Beyond ERISA: the auditor's responsibilities.

BEYOND ERISA: THE AUDITOR'S RESPONSIBILITIES

An advance look at revisions to the AICPA guide on auditing employee benefit plans

When Congress passed the Employee Retirement Income Security Act of 1974 (ERISA), it required, for the first time, auditing employee benefit plan financial statements on a broad scale. This was an event as significant in the history of auditing as adoption of the Securities Act of 1933. In many respects, the accounting and financial reporting standards for benefit plans--be they defined benefit, defined contribution or health and welfare benefit plans--are dictated by ERISA and by Financial Accounting Standards Board Statement no. 35, Accounting and Reporting by Defined Benefit Pension Plans, issued in 1980.

In response to ERISA, the American Institute of CPAs in 1983 issued the audit and accounting guide Audits of Employee Benefit Plans. For independent auditors, it has become our stock in trade for conducting audits of the financial statements of employee benefit plans.

A REVISED GUIDE

In 1988, in light of auditing and accounting standards issued by the AICPA and FASB since 1983 (particularly the AICPA's "expectation gap" auditing standards), amendments to ERISA passed in various tax acts plus other developments, the AICPA employee benefit plans committee was reestablished to revise the guide. A draft of the new guide will be exposed for comment in the spring of 1990.

Both the Department of Labor and Congress have been taking a hard look at the accounting profession's role under ERISA. This scrutiny is largely due to audit failures unrelated to health and welfare or pension programs. It also is due to perceived weaknesses in the DOL's ERISA enforcement process. To address these weaknesses, the DOL appointed its first chief accountant for pension and welfare benefits programs. The DOL's inspector general (IG) recently audited certain aspects of the ERISA enforcement activities. The DOL also recently has decided to add another 100 persons to its enforcement program.

Professionals serving as advisers, auditors and participants in plans today need to understand new, more sophisticated types of benefit programs. For example, 401(k) plans weren't even a concept in 1980 when the guide was being developed. These plans will be discussed in the new guide. Older types of plans have disappeared because of tax law changes.

The revised guide will identify new types of investments appearing in plan portfolios, such as futures and options contracts, collateralized mortgage obligations (CMOs), real estate mortgage investment conduits (REMICs) and bank investment contracts (BICs)--new types of contracts issued by banks that may appear similar to guaranteed insurance contracts (GICs) and other investment contracts issued by insurance companies.

HEALTH AND WELFARE PLANS

Accounting and reporting guidance for health and welfare plans found in chapter 4 of the 1983 guide is taken from an AICPA guide published in the 1960s. In the late 1970s, when the FASB was proposing new accounting by defined benefit pension plans, it decided not to add the subject of health and welfare benefit plan accounting to its agenda because of more pressing agenda items. It is unlikely a revised chapter 4 will be in the new guide when it is exposed for comment because its revision may depend on the conclusions reached by the FASB on its current project on accounting for the employer's cost of other postemployment benefits (OPEB), scheduled for completion at the end of 1990.

Benefit plan professionals are seeing more emphasis by unions and employers on issues related to health and welfare programs, specifically those providing postemployment-type benefits. This is not surprising, given the effect the FASB's OPEB project will have on the employer's accounting for benefit plans.

JUDGING RISK

The new guide will help the auditor focus on areas of possible audit risk in benefit plans. Statement on Auditing Standard no. 47, Audit Risks and Materiality in Conducting an Audit, provides guidance on the auditor's consideration of audit risk and materiality when planning or performing an audit. A few areas of employee benefit plans that may present audit risk are

1. Fair market value investments with no readily ascertainable market.

2. New types of investments.

3. Determination of benefit payments.

The revised planning chapter of the new guide will discuss how the auditor's judgment about the level of risk may affect staffing for an audit engagement, the extent of supervision required, an overall strategy for expected conduct of the staff, the scope of the audit and the need for professional skepticism.

The revised guide will apply the new AICPA standards to benefit plans. Changes in DOL and Internal Revenue Service reporting requirements, including changes in the reporting forms, also are addressed. The guide also will discuss how the provisions of SAS no. 8, Other Information in Documents Containing Audited Financial Statements, can be related to plan financial information contained in Form 5500, Annual Return/Report, which is filed with the IRS and the DOL. The current guide does not address the application of SAS no. 8 to form 5500.

