[Federal Register Volume 65, Number 180 (Friday, September 15, 2000)]
[Notices]
[Pages 56008-56010]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-23717]


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OFFICE OF MANAGEMENT AND BUDGET

Office of Federal Procurement Policy


Cost Accounting Standards Board; Accounting for the Cost of 
Employee Stock Ownership Plans

ACTION: Notice.

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SUMMARY: The Office of Federal Procurement Policy, Cost Accounting 
Standards Board, invites public comments concerning a Staff Discussion 
Paper on accounting for the cost of employee stock ownership plans 
(ESOP) under government contracts.

DATES: Comments must be in writing and must be received by November 14, 
2000.

ADDRESSES: All comments should be addressed to Dr. Rein Abel, Director 
of Research, Cost Accounting Standards Board, Office of Federal 
Procurement Policy, 725 17th Street, NW, Room 9013, Washington, D.C. 
20503. Attn: CASB Docket No. 00-03. The submission of public comments 
in writing, via letter, is requested, as receipt of a readable data 
file via Internet e-mail cannot be assured. To facilitate the CAS 
Board's review of submitted comments, you may include with your written 
comments a three point five inch (3.5'') computer diskette copy of your 
comments and denote the word processing format used.

FOR FURTHER INFORMATION CONTACT: Rein Abel, Director of Research, Cost 
Accounting Standards Board (telephone: 202-395-3254).

SUPPLEMENTARY INFORMATION:

A. Regulatory Process

    The Cost Accounting Standards Board's rules, regulations and 
Standards are codified at 48 CFR Chapter 99. Section 26(g)(1) of the 
Office of Federal Procurement Policy Act, 41 U.S.C. 422(g), requires 
that the Board, prior to the establishment of any new or revised Cost 
Accounting Standard, complete a prescribed rulemaking process. The 
process generally consists of the following four steps:
    1. Consult with interested persons concerning the advantages, 
disadvantages and improvements anticipated in the pricing and 
administration of Government contracts as a result of the adoption of a 
proposed Standard.
    2. Promulgate an Advance Notice of Proposed Rulemaking.
    3. Promulgate a Notice of Proposed Rulemaking.
    4. Promulgate a Final Rule.
    This proposal is step one of the four-step process.

B. Background and Summary

    In response to the Cost Accounting Standards (CAS) Board's 
continuing research, a number of commenters have identified accounting 
for the cost of employee stock ownership plans under government 
contracts as an issue requiring Board consideration. The primary 
concern raised is the lack of guidance concerning this matter in 
applicable government contracting regulations, and the attempt by the 
contracting parties, in certain cases, to apply various provisions of 
the CAS to accounting for the costs of ESOPs, when such CAS provisions 
do not explicitly address or even mention ESOPs. More specifically, 
issues have arisen in which the accounting for the cost of ESOPs have 
caused substantial controversies.
    This Staff Discussion Paper represents the results of research 
performed by the staff of the Cost Accounting Standards Board, and is 
issued by the Board in accordance with the requirements of 41 U.S.C. 
422(g)(1)(A). The statements contained herein do not necessarily 
represent the position of the Cost Accounting Standards Board.

C. Public Comments

    Interested persons are invited to participate by submitting data, 
views or arguments with respect to this Staff Discussion Paper. All 
comments must be in writing and submitted to the address indicated in 
the ADDRESSES section.

Nelson F. Gibbs,
Executive Director, Cost Accounting Standards Board.

Cost Accounting Standards Board Staff Discussion Paper--Issues 
Relating to Employee Stock Ownership Plans (ESOPs)

    The Cost Accounting Standards (CAS) Board is examining the 
accounting issues related to the measurement, assignment and allocation 
of costs associated with Employee Stock Ownership Plans (ESOPs) to 
government contracts. This Staff Discussion Paper (SDP) is part of the 
Board's deliberative process that may lead to a pronouncement by the 
Board on this topic. The purpose of this SDP is to solicit comments on 
the relevant issues.

