Expense recognition for ESOPs.
This month's column discusses a new method developed by the Financial Accounting Standards Board emerging issues task force (EITF) to calculate the employer's expense for certain employee stock ownership plans (ESOPs). Related accounting and reporting issues also are discussed.
EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: (203) 847-0700.
ISSUE no. 89-8
An ESOP is a defined contribution plan that invests primarily in the employer's securities.
ESOPs often are used by employers as financing vehicles. These "leveraged ESOPs" borrow funds from a financial institution. The employer either guarantees the debt or commits to contribute amounts to the ESOP to cover the debt service.
The loans may be structured in various ways. For example, the terms may provide for only interest payments for a number of years. Pre-payments may be required or voluntary. Repayment terms may be level or nonlevel, depending on the employer's expected future cash flows. Shares may be allocated to employees based on principal payments or principal and interest payments.
Accounting issues. The primary accounting issue is how the employer should recognize the expense for contributions made to an ESOP. Related issues are transition, the accounting for a change in accounting principle and the accounting for events occurring in different reporting periods.
Discussion. American Institute of CPAs Statement of Position no. 76-3, Accounting Practices for Certain Employee Stock Ownership Plans, requires the employer to charge to expense "the amount contributed or committed to be contributed to an ESOP" during the period.
Some believe that method, known as the "cash payment" method, may not be applicable to the types of ESOPs now being structured. Thus, diversity in practice has resulted.
In addition, several task force members objected to basing expense recognition only on the cash payment method.
Consensus. The task force concluded the following method (called the "shares allocated" method) should be adopted for all shares acquired by an ESOP after December 14, 1989: (1) Recognize interest expense as incurred each period and (2) recognize expense for the principal portion (the compensation element) by multiplying the original principal amount by the ratio of shares allocated for the period to total shares purchased.
The shares allocated method is computed as follows:
Shares allocated for the period/Total shares purchased x Original principal + Interest incurred for the period The expense recognized in each period would be reduced by the amount of any dividends used to service the ESOP debt.
Related accounting and reporting issues. We noted earlier the shares allocated method must be used by the employer to record expense for all shares acquired by ESOPs after December 14, 1989--which, by the way, is the date this consensus was reached by the task force.
What about companies with ESOPs existing before December 15, 1989?
The task force stated companies with existing ESOPs that held securities before December 15 could continue to use their present method as long as the expense recognized under that method is at least 80% of what would be recognized under the shares allocated method. If it's less than 80%, the cumulative difference must be expensed in the current period. If it's greater than 80% of what would be recognized under the shares allocated method, the expense may not be reduced. (Dividends should not be considered in the calculation.)
How would you account for the change in accounting principle?
The effect, if any, of initial application of this consensus should be reported as a cumulative effect of a change in accounting principle under Accounting Principles Board Opinion no. 20, Accounting Changes. If there's a difference between the expense recognized and the cash contribution, adjust the related debit in the equity account for that amount.
What if the debt payment, the allocation of related shares and the earning of those shares by the employees all occurred in different reporting periods?
Under those circumstances, the EITF noted it may be appropriate to accrue or defer the compensation part of the expense. For example, if a debt payment is made in 19X2 and the related shares are earned by the employees in 19X1, the cost of the shares should be accrued in 19X1, when the shares are earned.
Conversely, if the debt payment is made in a period before the shares are earned, the cost of the shares would be accrued in the latter period. However, that cost should not be deferred for more than one annual reporting period. In all cases, interest is charged to expense as incurred.
The EITF's example of computing expense for an existing ESOP that does not change to the shares allocated method is provided in exhibit 1 on page 57.
Securities and Exchange Commission requirements. Public companies are expected to disclose to the SEC the following concerning ESOPs:
1. A description of the plan, including employee groups covered, the basis for determining contributions and the nature and effect of significant matters affecting comparability of information for all periods presented.
2. The amount of cost recognized during the period.
(Those two disclosures are identical to the disclosures required for defined contribution plans described in paragraph 65 of FASB Statement no. 87, Employers' Accounting for Pensions.)
3. The method of recognizing expense.
4. Actual interest incurred on ESOP debt.
5. The amount that is contributed to the ESOP.
6. The amount of dividends on ESOP shares used for debt service by the ESOP.
Moreover, the SEC wants registrants to discuss the potential impact of leveraged ESOPs in the results of operations and liquidity section of management discussion and analysis of financial condition and results of operations, as required by item 303 of regulation S-K. Item 303 requires a discussion of material events that would cause reported financial information not to be indicative of future operating results or future financial condition. [Tabular Data Omitted]
JOHN GRAVES, CPA, director-technical services, and MOSHE S. LEVITIN, CPA, technical manager, of the American Institute of CPAs technical information division.
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|Author:||Levitin, Moshe S.|
|Publication:||Journal of Accountancy|
|Date:||Mar 1, 1990|
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