A brief overview of SASs nos. 53 through 61, as they relate to employee benefit plan audits, follows.

RESPONSIBILITIES FOR DETECTING ERRORS, IRREGULARITIES AND ILLEGAL ACTS

In its discussion of SAS no. 53, The Auditor's Responsibility to Detect and Report Errors and Irregularities, the revised guide will include considerations the auditor must give benefit plan matters to satisfy his or her responsibilities.

Regarding SAS no. 54, Illegal Acts by Clients, the revised guide will describe the consideration an auditor should give to the possibility of illegal acts by a client when auditing statements in accordance with generally accepted auditing standards. "Illegal acts" refers to violations of both laws and government regulations. The auditor's responsibility to detect and report misstatements resulting from illegal acts having a direct and material effect on the determination of benefit plan statement amounts is the same as that for errors and irregularities described in SAS no. 53.

An auditor ordinarily does not have sufficient basis for recognizing possible violations of laws and regulations that relate more to an entity's operations than to its financial and accounting policies. Even when violations have consequences material to the plan's financial statements, the auditor may not become aware of illegal acts unless he or she is informed by the plan management or there is evidence of a government investigation or enforcement proceedings in the records normally inspected during the audit.

The auditor nevertheless should keep in mind the possibility that illegal acts may have occurred. If specific information comes to the attention of the auditor concerning possible noncompliance with ERISA or DOL regulations that could have an indirect material effect on the financial statement amounts, the auditor should apply audit procedures specifically directed to finding whether an illegal act has occurred. The revised guide will discuss, for example, procedures the auditor should consider related to prohibited transactions.

USE OF ACCOUNTING ESTIMATES

The revised guide will include a discussion of the use of accounting estimates and how the auditor would satisfy his or her responsibilities under SAS no. 57, Auditing Accounting Estimates. While the responsibility for making estimates rests with the plan administrator, the auditor is responsible for evaluating the reasonableness of the estimates and should consider appropriate procedures in planning to perform the audit. Significant accounting estimates often affect elements of an employee benefit plan's financial statements, such as

* Asset values for nonmarketable investments.

* The obligation for accumulated postemployment benefits.

* The obligation for accumulated eligibility credits.

* Accrued experience rating adjustments.

THE AUDITOR'S REPORT 

SAS no. 58, Reports on Audited Financial Statements, deals with the form of the auditor's report. Statement of Position no. 88-2, Illustrative Auditor's Reports on Financial Statements of Employee Benefit Plans Comporting with [SAS] no. 58, updated the 1983 guide to conform the illustrative reports contained in chapter 12 to the new requirements of SAS no. 58.

Going concern considerations. The revised guide will discuss evaluating whether there is substantial doubt about the plan's ability to continue as a going concern in accordance with SAS no. 59, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern. While going concern considerations ordinarily relate to operating entities, a plan nevertheless may face the possibility of its "business" not continuing. An explanatory paragraph may be required regardless of the auditor's assessment of asset recoverability and the amounts and classifications of liabilities. For example, if the sponsoring employer 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 disclosing that fact.

COMMUNICATIONS TO MANAGEMENT AND AUDIT COMMITTEES

SASs nos. 60, Communication of Internal Control Structure Related Matters Noted in an Audit, and 61, Communication with Audit Committees, deal with communications to management or audit committees about the findings during the audit process. The discussion of SAS no. 60 will relate to the auditor's responsibility to communicate to the plan administrator information about the plan's internal control structure.

Communications with an audit committee (or similar body) on certain matters that arise in the conduct of an audit are required by SASs nos. 53 and 54, among others. The DOL has said, in the absence of a named fiduciary (normally, the plan administrator), the sponsoring entity's board of directors is responsible for the operations of the plan.

ADDRESSING THE IG'S REPORT

Another objective in revising the guide has been to work with the DOL in addressing some of the concerns raised by the IG in his 1988 report to Congress and the secretary of labor. These included concern the DOL was not satisfying its responsibilities in its own ERISA enforcement activities and independent auditors were not satisfying their responsibilities to the participants and the secretary of labor in performing audits of plan financial statements.

