2.7 Rabbi Trusts

Many entities have arrangements that allow their employees to defer some or all of their earned compensation (i.e., salary or bonus). Sometimes the employer uses a “rabbi trust”4 to hold assets from which nonqualified deferred compensation payments will be made. ASC 710 provides guidance on deferred compensation arrangements in which assets equal to compensation amounts earned (i.e., vested) by employees are placed in a rabbi trust. Such arrangements often permit employees to diversify their accounts by investing in cash, the employer’s stock, nonemployer securities, or a combination of these options. In all cases, the employer consolidates the rabbi trust in the employer’s financial statements.

The guidance in ASC 710-10-25-15 refers to four types of deferred compensation arrangements involving rabbi trusts. These four arrangement types, known as plans A, B, C, and D, differ on the basis of whether the plan permits diversification, whether the employee has elected to diversify, and the allowable forms of settlement:

Plan	Diversification	Settlement Options Permitted Under Plan
A	Not permitted	Delivery of a fixed number of shares of employer stock
B	Not permitted	Delivery of cash or shares of employer stock
C	Permitted, but employee has not diversified	Delivery of cash, shares of employer stock, or diversified assets
D	Permitted, and employee has diversified	Delivery of cash, shares of employer stock, or diversified assets

Deferred compensation arrangements in which the amounts earned are indexed to, or can be settled in, an entity’s own stock before being placed into a rabbi trust are within the scope of ASC 718. When the amounts earned in a deferred compensation arrangement (1) are within the scope of ASC 718 before being placed into a rabbi trust and (2) can be settled only in the employer’s stock (i.e., Plan A), the arrangement would be accounted for as an equity award under ASC 718 before the amounts earned are placed into the trust (provided that all other criteria for equity classification have been met). In addition, the deferred compensation arrangement would remain classified in equity and would therefore not need to be remeasured under ASC 710 after the amounts earned are placed into the rabbi trust.

Similarly, when the amounts earned in a deferred compensation arrangement (1) are within the scope of ASC 718 before being placed into a rabbi trust and (2) can be settled only in the employer’s stock or cash at the election of the employee (i.e., Plan B), the arrangement may be accounted for as a liability or equity award under ASC 718 before the amounts earned are placed into the trust. The deferred compensation arrangement would be classified as a liability after the amounts earned are placed into the rabbi trust.

For all other deferred compensation arrangements in which amounts earned are placed into a rabbi trust, the accounting depends on the terms of the arrangement and on whether the arrangement is viewed either as one plan or as substantively consisting of two plans.

Connecting the Dots

For all plans except Plan A, SEC registrants (or entities electing to apply SEC requirements) should consider ASR 268 and ASC 480-10-S99-3A, as discussed in SAB Topic 14.E, under which presentation must occur outside of permanent equity (i.e., as temporary or mezzanine equity) when redemption is outside the control of the entity. See Section 5.10 for discussion on the SEC guidance on temporary equity.

2.7.1 Accounting for a Deferred Compensation Arrangement as Two Plans (Plans C and D)

For an arrangement to be viewed as substantively consisting of two plans, the following two criteria must be met:

There must be a reasonable period within which the employee is required to be subjected to the risks and rewards of ownership (i.e., to all the stock price movements of the employer’s stock). ASC 718-10-25-9 defines this period as six months or more. Accordingly, once the share-based payment award is vested and placed into the rabbi trust, it would need to remain indexed to the employer’s stock for at least six months. After six months, the employee could elect to diversify his or her vested shares into various different money markets and equity-based mutual funds, which would be the beginning of the deferred compensation arrangement.
The option to defer the amounts earned under the share-based payment award must be entirely elective. If the employee is forced into a diversified account, the award would most likely be considered mandatorily redeemable under ASC 480. That is, the deferred compensation arrangement would have to be classified as a liability. Therefore, if the employee is “forced” to accept a liability in satisfaction of the share-based payment award, redemption is deemed mandatory. Accordingly, the entire arrangement would be accounted for as a liability from the grant date of the share-based payment award and not just from the beginning of the deferred compensation arrangement.

If the above two criteria are met, the deferred compensation arrangement is viewed as a share-based payment arrangement that is subsequently “converted” into a diversified deferred compensation arrangement (i.e., two plans). Accordingly, an entity applies the guidance in ASC 718 until the employee elects to diversify his or her amounts earned (“the share-based payment award”) and then applies the guidance in ASC 710 until the deferred amounts are received by the employee (“the deferred compensation arrangement”).

If the above two criteria are met and equity classification is achieved from the grant date of the share-based payment award until the employee elects to diversify his or her amounts earned, a public entity also must consider the guidance in ASR 268 (FRR Section 211) and ASC 480-10-S99-3A. ASC 480-10-S99-3A addresses share-based payment arrangements with employees whose terms may permit redemption of the employer’s shares for cash or other assets. Since the distribution of the amounts earned under the share-based payment award into a diversified account is viewed as settlement in cash or other assets (i.e., because the deferred compensation obligation must be classified as a liability in accordance with ASC 710 once the employee elects to diversify his or her amounts earned), the share-based payment award would be subject to the guidance in ASC 480-10-S99-3A. The guidance in ASC 480-10-S99-3A requires classification in temporary (mezzanine) equity from the grant date of the share-based payment award until the beginning of the deferred compensation arrangement. At the beginning of the deferred compensation arrangement, the amounts diversified would be classified as a liability under ASC 710.

2.7.2 Accounting for a Deferred Compensation Arrangement as One Plan (Plans C and D)

If the two criteria in the previous section are not met, the deferred compensation arrangement is viewed as one plan. When an arrangement is viewed as one plan, diversification would result in liability classification under ASC 718 for the share-based payment award from the grant date to the date the amounts earned are placed into the rabbi trust. Under ASC 718, an award that allows an employee to diversify outside of the employer’s stock would be indexed to something other than a market, performance, or service condition (i.e., the ultimate value received by the employee also is indexed to the performance of the assets into which they diversified). In accordance with ASC 718-10-25-13, an arrangement that is indexed to an “other” condition is classified as a share-based liability irrespective of whether the employee ultimately receives cash, other assets, or the employer’s stock. (See Chapter 7 for more detailed guidance on the accounting treatment of liability awards.) Accordingly, the deferred compensation arrangement would be classified as a share-based liability from the grant date until the amounts earned are placed into the rabbi trust. Once placed into the rabbi trust, the amounts earned would be classified as a liability pursuant to ASC 710 until the deferred amounts are received by the employee.

Footnotes

Rabbi trusts are generally used as funding vehicles to provide for the deferral of taxation to the employee receiving the compensation. That is, in a nonqualified deferred compensation plan, employees defer the receipt of compensation amounts earned by placing the amounts earned in a rabbi trust. By deferring receipt of the amounts earned, the employees are also deferring the taxability of those amounts. The employees will be subsequently taxed upon receiving the amounts that have been placed in the rabbi trust.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.