oversight

Thrift Savings Plan: Delayed Allocation of Failed System Development Costs to Participant Accounts

Published by the Government Accountability Office on 2003-07-22.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

United States General Accounting Office
Washington, DC 20548



          July 22, 2003

          The Honorable Thomas M. Davis
          Chairman
          Committee on Government Reform
          House of Representatives

          The Honorable Danny K. Davis
          Ranking Minority Member
          Subcommittee on Civil Service and
           Agency Organization
          Committee on Government Reform
          House of Representatives

          The Honorable Dave Weldon
          House of Representatives

          Subject: Thrift Savings Plan: Delayed Allocation of Failed System Development
          Costs to Participant Accounts

          The Thrift Savings Plan (TSP) is a retirement savings and investment plan for federal
          employees, governed by the Federal Retirement Thrift Investment Board (Board).
                                                             1
          The TSP is a defined contribution retirement plan available to eligible federal
          employees. The TSP had about 2.6 million participants and held about $100.6 billion
          in Net Assets Available for Benefits as of December 31, 2001, and about 3 million
          participants and $102.3 billion in Net Assets Available for Benefits as of December 31,
          2002.

          In 1997, the Board awarded a contract to American Management Systems, Inc. (AMS)
          to develop and implement a new record-keeping system for the TSP. In 2001, after
          several implementation delays, the Board terminated the contract, and the Board’s
          former Executive Director filed a lawsuit against the contractor on behalf of the TSP.2
          On June 20, 2003, 2 days after we provided a draft of this report to the Board for its




          1
           Under a defined contribution plan, employees have individual accounts to which employers, the
          employees, or both can make periodic contributions. Defined contribution plan benefits are based on
          the contributions to and the investment returns (gains and losses) on individual accounts.
          2
              The Executive Director who filed the related litigation resigned from his post on November 18, 2002.



                                                                        GAO-03-827R Accounting for TSP Costs
review, a settlement between the parties was reached.3 Then, on June 23, 2003, the
net unrecovered cost from the system development failure was allocated to
participant account balances as recommended in our draft report. While the loss has
now been allocated to participant accounts, albeit on a belated basis, we believe
there is value associated with issuing this product in response to the request to
illustrate the operative principles and concepts that should govern allocation of costs
in the future.

Since the TSP is an important component of retirement income for many federal
employees, participants must be assured of proper accounting of their funds.
Therefore, you asked us to examine federal oversight of the TSP and the TSP’s
accounting for its failed system development costs. Our report on federal oversight of
the TSP was issued in April 2003. 4 This report addresses whether (1) the TSP’s
management followed U.S. generally accepted accounting principles (GAAP) in
accounting for the costs associated with the failed development of the new record-
keeping system and (2) the TSP should have allocated the costs to participants’
accounts when the loss occurred.
Results in Brief
The TSP’s write-down of $41 million in failed system development costs, as an
expense on its 2001 income statement and balance sheet was consistent with GAAP.
However, the decision not to allocate those costs to participant accounts at the same
time was not consistent with the TSP’s practice of allocating expenses on a monthly
basis or with its accounting treatment of the expenses on the financial statements. In
prior accounting periods, the TSP had recorded administrative expenses on its
financial statements and reduced participant accounts for the expenses when
incurred. The effect of not concurrently allocating the expenses attributable to the
system write-down to individual accounts was that each then-existing participant
account was overstated by a pro rata amount.
This differing treatment for financial statements and account balances resulted in
aggregate reported TSP assets being $41 million less than the sum of individual
accounts from the end of July 2001 through the most recent June 23, 2003, posting of
the expense to accounts and allowed those who have withdrawn from the TSP since
2001 to not share in those costs. If the $41 million had been allocated to participants’
accounts in 2001, the TSP expense ratios would, on average, have been
approximately one-twentieth of 1 percent more—or about 41 cents per $1,000
account balance. Thus, the amounts chargeable to individual accounts would have
been minimal—ranging from virtually nothing for new employees to roughly $400 for
an account of $1 million.
The reason given by the Executive Director for not allocating the $41 million to
account balances at the time of the asset write down was confidence that the TSP
would prevail in the court action and that, in the final analysis, the TSP would not

3
 The lawsuit brought by the Board is still pending before the U.S. Court of Appeals for the District of
Columbia Circuit. While the parties have notified the Court that they have agreed to a settlement, as of
July 16, 2003, the Court has not dismissed the case.
4
U.S. General Accounting Office, Federal Pensions: DOL Oversight and Thrift Savings Plan
Accountability, GAO-03-400 (Washington, D.C.: Apr. 23, 2003).


