Two months ago the Financial Accounting Standards Board (FASB) was headed toward approving an accounting standard that could have been devastating for thousands of closely held trucking firms. But in early November it abruptly reversed course.
FASB is a private, nonprofit entity that issues standards for accounting that all companies using generally accepted accounting principles (GAAP) are expected to adopt. The standards take the form of numbered “Statements' (FASs) that are first issued as discussion drafts. Draft “Staff Positions” (FSPs) typically accompany an FAS to illustrate how it is applied in different situations. Both are posted on the Board's website (www.fasb.org) for a comment period and may be extensively modified before final adoption.
FAS 150 deals with “accounting for certain financial instruments with characteristics of both liabilities and equity.” One category of such hybrids in the case of closely held companies is “mandatorily redeemable” financial instruments. These include shares issued to principal owners that require the company to buy back, or redeem, the shares if the stockholder leaves or dies. Typically, these agreements stipulate a share price or a method for determining the price.
FAS 150 takes the position that because the company has an obligation to buy back the stock, the difference between that price and the book value of the shares is a liability. Companies often take out life insurance policies on major stockholders in an amount sufficient to cover the expense. But, under FAS 150, the value of the life insurance is not an offsetting asset because the date that the policy pays off is not known with certainty.
As many commenters pointed out, the upshot of this mismatch is that the entire net worth of many closely held companies would be wiped out. Companies without net worth would be unable to qualify for credit or for the sureties that most public contracts require.
FSP 150-3, issued November 7, defers the effective date of FAS 150 for mandatorily redeemable financial instruments issued by most companies, specifically, nonpublic companies not registered with the SEC. For instruments that must be redeemed on fixed dates for amounts that either are fixed or determined by reference to an external index, provisions of FAS 150 are deferred for one year, until after December 15, 2004. For all other mandatorily redeemable financial instruments, provisions of FAS 150 are deferred indefinitely, pending further Board action.
Another category of mandatorily redeemable shares is stock issued to employees in an employee stock ownership plan (ESOP). In FSP 150-4, also posted November 7, FASB stated that “ESOP shares or freestanding agreements to repurchase those shares are not within the scope” of FAS 150, because they are covered by earlier guidance.
The net effect of these two FSPs is to relieve many trucking companies of cumbersome, possibly crippling accounting standards — at least until Lap Three begins, after the FASB studies the issue further.
The bottom line: As I discussed in this column two months ago, FASB is not a government agency, and its pronouncements are “voluntary.” But it can have a life-or-death impact on any company that needs to follow GAAP accounting to win contracts, loans, or other business. Therefore, it pays to keep an eye on how FASB's Statements and Staff Positions affect your company, and to explain that impact to FASB. FAS 150 bears watching in particular, because there are more changes ahead, either in late 2004 or “pending Board action.”