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FASB Statement No. 150 and ESOPs

David Johanson

September 2003

On May 15, 2003, the Financial Accounting and Standards Board ("FASB") issued Statement No. 150 - Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity ("Statement 150"). Statement 150 establishes standards for how a company classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that a company classify a financial instrument that is within the scope of the statement as a liability. Many of those instruments were previously classified as equity. Statement 150 affects the company's accounting for types of freestanding financial instruments that have mandatory redemption features, some put options and forward purchase contracts that obligate the company to buy back its shares of company stock in exchange for cash or other assets. This sounds very similar to the repurchase of company stock pursuant to a put option under an ESOP; however, please refer to the scope limitation below. Furthermore, companies that include ownership restrictions in their articles of incorporation, and thereby avoid the put option requirements of Section 409(h) of the Internal Revenue Code of 1986, as amended, will clearly be outside of the scope of Statement 150.

Paragraph 17 of Statement 150 provides a scope limitation that will exclude most shares of company stock issued to and held by an ESOP. That paragraph indicates that Statement 150 does not apply to obligations under stock-based compensation arrangements if those obligations are accounted for under AICPA Statement of Position ("SOP") 93-6 - Employers' Accounting for Employee Stock Ownership Plans or related guidance. The potential problem, however, is that Statement 150 does apply to a freestanding financial instrument issued under a stock arrangement that is no longer subject to SOP 93-6 or related guidance. This suggests that stock that is distributed to employees after they leave the company, and is subject to a put option (and the company's articles of incorporation or charter do not include an ownership restriction), may trigger a liability on a company's balance sheet. It is understood from conversations with FASB that its view and intent is that the ESOP put option is part of an overall deferred stock compensation scheme governed by law and regulation and that the put option is part of the overall compensation scheme. Although accounting firms have come to differing conclusions on this issue, this author is confident that Statement 150 does not require ESOP companies to alter their ESOP accounting practices at this time to report any additional liabilities. Of course, FASB intends next year to publish a new standard regarding stock compensation schemes, including ESOPs, that require repurchase by the employer, and the thrust of Statement 150, which clearly would have included ESOPs absent Paragraph 17, gives the current thinking of FASB's staff. Meanwhile, FASB has delayed the effective date of Statement 150 for closely held companies until accounting periods starting after December 15, 2004. Many closely held companies, with or without an ESOP, complained that if Statement 150 required them to report additional liabilities on their financial statements, this would make their buy-sell and/or other repurchase obligations impractical.

The basic concern here is that FASB will attempt to require ESOP companies to fully and prematurely account for repurchase obligations in addition to the liability and contra equity accounting currently required by SOP 93-6. The ESOP community should remain vigilant and not jump to premature conclusions, as some attorneys and CPAs did when FASB issued Statement 150, that might support FASB in the wrong direction during 2004 when it establishes a new standard regarding stock compensation schemes, including ESOPs, that require repurchase by the employer.

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