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EBPAQC 401(k) Basics, Part 2 Participant Data & Contribution Testing

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1 EBPAQC 401(k) Basics, Part 2 Participant Data & Contribution Testing

2 Handouts for Today’s Event
You can download presentation slides (in PDF or PowerPoint format) and other handouts by clicking on in the toolbar at the bottom of your screen Instructions to how obtain your CPE Certificate for today’s event Webinar presentation slides (both .ppt and .pdf formats) Summary of EBPAQC Resources and Tools EBPAQC Common EBP Audit Deficiencies & Planning Tool EBPAQC Parties in Interest and Prohibited Transactions Primer Documentation of a Use of a Type 2 Service Auditor’s Report in an Audit of an EBP’s Financial Statements Summary of Key Plan Document Provisions Relevant to a Defined Contribution Retirement Plan Audit

3 Presenters Marilee Lau Jennifer Allen Moderator Crowe Horwath LLP
Mark Blackburn LBMC PC . Jennifer Allen Crowe Horwath LLP Travis Jack Metz & Associates PLLC

4 Introduction Marilee Lau Moderator

5 Today’s Forum Plan document, SSAE 16, and payroll testing
Participant data testing Contribution testing Parties in interest and prohibited transactions

6 Topics Discussed on Part 1
ERISA rules Types of plans Key parties Planning and risk assessment Internal controls

7 Plan Document, SSAE 16 and Payroll Testing
Travis Jack Managing Member Metz & Associates PLLC

8 Plan Document Types Plan specific (rarely used by smaller plans)
Prototype Standardized (most common) Nonstandardized Volume submitter (sample plan to be used by a provider sent to IRS for review) Determination letter Not required Amendments Adoption agreement “Roadmap” to plan operation More specific than basic plan document Summary Plan Description (useful but not a substitute)

9 Plan Document (Cont.) Purpose/Scope (Appendix A – Chapter 5)
Eligibility to participate Funding Employer Employee Entitlement to benefits Vesting Timing Plan operation and administration Fiduciary duties Run the plan solely to benefit participants Must act prudently (investment diversification)

10 Plan Document (Cont.) Auditor’s Concern
Must disclose key provisions in notes Plan document compliance dictates procedures Contributions (limits, matching, timing) Benefits (vesting, timing and availability) Eligibility (satisfy minimum requirements but may go beyond) Eligible compensation (used to calculate contributions) Key to establishing internal control May require discussion with legal counsel Must not discriminate Read and consider in planning process

11 EBPAQC Plan Document Tool
Assist members in understanding the plan entity and in designing substantive audit tests in various audit areas by summarizing key plan provisions that may be relevant to the plan audit. The tool is presented in Word format to allow auditors to cut and paste information to the audit program or other audit documentation as necessary. It may be included in the permanent file and updated each year as the plan is amended. It is not intended to replace the plan document in the audit files, but rather is a supplement that summarizes pertinent plan document information.

12 SSAE 16 and SOC 1 Reports Audit Guide – Chapter 4 and Appendix B
Internal control of plans typically consists of two levels Plan sponsor Applicable service organizations Service Organizations Typically the Trustee/Custodian Contributions Distributions Investment custody, valuation, and transactions Third Party Administrator (TPA) or a payroll service Recordkeeper Different Types Type I (Design) Type II (Design and Operation)

13 SSAE 16 and SOC 1 Reports Audit Guide – Chapter 4 and Appendix B
Effect on audit procedures Type I- Provide information to assess risk (i.e., design of controls) No basis to conclude on operating effectiveness without testing Type II- Provide a basis to rely on effective operations of controls and therefore REDUCE the extent of testing Read the report Tools in Benefit Plan Audit Quality Website Period under audit versus period tested in report Referencing specific testing to plan attributes Plan sponsor controls (user controls)

14 SSAE 16 and SOC 1 Reports Audit Guide – Chapter 4 and Appendix B
Report format Management’s assertions Have prepared accompanying description of services Description fairly presents services provided Types of services Related procedures Availability Controls provide reasonable assurance of achieving control objectives “Suitably designed and operating effectively” Independent service auditor’s report Description of controls Tests of controls and summaries of findings

