CONVERTING UNDERWRITTEN RETIREMENT FUNDS TO THE ACCRUAL-BASIS OF ACCOUNTING
Background
In 2005, the Financial Services Board (FSB) made it compulsory for all retirement funds registered with the FSB in terms of the Pension Funds Act of 1956 to submit financial statements to the FSB. Prior to this only privately administered funds submitted audited financial statements to the FSB, but underwritten funds submitted a two-page return, known as a Schedule B return. This was neither a full set of financial statements nor audited by an external auditor of the fund itself. These Schedule B returns were prepared on the cash-basis as this was all that was required by the FSB.
Due to this limited requirement, the administrators of these retirement funds designed their systems only to comply with the cash-basis. Most of the business they administered was in these underwritten funds and not in the private funds that required audited annual financial statements prepared on the accrual-basis. For this reason, when the FSB brought in the requirement for all funds (including underwritten funds) to prepare annual financial statements, the administrators made submissions to the FSB to allow them, for a limited period only, to submit annual financial statements for the underwritten funds on the cash-basis.
When it was required for the 2006 financial statements of retirement funds to be audited, most of these financial statements were still prepared on the cash-basis and were thus audited on this basis.
The FSB has indicated that going forward the cash-basis of accounting is no longer an accepted method of accounting for underwritten retirement funds. The new Regulatory Reporting Requirements, which will be issued by the FSB in due course, assume the accrual-basis. The FSB will be issuing a circular together with the new reporting requirements to indicate when the cash-basis will no longer be allowed, but it is not clear how the change-over from accrual-basis to cash-basis will be accounted for.
Impact of cash-basis of accounting
There is no theoretical basis in any accepted accounting practice for cash accounting for entities the size of some of the retirement funds that are accounted for on this basis. Some retirement funds that are accounted for on this basis have several billion rand in assets.
The biggest impact of the cash-basis of accounting is that most of the Statements of Net Assets and Funds (balance sheets) of these retirement funds have only two line items, namely “Investments” and “Members’ Accumulated Funds”. There are no accounts receivable or payable disclosed. Furthermore the income and expenses as reflected in the Statements of Changes in Net Assets and Funds (“income statements”) are not the true reflection of the transactions for the period under review as it only reflects the cash impact of the transactions and not the actual incurred income or expenses.
Impact of change to the cash-basis of accounting
This begs the question: How would annual financial statements be impacted with a change in accounting policy from the cash-basis of accounting to the accrual-basis of accounting? As South African retirement funds do not comply with International Financial Reporting Standards (IFRSs) but with regulatory requirements imposed by the FSB this becomes a bit more complex. It is submitted that the best international guidance available for the industry in deciding on the impact on the financial statements is still IFRSs.
Changing the basis of accounting is clearly a change in accounting policy by the retirement funds and in terms of IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors this would imply that the prior year figures in the financial statements would have to be restated. In terms of the changes approved in IAS 1 for financial years ended after 1 January 2009 it could mean that the impact on two prior years should be restated. Restatement of comparative information is, however, not currently allowed by the FSB.
In practice, restatement would give the best result to the Board of Trustees and FSB as users of the financial statements, as the figures would be comparable between the years. It would not be of much use, however, if the current year is kept on the accrual-basis and the prior year on the cash-basis, even if the impact of the prior year financials changing from the cash to the accrual-basis is done via a one line entry called “Prior year adjustment”. In the year that the adjustment is made, it would be very difficult for the FSB to monitor the performance of the fund as compared to the previous year.
Financial statement line items impacted
To understand fully the impact that the change in the accounting policy is going to have in the understanding and interpretation of the financial statements, the line items impacted by the change in accounting policy need to be analysed. A limited list of some of the line items impacted is as follows:
- Accounts receivable
- Accounts payable
- Contributions
- Benefits.
- Expenses (e.g. Administration expenses).
- Unclaimed benefits.
- Members’ accumulated funds.
The following is a short analysis of the impact on the line items mentioned above:
Accounts receivable and Contributions
On the accrual-basis all arrear contributions will be accounted for in the period for which they are in arrears. No longer will contributions include only those received but also those that are still owing to the fund.
The impact on the prior year is that the contributions and contributions receivable for the prior year would have to be recalculated by the administrators of the funds and restated. This would include late payment interest that may have accrued on the contributions of the prior year.
Accounts payable and benefits
Accounts payable will now be disclosed for all accruals for the following benefit and expense line items:
- Withdrawal, retirement and death benefits
- Fidelity insurance invoiced to the fund but unpaid at year end
- Administration and investment fees payable at year end by the fund
- Benefit payments and expenses paid by the administrator on behalf of the fund but not recovered at year end
For the prior year, as with accounts receivable, the administrators on behalf of the funds are to recalculate these line items and additional disclosure to restate the prior financial statements.
Unclaimed benefits
On the cash-basis of accounting for unclaimed benefits (depending on the fund’s definition of unclaimed benefits), these were included as part of the members’ accumulated funds for the year explained in an additional disclosure note used by some administrators for their administered funds to explain the impact of unclaimed benefits thus included.
On the accrual-basis, these members will be split out from the members’ accumulated credits for the current and prior years and shown separately as part of the current liabilities of the fund. The required note in terms of the accounting framework for retirement funds in South Africa would also now be applicable and would have to be restated for the prior year.
Members’ accumulated funds
The members’ accumulated funds would reflect all transactions on a member basis applicable to the current period on the accrual-basis and not only the transactions that had a cash implication within the current financial year.
For some, administering insurers’ funds as with some current administrators of private retirement funds, the accrual-basis of accounting will lead to an additional line item on the Statement of Net Assets and Funds under the Accumulated Funds’ portion of the statement called “Unallocated amounts”. This line item refers to transactions that have been accounted for in the accounting system of the administrator but that has not been allocated to members’ records on the administration system. In essence, this is a processing timing difference.
From the above, it is clear that a restatement of the prior year figures is the only real option available to Boards of Trustees of retirement funds and the FSB if comparability, understanding and applicability of the financial statements for retirement funds for the year that the accounting policy changes want to be maintained. From an auditing point of view, irrespective if the prior year line items are restated or not, there will be an impact in the audit procedures for the year of the change in accounting policy.
Administrators impacted
Most of the large administrators (also known as administering insurers) in South Africa that issue policies of insurance to retirement funds are impacted by this conversion from cash-basis to accrual-basis.
Some of the administrators have already converted their retirement fund clients from cash-basis from 2005 to 2006. This decision was based on that the 2005 financial statements were not audited and that the audit reports for 2006 are qualified based on the opening balances for the year. Due to this qualification, the decision was that an adjustment to the opening balances for 2006 is passed that incorporates all the adjustments required to convert the opening balances from cash-basis to accrual-basis.
Administrative issues to be addressed
From an administrator’s perspective, this results in certain challenges that need to be addressed in moving from a cash-basis of accounting to an accrual-basis of accounting. These challenges include, but are not limited to, the following:
- Tailoring their systems to cope with the move from cash to accrual accounting.
- Assessing their personnel’s training levels and improving these to ensure a smooth transition to the accrual-basis.
- Communication with underwritten fund trustees regarding the impact and understanding regarding the move from cash to accrual accounting in the year that the move occurs.
Johann Strauss CA(SA), BAcc (Hons), is an audit partner at SizweNtsaluba VSP.
