For Non-SEC filers – the Accounting Standards Codification (“ASC”) requires that an entity recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.

The ASC defines subsequent events as follows:
“Events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. There are two types of subsequent events:
a. The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events).
b.  The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (that is, nonrecognized subsequent events).”

In addition to the recognition requirement the ASC requires that the entity disclose both a) the date through which subsequent events have been evaluated by management, and b) the date the financial statements were issued or the date the financial statements were available to be issued. 
 
Financial statements are considered available to be issued when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance have been obtained, for example, from management, the board of directors, and/or significant shareholders/owners. The process involved in creating and distributing the financial statements will vary depending on an entity’s management and corporate governance structure as well as statutory and regulatory requirements.

Financial statements are considered issued when they are widely distributed to shareholders/owners and other financial statement users for general use and reliance in a form and format that complies with GAAP.”

What does this mean for my 401(k) Plan?
If you are responsible for your Plan (i.e. Trustee, main Fiduciary) you may be wondering how this requirement affects your Plan.  The requirement forces you as Fiduciary to disclose in writing that you have reviewed all subsequent events that occurred after your Plan Year End date for possible recognition in the financial statements as of the Plan Year End date, or for disclosure in the footnotes. If a footnote disclosure is not included in your Plan’s December 31, 2009 (or later) financial statements, then your financial statements are not in accordance with U.S. GAAP. 

Victor Fuentes

When I asked her about it, she was just so upset that the TPA hadn’t filed the forms and were giving her all sorts of excuses about why they hadn’t taken care of things. And while I totally agreed and could almost sympathize, she was rather taken aback when I inquired if she realized that she was ultimately responsible for filing the appropriate forms and returns, and ensuring that the plan was compliant. She was mistakenly under the impression that the TPA was going to take care of it, and now, because of her own ignorance about her specific fiduciary responsibilities that extend beyond hiring the right company, she was about to spend thousands of dollars and countless hours trying to make everything right. If you are like my friend and think that you have a good TPA and you can trust them to take care of things, I’m not saying that you can’t trust them to do their job, but you as the plan sponsor are directly responsible for compliance and timely filing. So have those discussions with your TPA about what needs to happen and who will do what. And don’t hesitate to ask them when things will happen and how you will know that such things, like filing your 5500, have been taken care of. They may do most of the work, but they still work for you.

Katie Thomas, CPA

Size of Plan

Did you know that terminated employees who are still in your plan cost you extra fees? Much of the audit work is completed based on the participant counts, which include eligible current employees and terminated employees with account balances. Most plans have guidelines for automatic distributions to terminated employees with small balances. Work with your third party administrator or ERISA attorney to ensure you are making the most cost effective decision for your plan. 

Level of Assistance

As a plan administrator much of the audit fee is in your control. The more you do, the less your auditor has to do. The less work your auditor does, the less you pay!

Your auditor should send you a detailed list called a “Client Assistance Request List” or “PBC List” (PBC = Prepared By Client). This should represent the majority of information your auditor will need to complete the audit. As a result, this document is your guide to minimizing fees. Here’s how:

Gather all the information on the list and provide it to your auditor all at once. Most auditors have several clients they are working on simultaneously, the fewer times they have to put down and pick-up your file the less time will be spent on.

If you have questions about something on the PBC List, ask your auditor. Each item on the PBC list has a purpose and providing the wrong thing to the auditor adds time. Similarly, not providing anything causes additional work for the auditor too. Answer no or indicate why you haven’t provided a requested item.

Eliminate the excess. An auditor’s job is to investigate and inquire. If we are given extra paperwork or unrequested documentation, we expect that you have provided it to us for a reason. We will likely review it and ask you why it was provided. Further, most 401k auditors will request documents from the employees’ personnel files. Rather than pulling the entire employee files and handing them to the auditor, flag the specific documents requested or pull them and provide only what has been requested. And if you don’t understand what the auditor is looking for, ask.

Questions from the auditor are inevitable; regardless of how prepared you are as a plan administrator. To minimize fees, respond to the auditor as quickly as possible. They may inquire regarding unusual transactions or may be waiting to hear back regarding the approval of the draft financial statements; the less time the auditor waits the less downtime for your plan and the fewer the excess fees.

A management letter is the plan administrator’s guide to fewer future audit fees. Auditors use the management letter as a tool to advise management as to errors and inefficiencies noted during the audit. Often they include a recommendation for how to prevent the errors or improve the processes going forward. Implementing recommendations from management letters will make for better administration of the plan and as a result, fewer fees.

If you are concerned about your audit fee, talk to your auditor. In addition to recommending the tips I have listed above, they will be able to specifically tell you how your plan can reduce fees.

