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Participant Loans--Is It Appropriate to Call Them Investments?
by Richard G. Thiermann, CPA, Partner
February 11, 2011

The Financial Accounting Standards Board (FASB) no longer thinks so.  In September 2010, FASB issued accounting standards update (ASU) 2010-25, Reporting Loans to Participants by Defined Contribution Pension Plans, which will require defined contribution plans to report loans as notes receivable and will eliminate the requirement to report participant loans at fair value. The ASU is effective for plan years ending after December 15, 2010, and must be applied retrospectively.

Background

In the past, participant loans have been classified in plan financial statements as investments.   Most plans valued participant loans at their unpaid principal balance, plus accrued interest.  This was considered to be a good faith estimate of the fair value of participant loans; however, accounting rules for investments required that observable inputs be used, when available, such as market interest rates, borrower's credit risk and historical default rates for developing the fair market values of participant loans.

Questions arose as to whether reporting participant loans at fair value was useful to financial statement users. Participant loans cannot be sold like other investments. Furthermore, if a participant defaults, the loan is protected by the participant's account balance. The participant's account balance would be reduced by the unpaid balance of the loan and the participant would be subject to income taxes on the deemed distribution. As such, the participant is the only party affected in the event of a default.  In light of these factors, FASB's new guidance requires that participant loans be reported as notes receivable from participants, which are segregated from plan investments and reported at the unpaid principal balance, plus accrued but unpaid interest. This new standard eliminates the requirement to report participant loans at fair value.

In the year of adoption, plans must reclassify participant loans on the Statement of Net Assets Available for Benefits for all years presented. Since most plans have already been valuing participant loans at unpaid principal
balance, plus accrued interest, this reclassification should not have a material effect on the net assets of the plan.

New Disclosure Requirements

There will be new disclosure requirements for the notes receivable, such as:

  • Accounting policy for loans
  • Nonaccrual and past due loans 
  • Allowance for loan losses 
  • Impaired loans

Form 5500 Reporting

As the standard applies only to financial statements prepared in accordance with generally accepted accounting principles, it will not affect the classification of participant loans on Form 5500. Form 5500 will still require the reporting of participant loans as an investment and the loans will still be reported on the supplemental schedule of assets held at year-end.

Plan sponsors will still be able to direct their auditors to perform a limited-scope audit on participant loans if they are covered by the appropriate certification.

Please contact Lindquist LLP with any questions about the implementation of ASU 2010-25.

Richard G. Thiermann, CPA, is a partner in Lindquist LLP's Southern California office.  Rich has 23 years of experience with audits of defined contribution, defined benefit, and health and welfare plans.  His professional memberships include the Western Pension & Benefits Conference, International Foundation of Employee Benefit Plans, American Institute of Certified Public Accountants, California Society of Certified Public Accountants and California Society of Association Executives.


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