Julie Norman considers the accounting treatment under IFRS 2/IAS 32 when accounting for warrants issued to a parent company
XYZ plc invests a further £250,000 in its subsidiary ABC plc in return for new ordinary shares, which increases its controlling interest to 80%. ABC plc has a number of employee options in issue when the new ordinary shares are issued to its parent company. In order to protect the parent’s interest from dilution, warrants are issued to the parent (‘the transaction’) at the same time as the share issue. These warrants may be exercised at the same time and on the same terms as any employee options are exercised. No extra consideration is received for the warrants.
ABC plc wants to understand how the warrants should be accounted for.
The accounting will be determined by the relevant financial reporting standard and so the initial consideration is whether the warrants are within the scope of IFRS 2, Share-based Payment, or IAS 32, Financial Instruments: Presentation.
IFRS 2 scopes in all share-based payment transactions (that is transactions in which an entity receives goods or services from a supplier in exchange for its equity instruments or for cash or other assets of an amount based on the value of its equity instruments), whether or not the entity can identify specifically some or all of the goods or services received, except:
- a transaction with an employee or other party in his/her capacity as a holder of equity instruments of the entity;
- or a transaction in which the entity acquires goods or services under a contract within the scope of paragraphs 8-10 of IAS 32 – that is to buy or sell a commodity surplus to its usage requirements or
- with a view to short term profit taking that can be settled net in cash or another financial instrument.
IAS 32 scopes in all types of financial instruments unless specifically excluded. Transactions accounted for under IFRS 2 are specifically excluded; the other exclusions are not relevant to this scenario.
In this scenario, the parent company is already a shareholder and it might therefore be interpreted that the transaction is outside the scope of IFRS 2 because the parent is a party acting in its capacity as a holder of equity instruments.
An alternative interpretation is that, there being no similar issue to any other shareholder, the share issue is, in substance, a fundraising with a ‘lender’ and the warrants issued represent the cost of obtaining finance. If this is the case and the warrants are considered to be in lieu of a cash fee for a lender’s services, or there might be other unidentifiable services, then IFRS 2 would be appropriate; however if the warrants are considered to be part of the overall return to a lender then IAS 32 would be the more relevant standard.
In the final analysis, the determination of the relevant standard should consider the purpose of the transaction.
In this scenario, the purpose of the transaction is to protect an existing shareholder’s interest in the ordinary share capital of the company rather than to pay a ‘lender’s fee in return for funding; and there is no evidence of other unidentifiable services being provided by XYZ plc. Accordingly, the transaction is considered to be an equity transaction with an existing shareholder and outside the scope of IFRS 2.
As the transaction is not within the scope of IFRS 2, it is then not excluded from IAS 32. IAS 32 paragraph 22 requires any consideration received for a written option or warrant on the entity’s own shares to be added directly to equity and any consideration paid (such as the premium paid for a purchased option) to be deducted directly from equity.
Changes in the fair value of an equity instrument are not recognised in the financial statements. As no consideration is received for the warrants there are no accounting entries to be made for the warrants until they are exercised. On exercise, the consideration received will be credited to share capital and share premium as appropriate.
How should XYZ plc account for the warrants it receives from ABC plc?
Investments in subsidiaries are generally scoped out of IAS 32 unless they are accounted for at fair value in accordance with IAS 39, Financial Instruments: Recognition and Measurement.
However, the warrant instruments received from ABC plc are within the scope of IAS 32 because they are derivatives over the interest in a subsidiary and, as they do not meet the definition of an equity instrument in the financial statements of XYZ plc, they are also within the scope of IAS 39. The warrants should therefore be recognised as a derivative instrument at fair value.
Julie Norman FCCA is a partner, Baker Tilly UK Audit LLP www.bakertilly.co.uk