Accounting guidance formerly contained in early editions of the AICPA’s Audit and Accounting Guide, Employee Benefit Plans, has been replaced by FASB’s ASC Topics 960, 962, and 965, which apply to three different types of plans. But, in the opinion of this author, these FASB standards, like the earlier editions of the guide, are flawed because they do not appear to require gross presentation of certain revenues and expenses consistent with other, more broadly applicable guidance.
Most significantly, although FASB’s employee benefit plan (EBP) standards require disclosure of administrative expenses (ASC 960-30-45-2h, 962-205-45-7h, and 965-20-45-3j), they do not define them, they make no distinction between those paid by the employer/sponsor and those paid by the plan, and, despite their undeniable character as related-party transactions (ASC 850-10-50-1), they require no quantitative disclosure of the employer/sponsor funded portion. Without any textual guidance, sample financial statements presented in the exhibits to ASC 960, 962, and 965 refer to employer-paid expenses only in a nonquantified, illustrative disclosure that reads: “Certain expenses incurred maintaining the Plan are paid directly by the Company and are excluded from these financial statements.” Therefore, this illustrative disclosure clearly implies that omission of employer-funded amounts from reported administrative expenses and contributions is acceptable under GAAP.
This author believes that, to the extent allowable by the Department of Labor (DOL), all administrative expenses incurred to enable a plan to further its purpose of providing benefits to participants should be included in its financial statements, without regard to whether the employer/sponsor’s absorption of such expenses is discretionary or mandatory. Examples of unallowable expenses include those incurred in connection with the formation, design, or termination of the plan. Accordingly, the primary obligation for allowable expenses is the plan’s, not the employer’s. Note, however, that determination of a primary obligor is only one of eight possible indicators of gross reporting, none of which is singularly dispositive (ASC 605-45-45-4–18, or soon, ASC 606-10-55-36).
By not requiring a gross presentation of such employer/sponsor-borne costs in the plan’s operating statement, the FASB standards fail to recognize the economic substance of an employer/sponsor’s unilateral absorption of such costs as both expenses of the plan and additional employer contributions, as well as the employer/sponsor’s role as an agent of the plan when making such expenditures on its behalf.
What Does Other GAAP Say?
Current GAAP further provides that reimbursements received for out-of-pocket expenses incurred “shall be characterized as revenue in the income statement” with related costs recognized as expenses (ASC 605-45-45-22 and -23). EBP administrative costs are commonly paid directly by the employer/sponsor on behalf of, rather than reimbursed to, the plan and its participant beneficiaries. Consequently, they are not “reimbursements” per se; nevertheless, they are substantially the same. This further suggests that another GAAP requirement (albeit nonspecific to EBPs) to present the gross employer/sponsor-borne costs as employer contributions revenue and the offsetting debit necessarily as expense should apply.
Also according to GAAP, a contribution is an “unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner,” and a “non-reciprocal transfer” is one “in which an entity incurs a liability or transfers an asset to another entity (or receives an asset or cancellation of a liability) without directly receiving (or giving) value in exchange” (ASC Master Glossary). The payment of an EBP’s expenses by the employer arguably does not qualify as a nonreciprocal transfer (or contribution) because such payments are part of employee compensation for services. It is this author’s view, however, that any benefits received by the employer are too indirect to be treated as exchange transactions; they are, in fact, contributions (especially when not required by the plan document), consistent with their characterization in the FASB standards and AICPA guide.
Although stated in GAAP only with respect to contributions received by not-for-profit organizations, “a contribution made and a corresponding contribution received generally are recognized by both the donor and the donee at the same time” (ASC 958-605-25-2). In other words, with respect to EBPs, there should be symmetry of reporting such that reported pension expense of the employer generally mirrors the employer contributions reported by the plan. Although GAAP is silent on the treatment of such expenses in the financial statements of employers, this author believes the foregoing principles that apply to not-for-profit organizations likewise should be applied to EBPs.
