Pens io n s. By Bob Scott

Transcription

1 Pens io n s M a k i n g t h e N u m b e r By Bob Scott O u r O w n

2 With the implementation of Governmental Accounting Standards Board Statement No. 68, Accounting and Financial Reporting for Pensions, about a year away, it is time to focus on what preparers of employer financial statements will have to do in order to implement this complex standard. Many employers know very little about the huge number we are about to record in our financial statements. This article will discuss the challenge employers face in standing behind a complex pension expense number that they did not prepare. We will then discuss the best practice solutions published by the American Institute of CPAs Government Audit Quality Center, which preparers can also use to gain understanding and assurance regarding what could be the largest number in our financial statements. And finally, we will discuss steps every employer should take to better understand both their pension plan and the public employee retirement system that administers it. THE EMPLOYER DILEMMA Under current standards, the focus of financial reporting is pension expense, defined by GASB Statement No. 27, Accounting for Pensions by State and Local Governmental Employers, as the annual required contribution. Pension expense is typically relatively small, compared to other items in the financial statements. Also, under current generally accepted accounting principles, there exists a huge degree of flexibility in terms of how the annual required contribution is determined, including extensive use of smoothing techniques. These factors make the risk of material misstatement for pension expense relatively low for most employers. Under GASB Statement No. 68, however, employers will be required to report the net pension liability, which the GASB defines as the total pension liability less fiduciary net position (the net financial resources being held by the plan that is available to pay benefits). Pension expense will now be the change in the net pension liability from the beginning to the end of the year, adjusted for certain deferred inflows and outflows of resources. Under current standards, the focus of financial reporting is pension expense, defined as the annual required contribution. The net pension liability will often be one of the largest numbers in an employer s financial statements. It could also be a very volatile number, given the requirements of GASB Statement No. 68 for reporting fiduciary net position at market value of assets and providing for relatively short amortization periods for the deferred inflows and outflows of resources. In addition, scrutiny of pensions and the affect they could have on an employer s financial health by the media, investors, and the Security and Exchange Commission are at an all-time high. These factors create a significant dilemma for many employers that have independently governed and managed employee retirement systems. These systems typically have their own staff, accounting function, and internal control systems, and are the sole keeper of the census data used for the valuation. They hire the actuary, approve all assumptions, and often hire a different auditor than the employer hires. In other words, the GASB is now asking preparers to record and stand behind a very material and volatile number for which they may have no direct control or first-hand knowledge. This dilemma becomes even greater for employers that are members of agent plans. This is because unlike cost-sharing and single-employer retirement systems, the agent retirement system will be required to disclose little if any actuarial information, such as the net pension liability in the notes to their basic financial statements, under GASB Statement No. 67, Financial Reporting for Pension Plans. Without actuarial information contained in the basic financial statements, the retirement system auditor will have little underlying actuarial information to use in rendering an opinion on those financial statements. The agent retirement system will also not be required to report the fiduciary net position for individual member governments in its basic financial statements, so again, there will be no audit coverage for individual agent employers at the retirement system level. Given the huge financial implications that pensions can have on an employer s financial operations, it is not August 2014 Government Finance Review 47

3 Exhibit 1: The Agent Employer Dilemma Public Employment System Member Government Complete and total control over the generation of each government s actuarial valuation and the tracking of fiduciary net position (assets) by city Complete and total responsibility for the reporting of the net pension liability and related pension numbers in their financial statements Little responsibility to audit anything actuarial or by government Valuation based on the assumptions and parameters set by retirement system No relationships Completely responsible for expressing an opinion on the financial statement including the pension number No relationships Auditor Actuary Auditor unreasonable for the GASB and others to expect government employers to have a firm grasp on these numbers and yet, for many governments, this will require a significant change in both mindset and in relationships with their retirement systems. A CONDUCTOR FOR THE ORCHESTRA The employer s dilemma is an even greater problem for the employer auditor, since it is virtually impossible to audit a number that the client cannot support or document. This situation is similar to individual musicians who each have their own music to play but don t currently function as a group. Without a conductor to coordinate the effort, the end product is unlikely to please anyone. Accordingly, the State and Local Government Expert Panel of the AICPA has provided best practice recommendations to help conduct the orchestra. These best practice recommendations, in the form of whitepapers, are also reinforced with auditing standards interpretations and the creation of a pension chapter Pension expense is typically relatively small, compared to other items in the financial statements. in the AICPA Audit and Accounting Guide, State and Local Governments. Currently, the panel has issued whitepapers for multi-employer cost-sharing and agent plans as well as testing of census data for cost-sharing and single-employer plans. (The whitepapers are available at gfoa.org/aicpawhitepapers.) The whitepapers provide a common-sense approach to having the retirement system s external auditor provide information or perform the audit procedures on the information that the retirement system maintains, with the remainder of the audit procedures performed by the employer s auditor. To facilitate the retirement systemlevel audit procedures and the resulting findings, the State and Local Government Expert Panel created schedules that were new to the accounting literature. Since only the GASB has the authority to define the contents of the basic financial statements, the retirement system auditor will not cover these schedules in their opinion on the system s financial statements; instead, it will have its own AICPA-defined opinion. 48 Government Finance Review August 2014

