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11.4 Accounting for ESOPs
Publication date: 30 Nov 2022
us Stock-based compensation guide
ASC 718-40 applies to all employee stock ownership plans, including those used to settle or fund liabilities for specified employee benefits, such as an employer's 401(k) plan matching contribution.
11.4.1 Accounting for nonleveraged ESOPs
Under ASC 718-40, employers that sponsor a nonleveraged ESOP should account for the arrangement as follows:
- Employers should report compensation cost equal to the contribution called for in the period under the plan.
- The shares contributed or acquired with the cash contributed should be allocated to participant accounts as of the end of the employee stock ownership plan's fiscal year and held by the ESOP until distributed to the employees at a future date, such as on the date of termination or retirement.
- Employers should generally charge dividends on shares held by the ESOP to retained earnings as described in ASC 718‑40‑25‑20.
11.4.2 Accounting for leveraged ESOPs
Under ASC 718-40, employers that sponsor a leveraged ESOP should account for the arrangement as follows:
- The issuance of new shares or the sale of treasury shares to the employee stock ownership plan should be recorded when the issuance or sale occurs, and should report a corresponding charge to unearned ESOP shares, a contra-equity account.
- Employers should recognize compensation cost equal to the fair value of the shares for those ESOP shares committed to be released to compensate employees directly.
ASC 718-40 uses the concept of "committed to be released" shares, which are "shares that, although not legally released, will be released by a future scheduled and committed debt service payment and will be allocated to employees for service rendered in the current accounting period." The legal release of shares generally does not occur until debt payments are made, but employee service to which the shares relate is continuous.
ASC 718-40 notes that the period of service to which the shares relate is generally defined in the ESOP documents. The shares are deemed to be committed to be released ratably during the accounting period as the employees perform services, and, accordingly, average fair values are used to determine the amount of compensation cost to recognize each reporting period. - For ESOP shares used to settle or fund liabilities for other employee benefits, employers should report satisfaction of the liabilities when the shares are committed to be released. Compensation cost and liabilities associated with such benefits should be recognized in the same manner as they would if an ESOP had not been used to fund the benefit.
- Employers should charge dividends on allocated and committed to be released shares to retained earnings; dividends on unallocated shares should be treated as a payment of debt or accrued interest or as compensation cost, depending on whether the dividends are used for debt service or paid to participants.
- For ESOP shares committed to be released that are designated to replace dividends on allocated shares used for debt service, employers should report the satisfaction of the liability to pay dividends when the shares are committed to be released for that purpose.
- Employers should credit the contra-equity account “unearned ESOP shares” as the shares are committed to be released, based on the original cost of the shares to the ESOP. The difference between the amount reported for compensation expense (the fair value of the shares committed to be released) and the amount credited to the contra-equity account (i.e., the cost of the shares to the ESOP) should be charged or credited to shareholders' equity in the same manner as gains and losses on sales of treasury stock (see ASC 505-30-30-5 through ASC 505-30-30-10).
- Employers should report redemptions of ESOP shares as purchases of treasury stock.
- Employers should report loans from outside lenders to their ESOPs as liabilities on the balance sheet and should report the related interest cost on the debt. Employers with internally leveraged ESOPs should not report the loan receivable from the ESOP as an asset and should not report the ESOP's debt from the employer as a liability, or recognize interest income or cost on the employer loan.
11.4.2.1 Recognition upon termination of an ESOP
ASC 718-40-40-7 states that the release of remaining suspense shares to participants upon termination of an employee stock ownership plan results in a charge to compensation in accordance with ASC 718-40-25-11 through ASC 718-40-25-14. It further states "compensation cost should equal the fair value of the shares at the date the ESOP debt is extinguished because that is when the shares are committed to be released."
However, ASC 718-40 defines "committed to be released shares" as "the shares that, although not legally released, will be released by a future scheduled and committed debt service payment." This definition implies that shares may be committed to be released prior to the extinguishment of ESOP debt and, therefore, a compensation charge could be recorded prior to the date of the debt extinguishment (i.e., at the time the shares are committed to be released in accordance with ASC 718-40-25-12).
As the definition in ASC 718-40 of "committed to be released shares" addresses situations other than termination of the ESOP, the guidance in ASC 718-40-40-7 should be followed only when accounting for a termination of an ESOP. In all other cases, the guidance in ASC 718-40-25-12 should be followed.
11.4.3 Commitments to make future contributions to an ESOP
Employers typically make cash contributions to employee stock ownership plans, either to fund debt service for a leveraged plan or to purchase shares that will be allocated to participants' accounts in the current fiscal period for a nonleveraged plan. On occasion, an employer may commit to make additional contributions to the ESOP (either leveraged or nonleveraged) in the future to purchase additional shares of the entity's stock, which will be allocated to the participant accounts of those employees providing service in the year the contributions are made. This may be the result, for example, of consideration for the plan trustees agreeing to extend the terms of an ESOP loan. Under ASC 718-40-25-13, compensation expense should only be recognized when the shares are committed to be released to participants, the definition of which includes allocation to employees providing service in the current accounting period, not just the commitment to make a cash payment. In this case, no expense should be recognized in the current year. It is the commitment to release shares based on service in the current accounting period, not the employer's cash contribution or commitment to make a future contribution, which represents the economic transfer of compensation to participants in exchange for service.
As noted in ASC 718-40-25-3 through ASC 718-40-25-6, if the employer decides to make an additional stock contribution and those shares are unallocated until some future date, the entity should report the share issuance as a reduction of shareholders' equity, as if they were treasury stock with a corresponding charge to unearned employee stock ownership plan shares (contra-equity). As such, until there is a commitment to release and allocate the shares to participant accounts, no compensation expense should be recorded. This is consistent for both leveraged and nonleveraged ESOPs.
Additionally, the balance sheet should not reflect a liability to the ESOP for a commitment by the employer to contribute additional consideration to the ESOP in the future nor a receivable by the ESOP for the employer’s commitment. In ESOP accounting, an entity typically eliminates transactions between the employer and the ESOP, and accounts for only external transactions. This is described in ASC 718-40-25-9(b), which explicitly calls for the elimination of any loans between the employer and the ESOP, as well as ASC 718-40-40-3, which states that, if the employer makes a contribution to the ESOP or pays dividends on unallocated shares that are used by the ESOP to repay the debt, the employer should charge the debt and accrued interest payable only when the ESOP makes the payment to the outside lender. As a contractual loan between the employer and ESOP plan is eliminated and not reflected as a payable by the employer, we similarly do not believe that the employer should reflect a commitment (even if legally binding) to make additional cash contributions to the ESOP plan in the future in exchange for future service as a liability.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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