Auditing defined benefit pension scheme assets, liabilities and disclosures in an entity’s accounts is not without challenges. It encompasses several of the more complex aspects of auditing, including auditing significant accounting estimates and the use of service organisations, management’s experts and auditor’s experts, as the Financial Reporting Council (FRC) notes in its report The audit of defined benefit pension obligations, based on 2017/18 audit quality reviews.

Appropriate focus on pension disclosures in financial statements also has a part to play in maintaining trust in audit – after all, pension scheme deficits in particular have been prominent in recent corporate failures and scandals.

With this is mind, early planning is crucial in allowing the auditor to accumulate sufficient appropriate audit evidence without duplication, and time and costs spiralling for not only the auditor, but for entity management, pension scheme trustees and their service organisations.

Relationships, and independence of the trustees

Defined benefit pension schemes, and their trustees, are independent of the entity and its management, which has considerable implications for the audit of the entity. While the auditor is engaged by the sponsor entity, other third parties will have been engaged by the pension scheme trustee or trustees, who are independent of the sponsor entity. As such, other permissions and authority will be required in order to obtain information relevant to completing the audit work.

One of the first steps an auditor can take is gaining a detailed understanding of the parties involved, so that audit requests can be directed to the right recipients in the right way, on a timely basis and with appropriate permissions.

To help auditors on this journey, ICAEW’s Audit and Assurance Faculty has produced a new web page describing the relationships between these parties, and exploring good practice in managing auditor requests.

Making audit requests

Given the many different parties involved and the complex relationships, making audit requests to the wrong parties or without the correct authorities can have an impact on the quality of audit evidence obtained and potentially waste auditor, trustee and management time.

Mindful of this, the following suggests ways the auditor may obtain information as efficiently as possible, without duplication.

Understanding the structure of the pension scheme at the planning stage will help ensure audit queries are managed appropriately and minimise superfluous requests. For example, are assets held centrally by a custodian or managed directly by investment managers?

Sponsor entity management should be the first avenue for audit requests – they should hold much of the information necessary for completion of the audit work.

That said, direct confirmations from third parties provide stronger audit evidence and will need to be requested on a timely basis, but they will need to be requested through entity management.

Some schemes may hold many investments, managed by many investment managers – it may not be possible for the auditor to obtain breakdowns of all the assets and the auditor will need to consider their approach carefully to ensure they understand where the risks lie.

Where the trustees give permission for the sponsor auditor to communicate with the scheme auditor, the sponsor auditor may be able to use information received from the scheme auditor to help minimise duplicative requests to the trustees and the trustees’ service organisations.

Where the employer is part of a multi-employer scheme, a higher degree of judgement is likely to be required by entity management and the sponsor auditor, in determining whether the entity’s share of assets and liabilities is reasonable. A higher degree of judgement might also be evident in the later years of reliance on ‘rolling forward’ a triennial valuation.

The faculty guide – with expanded definitions of parties involved and more information on auditor requests.

Who does what?

A summary of the roles of the parties and the relationships between them.

The pension scheme
The main activities of an occupational pension scheme include collection of contributions from the employer and members, the investment of contributions, and payment of benefits to members, as covered in Practice Note 15 (Revised) The audit of occupational pension schemes in the United Kingdom, which is available from the FRC. They are usually established under trust as a separate legal entity, independent of the sponsor entity. In this article and the guide, we refer to independence representing this legal separation of the pension scheme from the sponsoring entity rather than auditor independence requirements. The trust is governed by trustees, under a trust deed. The Pensions Regulator is responsible for regulating the areas where individuals access pensions via their employer.

Management (sponsor entity directors)
Sponsor entity management provides an ‘employer covenant’, which represents its willingness and financial ability to meet its legal obligation to support the pension scheme going forwards. The directors have a responsibility to ensure the sponsor entity’s financial statements comply with the reporting requirements of the International Accounting Standard (IAS) 19 Employee Benefits or the UK’s principal Financial Reporting Standard, FRS 102.

Management’s actuary
The sponsor entity’s directors will usually appoint an actuary (‘management’s actuary’) to enable them to comply with the reporting requirements of IAS 19 or FRS 102. Management’s actuary will advise on assumptions and assist the sponsor entity’s directors in fulfilling their responsibility to prepare the figures and disclosures in the financial statements and the related notes.

Trustees
Trustees run the pension scheme solely in the interest of participants and beneficiaries, ensuring it is run properly and that members’ benefits are secure. They ensure there is sufficient money in the scheme to pay members’ pensions as and when they become due. Trustees do not necessarily have first-hand actuarial or accounting experience and frequently look to other advisers for advice and services to help fulfil their responsibilities. They are required to engage certain advisers, such as a scheme actuary and scheme auditor, and they will also commonly engage custodians, legal advisers and scheme administrators.

Administrators
Trustees of pension schemes delegate aspects of administration to a third party, which may be in-house with the sponsoring employer, or through a specialist third-party administrator. The scheme administrator will normally receive member and employer contributions, maintain member records and calculate and pay benefits on behalf of the trustees.

Investment managers
Trustees appoint investment managers to manage the funds available for investment. A Statement of Investment Principles (SIP) will be put in place, which governs investment decisions, and the level of risk that is acceptable to the trustees.

Custodians
If the scheme invests in direct securities, trustees will normally appoint a custodian to hold the scheme investments on their behalf. Custodians provide safekeeping of the scheme’s assets, but they cannot buy, sell or transfer assets unless instructed to do so by the trustees.

Scheme actuary
For most defined benefit schemes, the trustees are specifically required by statute to appoint a scheme actuary to provide them with necessary valuations and advice. The scheme actuary provides an actuarial valuation of the liability representing the present value of the future payments to settle pension obligations at the year-end date, as well as providing estimates for the valuation of scheme assets.

Scheme auditor
Most occupational pension schemes will be required to produce annual financial statements and to appoint a scheme auditor in order to audit those financial statements.

Sponsor auditor
The statutory auditor of the sponsor entity’s financial statements. The sponsor auditor forms an opinion on whether or not the financial statements of the sponsor entity give a true and fair view. The auditor performs a risk assessment and determines whether or not there are risks of material misstatement related to balances, transactions and disclosures, including where an entity’s financial statements include a defined benefit pension scheme liability (or asset), and related disclosures. Where risks of material misstatement are identified, the auditor will plan and carry out audit work in order to obtain sufficient appropriate audit evidence that there are no material misstatements.

Sponsor auditor’s expert
Sponsor auditors may engage an auditor’s expert, with actuarial qualifications, in order to review the actuarial assumptions and calculations provided to sponsor entity management by management’s actuary, and the figures and disclosures in the sponsor entity’s financial statements.
The sponsor auditor’s expert, if engaged by the sponsor auditor, may also be involved in meetings or communications with sponsor entity management and management’s actuary, in order to assist the sponsor auditor to understand and challenge assumptions used and judgements made by sponsor entity management.

Definitions matter
There may be scenarios when it is helpful for auditors to look to International Standards on Auditing for their definitions of some types of third party. Confusion between, for example, a ‘management expert’ and a ‘service organisation’, can lead to an incorrect approach to audit evidence considerations.