Background

    The initial purpose of ESOPs was to encourage employee stock 
ownership of American industry. Such encouragement was contained in the 
Employee Retirement Income Security Act of 1974 (ERISA) and 
corresponding changes to the Internal Revenue Code. Congress has also 
commented on ESOP

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regulations dealing with the allowability of such costs for Government 
contract costing purposes. Specifically, the National Defense 
Authorization Act for fiscal year 1998 (Pub. L. 105-85, 844, Nov. 18, 
1997) included a section expressing the ``Sense of Congress'' on 
certain aspects of ESOP cost allowability.
    More recently, ESOPs have also been used for additional purposes. 
According to the Statement of Position (SOP) 93-6, issued by the 
American Institute of Certified Public Accountants (AICPA), these other 
purposes include the following:
     To fund a matching program for a sponsor's 401(k) saving 
plan, formula-based profit-sharing plan, and other employee benefits;
     To raise new capital or to create a marketplace for 
existing stock;
     To replace lost benefits from the termination of other 
retirement plans or provide benefits under postretirement benefit 
plans, particularly medical benefits;
     To be part of the financing package in leveraged buy-outs;
     To provide a tax-advantaged means for owners to terminate 
their ownership;
     To be part of a long-term program to restructure the 
equity section of a plan sponsor's balance sheet; and
     To defend the company against hostile takeovers.
    Although costs of ESOP sponsorship are not explicitly covered by 
CAS, guidance is included in Federal Acquisition Regulation (FAR), 
31.205-6(j)(8), and referred to in the Defense Contract Audit Agency 
(DCAA) Contract Audit Manual (Sec. 7-2114). These references either 
state or imply that a distinction exists between so-called ``pension'' 
and ``nonpension'' ESOPs.
    In general, the lack of a clear regulatory framework in this area 
has contributed to an environment in which a number of legal actions 
and other disputes have occurred between the Government and 
contractors. See, e.g., Ralph Parsons Co., ASBCA 37931, 91-1 BCA 23648, 
reconsideration denied 91-2 BCA 23751; Ball Corp., ASBCA 49118 (Apr. 3, 
2000).
    The CAS Board first considered the issue of accounting for ESOP 
costs at its May 1995 meeting, wherein it was decided to establish a 
case on this topic. At the Board's December 1995 meeting, the matter 
was further discussed and consideration was given to issuing an 
``interpretation'' on the topic. A draft interpretation was submitted 
by the staff to the Board at the Board's February 1996 meeting. In the 
ensuing Board discussion, the applicability of either CAS 9904.412 or 
CAS 9904.415 was identified as one of the major issues. Other issues 
discussed were the characterization of interest in leveraged ESOPs, and 
the valuation of shares that are released from the ESOP's suspense 
account and allocated to individual employee accounts. The Board 
determined that these issues were matters appropriate for the Board's 
consideration. The staff was instructed to continue with its research 
on this topic.
    As part of its research, the staff has consulted with various 
Government offices and other interested parties who have had experience 
with ESOPs. At the December 1998 open CAS Board meeting, the Director 
of Defense Procurement again urged the CAS Board to address the issue 
of accounting for the costs of ESOPs.