The IG's original report and a follow-up report issued in October 1989 criticized the quality of benefit plan audits. The comments, findings and recommendations in the 1989 report come, in large part, from a review conducted by members of the IG staff and CPA firms contracted to review a sample of 279 employee benefit plan audits. (See THE AICPA'S RESPONSE TO THE IG'S REPORT (and exhibits on subsequent pages) for a discussion of the AICPA's response to the IG's report.)

Limited-scope audit exemption. One of the major recommendations of the IG in his report was the elimination of the limited-scope audit exemption currently available under ERISA section 103 and the DOL regulations. Since 1978, the AICPA has, in congressional testimony and other forums, opposed limited-scope audits and called for their elimination. It is encouraging to see the IG now has recommended the AICPA's request be implemented. The secretary of labor also apparently is in agreement and will support proposed changes in the legislation that appear likely to be adopted by the 101st Congress.

Alleged audit deficiencies. Unfortunately, the other comments and recommendations in the IG's reports were critical of the audit work performed. The IG reported that in his opinion 64 of the 279 audits (23%) did not meet one or more elements of GAAS. However, he did not report whether in his opinion those deficiencies were minor or major.

A review by the AICPA staff noted that deficiencies did exist in a few audits. The review also confirmed, however, that there were many technical violations of reporting requirements and standards (stemming from differences in professional judgments based on existing conditions, facts and circumstances) that were inconsequential to the overall audit performance.

The IG's findings of alleged GAAS deficiencies relate to the auditor's responsibility to perform and report on an audit of the plan's financial statements in accordance with those standards. The IG also noted other failures related to ERISA and DOL information required to be reported by the plan administrator in the financial statements' footnotes and supplemental schedules. He reported that in his opinion 181 of the 279 plan financial statements did not meet ERISA or DOL requirements. Substantially all of the financial statements found to be deficient failed to contain certain disclosures specifically required under the law or the regulations. Those disclosures may or may not be required by generally accepted accounting principles. Further, the IG's findings were made without regard to any level or standard of materiality.

The most frequently occurring omissions included failures to disclose information about

* Termination priorities.

* Differences between financial statement amounts and form 5500 amounts.

* The plan's tax status.

* Investment exceeding 5% of net assets.

* Plan amendments.

* Pension Benefit Guarantee Corporation coverages.

The guide currently contains guidance on how the general fieldwork and reporting standards may be satisfied in employee benefit plan engagements. The IG did not indicate any areas in which proper guidance or appropriate interpretation of the standards was lacking. However, to help overcome some of the noted deficiencies, the revised guide will discuss further both ERISA and GAAS in most of the areas identified by the IG.

ALERTING PRACTITIONERS

The IG's comments did alert practitioners to areas of the ERISA audit in which plan professionals, administrators, trustees and--to a certain extent--auditors have become somewhat lax in preparing and filing information required to satisfy the law. The guide revision will further heighten the auditor's awareness. But, as already noted, no changes in GAAS requirements resulted from the IG's review. Any changes in practice required by and discussed in the revised guide result from the issuance of new SASs since the publication of the original guide in 1983.

THE AICPA'S RESPONSE TO THE IG'S REPORT

In November 1989, the U.S. Department of Labor (DOL) Office of the Inspector General (IG) issued a report entitled Changes Are Needed in the ERISA Audit Process to Increase Protection for Employee Benefit Plan Participants. The IG's report included findings and recommendations resulting from a review of the quality of selected audits performed by independent public accountants (IPAs) on privare pension and welfare benefit plans. The IG listed the following reasons for conducting the review:

* There are approximately 66 million U.S. workers and retirees depending on the financial integrity of these plans.

* Assets held by these plans total approximately $2 trillion.

* Adequate oversight of employee benefit plans is at least partially dependent on good audit coverage.

* Prior work identified significant problems with plan audits that have gone largely unresolved.

The IG examined the auditor's report and working papers of 279 randomly selected plans conducted for the 1986 plan year, assessing the degree of information and protection IPA audits provide plan participants.

