Posted by Maria T. Hurd, CPA
Contrary to popular belief, the audit procedures for a first-time audit of a previously small plan are not limited to the retirement plan’s financial activity for the year under audit. The auditors’ opinion on the financial statements covers the Statement of Net Assets, which includes the accumulation of activity in participants’ accounts since the plan’s inception. For that reason, the auditor must test the financial activity that resulted in the plan’s beginning balances. The nature, timing, and extent of auditing procedures to be applied in an initial audit will vary with the adequacy of plan records, the materiality of opening balances, and the complexity of plan operations.
Each year, plan sponsors and service providers push back or call us for a “second opinion” when they receive requests from us and from other auditors for years prior to the plan year under audit. To facilitate our communication of the requirement to audit beginning balances, this blog will discuss this requirement and the related American Institute of Certified Public Accountants (AICPA) guidance in detail.
Generally, ERISA does not require an audit of a retirement plan’s financial statements to be performed by an independent qualified public accountant (IQPA) until the plan becomes a large plan. Please refer to our previous blog: I Don’t Want to Grow Up, I Want to be a Small Plan for the definitions of small plan and large plan.
Significant work may be necessary to test the opening balances of individual participant accounts for a defined contribution plan. The auditor must obtain an analysis of the participant accounts for as many years as necessary to build up the opening balances, possibly from inception of the plan. The analysis ought to show, for each year, the additions and deductions to the individual participant accounts, in total and by individual participant, the employer contribution, withdrawals, forfeitures, investment income and realized and unrealized gains and losses, and plan expenses. The account balances and allocations for a selected number of employees can be tested from the start of their participation in the plan.
For a defined contribution plan, it is particularly important to test the allocation of the employer contribution, forfeitures, and investment income, gains, and losses to the individual participant accounts for a sufficient number of preceding years to obtain satisfaction that the opening balance is correct. The reason is that allocation misstatements made in preceding years would have resulted in incorrect distributions to participants who terminated in prior years, and, thus, to misstatement of the opening balance. If adequate tests of allocations to the opening balances of individual participant accounts cannot be performed because of inadequate records or for other reasons, a report modification may be necessary because of the scope limitation. The report modification could continue indefinitely because the ability to reach an opinion on each succeeding year’s closing balance could continue to be affected by the scope limitation on the preceding year’s opening balance.
ERISA, Title I, Section 209, requires plans to keep sufficient records to determine and report an employee’s benefits. As a result, when a previously small plan becomes a large plan subject to a financial statement audit, both plan sponsors and service providers should be prepared to provide participant account activity for prior years, especially as related to:
(a) Participant and employer contributions
(c) Amounts and types of benefit payments
(d) Participant account balance activity, and
(e) Discrimination testing and correction
(f) Census data
Just last week, a service provider and friend called me looking for a second opinion, hoping to hear that audit procedures of financial activity that took place several years prior to the year under audit were not necessary. Unfortunately, I had to be the bearer of bad news. According to the rules I have summarized in this post, his client’s auditor was not being unreasonable. Initial audits of formerly small plans pose a formidable challenge, but it is not an unsurmountable one. Teamwork between the plan sponsor, third-party administrator, record keeper, custodian, and the auditor is key to the success of the beginning balance test, success that results in achievement of a common goal – a favorable audit opinion.