Page 2                                                      GAO-03-827R Accounting for TSP Costs
suffer any losses due to the system development failure. The TSP’s former and
current independent auditors reviewed and concurred with this treatment. Given
uncertainties inherent in any court action and the fact that significant numbers of
account holders enroll and depart annually, in our view, allocating the $41 million to
account balances when the loss occurred would have been more prudent, as well as
being acceptable treatment under GAAP. In particular, allocation at the time the loss
occurred would have met two underlying concepts of accounting—consistency and
conservatism.
Background
The TSP was authorized by Congress under the Federal Employees’ Retirement
System Act of 1986 (FERSA). 5 As of December 31, 2002, the Board reported that the
TSP fund had approximately 3 million federal employee participants and
$102.3 billion in Net Assets Available for Benefits, making it one of the largest
retirement savings plans in the United States. The TSP is available to federal and
postal employees, members of Congress and congressional employees, members of
the uniformed services, and members of the judicial branch. The TSP provides
federal (and, in certain cases, state) income tax deferral on employee contributions
and related earnings. The TSP’s assets and earnings on these assets generally cannot
be used for any purpose other than providing benefits to participants and their
beneficiaries, and paying TSP administrative expenses. From December 2001 through
February 2003, approximately 720,000 new participants joined the TSP, while
approximately 510,000 participants withdrew. 6
In 1997, the Board awarded a contract to AMS to develop a new TSP record-keeping
system to provide participants with the ability to make investment changes and to
view updates of their account balances daily. Prior to the recent system upgrade
announced in mid-June 2003, participants’ interfund transfers could take up to
45 days to implement, and participants could only view monthly updates of their
account balances. In July 2001, after numerous implementation delays and
disappointing interim results, the Board terminated the 1997 AMS contract for
development of the new system and awarded a new contract to a different
contractor. At the time the contract with AMS was terminated, the TSP wrote off
$41 million of its capital assets as a result of the failed system development. At the
                                                                                     7
same time, a suit was filed on behalf of the TSP against AMS, seeking $50 million in
actual damages and $300 million in punitive damages. Then, AMS filed a contract
termination settlement claim against the Board for improper contract termination


5
 Pub. L. No. 99-335, 100 Stat. 514 (1986) (codified as amended largely at 5 U.S.C. §8351 and §§8401 –
8479).
6
 Withdrawals from the TSP include withdrawal of funds upon retirements from the federal
government, withdrawal of funds upon resignation from the federal government, and any other
removal of previously contributed funds from the TSP.
7
 The $50 million in actual damages being sought includes $30 million in invoices paid to the contractor,
$12 million in salaries and benefits paid for TSP staff and other contractors related to the system
implementation, $9 million in other start-up costs of the system implementation, and less $1 million
paid for off-the-shelf software that had future use to the TSP.



Page 3                                                      GAO-03-827R Accounting for TSP Costs
seeking $58 million in damages.8 On June 20, 2003, 2 days after we provided a draft of
this report to the Board for its review, a settlement was reached between the parties.
The net result of the settlement required AMS to pay $5 million to the TSP, thus
reducing the amount of the loss from $41 million to $36 million. On June 23, 2003, the
$36 million was allocated to the participant accounts on a pro rata basis, based on
respective investment fund balances.
The TSP prepares and reports its financial statements using GAAP. The TSP’s annual
financial statements are audited and have received unqualified or “clean” audit
opinions since its inception in 1987. Statement on Auditing Standards No. 69 (SAS
69), The Meaning of “Present Fairly in Conformity with Generally Accepted
Accounting Principles,” provides a definition of GAAP and discusses a hierarchy of
guidance that is to be followed. The statement describes four categories of
authoritative guidance, referred to as the GAAP hierarchy, which are listed in table 1.
Table 1: GAAP Hierarchy of Guidance

