ESOP Company Audit Guide: ASC 718-40 and Plan Accounting

An ESOP-owned company puts two audits in front of the same CPA firm: the sponsor's financial statements, where ASC 718-40 sets compensation cost and equity presentation, and the plan's own audit, where the central evidence is the value of company stock that no market prices. Both depend on the same appraisal.

ASC 718-40 for the sponsor

ESOP shares fall under ASC 718-40, not the general share-based payment guidance. The model for a leveraged ESOP, where the plan borrows to buy shares, works like this.

Compensation cost. The sponsor records compensation cost as shares are committed to be released, measured at the current fair value of the shares committed to be released. Expense recorded in earlier interim periods is not restated for later fair value changes, so a fall in value does not reverse earlier cost.

Shares committed to be released. Shares are not outstanding for basic and diluted EPS until they are committed to be released. For the sponsor the commitment reduces the unearned ESOP shares balance, with the debit to compensation expense or to dividends payable, depending on the purpose of the release.

Unearned ESOP shares. A contra-equity account for shares the ESOP holds that have not been released. Where stock is classified outside permanent equity, a proportional amount of the account is classified the same way.

Dividends.

• Dividends on allocated shares are charged to retained earnings.
• Dividends on unallocated shares paid to participants or added to their accounts are compensation expense.
• Dividends on unallocated shares used for debt service reduce the ESOP's loan rather than being expensed.

Repurchase obligation. In a private company ESOP, participants can require the company to buy back distributed stock. Section 409(h) of the Internal Revenue Code requires a put option under a fair valuation formula, exercisable for at least 60 days after distribution of the stock and, if not exercised, for an additional period of at least 60 days in the following plan year. Where plan terms set the repurchase price at fair value as of the preceding plan year-end, no compensation charge arises from the difference between that price and current fair value.

Distribution timing follows section 409(o): payment begins no later than one year after the close of the plan year in which the participant separates by reason of normal retirement age, disability or death, and for other separations no later than the fifth plan year after separation.

The valuation

For stock without a recognized market, the adequate consideration standard under ERISA section 3(18)(B) is fair market value determined in good faith by the trustee or named fiduciary under the plan's terms and Department of Labor regulations. It is the condition for the ERISA 408(e) exemption that covers ESOP stock purchases. The DOL released a proposed adequate consideration regulation on January 16, 2025, but it was withdrawn before Federal Register publication, so no regulation defines the process. The proposal described it as selecting a qualified independent appraiser, overseeing a written report that rests on complete, current and accurate information, and reviewing the report to confirm it can be relied on. Use it as a benchmark for the trustee's process, not as a requirement.

The auditor does not set value. The auditor evaluates whether the appraiser is qualified and objective, tests the data, and assesses methods and assumptions. Treat the valuation as an accounting estimate under AU-C 540, and consider an auditor's specialist. See also the related 409A valuation guide for how appraisals are read.

The plan audit

A plan with about 100 or more participants with balances at the start of the plan year is a large plan and attaches an audit report to Form 5500; an 80-120 rule applies near the line. Closely held employer stock usually cannot be certified by a qualified institution, so the limited-scope option does not cover it and the appraisal and trustee process become central. For calendar-year plans, Form 5500 is due July 31, and Form 5558 filed by that date extends it to October 15. Read 401(k) and benefit plan audit requirements and limited-scope audits.

Risk areas

1. Valuation date alignment. The appraisal date must match the plan measurement date, so financials, allocations and stock value tie.
2. Appraiser independence and documentation of how the trustee chose the firm.
3. Projections. Aggressive revenue or margin forecasts in the appraisal.
4. Participant data. Records that do not reconcile to the trust statement.
5. Leveraged loan records. The loan, suspense account and release calculations.
6. Repurchase obligation. Cash flow capacity to buy back stock as participants retire, and liquidity disclosure.
7. Operation versus plan document. Eligibility, vesting and allocations as written.
8. Missing trustee minutes or valuation reviews.

Audit procedures

• Reconcile shares held by the ESOP to the transfer agent or stock ledger, and to the trust statement.
• Recompute shares released for the year from the loan amortization and the release formula.
• Recompute compensation cost as shares committed to be released multiplied by current fair value, and agree unearned ESOP shares to the rollforward.
• Test dividend classification by share category.
• Read the appraisal and the trustee's written review, and agree the valuation date.
• Test the repurchase liability and disclosure, including the company's ability to fund it.
• For the plan: test contributions, participant allocations, distributions and the per-share price used for each.

Worked example

Example: A company's ESOP borrows $5,000,000 and buys 100,000 shares at $50. The loan is repaid over 10 years, so 10,000 shares, 10 percent, are released each year.

• Year 1 average fair value is $60. Compensation cost is 10,000 times $60, or $600,000.
• Unearned ESOP shares fall by 10,000 times $50, or $500,000, the cost basis of shares released.
• The $100,000 difference is credited to additional paid-in capital.

At year-end the appraisal values the stock at $52. The auditor tests the number against the appraiser's report. Year 2 expense then depends on the value when those shares are committed to be released. The $600,000 recorded in year 1 is not reversed.

PBC items to request

• ESOP plan document, trust agreement and loan agreements
• Valuation reports and the trustee's written review
• Share ledger, release schedule and participant allocation reports
• Trust statements and participant census
• Repurchase obligation analysis and cash flow forecast
• Trustee and board minutes
• Form 5500 drafts and prior-year audit report

See the PBC list guide.

Red flags

• Valuation increasing while the business weakens
• Valuation dates that do not match the plan year-end
• Repurchase price above plan terms
• Trustee approval with no documented challenge of the appraiser
• Participant counts that do not reconcile

Sources

• PwC Viewpoint, Stock-based compensation guide, Chapter 11 on ESOPs: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/stockbased_compensat/stockbased_compensat__3_US/Chapter-11--Employee-stock-ownership-plans-ESOps-added-September-2019/115_Questions_and_interpretive_responses_17.html
• 26 U.S.C. 409 (Cornell Legal Information Institute): https://www.law.cornell.edu/uscode/text/26/409
• U.S. Department of Labor EBSA fact sheet, proposed rule on adequate consideration (released January 16, 2025): https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/notice-of-proposed-rulemaking-relating-to-application-of-the-definition-of-adequate-consideration
• Holland & Knight, "The Rise and Fall of the DOL's Long-Anticipated Proposed Regulation" (February 2025), on the withdrawal: https://www.hklaw.com/en/insights/publications/2025/02/the-rise-and-fall-of-the-dols-long-anticipated-proposed-regulation

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error