauditor, at management’s request devotes attention

– Applies to DOL supplemental schedules in limitedscope audit

– Read for material inconsistencies

SAS 118

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Changes from prior limited scope report – per AICPA EBP Audit Guide:

Because of the significance of the information that we did not audit, we are unable to, and do not, express an opinion on the accompanying financial statements and supplemental schedules taken as a whole. The supplemental schedules are presented for the purposes of additional analysis and are not a required part of the financial statements but are required by the Department of Labor's Rules and Regulations for Reporting and Disclosure under the Employee Retirement Income Security Act of 1974. The form and content of the information included in the financial statements and supplemental schedules, other than that derived from the information certified by the trustee or custodian, have been audited by us in accordance with auditing standards generally accepted in the United States of America and, in our opinion, are presented in compliance with the Department of Labor's Rules and Regulations for Reporting and Disclosure under the Employee Retirement Income Security Act of 1974.

SAS 118

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Since DOL requires the auditor to express an opinion on the form and content of the information in the supplemental schedules, other than the certified information, be sure to perform any steps deemed necessary in order to provide such an opinion

SAS 118

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• Multiple vendors

• Excluded contracts (FAB 2009‐10)

• Mandatory contributions

• Audit reports – additional disclaimer

• Fixed income products

• Plan loans

• No prior year records

• Watch tax‐exempt status of organization

403(b) Plans