Pension Funds: Accounting Essentials

1. The Advanced Program in Accounting and Auditing Regulation – Module 28Pension FundsRichard BerrDirector, Valuations and ReportingJune 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