FASB Clarifies When ESOP Shares Must Show as Balance Sheet Liability

In FSB FAS 150-4, the staff of the Financial Accounting Standards Board (FASB) has stated that "if the employer must redeem, then the shares meet the definition of mandatorily redeemable shares under FAS 150," requiring that the obligation to buy back those shares show up as a liability on a company's balance sheet. ESOP companies that are S corporations or whose bylaws or articles of incorporation restrict ownership of "all or substantially all" of a company's issued and outstanding shares to employees or an ESOP trust may require that company stock be resold to the company or the ESOP. The new staff ruling indicates that FAS 150's requirement that the repurchase of these shares show up as a balance sheet liability would apply to these companies with a mandatory redemption. There is no obligation to record a liability while the shares are in the plan, however, as also clarified by the staff in the memo.

In Statement FAS 150-3, FASB indefinitely postponed the effective date of these new rules from accounting periods after December 15, 2004. This does not mean that the requirement will not be imposed, but FASB recognized many issues remain unresolved.

For ESOPs, it now appears that if a company cashes out the shares while they are still in the plan, then pays the employee the cash, that would not require accounting under FAS-150. Companies may have to provide an employee the choice to be paid out in shares, however, although few would choose that. Companies can also write their plans without an mandatory redemption rule. Because employees very rarely want to sell their stock to someone other than the plan or the company, and the company still has a right of first refusal, this would rarely be an issue. The main potential problem would be for larger ESOP S corporations where enough employees would be leaving in any one year and not under a mandatory obligation to sell their shares back to the plan or company. These situations could cause the company to exceed the 75-shareholder limit for S companies.

It is still not clear just when the company must record the liability for distributed shares subject to FAS 150, but it appears the liability would only occur at the point after the employees has left the plan and taken stock that is subject to the mandatory obligation to sell the shares back to the company.