4 A key principal throughout the whitepaper is that even though the employer auditor will be using audit evidence provided by the retirement system auditor, the opinion as to whether the employer s pension numbers are fairly stated rests solely with the employer auditor. The logical extension of this principal is that if the employer auditor is solely responsible for its opinion on the pension amounts, and the employer is ultimately responsible for the financial statements that those amounts appear in, then the employer is also solely responsible for the fair statement of the pension amounts. WHITEPAPER RECOMMENDATIONS Below is a summary of the whitepaper recommendations. Cost-Sharing Employers n Include a supplemental schedule of employer allocations in plan financial statements for which the retirement system auditor is engaged to provide an opinion. n Prepare a schedule of plan pension amounts by employer for which the retirement system auditor is engaged to provide an opinion. n Outline the responsibilities of the retirement system auditor for testing census data. n Describe the responsibilities of cost-sharing employers. Agent Employers As discussed above, agent employers are the most difficult because GASB Statement No. 67 does not require actuarially based information (e.g., the total pension liability or net pension liability) to be provided for either the retirement system as a whole or the individual employers. Accordingly, the whitepaper recommends breaking down the net pension liability into its two component parts of total pension liability less fiduciary net position, and it provides guidance for each component separately. The whitepaper also introduces the concept of using a service organization control report known as a SOC 1 Type 2 as an efficient way to gain evidence regarding the effectiveness of internal controls, thereby reducing the level of substantive testing by the retirement system auditor. The net pension liability will often be one of the largest numbers in an employer s financial statements. rate calculation. Total Pension Liability, Deferred Inflow, and Deferred Outflow of Resources. The plan actuary issues a separate actuarial report for each participating employer that includes net pension liability, deferred inflows and outflows by type and year, pension expense, and discount n The retirement system auditor either provides a SOC 1 Type 2 report for the applicable valuation period or it performs an attest engagement independently certifying the census data for each employer. n Employer auditor tests census data of active employees and confirms census data used by the actuary. n The employer auditor performs other tests and analytical review of the total pension liability, deferred amounts, and pension expense. August 2014 Government Finance Review 49

5 Fiduciary Net Position. The whitepapers provide two alternatives. The employee retirement system prepares a Schedule of Changes in Fiduciary Net Position by Employer and either: n The employee retirement system auditor is engaged to issue an opinion on the schedule as a whole, accompanied by a SOC 1 Type 2 report on allocations of inflows and outflows, or n The individual employer engages the retirement system auditor to issue an opinion on the schedule. Implications of the Agent Recommendations. The requirement for the auditor to express an opinion on the schedule as a whole is significant because it means that the auditor cannot just look at the totals that tie back to the Statement of Fiduciary Net Position; the auditor must also test the allocations between employers. This means that materiality will need to be lower The tremendous financial impact of defined benefit pensions on employer finances, combined with the intense media, investor, and SEC scrutiny, along with the new reporting requirements of GASB Statement No. 68, make the development of employer due diligence procedures an absolute necessity. than that of the financial statement audit, but still considerably higher than that of an audit of individual employer numbers. To provide additional assurance on the allocations, a SOC 1 Type 2 is also required. Many who have been following the formation of the audit strategies believe that ultimately, SOC 1 Type 2 reports offer the most efficient and common sense approach for providing some of the retirement system-level audit evidence to the employer auditor. Unfortunately, SOC 1 Type 2 must be performed during the reporting period for which they apply, and it is very doubtful that most agent plans will be in a position to have these procedures done in time for their employer members first year of reporting under GASB Statement No. 68. Accordingly, the whitepapers offer alternatives, but these alternatives will require substantially greater effort, possibly delaying the issuance of the financial statements and in all likelihood increasing audit costs. Retirement systems and their employer members will have to evaluate the alternatives available to them, and if a SOC 1 Type 2 approach is not feasible in the first year, they will need to determine whether it would be better to accept and explain a modified opinion on the pension numbers or incur the greater cost and time necessary for the alternative procedures. Single-Employer Retirement System. With the exception of testing of census data, the whitepapers do not address single-employer plans, as the State and Local Government Expert Panel felt that the unique and complex nature of multi-employer plans must be addressed first. Auditors will, however, inevitably look for parallels that can be applied to single-employer plans. For example, preparers may want to consider the desirability of having the actuarial certification letter addressed to them as the employer, rather than just the retirement system, as this creates a relationship between the actuary that performed the valuation and the employer that must report the numbers. 50 Government Finance Review August 2014