Category          Guidance

A (most           •   Financial Accounting Standards Board (FASB) Statements of Financial
authoritative)        Accounting Standards and Interpretations

                  •   Accounting Principles Board (APB) Opinions

                  •   American Institute of Certified Public Accountants (AICPA) Accounting
                      Research Bulletins

B                 •   FASB Technical Bulletins

                  •   Certain AICPA Industry Audit and Accounting Guides

                  •   AICPA Statements of Position

C                 •   Certain AICPA Accounting Standards Executive Committee Practice Bulletins

                  •   Positions of the FASB Emerging Issues Task Force

D (least          •   AICPA accounting interpretations and implementation guides
authoritative)
                  •   Other practices that are widely recognized and prevalent

Source: SAS 69.



In the absence of guidance in the four categories on a particular transaction, SAS 69
allows for consideration of other relevant accounting literature, such as FASB
Statements of Financial Accounting Concepts; AICPA Issue Papers; and Federal
Accounting Standards Advisory Board Statements, Interpretations, and Technical
Bulletins.
Scope and Methodology
In order to determine if the TSP followed GAAP in accounting for the costs of the
failed systems development and whether the costs should have been allocated to

8
 The $58 million in actual damages included $26 million of unpaid invoices and $32 million of other
costs to close the contract.


Page 4                                                       GAO-03-827R Accounting for TSP Costs
participant accounts when the contract was terminated, we reviewed relevant laws
and regulations, including FERSA and applicable federal regulations. We reviewed
accounting guidance associated with accounting for defined contribution plans,
systems development capitalization, and asset impairment, including Financial
Accounting Standard 121 (FAS 121), Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of; AICPA’s Audit and Accounting
Guide, Audits of Employee Pension Benefit Plans; and Statement of Financial
Accounting Concepts No. 2 (SFAC 2), Qualitative Characteristics of Accounting
Information. We also reviewed the TSP’s audited financial statements for calendar
years 2000, 2001, and 2002; literature published by the TSP; and minutes of Board
meetings. In addition, we interviewed officials from the TSP, the Department of Labor
(DOL), and another defined contribution plan provider. We requested and received
written comments from the Executive Director of the Board. These comments are
discussed in the Agency Comment and Our Evaluation section and are reprinted in
the enclosure. We conducted our work from January 2003 through May 2003 in
accordance with generally accepted government auditing standards.
Accounting Treatment for System Write-Down Was Acceptable
The TSP’s financial statement treatment of writing down the capitalized costs of its
failed system development costs was consistent with GAAP. FAS 121 provides
authoritative guidance (category A) for properly accounting for an impaired asset.
FAS 121 requires that when the carrying amount of an impaired asset exceeds its fair
                                                                 9
value, the impaired asset must be written down to its fair value. The difference
between the asset’s carrying amount and its fair value is to be recognized as an
impairment loss and a reduction of income from continuing operations. Therefore,
the TSP’s write-down of the failed system development costs, by recording an
expense of that amount and likewise reducing the asset value, was consistent with
FAS 121.
At the time the systems development contract with AMS was terminated, the TSP had
recorded a capitalized asset on its books for $65 million in systems development
costs. This amount represented contractor invoices totaling $53 million and
$12 million of internal development costs. Of the $53 million in contractor invoices,
$23 million had not yet been paid and was reflected as an account payable. Upon
contract termination, the Board rejected the $23 million in unpaid invoices and
decreased the capitalized asset by the same amount, resulting in a residual recorded
cost of approximately $42 million. This capitalized asset was considered impaired
and written down from approximately $42 million to an estimated fair value of
           10
$1 million. The $41 million write-down of the asset to its net realizable value was
reported on the Statement of Changes in Net Assets Available for Benefits as a
component of administrative expenses. Table 2 summarizes the systems development
write-down that resulted in a $41 million impairment loss on the capitalized asset.
While the write-down was not separately classified as an impairment loss, its

9
 FAS 121 defines fair value as “the amount at which the asset could be bought or sold in a current
transaction between willing parties.”
10
 The remaining $1 million represents a recoverable asset that the TSP determined, in conjunction with
the new contractor, to be of future use. The asset is off-the-shelf software that was used by the new
contractor in the system improvements.