15 SOC 1 Reports AU-C Section 402, Audit Considerations Relating to an Entity Using a Service Organization The user audit should be satisfied regarding the following: The service auditor’s professional competence and independence from the service organization The adequacy of the standards under which the type 1 or type 2 SOC 1 report was issued. The user auditor should consider the following: Document procedures performed Understand the services the user entity was contracted for Determine the report covers appropriate controls Evaluate of the proper date and period If appropriate operating effectiveness had been tested, auditor may reduce testing

16 SOC 1 Reports Considerations
May need more than one SOC 1 Report for different systems Need to understand exactly what controls are relevant to the 401(k) plan you are auditing Need to understand the plan sponsor’s complementary user controls and that they are effective Service Auditor’s report contains exceptions in testing and/or a modified report Communicating to plan management and/or plan governance internal control matters Fraud risk factors related to service providers

17 Payroll Chapter 2 in Audit Guide
Payroll controls, IT or manual, are important Contributions are usually a component of a participant’s payroll Rely on payroll controls Hiring Termination Proper salary or wages Proper payroll deductions for deferrals Bonus Test payroll controls/refer to payroll testing in plan sponsor audit Document that payroll was substantively tested (and ensure it was tested) in plan sponsor audit If you do not audit plan sponsor, test payroll controls

18 EBPAQC SOC 1 Documentation Tool
The tool is intended to assist members in documenting procedures and findings related to controls at a service organization that are likely to be relevant to the employee benefit plan’s internal control over financial reporting. It focuses on the user auditor’s use of a type 2 report.

19 Participant Data and AllocationsTesting
Mark Blackburn Partner LBMC PC 19

20 Participant Data and Allocations
401(k) plans provide an individual account for each participant and provide benefits based on the following: Amount contributed by the participant Amount contributed by the employer Investment income (loss) Plan expenses When a participant withdraws from a plan, the amount paid to the participant is the amount allocated to that participant account

21 Participant Data and Allocations
Relevant Assertions: The accuracy of the allocation of net assets to the individual participant accounts in accordance with the plan document. The completeness and valuation of participant accounts (including the forfeiture account) in total. The authorization of participant transactions and the accuracy that such transactions have been executed at the proper amount, in the proper period, and in accordance with the plan document and participant’s direction.

22 Participant Data and Allocations
Examples of identified risks of what could go wrong for participant data include: Participant investment options or salary deferral amounts may not be in accordance with their stated elections Allocations of income or expenses may be inaccurate, causing the participant’s account to be overstated or understated Lack of reconciliations or improperly prepared reconciliations by management could result in missing contributions or improper allocations. Employees not appropriately included or excluded from participating based on the plan’s provisions.

23 Participant Data and Allocations
Examples of identified risks of what could go wrong for participant data include: Employee and employer contributions are incorrect due to the use of a definition of compensation different from the plan’s provisions. Incorrect compensation or hours is used to determine compensation.

24 Participant Data Types of participant data that are tested vary from plan to plan and may include: Demographic data Date of Hire (DOH) Date of Birth (DOB) Date of Termination (DOT) Hours of service Payroll Data Wage rate Hours worked Earnings Contributions to the Plan Definition of compensation in plan document is essential Inclusion/exclusion of fringe benefits “W-2” or gross wages as a starting point Utilize work done on corporate audit Utilize SOC 1, if available

25 Automatic Enrollment Automatic enrollment – what is it?
A Company may automatically enroll employees in the Plan at a certain date as defined in the Plan document (i.e. date of hire, 3 months of service, etc.) unless the participant elects out of the Plan. Plans with auto enrollment features will have a stated deferral rate that they will enroll the participant at as well as a qualified default investment in which to put the contributions if the participant does not give investment direction timely. There can also be auto escalation clauses whereby each year of service, the participant’s contributions are automatically increased by a certain percentage as defined in the Plan unless elected differently by the participant. The participant has 90 days after the first contribution to get their money back if they did not intend to enroll and didn’t elect out timely.

