EBPAQC Audits of Employee Stock
Ownership Plans
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1
Employee Benefit Plan
Audit Quality Center
Audits of Employee Stock
Ownership Plans
Live Forum
April 20, 2010
2
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3
Presenters
Becky Miller, CPA
McGladrey & Pullen, LLP
David Bogus, ASA
Ellin and Tucker, Chartered
Hal Hunt, CPA
Mayer Hoffman McCann P.C
Mark Swanson, Esq.
Crowe Horwath LLP
.
4
Audit and Accounting Issues
•
•
•
•
•
•
Introduction to ESOPs
Common prohibited transactions
Leveraged ESOPs
Tax considerations
Stock valuation issues
Financial statement presentation
5
Introduction to ESOPs
Mark Swanson
Senior Manager
Crowe Horwath LLP
6
Introduction
• What is an ESOP?
– Employee benefit plan that must satisfy all
requirements of a qualified plan (IRC and DOL)
– Designed to invest primarily in employer
securities
– May borrow money to purchase employer
securities
7
Introduction
• ESOPs
– Provide an employee benefit
– Technique of corporate finance
– Business perpetuation
– Provide market for privately held / thinly traded stock
– Provide liquidity for estates of business owners
– Business acquisition technique
8
Introduction
• Benefits to Employee-Participants
– Employees not currently taxed on contributions
when contributed and allocated
– Taxation of earnings and contributions deferred
until distributed.
9
Introduction
• Benefits to Plan Sponsor
– Contributions are deductible
– Potential deductions for dividends paid to ESOP
– Possible elimination of federal income tax at corporate
and shareholder level
– Provide employees with incentives to enhance
productivity and profitability.
10
Introduction
• Benefits to Selling Shareholder(s)
– Provide market for shares
– Provide potential to realize higher value for shares
– Can control timing of transaction: Sell all at once
or over time
– Selling shareholder may be able to retain effective
control
– Ability to defer gain on sale under Sec. 1042.
11
Introduction
• Items to Note
– Different provisions can apply to C Corp ESOPs
and S Corp ESOPs
– For purposes of S Corp 100 shareholder rule,
the ESOP trust is treated as one shareholder.
12
Introduction
• Conclusion to Introduction:
– ESOPs are a great tool when used in appropriate
situations
– Provide a level of flexibility to meet needs to employeeparticipants, plan sponsor and selling shareholder.
13
Prohibited Transactions
Becky Miller, CPA
McGladrey & Pullen
LLP
14
Prohibited Transaction Implications for
ESOPs
• Remember, AG Chapter 11 on party-in-interest
transactions illustrates GAAS
• Potential ESOP issues
–
–
–
–
–
–
–
–
–
Purchase of stock
Sale of plan’s stock
Loan to acquire stock
Failure to follow plan or loan terms
Failure to follow prohibited transaction exemption
conditions on loan
Refinancing
Plan Termination
Application of dividends to debt service
Application of accumulated funds in ESOP to debt service
15
Commonly Encountered PTs
• Valuation not as of the transaction date
– No roll forward to the actual date
– Failure to recognize that purchase of stock by sponsor
out of the plan to fund distributions is subject to the
transaction date valuation rule
– Creative approach see PTE 2003-32
• Failure to properly release shares
– Principal only method when not eligible
– Principal and interest method, incorrectly calculated
– Some other disallowed method – e.g. fair market value
method
16
Commonly Encountered PTs
• ESOP loan not adequately documented
• ESOP appraisal not sufficient
• Special S corporation limitations not satisfied §4975(f)(6)(B)(ii) only works on a sale to a plan, not a
purchase from the plan
• Application of allocated dividends to debt service fails
the “return for value” standard – IRC §§ 404(k) and
4975(f)(7)
– This is the tax concept of “allocated” meaning dividends on
shares released from collateral and allocated into participant
accounts
17
Auditor’s Duties on Party-in-Interest
Transactions
• Gain an understanding of the transaction
• Gain an understanding of the applicable ERISA
exemption
• Compare the two for any inconsistencies
– Reconcile any inconsistencies
•
•
•
•
Document such effort in the file
Document the conclusions in the file
Report any PTs on the ERISA schedules
Material PTs will require discussion in the related party
footnote
18
Forms of ESOP Stock Purchase
Financing
• Direct loan – between lender and ESOP
– Commercial lenders
– Seller financing
– Participant puts of shares back to ESOP for note from ESOP
• Indirect or 2-step loan
– Lender to plan sponsor, sponsor to ESOP
– Mirror terms are not required
• Internal loan
– Sponsor to ESOP with no associated borrowing by sponsor
19
Indirect ESOP Structure
Chart
20
Direct Loan - Seller Financing ESOP
Structure
Chart
21
Share Release Formulas
• Standard – Principal and interest method
Number of shares
released
=
Number of shares held in
suspense account before X
release for current year
P and I for current year
__________________________
P and I for current year plus P
and I due for all future years
• Exception – Principal only method
– Release shares equal to the percentage of
principal paid
22
Other Potential Non-Exempt
Transaction Issues
•
•
•
•
•
•
Purchase of stock from plan to fund distributions
Dividends applied to debt service
Prepayments of debt service
Use of accumulated funds for debt service
Refinancing ESOP debt
Terminating an ESOP
23
Purchase of Shares
• Most plans distribute cash, not stock
• Distributions typically take place after annual
administration is completed – 3 to 9 months after
year-end
• Purchases from plan by a PII must be for not less
than FMV on the date of the transaction.