Jill Smith

The Internal Revenue Service (“IRS”) has stated that certain expenses are considered immediate and necessary. These expenses include the following:
• Medical expenses,
• Purchases of a principal residence,
• Certain tuition and other educational expenses,
• Prevention of foreclosure of principal residence,
• Burial and funeral expenses, and
• Certain repairs of damaged principal residences.

As the Plan Sponsor, you are required to determine whether an employee’s request does in fact meet the definition of an immediate and necessary expense and keep proper documentation of your decision.   

After the determination is made that an expense is an immediate and necessary expense, a Plan Sponsor must also determine if the employee has any other resources to satisfy this expense. If an employee has other resources available to help meet this expense, generally the Plan Sponsor should deny the hardship distribution request.  In certain circumstances the law includes assets of the employee’s spouse and minor children when defining “other available resources”. Hardship distributions should be utilized only as a last resort to satisfy expenses for the employee.  As the sponsor, you may rely on the employee’s representations relating to other resources unless you have actual knowledge to the contrary.

Another requirement that should be considered prior to approval of hardship distributions is there are other forms of distributions from the plan or available loans.  As a Plan Sponsor, you must determine that there is no other form of distribution available to the participant prior to approval of hardship distributions. You should also verify that the hardship distribution amount requested does not include more than an employee needs to satisfy the immediate and necessary need. This can be determined based on the documentation provided by the employee while determining that there is an immediate and necessary need. The IRS has cited record keeping of documentation for approval of hardship distributions as commonly neglected.

It is generally good practice to discuss with the employee prior to a hardship distribution the consequences of taking the distribution. They may have various penalties and taxes to pay depending on their situation. These penalties and taxes can be added into the hardship distribution amount in order to help the employee pay for the expense plus the penalties and taxes.

If the Plan Document allows for hardship distributions, have procedures in place in order to approve or deny the distribution request. These controls are imperative to help you as the Plan Sponsor consistently determine if the hardship distribution requests are valid.

Shelby Williams

Costs associated with fixing an operational failure fall into two groups; first, the cost to correct the error, second the cost to report the error to the IRS.

Some corrective actions can be completely free to the plan sponsor.  Some corrective actions costs will consist mostly of administrative costs.  For example costs to amend the plan document for updates required by law changes, or refund excess contributions to participants that exceeded 415 limits or caused the plan to violate ACP/ADP discrimination tests.  However sometimes corrective actions can be costly.

Like corrective action costs, costs to report the error to the IRS range from free to very costly.  The Correction programs provided for by the IRS (assuming that the plan is not under audit) are the self-correction program (“SCP”) and the Voluntary Correction Program (“VCP”).  The SCP is free.  However, the operational failure must meet certain criteria in order to qualify under the SCP.  If the failure does not qualify under the SCP, then the plan must submit the corrective action under the VCP and pay a fee based on the number of participants in the plan (up to a maximum of $25,000).

In order to qualify for the SCP the following must be complied with
• The failure must be an operation failure, accordingly the error was a failure to comply with the plan document
• The error occurred despite the plan having established practices and procedures in place to prevent the error
• The failure was corrected timely, within two years of the end of the plan year in which the failure occurred or the failure was not significant
• The failure was corrected using the principles set forth in Rev. Proc. 2008-50
• If needed, the plan sponsor effects changes to practices and procedures to ensure the failures don’t occur again
• Documentation of this correction and it qualification under the SCP is maintained

Following is an example of a compliance failure that, because of how it was handled, ended up costing the sponsor significantly more costs to correct.

Company A’s 401k plan failed the ADP/ACP discrimination testing in year XXX1.  The testing was properly performed by the Plan’s third party administrator and notified the Company of the excess contributions that should be made to certain highly compensated participants in order to pass the ADP/ACP test.  If the Company had made this reimbursement, the plan’s compliance deficiency could have been corrected without any cost to the Company.  However, the Company did not instruct their administrator to make the needed refunds.  In year XXX3, it was determined that the excess refund contributions had not been made.  Accordingly, the time period allowed to correct for the discrimination failure by making contribution refunds had passed (12 months after the plan year-end is the allowed time period).  The only option available to the plan was for the Company to make qualified non-elective contributions (QNECs) to non-highly compensated employees.  These QNECs, totaling more than $30,000, were additional contributions required to be made by the Company.  Additionally, if it is determined that the mistake was significant or that the plan did not have practices and procedures in place to ensure compliance, then the plan would not be eligible for the SCP correction program.  Accordingly, the deficiency would have to been reported to the IRS under the VCP and applicable fees totaling $5,000 (the plan had between 101 and 500 participants).  In addition to the fees paid to the plan and the IRS, the sponsor incurred additional fees from the administrator.  So instead of a simple refund of excess contributions by the plan, that would have cost the Company nothing, the Company ended up paying more than $40,000 to correct for the compliance deficiency. 