FINDINGS

With respect to the quality of audit work performed, the IG reported independent audits did not consistently comply with generally accepted auditing standards. The IG's review of the IPAs' working papers found 64 of the 279 plans reviewed (23%) did not meet one or more of the GAAS. In addition, the IG found there is a lack of monitoring by the Pension and Welfare Benefit Administration (PWBA) of the audit work performed by the auditor. A listing of the alleged nonadherence to GAAS is summarized in exhibit 1. Areas cited by the IG as examples of the auditor's failure to obtain sufficient competent evidential matter are shown in exhibit 2.

The IG also reported 181 of the 279 plans reviewed (65%) did not include disclosures required by the Employee Retirement Income Security Act of 1974 (ERISA), the DOL or generally accepted accounting principles. See exhibit 3 for the 16's findings.

RECOMMENDATIONS

The IG's recommendations are shown in exhibit 4.

The American Institute of CPAs has testified before two congressional subcommittees and presented its views on most of these recommendations. It emphasized audits conducted in accordance with GAAS are not designed to assure compliance with regulatory requirements and, if the DOL and Congress wish the independent auditor to expand the scope of work beyond an audit of the financial statements of a covered plan, they must be explicit in what they require.

In addition, the AICPA is on record, beginning in 1978 and most recently in 1988, as saying plan participants cannot be provided the full assurance contemplated by ERISA if the independent accountant's audit is restricted to exclude assets held in a bank or similar institution or an insurance carrier as permitted by section 103(a)(3)(C) of ERISA. If the DOL and Congress wish to remove this constraint on the utility of required audits, they need only eliminate the authority to impose limitations on the scope of audit. On January 23, 1990, Senators Nancy Kassebaum (R-Kan.) and Orrin Hatch (R-Utah) introduced S 2012, which removes the limited-scope option.

STEPS TAKEN BY THE AICPA

The AICPA has taken several steps to improve the quality of employee benefit plan audits. They include

* Assigning maximum priority to timely issuance of the revised audit and accounting guide, addressing areas requiring special attention such as clarifying the auditor's responsibility relative to information included in form 5500.

* Preparing GAAS, GAAP and ERISA compliance checklists for use by practitioners in connection with audits of the various types of benefit plans. The checklists will address audit planning and review, the study and evaluation of internal controls and reporting and disclosure requirements.

* Providing information about ERISA audits in the recently issued audit risk alert.

* Publicizing the results of the IG's study and findings.

In view of the IG's findings, firms conducting ERISA audits may wish to review their current guidance in this area.

EXHIBIT 2

Alleged failure to obtain sufficient competent evidential material

The following, in descending order of occurrence, were areas cited by the IG as examples of the auditor's failure to obtain what they believe was sufficient competent evidential matter:

* Testing of the plan's tax status, including review of an IRS tax

determination letter. * Testing of plan participants' data. * Inquiring about other testing of prohibited transactions. * Testing of subsequent events that might have an impact on the

plan's financial statements. * Testing of benefit payments. * Testing of contingencies and commitments. * Obtaining representation letters from plan management or

legal counsel. * Confirming plan assets. * Reviewing minutes.

EXHIBIT 4

IG's recommendations

The IG recommended the following to the PWBA:

* Full-scope audits of all plans with more than 100 participants

should be required. * Independent auditors should be required to test and report on

ERISA compliance. * Independent auditors should be required to report ERISA

violations directly to senior management, the board of directors

or its audit committee and PWBA for action. * The DOL and the AICPA should work together to improve

compliance of plan audits and reports with GAAS and ERISA. * The DOL's audit quality review procedures should be expanded

to include review of plan auditor's working papers. * The DOL should work with the AICPA to obtain specific

monitoring coverage of ERISA audits in peer reviews. [Exhibit 1 and 3 Omitted]

ANDREW J. CAPELLI, CPA, is a partner of KPMG Peat Marwick, New York. He is the chairman of the American Institute of CPAs employee benefit plans committee and was the chairman of the employee benefit plans and ERISA special committee, which prepared the 1983 audit and accounting guide Audits of Employee Benefit Plans. IAN MacKAY, CPA, is director of the AICPA federal government division. He is the staff aide to the employee benefit plans committee.