Page 5                                                     GAO-03-827R Accounting for TSP Costs
inclusion in administrative expenses resulted in a reduction of income from
                       11
continuing operations.
Table 2: TSP System Development Write-down Resulting in $41 Million Impairment Loss on Capitalized
Asset

            Contractor invoices (paid at time of contract              $30 million
            termination)

            Contractor invoices (not paid at time of contract          $23 million
            termination)

            Internal cost of system development                        $12 million

            Original capitalized asset                                 $65 million

            Less: invoices rejected                                    $23 million

            Capitalized asset                                          $42 million

            Less: estimated fair market value of capitalized asset     $1 million

            Impairment loss on capitalized asset                       $41 million

Sources: TSP and the 2001 Financial Statements of the Thrift Savings Fund.




At that time, these record-keeping system development costs constituted most of the
TSP’s recorded fixed assets. The write-down of the $41 million resulted in the TSP’s
total fixed assets being reduced from $50 million to $9 million. It also was a major
cause of the increase in administrative expenses from $62 million in fiscal year 2000
to $106 million for fiscal year 2001.
Nonallocation to Individual Accounts Was Inconsistent with Prior Practices
The decision not to allocate the expenses related to the failed system development to
participant accounts when the loss occurred was not consistent with the TSP’s
practice of allocating expenses on a monthly basis or with the accounting treatment
                                            12
of the expenses on the financial statements. Under FERSA, the Executive Director is
charged with prescribing regulations governing the TSP's allocation of net earnings,
net losses, and administrative expenses to participants' accounts. In prior accounting
periods, the TSP had recorded administrative expenses on its financial statements
and reduced participant accounts for the expenses when incurred.
The effect of not concurrently allocating the expenses attributable to the system
write-down to individual accounts was that each then-existing participant account
was overstated by a pro rata amount, and was thus not the most conservative



11
 The TSP classified the $41 million impairment loss as administrative expenses on its financial
statements since the amount was considered immaterial in relation to the TSP’s total assets of about
$100.6 billion.
12
     See 5 U.S.C. § 8439(a)(3) and 5 C.F.R. § 1645.4.



Page 6                                                               GAO-03-827R Accounting for TSP Costs
treatment available. Accounting guidance13 we reviewed related to private pension
                                                              14
plans and another defined contribution plan service provider we contacted stated
that the sum of participant accounts should be equal to total net assets. Under this
approach, the TSP loss should have been allocated to accounts when the loss
occurred. However, neither the guidance nor the other service provider offered any
insights related to allocation of expenses when such expenses might be recovered as
a result of pending litigation.
The decision not to allocate the expenses when the loss occurred, as was discussed
with the Board and documented in the February, April, and May 2002 minutes of the
Board meetings, was based on the belief that it was preferable to defer allocation
until after the outcome of the pending litigation against the original contractor was
resolved. The former Executive Director expected to prevail in the litigation and
stated that expenses from the failed systems development would be netted against
the anticipated recovery from the contractor. Nonallocation of these expenses was
disclosed in the TSP Fund’s 2001 financial statements, which received an unqualified
audit opinion. In a June 2002 letter, DOL suggested that the TSP obtain competent
advice concerning the propriety of the nonallocation procedure disclosed in the
financial statements. The TSP requested that another external auditing firm review
the accounting treatment; that firm reported in August 2002 that the treatment was
reasonable.
We were unable to locate any specific guidance on the proper accounting treatment
in cases for which expenses incurred by a defined contribution plan may be
recovered through a pending lawsuit. The AICPA’s Audit and Accounting Guide,
Audits of Employee Benefit Plans (category B guidance in the GAAP hierarchy),
which provides accounting and auditing guidance for private sector defined benefit
and defined contribution plans, states that individual participants’ account
information “should necessarily be in agreement with the aggregate participant
account information contained in the basic books and records.” Applying this
criterion, the $41 million should have been allocated to participants’ accounts when
the loss occurred. However, this guidance applies to private sector plans and not
federal plans such as the TSP. Instead, under FERSA, the Executive Director is
charged with prescribing regulations governing the TSP's allocation of administrative
expenses to participants' accounts. We did not find anything in the guidance or the
TSP regulations to suggest that the accounting treatment should be different
depending on any unusual circumstances, such as situations involving pending
litigation with a potential recovery.
Since this accounting event was unusual, we contacted another large defined
contribution plan service provider to determine what it might have done in a similar
situation. The large defined contribution plan we contacted has net plan assets of
approximately $140 billion. The representative we spoke with explained that that
plan had never been in a similar situation but that the plan allocates all expenses and
investment gains and losses to plan participants daily. Most of this plan’s expenses