Discussion

    A discussion of the more prominent ESOP issues follows with 
questions on each subject. Commenters who believe that the questions 
contained herein do not adequately cover all pertinent aspects of the 
topic are encouraged to submit comments dealing with any additional 
issues.
    There are two forms of ESOPs--nonleveraged and leveraged. 
Contributions to a nonleveraged ESOP are generally allocated to 
individual participant accounts before the end of the sponsor's fiscal 
year. A leveraged ESOP uses borrowed funds to acquire shares in the 
sponsoring company which are then held by the ESOP in a suspense 
account for potentially extended periods, prior to their release to 
individual employee accounts. In a leveraged ESOP, some maintain that 
the employer's periodic contribution to the ESOP contains two 
elements--the cost of employee compensation and the cost of interest on 
borrowed funds.
    Even though CAS do not deal explicitly with the costs associated 
with ESOPs, the parties to some government contracts have applied the 
provisions in existing Standards to support their position with respect 
to ESOP treatment.
    While the arguments have varied, at least one assertion has been 
that if an ESOP can be regarded as a ``pension'' ESOP, then it falls 
under the provisions of CAS 9904.412, Composition and Measurement of 
Pension Cost. This makes it easier, so some believe, to assert that the 
total of a contractor's payment to the ESOP, including any interest 
element, should be regarded as employee compensation. Others have 
asserted that if an ESOP is classified as a ``deferred compensation'' 
ESOP then the appropriate Standard for application is CAS 9904.415, 
Accounting for the Cost of Deferred Compensation. In this case, some 
have asserted that the cost measurement should not include interest 
while others have asserted that it should include interest. Thus, 
different interpretations of the various provisions of CAS by the 
contracting parties have become an element in recent disputes 
concerning accounting for ESOP contributions.
    The question as to whether interest costs attributable to leveraged 
ESOPs should be reimbursed by the Government is a procurement policy 
issue with broad ramifications. However, this issue is not within the 
purview of the CAS Board. As stated in the CAS Board's Statement of 
Objectives, Policies and Concepts (May 1992):

    ``While the Board has exclusive authority for establishing 
Standards governing the measurement, assignment and allocation of 
costs, it does not determine the allowability of categories or 
individual items of cost. Allowability is a procurement concept 
affecting contract price and in most cases is established in 
regulatory or contractual provisions.''
    Although accounting for the costs of ESOPs is addressed in the FAR 
and in other guidance applicable to cost allowability issues in 
Government contracting, the topic has not been dealt with explicitly in 
any of the existing CAS Board Standards. Private sector accounting 
standard setters have addressed the topic for financial reporting 
purposes. The current Statement of Position (SOP) on the topic was 
issued by the AICPA in November 1993 as SOP 93-6. This SOP was issued 
after an extensive promulgation process that included the publication 
of an exposure draft which attracted a significant number of comments. 
The SOP provides guidance on both periodic compensation cost 
measurement and applicable disclosure. It states that compensation 
costs and interest on borrowed funds should be reported as separate 
items in financial statements.
    SOP 93-6 further states that the fair value prevailing at the time 
when the shares are ``committed to be released for allocation to 
participant accounts'' should be used for charging employee 
compensation costs when that was the purpose for which the shares were 
released. The SOP similarly provides that the cost of shares acquired 
or transferred to ESOPs should be valued on the date they were acquired 
or transferred. Any difference in value between the acquisition date 
and the date when the shares are released to the employee accounts is 
recognized as an

[[Page 56010]]

equity adjustment in the financial statements.
    At this point it may be useful to restate the CAS Board's position 
on pronouncements issued by other authoritative bodies established to 
issue guidance affecting accounting for financial and tax purposes. In 
its Statement of Objectives, Policies and Concepts (May 1992) the Board 
stated:

    ``The Board will continue taking those other pronouncements into 
account to the extent it can do so in accomplishing its objectives. 
However, the Board recognizes that the purposes of these 
pronouncements are not intended to meet the objectives of contract 
costing. Therefore the Board will retain and exercise full 
responsibility for meeting the objectives of contract costing.''