26 Participant Data Potential audit steps
Compare appropriate demographic data from employer files to data maintained by the recordkeeper. Once you determine the eligibility requirements of the Plan, scan the census data for all employees outside those requirements. Then, select a few to see that they are not in the Plan. As a test for fraud, consider specifically looking at those in a position to influence the plan (i.e. payroll, human resources, CFO, etc.) to make sure they are not allowed to enter the Plan prior to meeting the eligibility requirements. Agree and reconcile employee deferrals from the census data to participant detail in total and for a sample of participants.

27 Participant Data Potential audit steps
Test the summarization of payroll journal to census data and trace postings of gross pay to general ledger. Test payroll data for one or more pay periods and for a number of participants by: Tracing the individual payrolls from the payroll journal to earnings records For participants paid on an hourly basis, testing payroll hours, or other supporting evidence and testing the computation of hours. Testing rates of pay to authorizations Testing calculations of earnings Reviewing personnel files for hiring notice, employment data, pay rates, etc. Determine that deferral rates are applied to defined compensation

28 Participant Data Errors found in testing Eligibility:
Employees not allowed to participate because they are “part-time”. Many part-time employees have enough hours to satisfy the hour requirement. Small businesses – look for spouses who are participating in the Plan, but who do not work for the company. Watch for failure to notify employees of eligibility. Does the workforce speak English and can they understand the Plan materials? Break-in-service – Company didn’t allow participants back in the Plan upon rehire in accordance with Plan document.

29 Participant Data Errors found in testing Eligibility, cont:
Plan Sponsor outsourced informing employees of eligibility. Outsourced service provider didn’t inform anyone for a year of their eligibility. Plan Sponsor is responsible for making sure service provider performs their duties. Compensation as defined by the plan included bonuses, but employee deferrals were calculated excluding bonuses. Plan Sponsor had to make additional contributions to make these employees whole.

30 Participant Allocations
Potential audit steps Investment income testing will be covered in Webinar #3. Participant allocation to individual investments – testing is typically a combination of: Reliance on SOC 1 (refer to previous webinar). Confirmation with participant (that they did not have any issues with their allocations). Overall analytical review of participant accounts. Determine whether the sum of the individual accounts reconciles with the total net assets available for benefits. Testing mathematical accuracy of individual participant accounts and determining whether opening participant account balance matches ending balance from the prior year statement.

31 Workpaper Documentation Tips
Information to consider including for participant data and allocations testing Plan provisions Participant allocation report by investment type by money type (EE contribution, ER match, Profit-sharing, rollover, etc) SOC1 report and related checklist Payroll data - compensation Participant hire date and age documentation, as applicable Participant election forms Confirmations

32 Changes in Plan Recordkeeper
Changes in outside recordkeepers are common but can increase risk if not managed properly Plan sponsors have a fiduciary responsibility to ensure that the change is monitored and performed properly

33 Changes in Plan Recordkeeper Overall Risks - What Can Go Wrong
Data transferred (participant/payroll) is not accurate or complete Changes in plan design

34 Changes in Plan Recordkeeper What Can Go Wrong for a 401(k) Plan
Potential delays in remitting employee deferrals which could be deemed a PROHIBITED TRANSACTION Participant data transfers, forfeitures Challenges in change in plan administration – paper to paperless What’s new for participants Participant notes receivable SOC 1 vs no SOC 1 Auto enrollment or deminimus cash outs?

35 Workpaper Documentation Tips
Key information to include in audit documentation Prior recordkeeper Allocation report by investment type Allocation report by money type (EE contribution, ER match, Profit-sharing, rollover, etc) Reconciliation between allocation report and investment statement Current recordkeeper

36 Workpaper Documentation Tips
Key information to include in audit documentation Minutes documenting approval of change in service provider Consider obtaining communication regarding transfer to employees Mapping between funds Re-election of investments Same investment options

37 Contribution & Party in Interest Testing
Jennifer Allen Partner Crowe Horwath LLP

38 Contributions and Contributions Receivable Assertions
Amounts received or due have been appropriately determined, recorded and disclosed in the proper period, in accordance with the plan’s provisions and with the applicable financial reporting framework An appropriate allowance has been made for uncollectible plan contributions receivable Participant’s contributions are authorized and have been executed at the proper amount, in the proper period and in accordance with the plan’s provisions and at the participant’s direction

39 Contributions and Contributions Receivable Assertions (Cont)
All active participants have been properly included in the employee eligibility reports and contribution records Appropriate and accurate participant data, including payroll information, is being utilized in determining amounts contributed to the plan

40 Contributions – Examples of Risks and WCGW
Employees are not appropriately included or excluded based on the plan’s provisions Employer or employee contributions are not properly calculated, authorized, or recorded in the proper period Employee and employer contributions are incorrect due to the use of a definition of compensation different than what is specified in the plan’s provisions, including the application of true-up contributions.

