Accounting and Reporting by Defined Contribution Plans
QUICK REFERENCE FOR DEFINED CONTRIBUTION PENSION PLANS
This guide has been organized so that the accounting and reporting guidance for defined contribution pension plans is contained in this chapter. Auditing guidance for defined benefit, defined contribution, and health and welfare benefit plans is contained throughout the guide. The following table has been developed to help you locate the areas in this guide that may pertain to an audit of a defined contribution pension plan. Not every area listed will be applicable to a particular client and the nature, timing, and extent of auditing procedures are matters of professional judgment.
Chapter 3 Accounting and Reporting by Defined Contribution Plans Chapter 5 Planning and General Auditing Considerations
Chapter 6 Internal Control Chapter 7 Auditing Investments
Chapter 8 Auditing Contributions Received and Related Receivables Chapter 9 Auditing Benefit Payments
Chapter 10 Auditing Participant Data, Participant Allocations, and Plan Obligations, in particular 10.15–.21
Chapter 11 Party in Interest Transactions Chapter 12 Other Auditing Considerations Chapter 13 The Auditor's Report, in particular
13.06 Standard reports for defined contribution plans 13.08–.46 Various other reporting situations that may
apply
Appendix A ERISA and Related Regulations Appendix B Examples of Controls
Appendix E Illustrations of Financial Statements: Defined Contribution Plans
Appendix G Summary of Objectives, Procedures, and Other Considerations for Auditing Investments
Appendix H Consideration of Fraud in a Financial Statement Audit 3.02 Defined contribution plans require an individual account for each participant and provide benefits based on (a) amounts contributed to the par-ticipant's account by the employer or employee, (b) investment experience on such amounts, (c) expenses, and (d) any forfeitures allocated to the account.
3.03 Under a defined contribution plan, the employer contribution rate is generally determined periodically at the discretion of the employer or by contractual agreement, or both. When a participant retires or withdraws from the plan, the amount allocated to the participant's account (if fully vested) rep-resents the participant's accumulated benefits. That amount may be paid to the participant or used to purchase a retirement annuity, as defined by the
plan agreement. The amount of benefits a participant will ultimately receive is generally not determined until the time of payment. By contrast, in a de-fined benefit plan, benefits are determinable and the contribution necessary to provide those benefits is actuarially determined. In other respects, defined contribution plans are similar to defined benefit plans.
3.04 Three general types of defined contribution plans exist: profit-sharing plans, money purchase pension plans, and stock bonus plans.
a. A profit-sharing plan is a defined contribution plan that is not a pension plan (as defined in the Internal Revenue Code [IRC]) or a stock bonus plan. Employer contributions may be discretionary or may be based on a fixed formula related to profits, compensation, or other factors. A profit-sharing plan must be designated as such in the plan document.
b. A money purchase pension plan is a defined contribution plan un-der which employer contributions are based on a fixed formula that is not related to profits and that is designated as a pension plan by the plan sponsor.
c. A stock bonus plan is a defined contribution plan under which distributions are normally made in stock of the employer, unless the participant elects otherwise.
3.05 A number of more specialized plans exist that are included in the three general types of plans. These include the following:
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A cash-or-deferred arrangement (also called a section 401(k) plan) may be incorporated into a profit-sharing or stock bonus plan (a few money purchase pension plans established before the Em-ployee Retirement Income Security Act of 1974 [ERISA] also incor-porate cash-or-deferred arrangements). Under such an arrange-ment, a participant is permitted to elect to receive amounts in cash or have them contributed to the plan as employer contribu-tions on the participant's behalf. A plan may also include a Roth 401(k) feature.r
A 403(b) plan∗is a retirement savings arrangement sponsored by certain not for profit organizations (such as hospitals and private colleges) and public schools. They are defined contribution plans with individual salary deferral limits that are similar, but not identical to, 401(k) programs. See paragraphs 3.59–.61 for further guidance.r
A thrift plan (also called a savings plan) is a profit-sharing or stock bonus plan under which participants make after-tax em-ployee contributions that are usually matched, in whole or in part, by employer contributions.r
An employee stock ownership plan (ESOP) is a stock bonus plan that may borrow money from, or on the guarantee of, a related∗ In November 2007 the Department of Labor, IRS, and Pension Benefit Guarantee Corporation published in the Federal Register, final rules for amending the 2009 Form 5500 annual return or report. Among the revisions to the 2009 Form 5500 is a realignment of the reporting rules of 403(b) plans (subject to Title I) to be compatible with those of 401(k) plans. This would mean that for the 2009 plan year the Employee Retirement Income Security Act of 1974 (ERISA) audit requirement for annual audits of plan financial statements by independent qualified public accountants will also pertain to 403(b) plans.
