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Under scrutiny: are pension plans being audited properly?

Listen up. An individual's retirement is sacred. Remember the uproar when it became clear that most Enron employees' retirement had been wiped out? Our profession provides the public with a sense of security about their retirement.


Generally, all pension plans with 100 or more eligible participants require an annual audit by a qualified CPA firm. In turn, firms, corporations and trust funds should be hiring qualified consultants, actuaries, attorneys and administrators to oversee these pension plans--and CPA firms to audit them.

A few years ago, the Office of the Chief Accountant-Employee Benefits Security Administration of the U.S. Department of Labor reviewed of a sample of plans that filed Form 5500 with an attached audit report for the year ended Dec. 31, 1992. The DOL found a 19 percent error rate, indicating that auditors failed to comply with one or more of the established professional standards.

The DOL has performed another review of employee benefit plans for the year ended Dec. 31, 2000, and even though the results are not final, it appears that there is not a marked improvement.

Employee benefit plan audits must be performed in accordance with professional standards and guidance and cover the full scope of audit procedures, not just an audit of the investment assets.

This article highlights important procedures related to audits of defined contribution plans, although many of the steps also would be applicable to defined benefit plan audits.


During the planning phase of an employee benefit plan audit, the auditor normally should request the following information from the plan's administrator:

1) Access to the employee's census data for the plan year, including date of hire, termination date, hours worked, employee contribution and employer matching (if it applies). birth date and compensation.

2) A cumulative listing of all the participants' accounts for defined contribution plans, including 401(k) plans.

3) A cumulative trust statement from the financial institutions that hold the pension's trusts investments.

4) A listing of all participant loans and their activity during the year, along with the requirements to obtain a loan.

5) Access to the pensioner's files containing documentation for the monthly pension benefits that the participant is receiving, including the approval for the pension benefit.

6) The SAS 70 reports describing the internal controls for the service organizations that hold the pension fund investments, execute transactions and maintain the related accountability. Distinguish between a Type 1 report that documents internal controls and a Type 2 report that both documents and tests internal controls. A Type 2 report may be used to assess control risk below the maximum. Even though you as the auditor rely on the SAS 70 report for internal control purposes, it is still your ultimate responsibility to read the report and determine if the controls described apply to your client and to carefully evaluate any caveats.

In addition to the information requested from the administrator, the auditor should prepare a planning test scope worksheet to calculate and document the amount that will be considered material to the financial statements in planning the audit. (Note: the DOL considers any dollar amount material.) In addition, the auditor should analyze the change in the financial line items from the prior year's audited financial statements to this year's ending general ledger balances and indicate the assessed audit risk and the evaluation of the control environment.

Consideration also must be given to SAS 99, Consideration of Fraud in a Financial Statement Audit, and should be documented within your audit planning notes. SAS 99 establishes standards and provides guidance to auditors to fulfill their responsibility as to whether the financial statements are free of material misstatement, whether caused by error or fraud.

A determination of whether or not you're going to use a substantive approach or place reliance on internal control should be included within these planning notes. Discussion with the administrator/employer also should cover any related parties involved with the pension trust fund; reportable conditions in internal control; prohibited transactions; commitments and contingencies; subsequent events; and risks and uncertainties.


Whether or not you're going to rely on the internal control system of the administrator/employer, you still need to know what to test and look for. From my experience, this is an area where some firms run into problems when they audit employee benefit pension plans. This is also the part of the audit where you can provide clients with value-added service by recommending improvements within their system or by having them accumulate the necessary plan documents that are missing from the administrator's files.

1) Investment asset testing. Obtain a copy of the pension plan's investment policy guidelines, which indicate what type of investments the fund is allowed to invest in. In addition, a lot of policies indicate the maximum percentage that can be maintained in each category. I would highly advise against a pension board in which the directors/trustees are responsible for the investments. You want the expertise of an investment manager, which also adds a layer of fiduciary liability protection.