GAAP already requires EBPs to disclose “noncash employer contributions” (ASC 960-30-45-2c, 962-205-45-7c, and 965-20-45-3a). Although noncash employer contributions typically consist of employer securities, the term is not limited to them; accordingly, it may encompass direct payments by employers to third parties on behalf of the EBP. Whether direct employer payments of plan administrative expenses are discretionary or mandatory under the plan document, this author believes that there is no discernable substantive difference in terms of benefit to participants. Both direct and indirect payments are employer contributions. Since the non–EBP-specific standards on contributions permit only the nature of any indirect contributions to be disclosed optionally outside the financial statements (i.e., in a note), the amount thereof (if material) presumably must be shown on the face of the financial statements.
Accordingly, in the opinion of this author, material direct payments of plan expenses by employers should require recognition under GAAP as both contribution income and administrative expense.
Investment Management Fees
Similarly, there are frequently other administrative costs hidden in the financial statements of EBPs by netting them against investment income. Fees charged to plans by investment managers or similar service providers for buying, selling, or holding investment securities (or managing, accounting for, and reporting investment activities) are subject to diversity in accounting practice, but the alternatives are not discussed in the EBP standards or elsewhere in GAAP.
Though not prescribed by GAAP, for purposes of computing investment gains and losses, transaction fees associated with buying securities are almost universally treated as part of their cost, and those fees associated with selling them are deducted from sales proceeds. Accordingly, such fees typically reduce net investment income reported in an EBP’s financial statements, without disclosure, while other, nontransactional investment management fees may be treated the same way or classified among administrative expenses (appropriately, in this author’s opinion), also without disclosure. Whether specifically applicable to EBPs or not, GAAP neither permits nor prohibits the netting of such fees against investment return, nor does it require or suggest an accounting policy disclosure as a choice between acceptable alternatives as otherwise required (ASC 235-10-50-3).
Although the risks of material understatement or overstatement with regard to employer/sponsor-funded administrative expense are not mentioned in the guide, auditors should be alert to such risks and assure themselves that sufficient auditing procedures are applied at the employer level, typically consisting of tests of cash disbursements and recorded accounts payable and a search for unrecorded liabilities, using a performance materiality threshold appropriate to the EBP’s, rather than the employer’s, financial statements.
To assess the materiality of any perceived misstatement resulting from client resistance to a gross presentation, auditors must consider, among other things, the size and nature of the misstatement in relation to particular classes of transactions, account balances (or financial statement line items) or disclosures, and the financial statements as a whole (AU-C 450.11, or, for 11-K filers, AS 2810.17). Therefore, in addition to the traditional measures of materiality, addressing the risk of understatement requires one to quantitatively assess materiality of both unrecorded administrative expense and employer contribution revenue or net investment return in relation to the would-be gross value of these reported items, considering also for the former the user sensitivity concerns typically associated with related-party transactions. Whenever a gross-up audit adjustment believed to be material is proposed, it must be communicated to the governance body of the plan sponsor as a significant audit adjustment (AU-C 260.14a and AS 1301.19).
What Should FASB Do?
The main operative principle for determining either gross or net presentation of revenue items (and related expenses) is determining who is acting as a principal, rather than as an agent, with regard to certain transactions (ASC 605-45-45-1–18 or ASC 606-10-55-36). Therefore, the standards specifically applicable to EBPs (ASC 960, 962, and 965) should direct users to consider this more broadly applicable FASB guidance in determining if investment-related fees and any employer/sponsor funded administrative expenses should be grossed up and included in both revenue and expense.
In October 2016, these concerns were communicated to members of the FASB staff, who have acknowledged the inconsistencies; as of February 2017, the issue is now in the early stages of consideration to be added to FASB’s agenda. In the meantime, since it is not clearly stated that the relevant GAAP provisions cited above are applicable to EBPs, unless they suspect management intent to mislead users, auditors can only recommend, but not require, gross-up treatment in the financial statements of an EBP.