ESOP Accounting Guide: What You Need to Know

Employee stock ownership plans (ESOPs) are a terrific benefit to employees and a smart financial tool for many businesses, but they do impact company financial statements in unique ways. In this post, we provide a quick primer on ESOP accounting so you can better understand these impacts.

ESOP Accounting Authority and Background

Both leveraged and non-leveraged ESOPs must follow GAAP principles as governed by the Financial Accounting Standards Board (FASB). ESOPs specifically fall under Accounting Standards Codification (ASC) Subtopic 718-40. This subtopic relates to stock compensation and equity awards. The most important point to understand about Subtopic 718-40 is that it requires that all equity awards granted to employees and nonemployees be accounted for at “fair value.”

ESOP Accounting Basics

How do I record ESOP expenses?

ESOP expenses are accounted for as a liability on the balance sheet. ESOP compensation expenses should be reported based on the fair market value of the shares that were released during the reporting period.

How does an ESOP affect the balance sheet?

Of the three parts to a balance sheet, ESOPs only affect liabilities and equity. ESOPs do not affect the assets section since plan assets are not reported as sponsor assets.ESOPs can create the appearance of excessive liability on a company’s balance sheet because accounting rules do not allow companies to record ESOP inside loan receivables as an asset. As a result, the balance sheet reflects not only an increased liability, but also reduced company equity.

Is ESOP an expense?

ESOP contributions do appear as an expense on the balance sheet, specifically, as compensation expenses.

What type of account is an ESOP?

The IRS classifies ESOPs as IRC section 401(a) qualified defined contribution retirement plans that are stock bonus plans.

Considering Accounting in ESOP Transactions

Businesses that are considering forming an ESOP should discuss the plan with a CPA who is familiar with ESOPs to understand exactly how an ESOP will affect their financial statements. This is particularly important for companies that will create leveraged ESOPs because lenders will be examining these financial statements closely. This is one reason why it is helpful to work with lenders who are familiar with the ins and outs of ESOPs and how these plans can affect financial documents and amount of debt liability a business appears to have.

Accounting for Leveraged ESOPs

Most ESOPs begin as leveraged ESOPs. Leveraged ESOPs borrow funds to purchase shares from the company owner who is selling to the ESOP and subsequently to the selling shareholders in later stages as an ESOP matures. These shareholders are typically plan participants who are retiring and seeking their distributions.

• Record Debt as a Liability. According to ASC 718-40, leveraged ESOPs must record the debt of the ESOP as a liability. Any shares that are purchased should be recorded as a contra equity account on the balance sheet. The contra-equity accounting remains in place until the shares are no longer used as collateral against the borrowing. As debt is repaid, the liability is reduced and shareholder equity increases.
• Contributions Classified as Compensation Expenses. Amounts contributed to the ESOP each year are accounted for as compensation expenses. The dollar amount value of these expenses is based on the fair market value of the shares the year they are released from the suspense account. Any dividends paid also qualify as compensation expenses.
• Accounting for Interest. Any interest on those contributions must be separately identified and charged as interest expense.
• Using the Footnotes. Plan sponsors should use the footnotes section of the financial statements to disclose the debt’s terms, interest rate, and other significant information concerning the guarantee.

Accounting for Non-Leveraged ESOPs

Since non-leveraged ESOPs do not borrow funds to acquire company stock, the accounting is simplified. Non-leveraged ESOPS are funded directly by the employer via cash contributions or stock grants.  

• Shares and Cash Contributions are Compensation Expenses. Newly issued shares, cash contributions to the plan, or dividends are classified as compensation expenses on the balance sheet. The reported amount is equal to the cash contribution or, if shares, the fair market value of the shares on the date they were contributed to the plan. In non-leveraged ESOPS, all contributions will qualify as tax deductions for the plan sponsor.
• Using the Footnotes. Again, the footnotes should be used to provide relevant information about ESOP funding. This may include: the company’s ESOP funding policy, who the ESOP covers, and the amounts contributed and charged as expenses during the reporting period.

Contact Aegis For ESOP Guidance  

Aegis Trust Company is not a CPA and nothing in this post should be taken as financial advice. We recommend consulting with a CPA who is familiar with ESOPs for financial advice related to ESOP accounting. To learn more about ESOPs, visit our ESOP blog. For additional information and guidance about ESOP transactions or trustee services, contact the Aegis team.