2) Investment fees. All administrators should have signed copies of the investment manager's contract that lists the basis for their fees. Recalculate those fees based on the contract language and compare that with what was paid for reasonableness.

3) Participant account testing (defined contribution plans). The purpose of this test is to corroborate that the participant's accounts are being allocated the proper amount of revenue and expenses. Based on the plan document, the auditor needs to trace the contributions made on behalf of the participant either from employer contributions or from the participant's own contributions to their respective account. Auditors should determine that these contributions have been deposited as soon as possible after the pay date. If it's the participant's own contributions, auditors need to verify that the amount requested to be taken out of each paycheck is in accordance with what the participant requested. For any withdrawals, whether for a loan or pension distribution, verify that the proper written requests have been submitted to the administrator and approved and that the amount approved was distributed from the participant's account. It is important to test that the allocation of the operating expenses and investment income is being properly allocated to each of the accounts based on the participant's elections and the provisions in the plan document.

4) Balance test (defined contribution plans). The total balance of all the participant account balances should equal the audited fund balance after the allocation of investment earnings and operating expenses. A common error that I see is that the investment earnings are not being allocated properly or on a timely basis. I have seen plans where millions of dollars have not been allocated or have been allocated incorrectly. Make sure that the investment earnings and operating expenses are being allocated on the same basis to active and inactive participants. In some situations funds have allocated the investment earnings only to the active participants and the expenses to all participants. This is not allowable and when they learn of it, the DOL will insist the error be corrected.

5) Pension benefit testing. This test determines that the pensioner has submitted all of the proper documentation and that the calculation of the pension benefits is correct and in line with the plan document's provisions, and that the benefits have been approved. Some steps you should take: verify the pensioner's signature on the back of the cleared check; verify the name and amount on the check agrees with the check register; that the member is vested and has enough past and future service to earn a pension; that the member or beneficiary is eligible for the type of pension elected; and ensure that plan amendments have been properly followed.

6) Participant investment transfer testing. This test can be easy or difficult depending on the type of records maintained by the administrator and how often participants can choose to reallocate their investment choices or buy and sell investments that they own. Auditors must determine how the process works for a participant to make the different investment choices and what the authorization process is for doing this. The next step is to determine what type of records are kept regarding these transactions, either at the administrator's location or at the financial institution where the transaction requests are submitted and carried out. After that has been determined, auditors need to verify that the requests made by the participants were completed in a timely and accurate manner.

These testing areas are a very important part of the annual audit and the area that your client cannot see when you submit the annual audited financial statements to them. If you only focus on auditing the investments and do not concentrate on how the funds are being disbursed and allocated, then you're doing the participants an injustice--and you're overlooking some very important areas that require analysis.



Your primary field work following testing is an analysis of the investments and investment earnings. For a great majority of the single-employer pension plans, the auditing firms issue a DOL limited scope audit (DOL regulation 2520.1035(d)). The auditor needs to obtain a certification from the trustee or custodian that the investments and transactions contained within the statement are complete and accurate.

A big error that some auditors make here is to think that the DOL limited-scope audit means that they do not have to test contributions, investment transfer requests and benefit payments. These areas still require full audit procedures. The limited-scope certification only relates to the investments and investment earnings. In addition, plan investments not held by a qualified trustee/custodian, such as real estate, mortgages and participant loans, also are not covered by the certification. Under these regulations, only qualified trustees and custodians can issue the limited scope certification.

For years, the DOL has rightly tried to eliminate--through legislation--the scope limitation clause for these audits.

I believe the first step in auditing your investments is performing or obtaining a reconciliation using the prior year ending audit balance plus and minus all investments, income earned, and realized and unrealized gains and losses during the year, which should equal the ending fair market value balance per the trust statement provided by the financial institution holding the investments.

This is a way to determine that all of your assets exist and the pension plan accounted for all of the investment transactions during the year.