13
 The accounting guidance we reviewed included the AICPA’s Audit and Accounting Guide, Audits of
Employee Benefit Plans.
14
 The other service plan provider we contacted is also a large defined contribution plan with
approximately $140 billion in net plan assets available for benefits.


Page 7                                                     GAO-03-827R Accounting for TSP Costs
are for services provided by third parties, and the plan remits payment for these
services each day.
Notwithstanding the lack of specific guidance on the proper accounting treatment of
allocating a loss to participant accounts in a defined contribution plan when there is a
pending lawsuit with a potential recovery, financial accounting concepts suggest that
the TSP accounting treatment was not applied in accordance with the accounting
concepts of consistency and conservatism. According to SFAC 2, accounting
treatment across accounting periods should be consistent in order to increase the
informational value of accounting data. The decision not to allocate the
administrative expenses related to failed systems development as the TSP had
allocated all other administrative expenses when the loss occurred and in prior
accounting periods was inconsistent. In addition, not allocating the loss to plan
participants in 2001 was inconsistent with the financial statement accounting
treatment.
SFAC 2 also addresses the concept of conservatism. The statement indicates that in
determining the appropriate accounting treatment when there are uncertainties, the
preferable method is one that does not overstate assets or understate expenses and
therefore does not overstate operating results. By recording the loss on the financial
statements, but not allocating administrative expenses related to the failed systems
development, individual plan participants’ assets were overstated and thus did not
reflect the most conservative method of accounting. Given uncertainties inherent in
any court action and the fact that significant numbers of account holders enroll and
depart annually, in our view, allocating the loss to account balances when the loss
occurred would have been more prudent, as well as being acceptable treatment under
GAAP. In particular, allocation would have met two underlying concepts of
accounting—consistency and conservatism.
Because these expenses were not allocated, the sum of all participants’ plan accounts
was more than the Net Assets Available for Benefits reported on the financial
statements from when the loss occurred to June 2003 when the lawsuit was settled.
Although the loss in relation to the $100.6 billion fund balance as of December 2001
(approximately .04 percent) is insignificant, the timing of the allocation to individual
accounts may be sensitive to some plan holders. If the $41 million loss had been
allocated in 2001, plan holders would have been charged approximately one-
twentieth of 1 percent–-or about 41 cents more per $1,000 in their account balances.
Thus, the amounts chargeable to individual accounts would have been minimal—
ranging from virtually nothing for new employees to about $400 for an account of
$1 million. Given that the average account balance in 2001 was approximately $39,000
(i.e., $100.6 billion in Net Assets Available for Benefits divided by 2.6 million
participants), the average additional charge for administrative expenses for the year
would have been about $16.
As a result of the settlement between the parties related to the system development,
the TSP recovered approximately $5 million, which partially offsets the $41 million in
previously recorded but unallocated administrative expenses. We confirmed that the
resulting $36 million net loss was allocated to participants’ accounts on June 23, 2003.