Avoid costly compliance failure costs by proper and timely administration of plan compliance requirements.

Kim Lubbers, CPA

Back to Fair Value Measurement Disclosure (FAS 157)

If you are a Plan Administrator responsible for overseeing the audit of your Employer’s 401K Plan (“Plan”), then your auditor may have advised you that he/she will need more information on completing the Fair Value Measurement disclosure for the Plan’s 2009 fiscal year end.

Let’s start with a recap of what the Fair Value Measurement disclosure is about.  Fair Value Measurement provides a framework for measuring fair value, and which the framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements).  The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used maximize the use of observable inputs and minimize the use of unobservable inputs. 

In the prior year audit you probably worked with your Plan’s third party administrator (“TPA”) and Plan auditor to assist with the creation and presentation of the Fair Value Measurement disclosure.  The final disclosure most likely looked like the following table:

Changes for 2009 Audits

The Accounting Standards now require “additional detail” on the nature of the investments within each category. 

To find this “additional detail” there are a few places that you can research, as follows:

1. The easiest process would be to call your TPA, or investment advisor and have him/her provide the nature/type of each investment. For example, most mutual funds can be grouped in categories, such as: Domestic stock, International stock, Growth, Bonds, Balanced. 
2. Most TPA websites will have a link to the investments your Plan offers. The investment section will most likely categorize your Plan’s investments by nature/type.  If you can not find the investment link, then call your TPA and have them guide you through their website.
3. You may be able to request your TPA to provide the Fair Value Measurement input level recommendations, and nature/type recommendations.  You can then use this information to prepare the disclosure.  

An example of a disclosure for the 2009 Plan year audit may look like the following: 

Additional Notes:

1. The Fair Value Measurement disclosure should be presented in your Plan’s financial statements comparatively.  This means that the current fiscal year disclosure and the prior fiscal year disclosure should be presented in the current fiscal year financial statements.  However, the disclosure requirement is not retrospective, which means that the prior fiscal year disclosures do not need to be updated for the new disclosure requirements. 
2. Fair Value Measurement still requires that assets/liabilities at Level 3 inputs have a reconciliation showing the summary of changes in fair value.  This is only required for the current fiscal plan year. 

If you have any questions on the new Fair Value Measurement disclosure requirements, and how it affects your plan, please feel free to post a question, or contact us directly. 

Victor Fuentes

You can order the complete survey at pcsa.org; however, there is a charge if you aren’t a PCSA member. I’d like to share some interesting findings from the survey here:

• Approximately 57 percent of plan sponsors made changes to their 403(b) plans because of new regulations
• Fewer small organizations made changes as a result of the new rules than large organizations (just over 48% of plans with 1-49 employees made changes vs. nearly 70% of plans with 200 or more employees)
• Overall plan participation by employees held steady from 2008 to January 2010 (76% of eligible)
• There was an increase in the number of plans permitting Roth after-tax contributions (14% in 2009, up from 11% in 2007)
• Fewer participants (1.3%) took hardship withdrawals in 2009
• Approximately 33% of survey respondents are unsure if their plan has an investment policy statement

What changes have you made to you 403(b) plan recently?  Does your 403(b) plan have an investment policy?  We’d like to hear from you!

Jessica Puckett, CPA, CFE

Following we will just address the ADP and ACP test.  The other tests will be covered in subsequent articles.  The ADP (“Actual Deferral Percentage”) and ACP (“Actual Contribution Percentage”) test are annual compliance tests, mandated by the IRS, is to ensure that the 401(k) plan does not discriminate in favor of highly-compensated employees.  Before we discuss the test, we first need to understand who is considered to be highly compensated.

HCE

Highly Compensated Employees (HCEs) (414(q)(1)) are employees who:

• For the preceding year had compensation of more than $110,000 (for 2009 and 2010, subject to COLA in later years) and, if the employer so elects, was in the top 20% of paid employees OR
• Who owns greater than 5% of the business, or a family member of a 5% owner
ADP Test

The ADP test measures the deferral rates of two groups: Highly Compensated Employees (HCEs) and Non-Highly-Compensated Employees (Non-HCEs).  For the ADP test the ratio is salary deferred divided by compensation.  The average percent of salary deferred by and to HCEs cannot exceed certain limits based on the average percent of salary deferred by and to the Non-HCEs in the current or preceding year. Essentially, the Non-HCEs of salary deferred as a group on average determine how much the HCEs of salary deferred can be as a group on average. A plan will pass the test if:

• The average deferrals for the HCEs do not exceed 1.25 times that of the average deferrals for the Non-HCEs, or

• Average deferrals of HCEs do not exceed the lesser of (a) two percentage points above or (b) two times the average deferrals of Non-HCEs

ACP Test

The ACP test is exactly the same as the ADP only the numerator of the ratio are matching contributions and/or employee after-tax contributions instead of salary deferrals.  The same ratio limits between HCE’s and Non-HCE’s are applied to this ratio to determine if the plan has passed the ACP test.