24
Dividends for Debt Service
• Only dividends on shares acquired with debt
• Dividends on allocated shares may only be used
where the FMV of the stock returned in exchange
for the use of such dividends is not less than the
dollar value of the dividends so applied
– Can use shares released from dividends paid
on unallocated shares to make up any
difference.
25
Prepayments of Debt Service
• Technically a refinancing unless loan agreement permits
such action
• Watch loan terms
– Typically apply to interest then principal
• Collateral release
– If principal only – no problem
– If principal and interest – changes denominator
• Watch for Excel© failures
26
Use of Accumulated Funds for Debt
Service
• Debt service limited to:
– Collateral
– Employer contributions for Debt Service and
earnings thereon
– Dividends on shares acquired with the debt and
earnings thereon
27
Refinancing of ESOP Debt
• Exclusive Benefit requirement
• Field Assistance Bulletin 2004-1
28
ESOP Terminations
• Sale of stock
• Cancellation of debt
• Holdbacks on purchase price
– Can’t take a receivable from the new plan
sponsor
– Typically holdback is deposited in cash in an
escrow account
29
Tax Considerations
Mark Swanson, Esq.
Senior Manager
Crowe Horwath LLP
30
Tax Considerations
• Topics:
– Deduction Limits
• C Corp
• S Corp
– Section 415
– S Corp ESOPs: Section 409(p)
– Diversification: Section 401(a)(28)
31
Tax Considerations
• Deduction Limits
– Note differences for C and S Corporations
– C Corp
• Contributions used to pay principal can be as high
as 25% of participant compensation
• No limit on deduction for loan interest
• Separate deduction limit for ESOP contributions to
pay principal and deduction for contribution to other
qualified plans
32
Tax Considerations
• Deduction Limits (continued)
• Dividends paid on stock held in ESOP deductible if:
– Reasonable: What’s reasonable? General rule is amount of
dividend Sponsor can reasonably expect to pay on a
recurring basis
– Paid in cash directly to or through ESOP to participants
– Reinvested in employer securities (if participants have been
given election to receive dividend in cash); or
– Used to repay ESOP loan on shares (allocated and
unallocated) aquired with the loan being repaid. Dividends
on allocated shares subject to ‘fair market value’ test.
33
Tax Considerations
• Deduction Limits (continued)
– Fair Market Value Test:
If dividends on shares allocated to
participant accounts are used to make loan repayments, shares with a fair
market value at least equal to the dividends must be allocated to
participant accounts.
• Example: Fair Market Value = $16 / share
– $200,000 loan repayment. $100,000 is a dividend. 10,000 shares released
from suspense account of which 5,000 are attributable to dividends.
– Fair market value of shares released with dividends = $80,000
– Allocation would be based on 6,250 shares allocated on basis of dividends
and remaining 3,750 shares allocated based on employer contribution.
Check plan document to determine how shares are allocated based on
dividends and employer contribution.