The auditor has to determine what kinds of investments the plan has and that the fair market value for those investments is reasonable. As well as identify the investments as to whether they are investments in a discretionary trust; common or commingled trust; master trust; real estate; mortgages; limited partnerships; investments with insurance companies; hedge funds; mutual funds; derivatives; group annuity contracts; or joint venture arrangements and other investment types.

After identifying the investments, the auditor must make a determination that the fair market value listed for the investments on the trust statement appears reasonable. For the investments that have a readily determinable market price, the auditor can check the market value by using various market listings that show the last bid price of stocks and bonds and government obligations.

For investments that do not have a readily determinable market value, consider other procedures, such as using a specialist engaged by the plan to value those investments (such as an appraiser for the real estate held by the plan); determining what criteria the financial institution used in valuing the investments to see if they were valued in good faith; do market comparisons of similar investments to the extent possible; and discuss these investments with the plan's investment managers or investment consultants.

The plan document and IRS determination letter must be evaluated for any recent changes in tax laws and regulations. During the course of the audit, the auditor should be alert for any violations of tax laws and regulations.

An area that pension plans need to be aware of--and avoid--is Unrelated Business Taxable Income. Unrelated business taxable income is the gross income derived by an organization from any unrelated trade or business it regularly carries on.


Pension audits are extremely important, and we as a profession need to continue to improve the quality of work that we perform on these audits, not only for the profession, but also for the millions of participants who are counting on auditing firms to be the watchdogs of their pension plans.

The DOL should have the results from its new study sample of 300 audits by April 2004, but preliminary results do not show the improvement that we had hoped for. These errors must be stopped and the profession needs to take control.

The AICPA Council and board of directors recently have created an Audit Quality Center for Employee Benefit Plans. The center will address issues affecting audit quality and will be an addition to the steps taken over the years by the AICPA, DOL and the International Foundation of Employee Benefit Plans to strengthen employee benefit plan audit performances.

I believe that while the AICPA has started building a solid foundation, we should consider strengthening efforts in California. CalCPA has created a pension audit task force chaired by University of Southern California professor William Holder. As a task force member, I will recommend that additional emphasis be placed on audits of employee benefit plans during the peer review process; that California Audit Quality Centers be established; and that firms wanting to perform audits of these plans belong to the California Audit Quality Center.

Additional considerations would be to require a minimum number of continuing education hours in employee benefit plan audits annually. And that once every three years, when your firm's peer review is performed, a minimum number of your firm's employee benefit audits must be selected.

This is our profession and we need to continue to take charge of it before someone else does. Millions of plan participants need to feel comfortable with their pension plans and know that the CPA firm auditing their plans has the expertise and ability to do so.

RELATED ARTICLE: Auditing the audits

The U.S. Department of Labor's review of 300 pension audits nationwide for the year ended Dec. 31, 1992 found:

1) Firms with 20 or less employees were responsible for 64 percent of the deficient audits;

2) For audits that did not comply with professional standards, the DOL believed that the lack of technical knowledge was a result of the practitioner not being aware of the applicable professional guidance, such as that provided by the AICPA Employee Benefit Plans Audit Guides. In some cases, firms didn't have this guide in their office or didn't know it existed;

3) Lack of adequate internal quality controls within the CPA firm (supervision, audit reviews audit programs);

4) One practitioner had little or no workpapers because he stated his audit fee was $750 and therefore stopped working once he reached that level;

5) Failure to perform necessary work. Many of the audits had no workpapers or documentation in areas such as management representations, internal controls, commitments and contingencies, and subsequent events;

6) Not understanding the limited scope exception;

7) The audit areas relating to participant data, plan obligations, benefit payments and party in interest/prohibited transactions that are unique to employee benefit plans had the most number of audit failures due to lack of work or no work in those areas.


Alex Miller, CPA is a vice president at Hemming Morse Inc. CPAs. You can reach him at
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Author:Miller, Alex
Publication:California CPA
Article Type:Cover Story
Geographic Code:1USA
Date:Mar 1, 2004
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