ESOP: Financial Statement Audits

An Employee Stock Ownership Plan, by definition, is a qualified retirement plan consisting of either a stock bonus or a stock bonus/money purchase combination plan, which is designed to invest primarily in qualifying employer securities. It is a defined contribution plan which maintains individual accounts for each participant, and each participant’s eventual benefit is determined by the amount of allocations to his account, the investment performance of the account, and allocation of forfeitures, and administrative expenses incurred.
 
The AICPA Audit Guide, “Audits of Employee Benefit Plans”, devotes only about a dozen pages to ESOP plans, on the theory that ESOP plan audits should follow the general guidance applicable to all defined contribution plans. Where ESOPs are different, the Audit Guide provides a brief discussion of those differences:

Valuation of Stock

If the sponsor’s stock is not publicly traded, it’s fair value must be established by appraisal, generally on an annual basis. For an auditor, the appraisal is critically important for the fair presentation of the plan’s assets, amounts allocated to participants’ accounts, and benefit expense for retiring/terminating participants. The Audit Guide chapters on fair value measurement and using the work of an expert are particularly relevant to testing these areas.

Prohibited Transactions

ESOPs invest primarily in qualified securities of the plan sponsor, which requires that normal diversification rules and certain prohibited transaction rules do not apply. Leveraged ESOPs may borrow funds from the sponsor or from a third party, to acquire those securities, also based on a statutory PT exemption.

Plan Debt

For a leveraged ESOP, debt is an integral feature, and the audit must include appropriate tests of debt balances, payments, interest accruals, and compliance with debt covenants.

Fiduciary Responsibility

Actually, the Audit Guide does not address any fiduciary concerns unique to ESOPs, and that is surprising. Payment of an incorrect benefit amount based on an incorrect valuation is a fiduciary violation, as described in EPCRS guidance. And recent litigation has focused on ESOPs that continued to hold sponsor stock when the prudence of such holdings became questionable.

And that’s pretty much all the AICPA Audit Guide has to say.  

But wait. There’s more

The IRS has a lot to say about ESOPs - well over 100 pages in its Examination Guide, which offers a good outline on how ESOPs function, what unique tax rules apply, and how an IRS examiner should verify compliance with those rules.
 
For a look at what the IRS considers important about ESOPs, download a copy for yourself.