34
Tax Considerations
• Deduction Limits (continued)
– S Corp
• Contributions used to pay principal and interest limited to 25% of
participant compensation
• No separate deduction limit for ESOP contributions and contributions to
other plans
• While not a deduction issue per se, S Corp distributions may be used to
repay the ESOP loan. Distributions on shares allocated to participant
accounts that are used for loan repayments are subject to the fair market
value test.
35
Tax Considerations
• Deduction Limits (conclusion)
– Both C and S Corp
• Contributions exceeding 415 limits are not deductible
• Nondeductible contributions subject to 10% excise tax
under IRC Sec. 4972.
36
Tax Considerations
• Section 415
– Limits annual additions to participant accounts in all plans
sponsored by the employer to the lesser of 1) 100% of the
participant’s compensation or 2) 49,000 (2010).
– Includes 401(k) deferrals (but not catch up contributions).
– If plan permits, shares released from suspense account can be
valued at lesser of fair market value or contribution.
– Special Rule for C Corps: If no more than 1/3 of the employer
contribution applied to principal and interest is allocated to highly
compensated employees, the contribution attributable to loan
interest and reallocation of forfeitures of leveraged shares aren’t
treated as annual additions.
37
Tax Considerations
•
S Corp ESOPs: Section 409(p) Anti-Abuse Rules.
– Simple result of a complex test: Disqualified Persons (DP’s) cannot own more than
50% of the S-Corp ESOP shares, non-ESOP shares and Synthetic Equity.
– Consequences of a violation have been termed “draconian.”
• Corporation pays 50% excise tax on prohibited allocations and 50% excise tax
on fair market value of synthetic equity held by a DP
• Prohibited allocations treated as distributions to individual and subject to taxes
and penalties.
• Prohibited allocations include:
– Stock and stock related allocations made to DPs during year of failure
– Stock and stock related balances in DP accounts at the beginning of the
year
38
Tax Considerations
•
Section 409(p) (continued)
– Defining the Key Terms: DP and Deemed-Owned Shares
• Disqualified Person (DP)
– Individual who owns 10% of all Deemed-Owned shares
– Member of family owning 20% of all Deemed-Owned shares
• Deemed-Owned shares include:
– ESOP shares: actual and pro-rata share of suspense shares
– Synthetic Equity:
» Determined by reference to shares
» Determined by reference to deferred compensation
» Determined by reference to rights to acquire interests in certain
related entities
– Deemed -Owned shares do not include stock directly owned by the
individual or family
39
Tax Considerations
•
Section 409(p) (continued)
– Defining the Key Terms: Synthetic Equity
• Synthetic Equity that is determined by reference to shares
– Warrants
– Options
– Restricted Stock
– Deferred issuance stock right
– Payments based on share value or appreciation such as phantom stock and SARs.
– Person entitled to the Synthetic Equity is treated as owning the corresponding
number of shares of stock
• Synthetic Equity that is determined by deferred compensation
– Includes right to receive property in a future year or transfer of property still subject
to vesting at the end of the plan year of transfer
– Remuneration under and arrangement deferring compensation to a date more than 2
½ months following the entity’s taxable year.
– Converted into shares by taking present value of deferred compensation / FMV of
stock
40
Tax Considerations
• Section 409(p) (continued)
– Defining the Key Terms: Synthetic Equity
• Synthetic Equity that is determined by reference to rights to
acquire interests in certain related entities
– Includes right to acquire stock or similar interest in a
related entity where:
» The related entity is the only significant assets of the S
Corp; and
» The S Corp is the only significant owner of that related
entity
41
Tax Considerations
•
Section 409(p) (continued)
– Defining the Key Terms: Synthetic Equity
• Pro-rata rule: If ESOP owns less than 100% of the S-Corp, shares of
synthetic equity = percentage owned by ESOP
• Synthetic Equity Example :
– ESOP owns 35% of S-Corp shares with a FMV of $100.
– CEO has option to purchase 100 shares
– CEO entitled to $100,000 in 10 years under nonqualified deferred
compensation plan. The present value is $60,000 using 5%
discount rate. Value of synthetic equity is 600 shares ($60,000 /
$100).
– CEO is considered owning 245 shares as synthetic equity
((100+600)*35%).
42
Tax Considerations
•
Section 409(p) (continued)
– Defining the Key Terms: Synthetic Equity
• CAUTION : When share price drops, Synthetic Equity based on deferred
compensation can ‘sneak up’ and possibly cause nonallocation year.
