Background
The DOL’s rules and regulations require the notes to audited ERISA plans’ financial statements to include an explanation of differences, if any, between the information contained in the audited financial statements and the net assets, liabilities, income, expense, and changes in net assets reported on Form 5500 Schedule H.
The inconsistencies are most often classification or timing differences resulting from inconsistent use of the cash and the accrual methods of accounting. When inconsistencies indicate that there is an error, then the misstatements should be corrected if they are material.
One would expect the application of the accrual basis to be defined consistently by the Generally Accepted Accounting Principles (GAAP) and the Form 5500 instructions, but there are many differences worth noting, as follows:
DISTRIBUTIONS: GAAP Accrual Basis vs. 5500 Accrual Basis
Benefits payable must be reported on Form 5500, line 6(b), but are not recorded in accrual basis plan financial statements.
The 5500 instructions read as follows:
“Line 6b. Enter the total liabilities at the beginning and end of the plan year. The amount to be entered in line 6b for accrual basis filers includes, among other things: 1. Benefit claims that have been processed and approved for payment by the plan but have not been paid;………”
GAAP follows the 1099-R distributions
Even if it is counterintuitive, accrual basis GAAP financial statements report benefit distributions when paid, such that benefit payments can generally be reconciled to the total distributions reported on Forms 1099-R.
Reconciliation Example
Benefits approved but not yet paid reported on Form 5500 but not on the GAAP financial statements are a common reconciling item on the audited financial statement disclosures, as presented on this sample disclosure from the AICPA’s audit guide:
K. Reconciliation of Financial Statements to Form 5500
| 20X1 | 20X0 | |
| Net assets available for benefits per the financial statements | $9,218,000 | $8,035,000 |
| Amount allocated to withdrawing participants | ($50,000) | ($35,000) |
| Net assets available for benefits per the Form 5500 | $9,168,000 | $8,000,000 |
The following is a reconciliation of benefits paid to participants per the financial statements per the financial statements for the year ended December 31, 20X1, to Form 5500.
| Benefits paid to participants per the financial statements | $520,000 |
| Add: Amounts allocated to withdrawing participants at December 31, 20X1 | $50,000 |
| Less: Amounts allocated to withdrawing participants at December 31, 20X0 | ($35,000) |
| Benefits paid to participants per Form 5500 | $541,000 |
Amounts allocated to withdrawing participants are recorded on the Form 5500 for benefit claims that have been processed and approved for payment prior to year-end, but not yet paid as of that date.
Corrective Distributions: Distribution Expense or Reduction of Revenue?
In addition to reconciliations between the 5500 and the financial statements for benefit distributions, discussed above, corrective distributions are also subject to different accounting, reporting and disclosure rules. FinREC sees them as a reduction of revenue and the 5500 has a separate line 2f for corrective distributions. To reduce revenues or to decrease expenses….seems equivalent, but let’s discuss:
5500 Reporting and Disclosure Rules for Corrective Distributions:
Form 5500, Schedule H provides a separate line for corrective distributions, as follows:
| f. Corrective Distributions (see instructions)………… | 2f |
The instructions for this line indicate that:
“Line 2f: Include on this line all distributions paid during the plan year of excess deferrals under Code section 402(g)(2)(A)(ii), excess contributions under Code section 401(k)(8), and excess aggregate contributions under Code section 401(m)(6). Include allocable income distributed. Also include on this line any elective deferrals and employee contributions distributed or returned to employees during the plan year, as well as any attributable income that was also distributed.”
FinREC: Accrual Basis Revenues Should be Reduced
The Financial Reporting Executive Committee (FinREC) recommends that the ineligible contributions be reported as a payable on the plan financial statements and an offsetting reduction in the contribution amount originally recorded when the excess contribution was made because the contributions were ineligible for that plan year.
Passed Adjustment or Reconciliation?
Corrective distributions are seldom a material number to the financial statements. In our audit practice, we choose to Pass on the Adjustment by recording a PAJE, indicating that we will not reduce corrective distributions as reported on the Form 5500 while also reducing contribution revenue by the corrective distribution amount. With a PAJE, we document that we acknowledge FinRECs recommendation to reduce revenue, but choose to take a different, albeit arguably incorrect approach, since it does not have a material effect on the financial statements. Through the use of a PAJE, our financial statements agree to the 5500 and a reconciliation note is not necessary. See our previous blog on this topic Form 5500 Participant Count: Cash or Accrual Basis? To Audit or Not to Audit? for more details.
Accrual Basis: Same Data, Two Conclusions
As we have seen in this blog, two regulatory agencies can look at the same set of distribution data and come up with different approaches on how to report the transactions on the accrual basis. In our next blog, we will discuss accrual basis challenges related to contributions. Stay tuned…