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Employee Benefit Plansparty (a party in interest as defined in section 3(14) of ERISA) for the purpose of acquiring securities issued by the plan sponsor and that invests primarily in such securities (a leveraged ESOP). The term employee stock ownership plan is also generally applied to (a) nonleveraged stock bonus plans that satisfy various require-ments set forth in section 4975(e)(7) of the IRC and (b) profit-sharing plans (and certain pre-ERISA money purchase pension plans) that invest primarily in securities issued by the plan spon-sor (see illustrated ESOP financial statements in appendix E).
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A tax credit employee stock ownership plan is a profit-sharing or stock bonus plan established before 1987 that satisfies the require-ments of section 409 of the IRC. The sponsor of such a plan is al-lowed a tax credit, rather than a deduction, for its contributions.Before 1982, these plans were commonly known as TRASOPs (for Tax Reduction Act stock ownership plans), and the maximum al-lowable credit was based on the plan sponsor's investments that qualified for the investment tax credit. In 1982, TRASOPs were succeeded by PAYSOPs (payroll stock ownership plans), under which the credit was based on the plan sponsor's payroll.
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A target benefit plan is a form of money purchase pension plan under which the employer's annual contribution on behalf of each participant is the actuarially determined amount required to fund a target benefit established by a plan formula. The target benefit is usually based on compensation and length of service. For some target benefit plans, the substance of the plan may be to provide a defined benefit. For such plans, accounting and reporting as de-fined benefit plans, as discussed in chapter 2, "Accounting and Reporting by Defined Benefit Pension Plans," of this guide, may be more appropriate.r
A Keogh plan (also called an HR 10 plan) is any defined benefit or defined contribution plan that covers one or more self-employed individuals.r
A Simple Plan or Savings Incentive Match Plan for Employees is a tax-favored retirement plan available to employers that have no more than 100 employees who earned more than $5,000 or more in compensation during the preceding calendar year. The employer's only required contribution is dollar-for-dollar matching contribution of 3 percent of employee's compensation or a limited profit-sharing type contribution. Employer contributions are fully vested at all times.Regulatory Reporting Requirements
3.06 ERISA established annual reporting requirements for employee ben-efit plans, including defined contribution plans. Those requirements, including financial statement and schedule requirements, are described in appendix A.
(See exhibit A-1 in appendix A of this guide for examples of Form 5500 sched-ules). The financial statements required by ERISA are a comparative statement of net assets available for benefits and a statement of changes in net assets available for benefits. The schedules required by ERISA, if applicable, include Schedule H, line 4i—Schedule of Assets (Held at End of Year) and Schedule of Assets (Acquired and Disposed of Within Year), Schedule H, line 4j—Schedule of Reportable Transactions, Schedule G, Part I—Schedule of Loans or Fixed
In-come Obligations in Default or Classified as Uncollectible, Schedule G, Part II—
Schedule of Leases in Default or Classified as Uncollectible, and Schedule G, Part III, Nonexempt Transactions. For guidance on how to report delinquent participant contributions, see the frequently asked questions about reporting delinquent participant contributions on the Form 5500 at the EBSA Web site at www.dol.gov/ebsa/faqs/faq_compliance_5500.html.