• Example:
– ESOP owns 35% of S-Corp shares. FMV dropped from $100 to $50.
– CEO has option to purchase 100 shares
– CEO entitled to $100,000 in 10 years under nonqualified deferred
compensation plan. The present value is $60,000 using 5% discount rate.
Value of synthetic equity is 1,200 shares ($60,000 / $50).
– CEO is considered owning 455 shares as synthetic equity
((100+1,200)*35%).
43
Tax Considerations
• Section 409(p) (continued)
– Defining the Key Terms: Family Member
ANY ANCESTOR
WHO’S ALIVE**
ANY ANCESTOR
WHO’S ALIVE**
BROTHER** OR SISTER**
INDIVIDUAL BEING TESTED
SPOUSE
BROTHER** OR SISTER**
ANY LINEAL DESCENDANT**
ANY LINEAL DESCENDANT**
ANY LINEAL DESCENDANT**
ANY LINEAL DESCENDANT**
** Plus spouse of this person
44
Section 409(p) Example
40% ESOP
0
Synthetic
Equity (Prorata)
0
DP % w/
Synthetic
Equity
18.00%
Synthetic
Equity
DP with
Synthetic
Equity?
Yes
Total ESOP
& Deemed
Owned
Shares for
DP
18,000
A
ESOP Shares
18,000
DP %
18.00%
DP ?
Yes
B
12,500
12.50%
Yes
0
0
12.50%
Yes
12,500
C
10,000
10.00%
Yes
0
0
10.00%
Yes
10,000
D
7,500
7.5%
No
52,500
21,000
23.55%
Yes
28,500
52,000
-
0
0
52.00%
-
0
0.00%
125,000
50,000
33.33%
Yes
Others
E
No
50,000
Total DP
Total
48,000
100,000
71,000
177,000
119,000
277,500
Total DP% 42.88% (119,000 / 277,500)
45
Tax Considerations
• Section 409(p) (conclusion)
– Correction/Preventive Measures
• Plan document includes procedure for transferring stock to a
non-ESOP account within an ESOP to prevent a violation.
• Shares transferred results in UBTI but can be paid by
redeeming shares out of the non-ESOP account.
• Exchange, reallocate or recharacterize assets if there is
reasonable possibility nonallocation year will occur without
taking action. This usually involves exchanging shares in DPs
accounts for assets other than company stock held in non DP
accounts.
• Eliminate or change the Synthetic Equity
46
Tax Considerations
• Diversification (IRC Sec. 401(a)(28))
– Allows participants to reduce risk of having too much
allocated to employer stock
• A Qualified Participant must be permitted, during the
Qualified Election Period, to diversify a certain
percentage of their employer stock.
• Applies only to shares acquired after 1986 if plan so
provides.
47
Tax Considerations
•
Diversification (continued)
– Qualified Participant
• Age 55 and 10 years of participation in the ESOP.
– Definition of “Years of Participation” can be elusive. Does it
include years after termination of employment or just years which
eligible for contribution? Absent specific definition in plan, most
conservative approach is to count service while an inactive
participant.
• Recent request for technical assistance issued by the IRS National
office to the “ESOP Cadre” indicates that unless the plan contains an
acceptable definition, a year of participation includes all years (or
parts thereof) in which the participant had an account balance.
48
Tax Considerations
• Diversification (continued)
– Qualified Election Period
• 6 Years
• Starts with plan year after becoming a qualified participant
• Election made in 90 day period following end of plan year and
can be revoked or modified during the 90 day period.
• Participant’s election must then be implemented within 90 days
after the close of the election period.
• Example:
– Calendar year plan. Participant becomes qualified
participant in 2009. Initial election period is January 1 –
March 31, 2010. Participant’s election implemented April 1
– June 30, 2010.
49
Tax Considerations
• Diversification (continued)
– Shares eligible to diversify
• First 5 election periods: 25% of the shares ever
allocated to the participant’s account less previously
diversified shares.
• 6th election period: 25% is increased to 50%.
• No diversification required if amount subject to
diversification is less than $500. Note: This really
means that the shares ever allocated and subject to
diversification are less that $500.