Page 8                                            GAO-03-827R Accounting for TSP Costs
Conclusion
The financial statement treatment of writing down the failed system development
costs was consistent with GAAP; however, we believe it would have been prudent to
also write down the participants’ accounts when the loss occurred. Not allocating the
loss to individual participant accounts when it occurred was based on a premise of
recovery for which there was no certainty. It also marked a departure from routine
cost allocation practices, and in this situation, a significant number of account
holders have departed from the TSP and were not allocated a share of these costs.
Although we would hope that the Board does not have to face unusual circumstances
similar to this again, it is important that consistency and conservatism principles and
concepts govern future accounting and allocation decisions.
Recommendation for Executive Action
To be consistent with the financial statement treatment and its routine allocation
practices, in light of uncertainties involving the litigation, and to prevent a growing
percentage of account holders from departing the TSP and not sharing in the system
failure costs, we recommend that the Federal Retirement Thrift Investment Board
require the Executive Director to allocate the loss as soon as possible to participant
accounts in the most equitable and efficient manner.
Agency Comments and Our Evaluation
In commenting on a draft of our report, the Executive Director discussed the June 20,
2003, settlement and the resulting $36 million allocation to participant accounts on
June 23, 2003. We verified that the allocation was made, thus implementing the
recommendation in this report.
                                         -----

As agreed with your offices, unless you release its contents earlier, we plan no further
distribution of this report until 30 days after its date. At that time, we will send
copies to interested congressional committees as well as the Executive Director of
the Federal Thrift Retirement Investment Board and the Secretary of Labor. We will
also make copies available to others on request. In addition, the report will be
available at no charge on the GAO Web site at http://www.gao.gov.

If you have any questions concerning this report, please contact me at (202) 512-6906
or Casey Keplinger at (202) 512-9323. Heather Dunahoo also made major
contributions to this report.




McCoy Williams
Director
Financial Management and Assurance


Enclosure


Page 9                                             GAO-03-827R Accounting for TSP Costs
Enclosure


Comments from the Federal Retirement Thrift Investment Board




(195007)




Page 10                                  GAO-03-827R Accounting for TSP Costs
This is a work of the U.S. government and is not subject to copyright protection in the
United States. It may be reproduced and distributed in its entirety without further
permission from GAO. However, because this work may contain copyrighted images or
other material, permission from the copyright holder may be necessary if you wish to
reproduce this material separately.
                         The General Accounting Office, the audit, evaluation and investigative arm of
GAO’s Mission            Congress, exists to support Congress in meeting its constitutional
                         responsibilities and to help improve the performance and accountability of the
                         federal government for the American people. GAO examines the use of public
                         funds; evaluates federal programs and policies; and provides analyses,
                         recommendations, and other assistance to help Congress make informed
                         oversight, policy, and funding decisions. GAO’s commitment to good
                         government is reflected in its core values of accountability, integrity, and
                         reliability.


                         The fastest and easiest way to obtain copies of GAO documents at no cost is
Obtaining Copies of      through the Internet. GAO’s Web site (www.gao.gov) contains abstracts and full-
GAO Reports and          text files of current reports and testimony and an expanding archive of older
                         products. The Web site features a search engine to help you locate documents
Testimony                using key words and phrases. You can print these documents in their entirety,
                         including charts and other graphics.

                         Each day, GAO issues a list of newly released reports, testimony, and
                         correspondence. GAO posts this list, known as “Today’s Reports,” on its Web
                         site daily. The list contains links to the full-text document files. To have GAO e-
                         mail this list to you every afternoon, go to www.gao.gov and select “Subscribe to
                         e-mail alerts” under the “Order GAO Products” heading.


Order by Mail or Phone   The first copy of each printed report is free. Additional copies are $2 each. A
                         check or money order should be made out to the Superintendent of Documents.
                         GAO also accepts VISA and Mastercard. Orders for 100 or more copies mailed to
                         a single address are discounted 25 percent. Orders should be sent to:

                         U.S. General Accounting Office
                         441 G Street NW, Room LM
                         Washington, D.C. 20548

                         To order by Phone:    Voice:     (202) 512-6000
                                               TDD:       (202) 512-2537
                                               Fax:       (202) 512-6061


                         Contact:
To Report Fraud,
                         Web site: www.gao.gov/fraudnet/fraudnet.htm
Waste, and Abuse in      E-mail: fraudnet@gao.gov
Federal Programs         Automated answering system: (800) 424-5454 or (202) 512-7470


                         Jeff Nelligan, Managing Director, NelliganJ@gao.gov (202) 512-4800
Public Affairs           U.S. General Accounting Office, 441 G Street NW, Room 7149
                         Washington, D.C. 20548