If it is determined that the Plan has failed either the ADP or ACP test, corrective action must be taken with in certain time limits in order for the Plan to maintain it’s qualified status.  The employer may select from various options depending on the time period when the failure was discovered.  These options will be discussed in future articles.

 Joe Goodmiller

While this control is often overlooked by employers who offer 401(k) plans to their employees, it is an important control to mitigate additional risk taken on by the employer. For example, a participant who has turned in an election form wishing to participate, might not have had contributions withheld from their compensation because of mistakes such as the paper getting lost in transit to the correct person who will make sure the participant is signed up. With no paperwork in the file stating there was or was not an election made, it might just be assumed that the participant did not wish to participate and has declined enrollment by not turning in a form. The participant can potentially come back and order the company to pay for the missed deductions plus any interest that would have been made on those contributions.  Rev. Proc. 2008-50 provides guidance on what is required of the employer to do in such cases. For example, in the case discussed previously, an employer would be required to make the employee “whole” by contributing an amount equal to 50% of the employee’s missed deferrals that would have been made if the employee had been timely included in the plan.  With an adequate control in place, this situation could have been avoided since as soon as it was noted that there was no paperwork in the file regarding whether the participant wished to participate or not they can follow up with the employee and the situation can be corrected.

As companies review their control procedures, this is one control that is both simple to execute and highly effective in protecting the plan from large amounts of risk. A best practice related to 401(k) enrollment forms is to have an option for the participant to check if they do not wish to participate in the plan. This allows the plan administrator to simply require, as one of their controls, that every participant who is eligible to return the form indicating their participation election. If declining enrollment is not an option on the election form, simply have the employee sign and date a form that says they do not wish to participate and include the information in the employee’s personnel file.

Shelby Williams

To be brief, the IRS required compliance testing is a test or series of tests (The types of tests is based on your Plan’s elections) that provide for equal tax breaks to all participating employees, and not just highly compensated employees (HCEs).  In general, the tests compare the contribution and deferral ratios of the HCEs (as defined by the IRS) to those of the non-highly compensated employees (NHCEs) (as defined by the IRS).  These tests are commonly known as the ACP and ADP tests, and the mechanics of these tests is the subject of another conversation.  If the ratios of the HCEs is greater than the NHCEs’ ratios by a certain amount, then the Plan will be considered as failing the compliance tests.  The percentages must be adjusted in order for the Plan to pass the tests. The most common methods the Plan can follow to correct the failures are as follows:

1. The plan can contribute a qualified non-elective contribution (QNEC) to the NHCE’s in order to bring the ratios in compliance.
2. Refund excess contributions (plus earnings and minus losses) to the NHCE’s (based on IRS rules), beginning with the NHCE who has the highest dollar contribution for the Plan year, then reducing the other NHCEs’contributions until the ratios are in compliance, and all the HCE’s end up having the same contribution for the year.  This is a very common method to correct a compliance failure but can pose a couple issues to the participating employee as discussed in the next section.

Consequences to Participating Employee of a Refund

The intended effect of the refund is to restore each participant and the Plan to the financial position it would have been in had the contributions been limited to pass the compliance tests in the first place.  The participating employee receiving a refund will include the refund as taxable income in the year the refund was received, not the year the contribution was made.  The requirement to include the refund as taxable income is unfavorable to employees, as they originally made the contribution in order to increase their retirement funds, and to take advantage of the tax deferral opportunity.  However, it is important to acknowledge that the refund is not a penalty to the participating employee, but a requirement mandated by the IRS to provide for equal benefits to all employees.

Consequences to Employer
Generally if the Employer chooses to make a QNEC, and the QNEC is made prior to the end of the Plan year, then there is no consequence. If the Employer chooses to refund excess contributions, they need to do so within 2 ½ months after the Plan year end, otherwise the Employer will be subject to a 10% penalty on the calculated failure amount.  If the failure continues to go unmitigated the Plan can lose its tax free status, in which the Plan assets would be distributable to Participants and included in their taxable income for that year.

How an Employer can avoid failing the Tests
There are several strategies that a Plan can initiate to mitigate or reduce the likelihood of failing the compliance tests.  A compliance specialist should be contacted to assist with these strategies.  Your Plan auditor can also assist in explaining the accounting treatment for these strategies and for the corrective methods discussed above.

Victor Fuentes