50
Tax Considerations
•
Diversification (continued)
– Implementing election
• Transfer within ESOP:
– Must contain 3 investment options “not inconsistent with regulations
prescribed by the Secretary.” Interpreted to mean 3 diverse investment
options within the meaning of 404(c).
– Not ‘recommended’ option due to participant directed investment
requirements and fiduciary liability regarding monitoring investment
options.
• Transfer to another plan sponsored by Employer
– 3 investment options required
– Best to track as separate source
– Usually viable alternative when Sponsor has 401(k) plan.
• Permit distribution to participant
– Can be rolled to IRA
– Subject to 10% penalty if participant not 59 ½.
51
Tax Considerations
•
Diversification (continued)
– Practical Considerations
• Election period: 90 days following end of plan year. Election applies to shares
allocated as of end of plan year preceding election period. Balances may not
be available.
• Implementation period: 90 days following end of election period. Share value
may not be known.
• Shares eligible for diversification: 25% (50%) of shares ever allocated less
shares previously …. Shares ever allocated would include shares previously
distributed, reallocated to other accounts or otherwise transferred.
• Less shares previously …. Notice 88-56 states “***; less the number of shares
previously distributed, transferred, or diversified pursuant to a diversification
election. Does this mean shares previously distributed or transferred for any
reason or just shares that were distributed or transferred pursuant to a
diversification election? Conservative approach would be to reduce shares
that were previously diversified.
52
Valuation
David Bogus, ASA
Principal
Ellin and Tucker,
Chartered
53
Standard of Value for Valuation
Purposes
•
•
•
•
The ESOP may not pay more than “adequate consideration” for employer company
stock.
ERISA defines adequate consideration as the “fair market value” of the asset (company
stock) as determined in good faith by the trustee.
DOL proposed regulations define fair market value as “the price at which an asset
would change hands between a willing buyer and a willing seller when the former is not
under any compulsion to buy and the latter is not under any compulsion to sell, and
both parties are able, as well as willing, to trade and are informed about the asset and
the market for such asset.”
The IRS sets forth a similar definition for fair market value as “the price at which
property would change hands between a willing buyer and a willing seller when neither
is acting under compulsion and when both have reasonable knowledge of relevant
facts.”
54
Standard of Value for GAAP
Purposes
•
•
•
•
•
ASC 820 (formerly SFAS 157) establishes “fair value” as the standard of
value.
Provides a single authoritative definition of fair value for financial reporting.
Establishes a framework for making fair value measurements.
Fair value is defined as “the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date.”
Market participants are independent of the reporting entity, knowledgeable,
able to transact and willing to transact.
55
Entry Price Versus Exit Price
•
ASC 820 describes fair value from the perspective of an exit (sale)
price rather than an entry (purchase) price.
• Exit price is to be considered from the perspective of market
participants in the principal (or most advantageous) market for the
asset or liability.
• The principal market trumps the most advantageous market.
56
Highest and Best Use of an Asset
•
A fair value measurement also assumes the highest and best use of
an asset from the perspective of market participants, regardless of
intended use.
• It also requires considering that the use of the asset is: (i) physically
possible; (ii) legally permissible; and (iii) financially feasible.
• Highest and best use is based on the use of the asset and generally
results in maximizing the value. As such, the valuation premise may
be either “In-Use” or “In-Exchange.”
57
Fair Value Hierarchy
• ASC 820 specifies a hierarchy approach to determining fair value
based on Level I, Level II or Level III inputs.
• Level 1 – Inputs are observable market inputs that reflect quoted
prices for identical assets or liabilities.
• Level 2 – Inputs are observable market inputs other than quoted
prices for identical assets or liabilities (i.e. quoted prices for similar
assets, quoted prices for identical assets in markets that are not
active).
• Level 3 – Inputs are unobservable market inputs.
58
Valuation Approaches
• Cost (or Asset) Approach
• Income Approach
• Market Approach
59
Cost Approach
• A general way of determining a value indication of a
business, business ownership interest, or security by
using one or more methods based on the value of the
assets of that business net of liabilities.
• Based on the economic principle of substitution.
• Least commonly applied approach for valuing ESOP
shares.
60
Income Approach
• A general way of determining a value indication of a business,
business ownership interest, security, or intangible asset using one or
more methods that convert anticipated benefits into a present single
amount.
• Based on the economic principle of anticipation (expectation).