3.07 Some defined contribution plans are required to register and report to the Securities and Exchange Commission (SEC). Regulation S-X prescribes the form of the statements of financial position and statements of income and changes in plan equity that those plans must file with the SEC. The SEC has amended its rules for Form 11-K to permit plans subject to ERISA to file fi-nancial statements in accordance with ERISA rather than in accordance with Regulation S-X.
3.08 In accordance with the requirements of ERISA sections 105 and 209, the plan administrator must furnish to any participant who so requests in writing—but not more than once a year—a statement of the participant's total vested and nonvested accrued benefits.
Financial Statements
3.09 The primary objective of a defined contribution plan's financial state-ments is to provide information that is useful in assessing the plan's present and future ability to pay benefits. To accomplish that objective, a plan's finan-cial statements should provide information about (a) plan resources and how the stewardship responsibility for those resources has been discharged, (b) the results of transactions and events that affect the information about those re-sources, and (c) other factors necessary for users to understand the information provided. In a defined contribution plan, the plan's net assets available to pay benefits equal the sum of participants' individual account balances. Accord-ingly, the plan's ability to pay benefits relates to the plan's ability to pay indi-vidual participants the then current value of their account balances when due.
It should be recognized that (a) information in addition to that contained in a plan's financial statements is needed in assessing the plan's present and future ability to pay benefits when due and (b) financial statements for several plan years can provide more useful information for assessing the plan's future ability to pay benefits than can financial statements for a single plan year. FASB ASC 230, Statement of Cash Flows, exempts certain benefit plans from the require-ment to provide a staterequire-ment of cash flows. Plans should consider providing a statement of cash flows when that statement would provide relevant informa-tion about the ability of the plan to pay benefits (for example, when the plan invests in assets that are not highly liquid or obtains financing for investments).
3.10 FASB ASC 962-205-45-1 states that unless the financial statements are not intended to be presented in accordance with GAAP, the financial state-ments of a defined contribution plan should be prepared on the accrual basis of accounting1 and should include (a) a statement of net assets available for
1The accrual basis requires that purchases and sales of securities be recorded on a trade-date basis. If the settlement date is after the financial statement date, however, and (a) the fair value of the securities purchased or sold immediately before the financial statement date does not change significantly from the trade date to the financial statement date and (b) the purchases or sales do not significantly affect the composition of the plan's assets available for benefits, accounting on a settlement-date basis for such sales and purchases is acceptable.
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Employee Benefit Plansbenefits as of the end of the plan year2and (b) a statement of changes in net assets available for benefits for the year then ended.
3.11 Appendix E provides illustrative financial statements for a defined contribution plans. The information should be presented in sufficient detail to assist readers of plan financial statements in assessing the plan's present and future ability to pay benefits.
Fair Value Measurements
3.12 FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value, and provides a framework for measuring fair value, and requires disclosures about fair value measurements. The following paragraphs summa-rize FASB ASC 820 but are not intended as a substitute for reviewing FASB ASC 820 in its entirety.
3.13 Meeting the requirements of FASB ASC 820 requires coordination among plan management, custodians, investment fiduciaries, and plan audi-tors. Plan sponsors and plan administrators will need to determine whether they have the appropriate valuation processes in place and sufficient data to determine the fair value of the plan's investments using the framework pro-vided and to present the disclosures about the use of fair value measurements required. Although plan management can outsource the mechanics of the valu-ation process, they need to retain responsibility for the oversight of the final val-uations, including determining the adequacy of the related footnote disclosures.
Definition of Fair Value
3.14 FASB ASC 820-10-20 defines fair value as "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."
Valuation Techniques
3.15 Paragraphs 24–35 of FASB ASC 820-10-35 describe the valuation techniques that should be used to measure fair value as follows:
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The market approach uses prices and other relevant information generated by market transactions involving identical or compa-rable assets or liabilities. Valuation techniques consistent with the market approach include matrix pricing and often use market multiples derived from a set of comparables.r
The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indi-cated by current market expectations about those future amounts.Valuation techniques consistent with the income approach include present value techniques, option-pricing models, and the multi-period excess earnings method.