41 Contributions – Examples of Risks and WCGW
Contributions are not accurate, complete or remitted in accordance with the plan’s provisions (ex: manual checks, bonuses) Participant deferral percentages entered into payroll are inaccurate Incorrect compensation or hours is used to determine compensation Excess contributions such as failure to pass the ADP test are not properly determined or recorded

42 Contributions Received and Receivable
Read the Plan Document – know what types of contributions are allowed in the Plan. Employee contributions – does the Plan allow catch-ups? Rollovers? After-tax? Roth? Employer contributions – is the Plan a safe harbor plan? Do they have a matching contribution and/or a profit sharing contribution?

43 Contributions Types of Contributions Employee Pre-tax
Catch-up contributions After-tax Roth Rollovers Employer Matching Safe Harbor Profit sharing Discretionary Qualified non-elective contributions (QNEC) Merged plans

44 Contributions Definition of compensation
Applying an incorrect definition of compensation is one of the most common operational errors for a DC plan Read the Plan Document Identify the types of compensation that are included and the types that are excluded Bonuses, commissions, shift differentials, moving costs, etc. May have different definitions for different calculations (for example, employee deferrals vs employer matching contributions) LLC’s – risk of neglecting to include K-1 earnings Application of IRC annual compensation limit Knowing the specifics here will help you design effective samples as well as appropriate tests

45 Contributions – Example Substantive Procedures
Refer to Chapter 5 of Guide for additional procedures and guidance Agreeing total contribution amounts (by type) from the plan sponsor’s records to the plan’s reports (e.g. trustee or custodian/recordkeeper reports) Perform analytical procedures and compare results to prior period and expectations (e.g. average deferral per participant; ratio of employer match to participant deferrals)

46 Contributions – Example Substantive Procedures
Testing whether forfeiture amounts, if any, have been properly applied in accordance with the plan document Vouching contributions to wire transfer notices or other supporting evidence Determine that accruals for contributions have been recorded in accordance with the applicable financial reporting framework and test the amounts of such accruals, such as by vouching to subsequent receipt

47 Contributions – Example Substantive Procedures
Evaluating the reasonableness of the plan’s allowance for estimated uncollectible accounts Employer profit sharing contributions and discretionary contributions – Agree to authorization in minutes. Recalculate allocation to a sample of individual participant accounts. Employer contributions – Qualified Non-Elective Contributions – Agree the calculation of the QNEC provided by the TPA to the Plan in total and for a sample of individual participant accounts.

48 Contributions – Example Substantive Procedures
Obtaining a schedule or inquiring of plan management about the timeliness of employee salary deferral contribution remittances to the plan. Failure to timely remit such amounts constitutes a prohibited transaction.

49 Contributions – Example Procedures for Sample of Participants with Contributions
Agree any demographic information relevant to eligibility determinations from the recordkeeper back to personnel files of the plan sponsor Determine that the participant was eligible under the plan terms and elected to join the plan or were enrolled automatically in accordance with plan provisions Determine that the participant authorized the deferral rate or deferral amount or for plans with automatic enrollment provisions, deferrals have been appropriately made in accordance with those provisions, including auto escalation provisions

50 Contributions – Example Procedures for Sample of Participants with Contributions
Recalculate contributions, by type, in accordance with the plan and IRC limits, including the proper definitions of eligible compensation, automatic deferral rates, and matching contribution formulas. Consider confirming such information with participants. Employee deferral Total of employee and employer contributions Agree contributions to recording in the participant’s account and determine recorded in the investment option selected by the participant.

