A company is getting sued by a group of consumers and did not want bad publicity

Question

A company is getting sued by a group of consumers and did not want bad publicity.

Because they did not have cash reserves, the primary shareholder (55% owner) of the company

transferred 50,000 shares to the plaintiff to settle the case in the current year (December). The market

value of the shares at the time of transfer was $35 per share.

Does the Company need to report anything in its annual financial statements for the current year

related to the transaction? The answer can only be supported by official US authoritative literature as it

is being presented to a client and has significant legal ramifications.

Explanation / Answer

The value of the shares transferred should be reflected as an expense in the company’s financial statements with a corresponding credit to contributed (paid-in) capital.

This transaction is similar to those described in FASB ASC paragraph 718-10-15-4 (Compensation — Stock Compensation Topic), which states that “share-based payments awarded to an employee of the reporting entity by a related party or other holder of an economic interest35 in the entity as compensation for services provided to the entity are share-based payment transactions to be accounted for under this Topic unless the transfer is clearly for a purpose other than compensation for services to the reporting entity.” As explained in this paragraph, the substance of such a transaction is that the economic interest holder makes a capital contribution to the reporting entity, and the reporting entity makes a share-based payment to its employee in exchange for services rendered.

The problem of separating the benefit to the principal stockholder from the benefit to the company cited in FASB ASC Topic 718 is not limited to transactions involving stock compensation. Similar accounting is required in this transaction where a principal stockholder pays an expense for the company, unless the stockholder’s action is caused by a relationship or obligation completely unrelated to his position as a stockholder or such action clearly does not benefit the company.

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