FAS 150: You're off the hook - for now

By Randy Bonnecaze

The construction business recently got some good news. The Financial Accounting Standards Board (FASB) decided to indefinitely postpone implementing some provisions of its Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (FAS 150).

The provisions are controversial because they call for companies to recognize liabilities and expenses related to buy-sell agreements with mandatorily redeemable shares. These types of agreements are common succession planning tools for privately held construction companies. And recognizing the items mentioned may significantly lower equity.

Why the changes? In this post-Enron era, regulators and legislators alike want to make financial statements more practical for end users and more transparent to the public. The idea behind FAS 150 is that a company's balance sheet should more accurately reflect the potential effect of its buy-sell agreement's mandatory provisions.

Currently, the potential liability and expense associated with buy-sell agreements don't affect either the balance sheet or income statement. Businesses should recognize liabilities when they can be reasonably estimated and are certain to occur. And because buy-sell agreements are carefully crafted to provide the shareholder and the company with a defined payout to deal with a succession, these agreements typically meet the qualifications for a liability.

What could happen? But if all of FAS 150's provisions are implemented, the equity of many businesses will take a big hit because they will have to record the redeemable stock's value as a cumulative effect of a change in accounting principle. Doing so would reduce income (and thereby equity) in the year of recognition with a corresponding recognition of a liability. (This recognition may require annual adjustment, depending on the methods used to determine value in the buy-sell agreement.)

Although many companies use life insurance contracts to cover the full amount of their buy-sell agreements' future liability, insurance benefits would be considered gain contingencies, which are not recognized until receipt. Therefore, businesses could not use them to offset the recognition of the recorded liability.

The bottom line for you? Sureties often grant bonding lines based on the amount of a company's equity. But if the value of your redeemable shares is significant, your equity could easily go from a healthy amount of retained earnings to a deficit. And with less equity comes a lower bonding capacity.

How can you prepare? Now that FASB has postponed implementing these provisions, you may want to take the opportunity to revisit your buy-sell agreement. One potential coping measure is to recharacterize your agreement's mandatory provisions as contingent, which could make FAS 150 not applicable.

But regardless of whether FASB ever implements the provisions, you should expect to face further scrutiny from sureties and banks. They'll both likely be asking more pointed questions about succession plans and buy-sell agreements to more fully view the financial picture they use to determine your construction company's bonding capacity and credit limit.

Are you safe indefinitely? FAS 150's postponement was largely thanks to the construction industry's well-organized outcry against the negative effect of these provisions on nonpublic contractors and the economy as a whole. But how long FASB will listen to these voices is unclear. By learning about FAS 150's potential effects now, you could ultimately save yourself if it's ever fully implemented.

Editor's Note: Randy J. Bonnecaze is a Certified Public Accountant (CPA) with Hannis T. Bourgeois LLP, Baton Rouge.