The Employee Ownership Update
November 25, 2003
FASB Clarifies When ESOP Shares Must Show as Balance Sheet LiabilityIn 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.
FASB Says Closely Held Companies Can Choose Intrinsic Value or Fair Market Value of Equity CompensationAt a November 11 meeting, the Financial Accounting Standards Board (FASB) tentatively proposed that, when accounting for equity compensation awards, closely held companies be able to choose between the intrinsic value method for accounting (the approach now being used by almost all closely held companies) or the fair value method (the method that would require equity awards to be expensed based on an assessment of their present value at the time of grant). While companies could choose either method, FASB said that the fair value method would be the "preferred" approach.
While the proposal may seem to be a significant concession to closely held companies, the intrinsic method would require companies to use variable accounting under APB 25, which means they would have to adjust their expenses to reflect changes in the value of the options. For most closely held companies, this would not be an improvement over expensing at fair value.
Bill to Limit Options Expensing IntroducedBarbara Boxer (D-CA), Mike Enzi (R-WY) and other Senators have introduced the "Stock Option Accounting Reform Act" to limit the implementation of stock options expensing rules by the Financial Accounting Standards Board. The bill would:
- Limit expensing to the top five named officers of a company.
- Exempt businesses with under $25 million in revenues and $25 in market value, with these businesses retaining that exemption for three years after an IPO.
- Require that expensing ignore volatility and allow companies to "true-up" options expenses for actual experience with forfeitures.
- Mandate a study by the SEC on the impact of expensing, with a special focus on the impact on broad-based ownership.