6 MAKING THE NUMBER OUR OWN The tremendous financial impact of defined benefit pensions on employer finances, combined with the intense media, investor, and SEC scrutiny, along with the new reporting requirements of GASB Statement No. 68, make the development of employer due diligence procedures an absolute necessity. When combined with the additional procedures in the State and Local Government Expert Panel best practice recommendations, this employer due diligence should provide preparers with adequate substantive evidence regarding the fair statement of their number. Possible due diligence and implementation procedures should include the following. n Develop an understanding of all pension plans sponsored by the employer, including: u Benefit provisions and how employer actions can affect benefits. u Funded status and whether it has been improving or declining over time. u The reasonableness of all actuarial assumptions, especially the investment return assumption. u Whether a high investment rate of return indicates an extremely high investment risk and leverage. u Whether current funding efforts have been adequate to keep both rates and funded status stable over time. n Perform an annual review of retirement system financial results, including: u Review the basic financial statement, including reading the audit opinion and looking for any opinion modifications or matters of emphasis. The days of an employer simply accepting the pension reporting package numbers provided by the retirement system and inserting them without question into their financial statements are going away. u Review the management discussion and analysis section and the footnotes for key issues, including subsequent events. u Review both the actuarial and investment sections of the comprehensive annual financial report for significant trends. If a CAFR is not prepared, obtain this information as stand-alone reports. u Obtain the management letter and determine whether the retirement system auditor reported any significant deficiencies or material weaknesses. u Inquire of the retirement system regarding any internal audit or other communications that the employer should be aware of. n Discuss implementation in advance with the plan, including: u Which measurement and valuation dates does the plan envision using, and when will the GASB Statement No. 68 numbers be available? u Does the plan anticipate a blended discount rate being used? If the answer is yes to the blended rate, what measures would allow for only the long-term rate of return being used, and what would be the impact on contributions? u For a multi-employer plan, is the plan aware of the State and Local Government Expert Panel s whitepapers, and is it willing to follow the best practice recommendations? Has the plan discussed the best practice alternatives with its auditor and determined which it will follow? Does the plan anticipate problems or delays due to the new accounting requirements? u Discuss implementation in advance with the employer s auditor: What additional client representations will the auditor be asking for, and can you see them in advance? Should internal control documentation be enhanced to include greater detail on the reports provided to the retirement system? What additional audit procedures does the auditor anticipate because of GASB Statement No. 68? August 2014 Government Finance Review 51

7 Check Out the GFOA s New Website Employers need to understand their responsibilities for objective, unbiased reporting of their pension commitments. Based on the measurement date and issuance date provided by the plan, can this testing be done at interim rather than year-end? Testing the new pension numbers at mid-year makes it possible to spot and correct problems in a timely manner without needing to delay issuance of the financial statements. BRAVE NEW WORLD Please visit the re-designed to find information on the many products and services offered by the GFOA. The site has an improved look and enhanced navigation to allow you to find the material you need quickly. Highlights include: n Topic search feature allowing members to easily identify all GFOA products, services, and information on a specific topic of interest to finance officers. The days of an employer simply accepting the pension reporting package numbers provided by the retirement system and inserting them without question into their financial statements are going away. Employers need to understand their responsibilities for objective, unbiased reporting of their pension commitments. GASB Statement No. 68 is but one indicator of how the world of public pensions is changing, and of the need for government employers to make the pension number their own. y n Access to articles from the GFOA s bimonthly membership magazine, Government Finance Review. n Expanded state and provincial association event calendar listings. n Job openings in governments throughout the country that you can easily post and search. n Tools and resources from the GFOA s Federal Liaison Center. n Presentations and handouts from the GFOA s annual conference. The GFOA will continue to add helpful resources to the website throughout the year. Government Finance Officers Association BOB SCOTT is chief financial officer/assistant city manager for the City of Carrollton, Texas, where he is responsible for all aspects of the city s financial operations. He has extensive experience in accounting and financial reporting issues, having served on various Governmental Accounting Standards Board review committees and task forces, and on the Governmental Accounting Standards Advisory Council. Scott was also a reviewer for the last three editions of the GFOA s Governmental Accounting, Auditing, and Financial Reporting (known as the Blue Book ) and other GFOA publications. He is a past chair for GFOA s Committee for Accounting, Auditing and Financial Reporting and has served on the GFOA s Executive Board. Scott currently serves on the American Institute of CPAs State and Local Government Expert Panel. In 2008, the AICPA named him the outstanding CPA in local government. 52 Government Finance Review August 2014