    In the light of this statement the first question may be stated as 
follows:
    1. Does GAAP (SOP 93-6) provide sufficient guidance for accounting 
for the costs of ESOPs for Government contract costing purposes? Please 
discuss the rationale of your answer to this question.
    If the answer to question 1, above, is no, then the Board would 
like to receive comments as to whether one of the existing CAS does or 
could be expanded to provide adequate guidance.
    As noted earlier, CAS have been applied to these issues by the 
various parties to the Government contracting process. As there has not 
been any direct reference to ESOPs in any of the Standards, a party 
applying CAS to ESOP accounting must first identify a Standard that 
would be applicable in a particular instance. In general, the choice 
has been between CAS 9904.412 and CAS 9904.415.
    To develop criteria for distinguishing the circumstances in which 
either of these two Standards may be applicable, two different types of 
ESOPs have been identified. The first type embraces the so-called 
``pension ESOPs'' which are distinguished principally by the 
characteristic that they offer their participants, benefits for life. 
All other ESOPs are referred to as ``nonpension'' or ``deferred 
compensation ESOPs.'' In practice, it appears that the provisions of 
CAS 9904.412 have been applied to the first group of ESOPs, while the 
provisions of CAS 9904.415 have been applied to the second group. This 
attempt to distinguish between pension and deferred compensation ESOPs 
seems to be a categorization that is currently found only in the field 
of Government contract cost accounting. In the broader context, when 
accounting for ESOPs is discussed, this particular categorization is 
not used. Therefore, the question arises as to whether this distinction 
between pension and deferred compensation ESOPs is an approach that 
should be included in any future CAS Board promulgation on this topic.
    2. Do you believe that distinguishing between ``pension'' and 
``deferred compensation'' ESOP type is useful in the Government 
contract costing environment and that this feature should be included 
in any future CAS Board promulgation on this topic? Please include the 
rationale for your answer to this question.
    3. If you believe that a distinction between ESOP types is useful 
and should be included in any future CAS promulgation do you also 
believe that amendments, or an interpretation, to CAS 9904.412 and/or 
CAS 9904.415, is the appropriate action for the Board to take?
    Another area where differing opinions exist, concerns the 
measurement date for determining the fair value of shares released to 
employee accounts. Some ESOPs hold shares of the sponsor company in a 
suspense account for the purpose of subsequent distribution to 
employees. It is likely that the fair value of these shares will change 
while the shares are held in the suspense account prior to being 
transferred to individual employee accounts. Accordingly, two different 
dates have been suggested as measurement dates for the purpose of 
determining the fair value of the shares released to individual 
employee accounts.
    The FAR, at section 31.205-6(j)(8), stipulates that ``* * * the 
value of the stock contribution shall be limited to the fair market 
value of the stock on the date that the title is effectively 
transferred to the trust.'' The FAR provisions do not, however, address 
what valuation applies on the date when shares are actually released to 
employees for determining individual employee compensation costs. In 
other words, the FAR implies that the cost of the shares at the time of 
their acquisition by the ESOP should also be used as their fair value 
at the time of their release to individual employee accounts.
    4. Do you believe that the fair value of the shares released by an 
ESOP to individual employee accounts should be established at the date 
when the title to these shares is transferred to the ESOP or should it 
be the date when the shares are committed to be released to employee 
accounts? If you would like to propose a different date or a modified 
version of the two dates referred to above, please explain.
    The cost allocated to contracts may also be different depending on 
what is to be measured--the cost to the company or the amount of 
compensation received by the employee. The compensation received by the 
employee is the fair value of the shares or other consideration 
received by the employee. The cost to the company may be measured 
differently depending on whether the cost is measured as (1) the fair 
value of the shares on the date the sponsor transfers the shares to the 
ESOP; (2) the fair value of the shares on the date the ESOP purchases 
the shares; (3) the amount of the sponsor's cash contribution to the 
ESOP; or (4) a combination of the above.
    5. For contract costing purposes, should a distinction be made 
between measurement of the ``cost to the company'' or measurement of 
compensation ``received by the employee?'' Please explain. If a 
distinction should be made, please also comment on the method that 
should be used to measure this amount.
    In certain circumstances when CAS 9904.415 has been applied to 
accounting for ESOPs, further disputes may occur. CAS 9904.415 
identifies two different methods for determining the present value of 
future benefits depending upon the method of settling the deferred 
compensation obligation.
    CAS 9904.415-50(d) provides guidance for the calculation when the 
settlement ``is to be paid in money,'' while CAS 9904.415-50(e) 
provides guidance when ``the compensation is received by the employee 
in other than money.'' These two approaches, CAS 9904.415-50(d) and 
(e), generally produce different present values of the future benefit 
and hence, different cost for contract costing purposes.
    6. Should the form of payment of ESOP benefits to the employee make 
a difference in measuring the cost allocable to Government contracts? 
If so, how should the cost be determined?

[FR Doc. 00-23717 Filed 9-14-00; 8:45 am]
BILLING CODE 3110-01-U