51 Rollover Contributions – Example Substantive Procedures
Determine plan document allows for rollovers Obtain a listing of rollovers and agree to the plan’s financial statements For sample of rollovers: Test investment elections, if applicable Test that the rollover amount properly applied to correct participant’s account

52 Errors Found in Testing Contributions
One pay period of deferrals was never received by the Plan. Payroll service was erroneously calculating the match by failing to treat Roth deferrals as a deferral eligible for match. Participant contributions were credited to the wrong participant’s account. Lots of errors in the definition of compensation. (e.g. improperly including/excluding bonuses) Make sure the person in charge of determining eligible compensation knows the plan document. Late remittances – Watch out for manual check runs and decentralized payroll operations.

53 Workpaper Documentation Tips
Key information to include in audit documentation Definition of eligible compensation Types of contributions allowed Contribution formulas and limits Copies of reports used in testing contributions (payroll reports, trust statements, participant level reporting) Identity of individuals selected for testing of contributions to a sample of participants An understanding of the internal controls associated with contributions

54 Party in Interest/Prohibited Transactions
A party in interest is a fiduciary or employee of the plan, any person who provides services to the plan, an employer whose employees are covered by the plan, an employee association whose members are covered by the plan, a person who owns 50 percent or more of such an employer or employee association, Relatives of such person just listed A prohibited transaction is a transaction between a plan and a party in interest that is prohibited under Section 406(a) of ERISA Statutory and administrative exemptions are available

55 What is Prohibited Section 406(a) provides that a fiduciary shall not cause a plan to engage in a transaction if he knows or should know that such transaction constitutes an indirect or direct: Sale or exchange or leasing of property between the plan and a party in interest; Loan or other extension of credit between the plan and a party in interest (includes delinquent participant contributions); Furnishing of goods, services or facilities between a plan and a party in interest; Transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan, or Acquisition, on behalf of the plan of any employer security or employer real property in violation of section 407(a); and No fiduciary shall permit the plan to hold any employer security or employer real property if he knows or should know that holding such security violates section 407(a)

56 Exceptions to Prohibited Transactions
In accordance with plan document and reasonable compensation for services performed Reasonable compensation for office space and legal, accounting, and other services necessary for the operation of a plan are permitted if certain conditions are met In-House Asset Manager (INHAM) Class Exemption

57 Why are Parties in Interest Important
Should be able to identify parties in interest of the plan Party in interest vs. related party Recognize the transactions between the parties in interest and the plan and understand the purpose of the transaction Identify whether the transaction is prohibited Plan sponsor may need to seek advice from ERISA counsel Required reporting & disclosure

58 Parties in Interest – Audit Steps
Typical auditing procedures to determine existence Evaluate the plan administrator's procedures for identifying and properly accounting and reporting for party in interest transactions. Request from client a listing of parties in interest and any transactions with these parties during the period. Review filings (for example, Forms 5500 and LM-2) and correspondence by the reporting entity with the DOL and other regulatory agencies for the names of parties in interest. Review prior years' working papers for the names of known parties in interest. Inquire of the plan administrator whether any prohibited transactions have been identified as a result of past DOL, IRS, or other governmental examinations. Review agreements with service providers. Provide audit personnel with the names of known parties in interest. Review the minutes of applicable governance meetings

59 Parties in Interest – Audit Steps (cont)
Typical auditing procedures to test identified transactions Obtain an understanding of the business purpose of the transaction. Examine invoices, executed copies of agreements, contracts, and other pertinent documents. Determine whether the transaction has been approved by the board of trustees or other appropriate officials. Test for reasonableness the compilation of amounts to be disclosed or considered for disclosure. Inspect or confirm and obtain satisfaction concerning the transferability and value of collateral. Other testing procedures described in the AICPA’s Accounting and Audit Guide for Benefit Plans

60 Workpaper Documentation Tips
Key information to include in audit documentation Listing of parties in interest Listing of related parties An understanding of management’s internal controls related to identification of parties in interest and related parties Listing of types of transactions involving parties in interest and related parties Support for disclosure in the financial statements of party in interest and/or related party transactions Evidence of how these transactions were evaluated to conclude upon whether they constituted a prohibited transaction

61 Question & Answer Session

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64 Copyright © 2014 American Institute of CPAs. All rights reserved.
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