Financial Accounting Standards Board Considers Whether ESOP Shares Are Liabilities

The Financial Accounting Standards Board (FASB) has reopened the question of whether shares held by an ESOP that are mandatorily redeemable upon the occurrence of an event certain to occur, such as death, termination, or retirement, should be accounted for as a liability rather than equity. Previously, in Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity," FASB required companies to classify certain kinds of financial instruments this way, but it excluded ESOPs and other retirement plans subject to further review. That further review is now under way.

The issue for ESOPs is that the trustee has no put option when the shares are held by the trust, so, arguably, the shares should not be considered as mandatorily redeemable (this same argument has been made by some ESOP attorneys and appraisers with regard to not reducing liquidity discounts for ESOPs because the trust does not have a put option). Companies that translate stock value into cash before distribution presumably would not have to account for the shares as a liability. If ESOPs do turn out to be covered by this requirement, the added liabilities could make it more difficult to obtain financing.

It is not clear what FASB will do on this issue. Some board members have indicated that they favor an exemption for financial instruments that are redeemed at fair market value, for instance. It is also not clear whether FASB will issue specific rules or more general principles. Becky Miller of McGladrey & Pullen, widely viewed as the leading expert on ESOP accounting issues, has told us she does not believe principles-based accounting would present a problem for ESOPs on this issue.

Companies wanting to express views on this would best be advised to do so through their accountants. FASB is not receptive to arguments about what this might or might not do to the ability of ESOP companies to obtain credit, just as they were not about the purported effect of accounting for options on companies' willingness to grant them. Instead, the arguments need to be couched in terms of the legal and financial issues involved.

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