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The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (often referred to as current replacement cost). Fair value is determined based on the cost to a market participant (buyer) to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence.2ERISA requires that this statement be presented in comparative form.
3.16 FASB ASC 820-10-35-24 states that valuation techniques that are appropriate in the circumstances and for which sufficient data are available should be used to measure fair value.
3.17 As explained by paragraphs 25–26 of FASB ASC 820-10-35, valu-ation techniques used to measure fair value should be consistently applied.
However, a change in a valuation technique or its application is appropriate if the change results in a measurement that is equally or more representative of fair value in the circumstances. Such a change would be accounted for as a change in accounting estimate in accordance with the provisions of FASB ASC 250, Accounting Changes and Error Corrections.
The Fair Value Hierarchy
3.18 The fair value hierarchy in FASB ASC 820-10-35 prioritizes the in-puts to valuation techniques used to measure fair value into 3 broad levels. The 3 levels are as described in the following paragraphs:
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Paragraphs 40–41 of FASB ASC 820-10-35 state that level 1 in-puts are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to ac-cess at the measurement date. An active market, as defined by the FASB ASC glossary, is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and should be used to measure fair value whenever available, ex-cept as discussed in FASB ASC 35-43. FASB ASC 820-10-35-44 provides guidance on how the quoted price should not be adjusted because of the size of the position relative to trading vol-ume (blockage factor) but rather would be measured within level 1 as the product of the quoted price for the individual instrument times the quantity held.r
Paragraphs 47–51 of FASB ASC 820-10-35 explain that level 2 inputs are inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly or in-directly. If the asset or liability has a specified (contractual term), a level 2 input must be observable for substantially the full term of the asset or liability. Adjustments to level 2 inputs will vary depending on factors specific to the asset or liability. Those factors include the condition and location of the asset or liability, the ex-tent to which the inputs relate to items that are comparable to the asset or liability, and the volume and level of activity in the mar-kets within which the inputs are observed. An adjustment that is significant to the fair value measurement in its entirety might render the measurement a level 3 measurement, depending on the level in the fair value hierarchy within which the inputs used to determine the adjustment fall. Level 2 inputs include— quoted prices for similar assets or liabilities in active mar-kets.
— quoted prices for identical or similar assets or liabilities in markets that are not active.
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Employee Benefit Plans— inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves observable at commonly quoted intervals, volatili-ties, prepayment speeds, loss severivolatili-ties, credit risks, and default rates).
— inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs).
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As discussed in paragraphs 52–55 of FASB ASC 820-10-35, level 3 inputs are unobservable inputs for the asset or liability. Unob-servable inputs should be used to measure fair value to the extent that relevant observable inputs are not available, thereby allow-ing for situations in which little, if any, market activity exists for the asset or liability at the measurement date. Unobservable in-puts should be developed based on the best information available in the circumstances, which might include the entity's own data.In developing unobservable inputs, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. Unobservable inputs should reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the asset or liability (in-cluding assumptions about risk). Assumptions about risk include the risk inherent in the inputs to the valuation technique. A mea-surement (for example, a mark-to-model meamea-surement) that does not include an adjustment for risk would not represent a fair value measurement if market participants would include one in pricing the related asset or liability. The reporting entity should not ig-nore information about market participant assumptions that is reasonably available without undue cost and effort. Therefore, the entity's own data used to develop unobservable inputs should be adjusted if information is readily available without undue cost and effort that indicates that market participants would use different assumptions. FASB ASC 820-10-55-22 discusses level 3 inputs for particular assets and liabilities.
As explained in FASB ASC 820-10-35-37, in some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The level in the fair value hierarchy within which the fair value measurement in its entirety falls should be determined based on the lowest level input that is significant to the fair value measurement in its entirety.