ESOP accounting

[Guest LAT RBS]

Good afternoon,

I have a client who is setting up an ESOP. My understanding is this will be a leveraged plan via an employer loan. However, my client has become very sketchy on explaining the actual accounting transactions for the following 1) the actual transference of stock from the company to the ESOP (a separate entity) and 2) how the monthly contributions to the ESOP will be accounted for.

Can someone shed some light as to the typical DR's and CR's both B/S and I/S that I would expect to see?

Also, a few other items in which they could not explain:

1) How is the employee's investment growing if a) the plan contributions remain at a constant level year after year and 2) the employer is receiving the debt service from the contributions being made?

2) If the outside investments being made result in negative earnings, the debt incurred to cover those investments is then the responsibility of whom to cover?

The last two questions made be a bit specific to my client, but if it is general enough, I would appreciate feedback.

Regards,

LAT

[QDROphile]

The ESOP Association and the National Center for Employee Ownership web sites have education materials available to help you understand how leveraged ESOPs work.

[Marcus R Piquet]

Dear LAT,

The Sponsor's GAAP accounting for the ESOP is very unique. The accounting is governed by the AICPA's Statement of Position 93-6. In a nutshell:

1) The debt of the Trust is booked as a liability (credit) on the sponsor's books and the offsetting entry is a debit to a contra-equity account called Unearned ESOP Shares;

2) The annual contributions are "redefined" as the average fair market value of shares released from suspense in a given year; this adjustment is made by plugging your ESOP Compensation Expense (could be DR or CR) with an offsetting entry to APIC (could result in negative APIC).

That being said, that is just the beginning of the potential complexities. Your client should consider consulting a CPA firm that has significant experience with GAAP ESOP accounting. At the least they could make sure that the transaction is booked properly and teach them how to account for the plan on an ongoing basis. Most CPA firms do not have that kind of experience. Please email me or give me a call if you need more specifics on the accounting, as it would take far too long to explain it all here.

As for your next question, as the employer makes contributions to the plan (which the plan returns to the employer in the form of debt service), the shares purchased with that debt are released from collateral and allocated to the participants. The participants effectively see annual employer contributions as an increase in the number of shares in their stock account. Furthermore, shares allocated in previous years are revalued annually in accordance with an independent appraisal of company shares, so the participants will also see an increase (or decrease) in the value of previously-allocated shares.

I'm not sure I understand your final question. What do you mean by "outside" investments? Are you referring to investments made outside the ESOT? If the sponsoring company makes investments which perform poorly and is forced to incur debt to cover that poor performance, this will negatively affect the appraised value of the company stock which will impact the ESOP participants because their stock is subject to annual valuation. When you refer to "covering" the debt, the ESOT is not legally obligated to service the employer's debt, and using plan assets to service the employer's debt would be a prohibited transaction. Please clarify this question a bit.

Best regards,

Marcus Piquet

ProfESOP Group LLC

Roorda, Piquet & Bessee, Inc. CPA's

[Guest LAT RBS]

Marcus,

Thank you for your reply.

In regard to the "outside" investments, I mean, the owner is taking a part of the contributions already made and investing in marketable securities. The ESOP is cutting him a check in which he will invest. Over time, I understand, that he will be able to borrow against the invested securities, from the investment firm, up to 90%. That loan is then to be re-invested in additional securities. Any monies earned on the investments that he collects is to partially help him pay the debt service of the loan against the securities. However, the residual monies is where I am unclear as to the ownership of. You answered quite a bit by the ESOT not being obligated to cover the debt service, but is there an obligation that the investments being made by the owner going back into the ESOP?

And if I may just re-visit the accounting of the contribution for a minute and emplore your help there as well. My client is making a set amount monthly contribution to the ESOP. The client states the contribution from the company books is an expense item, but I do not understand the offsetting entry. I would assume it would be a credit to cash; however, the client states there is no cash transferring. Where that may be true, I do not understand how that can be. Reason being, the owner is being paid from the ESOP from the contributions. Which would have to be in cash. But if no cash is transferred from the company to the ESOP, how does cash get to the owner?

Again, thank you for your insight and I apprecaite any additional information you may be able to share.

Regards,

Lynn

Dear LAT,

The Sponsor's GAAP accounting for the ESOP is very unique. The accounting is governed by the AICPA's Statement of Position 93-6. In a nutshell:

1) The debt of the Trust is booked as a liability (credit) on the sponsor's books and the offsetting entry is a debit to a contra-equity account called Unearned ESOP Shares;

2) The annual contributions are "redefined" as the average fair market value of shares released from suspense in a given year; this adjustment is made by plugging your ESOP Compensation Expense (could be DR or CR) with an offsetting entry to APIC (could result in negative APIC).

That being said, that is just the beginning of the potential complexities. Your client should consider consulting a CPA firm that has significant experience with GAAP ESOP accounting. At the least they could make sure that the transaction is booked properly and teach them how to account for the plan on an ongoing basis. Most CPA firms do not have that kind of experience. Please email me or give me a call if you need more specifics on the accounting, as it would take far too long to explain it all here.

As for your next question, as the employer makes contributions to the plan (which the plan returns to the employer in the form of debt service), the shares purchased with that debt are released from collateral and allocated to the participants. The participants effectively see annual employer contributions as an increase in the number of shares in their stock account. Furthermore, shares allocated in previous years are revalued annually in accordance with an independent appraisal of company shares, so the participants will also see an increase (or decrease) in the value of previously-allocated shares.

I'm not sure I understand your final question. What do you mean by "outside" investments? Are you referring to investments made outside the ESOT? If the sponsoring company makes investments which perform poorly and is forced to incur debt to cover that poor performance, this will negatively affect the appraised value of the company stock which will impact the ESOP participants because their stock is subject to annual valuation. When you refer to "covering" the debt, the ESOT is not legally obligated to service the employer's debt, and using plan assets to service the employer's debt would be a prohibited transaction. Please clarify this question a bit.

Best regards,

Marcus Piquet

ProfESOP Group LLC

Roorda, Piquet & Bessee, Inc. CPA's

[BeckyMiller]

First - it is best practices for your client to actually cut a check to the ESOP for the debt and have the ESOP give the money back. I know it is a nuisance but it makes it easier upon any IRS or DOL audit and it keeps the record straight on who is the fiduciary, at least with respect to that action.

Now the entries:

Cash into ESOP

Compensation cost for the principal portion

ESOP interest for the interest portion

Cash

Cash back from ESOP (if the loan is between the ESOP and the sponsor)

Cash

Unearned ESOP shares for the principal

ESOP Interest for the interest income

I am assuming that you have an inside loan, because otherwise, you would have to be cutting checks.

At the end of the year, you need to true up this entry for an difference between the principal payments made and the original cost of the shares released. That entry goes between ESOP compensation cost and Unearned ESOP shares and, as noted above, the market value adjustment. That goes between ESOP compensation cost and APIC.

If you have to capitalize costs into inventory or self-constructed assets, the ESOP costs are also part of the costs subject to such capitalization.