When a company decides to establish an ESOP, the company and its stakeholders should consider and understand the significant financial statement implications. A company may form two different types of ESOPs: a leveraged ESOP and a nonleveraged ESOP. Leveraged ESOP transactions are the most common transaction type in the formation of an employee-owned structure. After a 100% leveraged ESOP transaction, the formation greatly affects the company’s equity and debt, often decreasing the equity. All current and future financial statement users should understand the impact of these transactions to the financial statements, which allows the company to continue its operations successfully. During ESOP formation and afterward, the board of directors, management, lenders, bonding agencies, and customers all use the financial statements and often need to understand and assess the impact.
The purpose of this publication is to describe the basics of accounting for leveraged ESOP transactions so that all potential financial statement users can anticipate the accounting presentation and structure the transaction where possible to minimize any complications created by the accounting.
Table of Contents
Background on Specific ESOP Accounting Authority
Income Statement and Earnings per Share
Statements of Changes in Stockholders' Equity
Statements of Cash Flows
Contributions Paid in Advance of Required Debt Service
ESOPs and ASC 810: Variable Interest Entities
Other than the obvious increase in cash or other assets resulting from the financing aspect of certain plan structures, an ESOP has no direct effect on the asset side of the balance sheet. The assets of the plan are not reported as assets of the sponsor. If the sponsor has a note receivable from the plan because internal financing was used, that note receivable is not recorded as an asset; instead, it affects the equity section.
Under ASC 805-50, the employer has the option to apply pushdown accounting in an ESOP transaction in which there is a change in control related to the transaction. Per ASC 810-10-15, a controlling financial interest under GAAP is “as a general rule ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity.” There are additional factors to consider related to control based on the specific terms of the transaction agreement and governance of the employer and ESOP trust. Therefore, careful consideration should be given to identifying a change in control situation beyond 50% of the outstanding shares being held by the ESOP.
Where it has been determined there is a change in control, the acquirer, which in the case of an ESOP transaction is the ESOP trust, may elect to apply pushdown accounting in the employer’s financial statements. In applying this accounting treatment, the employer would record all of the assets and liabilities at fair value, record the liabilities incurred in the transaction, and record goodwill in a transaction in which the transaction price was greater than the fair value of the assets. If the transaction results in a bargain purchase, this would be recorded through equity of the employer.