• Direct capitalization method – the capitalization (i.e. the division by an
appropriate rate of return) of a constant or a constantly changing
stream of economic income.
• Yield capitalization – the present value of a non-constant stream of
projected economic income.
61
Market Approach
• A general way of determining a value indication of a business,
business ownership interest, security, or intangible asset by using
one or more methods that compare the subject to similar businesses,
business ownership interests, securities, or intangible assets that
have been sold.
• Based upon the related economic principals of competition and
equilibrium. That is, in a free and unrestricted market, supply and
demand factors will drive the price to a point of equilibrium.
62
SAS No. 73 – Using the Work of a
Specialist
•
•
•
•
•
SAS No. 73 provides guidance to the auditor who uses the work of a specialist
in performing an audit in accordance with GAAP.
The auditor should consider various factors when evaluating the professional
qualifications of the specialist.
The auditor should obtain an understanding of the nature of the work
performed or to be performed by the specialist.
What if the auditor believes the findings of the valuation specialist are
unreasonable?
What if the valuation specialist currently engaged by the ESOP was engaged
by either the company and/or the selling shareholder to perform similar
(valuation) services prior to the formation of the ESOP?
63
SAS No. 101 – Auditing Fair Value
Measurements and Disclosures
• The auditor should obtain an understanding of the entity’s process for
determining fair value measurements and disclosures.
• The auditor should evaluate whether the fair value measurements and
disclosures are in conformity with GAAP.
• What if auditor requests a copy of the valuation report? Should it be
provided? Who should provide it?
• See “White Paper on Recommended Procedure for ESOP Companies
in Response to Auditors Request for ESOP Valuation Report.”
Prepared by a Task Force of The ESOP Association’s Interdisciplinary
Advisory Committee on Fiduciary Issues for members of The ESOP
Association.
64
ERISA Requirements
•
•
IRC 401(a) requires annual valuation of ESOP shares.
Form 5500 questions include: (i) whether any non-cash contributions
(i.e. closely-held stock) were made to the plan, the value of which was
set without an appraisal by an independent third party; and (ii)
whether the plan holds any non-publicly traded securities that were
not appraised by an independent third-party.
• A problem may exist if “YES” is the answer to any of the above.
65
Guidance for Determining Value
• Revenue Ruling 59-60 provides methods for valuing shares of stock of
closely-held corporations for estate and gift tax purposes. However,
the factors may be used to determine values of assets in qualified
plans.
• Examination steps of determined value.
• When appropriate, stock values should be discounted due to a lack of
marketability and, if appropriate, a control premium should be added
to the stock value.
66
Typical Valuation Questions
• Determination of multiples from guideline
public company method
• Reliance/use of management forecasts
• Application of premiums and/or discounts
• Terminal value calculation in discounted
cash flow analysis
67
Timing of Valuation
• DOL regulations require that fair market value be determined as of the
date of the ESOP transaction.
• Typical annual valuations for ESOP administration purposes are
typically done the last day of the plan year.
• What if the ESOP purchases, or sells, shares of company stock during
the following year?
68
ESOP Plan Accounting and
Financial Reporting
Hal J. Hunt, CPA
Partner
Mayer Hoffman McCann P.C.
