Financial Accounting Standard #150
a.k.a. How to Lose Your Credit Relationships and Confuse Investors

The Financial Accounting Standards Board (FASB) recently issued FAS 150, Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity. At first glance, you may not think this new standard will affect you and your privately-held company. If your company has a stock redemption agreement, you have reason to be concerned about this new standard.

The pronouncement covers financial instruments. A financial instrument can be stock, membership interests in limited liability companies, and partnership interests. A mandatorily redeemable financial instrument (MRFI) will be classified as a liability unless the redemption is required to occur only upon the liquidation or termination of the reporting entity. A financial instrument issued in the form of shares is mandatorily redeemable if it embodies an unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date or upon an event certain to occur.

Since death is an event “certain to occur,” a stock redemption agreement that obligates the company to redeem a stockholder's stock upon the death of the stockholder makes the stock an MRFI. In most situations, all of the stock of an entity is an MRFI since redemption agreements cover all stockholders. As a result, the entire equity section of the balance sheet (if the redemption price equals total equity) could potentially be reclassified to a liability on the balance sheet and titled “shares subject to mandatory redemption.” In other words, the equity section just turned into a liability. Going forward, the equity detail previously disclosed on the balance sheet will be disclosed in the notes to the financial statements. In order for the stock to not qualify as an MRFI, the stockholder agreement would need to include a “right of first refusal” provision.

For mandatorily redeemable financial instruments of a nonpublic entity, FAS 150 shall be effective for existing or new contracts for fiscal years beginning after December 15, 2003. As a result of both public and private industry comments, the FASB has agreed to amend FAS 150 to delay the effective date until fiscal years beginning after December 15, 2004 for mandatorily redeemable stock issued by nonpublic entities. Issuance of this amendment is expected before December 31, 2003.

The impact of this pronouncement will effect loan covenants, bonding, and succession planning. The delay in implementation should provide more time for impacted entities to meet with bankers, bonding agents, and other users of the financial statements to modify borrowing arrangements and other contracts that may be effected by FAS 150. (For example, lending agreements may need to stipulate the exclusion of FAS 150.)

Please keep in mind that we have provided only a summary of the new standard. Please give us a call if you are concerned that your business may be impacted by FAS 150. As a result of the planned delay in implementation, we have the opportunity to plan for this change and minimize the impact to you and your business.

Mary F. Actor, CPA
Director of Assurance Services