The Advanced Program in Accounting and Auditing Regulation – Module 28 Pension Funds Richard Berr Director, Valuations and Reporting June 20, 2006 `

2 Agenda Types of Plans Investments-Recording and Valuation Valuation of Liabilities GAAP measurements versus regulatory measurements Internal Controls and Enterprise Risk Other Issues

3 Types of Plans- Defined Contribution Plan Employee and/or employer contributions based on percent of salary into individual account. Employee bears the risk if investment returns are insufficient. No predetermined benefit formula. Plan has no liabilities for benefits.

4 Types of Plans- Defined Benefit Plans Promise to pay a series of payments. Employer and/ or employee contributions are pooled into a general fund with no separate individual account. Individual contributions have no determination in the amount of benefits. Benefits are usually based on years of service and salary level. Sponsor or sponsor and beneficiaries bear investment risk Accrued benefits are treated as liabilities of Plan. Measurement of assets and liabilities determine contribution and benefit rates.

5 Recording of Investments Purchases and Sales recorded on trade date basis Dividend Income recognized on the ex-dividend date Interest Income recognized on accrual basis Investment income should include both realized and unrealized gains and losses.

6 Valuation of Investments What method should you use for valuing investments?

7 FAIR VALUE

8 Valuation of Investments-Fair Value Definition of Fair Value An estimate of the amount of consideration that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act. Determination of Fair Value depends on instrument

9 Valuation of Investments Determination of Fair Value Public Equities Money-Market Bonds Hedge Funds Derivatives Private Equity, Real Estate, Infrastructure, Timber

10 Valuations of Investments Importance of Valuation Policy Pricing Committee New Product Process

11 Valuation of Liabilities Present value of future cash flows Plan design has significant impact Need to incorporate best estimates in determining cost of benefits Rate of return on the assets Salary escalation Inflation Difference between actual and estimates are recorded as experience gains or losses

12 Valuation of Liabilities – Economic Assumptions Discount Rate Inflation Regulatory issues related to benefit levels Salary increases

13 Valuation of Liabilities – Non-Economic Assumptions Mortality and current year new entrants Spousal Status Withdrawal Rates Retirement Rates

14 GAAP versus Regulatory Determination of surplus/deficit may not necessarily be the same Financial statements disclose actuarial value under GAAP Regulatory requirements are used to determine the level and timing of contributions and benefits

15 Internal Controls and Enterprise Risk Management Emphasis on internal controls increasing Sarbanes-Oxley Act in the U.S. Not required for pension plans but… CFO and CEO certification of financial statements. Documentation of internal controls. Internal testing. No evidence then no control. Attestation by external auditors.

16 Enterprise Risk Key risks that may keep the business from completing its objectives Annual assessment using COSO framework Regular reporting of key operational risks

17 COSO FRAMEWORK

18 Other Issues Consolidation of entities Application of accounting pronouncements Changing role of the external auditor