69
ESOP Plan Accounting and Financial
Reporting Topics for Discussion
• GAAP for ESOP Plans
• Leveraged ESOP Plan Financial Statement
Presentations
• Reconciliation to Participant Accounts
• ESOP Plan Footnotes
• Other ESOP Accounting and Financial Reporting
Matters
• Resources
70
GAAP For ESOP Plans
• A&A Guide Chapter 3 GAAP for defined
contribution plans (FASB ASC 962, Plan
Accounting–Defined Contribution Pension Plans)
• Topic 962 prescribes the general form and
content of financial statements of these plans
• A&A Guide Appendix E.Ill, Illustrations of
Financial Statements: Employee Stock
Ownership Plans (See Exhibits E-7, E-8 and E-9)
71
GAAP For ESOP Plans
• Other GAAP may also apply to defined
contribution plans (ESOPs) as described on
the following slides
72
GAAP for ESOP Plans
 FASB ASC 820, Fair Value Measurements
and Disclosures
 FASB ASC 825, Financial Instruments (as it
relates to ESOP debt obligations) may
require additional disclosures about
financial instruments such as fair value,
concentrations of credit risk and market
risk
73
GAAP for ESOP Plans
However, Topic 825 applies to all entities but is
optional (FASB ASC 825-10-50-3) for an entity that
meets all of the following criteria:
 the entity is a nonpublic entity and
 the entity's total assets are less than $100 million on
the date of the financial statements and
 the entity has no instrument that, in whole or in part, is
accounted for as a derivative instrument under Topic
815
74
Leveraged ESOP Plan Financial
Statement Presentation
A&A Guide Appendix E.III, Illustrations of
Financial Statements: Employee Stock
Ownership Plan, Exhibit E-7
• Unallocated - Shares and other assets
available as collateral on loan
• Allocated - Shares and other assets released
from collateral
75
Leveraged ESOP Plan Financial
Statement Presentation
A&A Guide Appendix E.III, Illustrations of Financial Statements: Employee Stock Ownership Plan,
Exhibit E-7 footnote 1:
•
The columns reflected in the example are appropriate for the presentation of a leveraged ESOP. For
a nonleveraged ESOP, the presentation would reflect only the total column without the segregation
between allocate and unallocated.
•
Allocated and unallocated designations distinguish between assets that belong to plan participants
and those that are still available as collateral for the ESOP loan. Under the Employee Retirement
Income Security Act of 1974 (ERISA), the lender has access to the securities held by the plan, that
represent unallocated employer contributions to service the debt, and any earnings on those
amounts. Earnings on temporary cash investments also are available to the lender.
•
An accrued employer contribution for current or future debt service is, therefore, reflected on the
Statement of Net Assets Available for Benefits and the Statement of Changes in Net Assets Available
for Benefits in the Unallocated column. In contrast, an employer contribution accrued to fund
distributions to terminated participants is reflected in the Allocated column.
•
This distinction is not reflected in the participant account balances when reporting to the participant
under ERISA. Contributions accrued for future debt service are allocated to the accounts of plan
participants.
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Reconciliation to Participant
Accounts
• Non-leveraged ESOPs--net assets available to pay plan benefits
should reconcile to the sum of the participant accounts
• Leveraged ESOPs--a reconciliation from participant accounts to
allocated column on ESOP financial statements may be necessary and
common reconciling items include:
– Share release
– Accrued contribution for debt service
– Accrued dividends for debt service
– Interest expense
77
Reconciliation to Participant
Accounts
• Shares “Released” versus Shares “Allocated”:
– Shares are released when the contribution is made and applied to
debt service.
– Shares may be allocated at this same time or earlier, upon accrual
of contribution
– Contribution for current year debt service is allocated to
participants in the plan’s records
• Contribution revenue remains in “unallocated” column as it is
available to make payments on the loan
– Dividends on unallocated shares can be used for debt service
• Dividends on allocated shares also can be used for debt
service, but remain in the allocated column
78
Reconciliation to Participant
Accounts (Exhibit E-8 of the Guide)
a
b
c
d
e
f
g
h
Total Allocated at year end per F/S
$
Accrued Employer contribution for debt service
Accrued Dividends on collateral
Accrued interest expense
Total allocated per participant accounts
Total ESOP
$
FMV of Stock and Cash Held as Collateral 58,293,000
Debt -73,970,000
-15,677,000
Difference – net fair value of collateral
Reconciliation ( e - f + g )
35,616,000
8,607,000
459,000
-1,396,000
43,286,000
27,609,000
-15,677,000
0
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ESOP Plan Footnotes
• Plan Description and/or Summary of Significant
Accounting Policies Footnote to include:
–
–
–
–
–
–
–
Voting rights
Participant accounts—allocated and unallocated
Release of shares--principal and interest versus principal only
Put Option--Put to sponsor is not a plan transaction
Diversification
Valuation of company stock
Tax Status
80
ESOP Plan Footnotes
• Investment in Company Stock Footnote to
include:
– Number of shares—allocated and unallocated
– Cost of shares—allocated and unallocated
– Estimated Fair Value—allocated and
unallocated
81
ESOP Plan Footnotes
• Fair Value Measurements (Topic 820)
Footnote to include:
– Valuation methodologies
– Identification of plan assets and related Fair
Value Hierarchy Levels
– Reconciliation of Fair Value Level III assets for
the period(s)
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ESOP Plan Footnotes
A&A Guide Exhibit E-9, Note F entitled Fair Value Measurements:
The fair value of the XYZ company common stock held by the plan is valued at
estimated fair value based upon an independent appraisal. This appraisal was
based upon a combination of the market and income valuation techniques
consistent with prior years. The appraiser took into account historical and
projected cash flow and net income, return on assets, return on equity, market
comparables and estimated fair value of company assets and liabilities. The
preceding methods described may produce a fair value calculation that may
not be indicative of net realizable value or reflective of future fair values.
