New math for ESOPs.

• Author: Akresh, Murray S.
• Position: Employee stock ownership plans - Includes related article

Under the new ESOP rules, your employees are in for some changes in their earnings, so get set for a crash course in fair-value accounting.

Sharpen your pencils and fire up your calculators, because new ESOP accounting rules have arrived. The Accounting Standards Executive Committee, the rule-making body of the American Institute of Certified Public Accountants, has issued Statement of Position 93-6, effective for fiscal years beginning after December 15, 1993 (the first quarter of 1994 for companies with calendar-year ends). This set of complex new accounting rules puts a whole new spin on ESOP accounting procedures, and the ramifications reach far beyond financial reporting. That's why it's important for financial executives to understand the requirements of SOP 93-6 and its implications.

SOP 93-6 requires you to measure compensation based on the fair value of the ESOP shares committed to be released rather than the cost of the shares to the ESOP. This accounting also applies in situations where companies use ESOPs to settle or fund other employee benefits, such as a 401(k) match (a KSOP) or contributions to a profit-sharing plan.

The SOP also changes accounting procedures for dividends and earnings per share. Before, all ESOP shares were considered to be outstanding. Therefore, dividends on shares the ESOP held were charged to retained earnings, and the shares were outstanding for EPS purposes. By contrast, the SOP requires that only dividends on allocated ESOP shares be charged to retained earnings. Dividends on unallocated shares are now charged to compensation if you pay them to participants or account for them as debt reduction or accrued interest, if you use them for debt service (effectively charging compensation expense for all dividends on unallocated shares). Likewise, only shares committed to be released are considered outstanding for EPS purposes. Earnings per share are also affected by the increased compensation expense.

As shown in the illustration on page 47, which is based on one of the Statement of Position illustrations, the new rules will increase compensation expense in two important ways. First, dividends on unallocated shares used for debt service no longer reduce compensation expense, and the compensation expense is based on the fair value of shares, increasing the expense if that value is turns out to be greater than the cost of the shares.

However, the illustration doesn't show the effect of the increased...