Furthermore, although the plan believes its valuation methods are appropriate
and consistent with other market participants, the use of different
methodologies or assumptions to determine the fair value of certain financial
instruments could result in a different fair value measurement at the reporting
date.
83
ESOP Plan Footnotes
A&A Guide Exhibit E-9, Note G entitled Loan Payable:
In 20XX, the plan entered into an $80 million term loan agreement with a bank.
The proceeds of the loan were used to purchase company's common stock.
Unallocated shares are collateral for the loan. The agreement provides for the
loan to be repaid over ten years. The estimated fair market value of the note
payable as of December 31, 20X2 and 20X1 was approximately $77 million and
$82 million, respectively, determined by using interest rates currently
available for issuance of debt with similar terms, maturity dates and
nonperformance risk. The scheduled amortization of the loan for the next five
years and thereafter is as follows: 20X3—$6.5 million; 20X4—$7 million;
20X5—$7.5 million; 20X6—$8 million; 20X7—$8.5 million; and thereafter—
$36.5 million. The loan bears interest at the prime rate of the lender. For 20X2
and 20X1 the loan interest rate averaged 7.34 percent and 5.12 percent,
respectively.
84
ESOP Plan Footnotes
 A&A Guide Exhibit E-9, Note H entitled Employer Contributions:
The company is obligated to make contributions in cash to the
plan which, when aggregated with the plan's dividends and interest
earnings, equal the amount necessary to enable the plan to make
its regularly scheduled payments of principal and interest due on
its term loan.
85
ESOP Plan Footnotes
A receivable from the employer must meet requirements of FASB ASC 960310-25-2:
Employer’s contribution receivables are amounts due as of the report
date. Amounts due include those pursuant to formal commitments and
legal obligations. Evidence of a formal commitment may include (a) a
resolution by the employer’s governing body approving a specific
contribution, (b) a consistent pattern of making payments after the plan’s
year-end pursuant to an established funding policy that attributes such
subsequent payments to the preceding plan year, (c) a deduction of a
contribution for federal tax purposes for periods ending on or before the
reporting date, or (d) the employer’s recognition as of the report date of a
contribution payable to the plan.
86
Other ESOP Accounting and
Financial Reporting Matters
• Other Regulatory Issues:
– SEC/PCAOB related to S-8 Registration of
ESOP shares and Form 11-K Filings
– An ESOP is required to register, and be
regulated, as a bank holding company before
acquiring control of 25 percent or more of any
class of voting securities of a bank or bank
holding company
87
ESOP Accounting and Financial Reporting
Resources
•
•
•
2010 AICPA Audit & Accounting Guide, Employee Benefit Plans – to be
available in May 2010
2010 Audit Risk Alert for Employee Benefit Plans – to be available in May 2010
EBPAQC Authoritative Accounting and Reporting Standards For Employee
Benefit Plans: FASB Accounting Standards Codification™
88
Question & Answer Session
Submit questions in the box on the left-hand
side of the screen
89
Upcoming Events
•
AICPA Annual Webcast on Employee Benefit Plans Strategic Briefing, April 28, 2010,
2:00 – 4:00 pm ET
•
AICPA National Conference on Employee Benefit Plans, Las Vegas, NV, May 11 – 13,
2010
•
AICPA Employee Benefit Plan Audit Workshop for Defined Benefit and Defined
Contribution Plans, March 29 – 30, 2010, Chicago, Illinois; July 26 – 27, 2010, New York,
New York
•
AICPA Annual Employee Benefit Plans Accounting, Auditing and Regulatory Update
Conference, Washington, DC, December 13 – 14, 2010
90
Employee Benefit Plan Audit Quality
Center
Thanks for Participating!
91