Distributions of assets, or: you spin and I’ll carve!

Here’s the background to another issue recently discussed by CPA Canada’s IFRS Discussion Group:

  • IFRIC 17 Distributions of Non-cash Assets to Owners addresses a situation when an entity distributes assets other than cash as dividends to its owners acting in their capacity as owners. In this situation, an entity measures the dividend payable at the fair value of the assets to be distributed. On settlement, any difference between the carrying value of the assets distributed and the carrying amount of the dividend payable is recognized in profit or loss.
  • Paragraph 5 of IFRIC 17 states, in part, that “[t]his Interpretation does not apply to a distribution of a non-cash asset that is ultimately controlled by the same party or parties before and after the distribution.”

Against that background, the group discussed the following fact pattern:

  • An entity (“ParentCo”) decides to spin off one of its non-core assets (e.g., a mineral property) to its shareholders. The entity’s shares are listed on a stock exchange and it has many shareholders. There is no shareholder or group of shareholders that can exercise control over the entity.
  • The asset to be spun-off does not constitute a business. Prior to the spin-off, the entity did not prepare separate financial information for the asset other than to capitalize certain expenditures that were incurred in connection with its acquisition and development.
  • To conduct the spin-off, the entity will create a new subsidiary (“SpinCo”) and then concurrently:
    • assign the asset to that subsidiary in return for shares of SpinCo;
    • distribute the shares of SpinCo to its shareholders; and
    • apply to list the shares of the SpinCo on a stock exchange.

The group agreed that the transaction is within the scope of IFRIC 17. IFRIC 17.5 states that it does not apply to “a distribution of a non-cash asset that is ultimately controlled by the same party or parties before and after the distribution,” but in this case the fact pattern is designed so that’s not the case. The members then went on to discuss whether the interpretation applies to the recognition and measurement of the asset within the financial statements of SpinCo, as it does within those of ParentCo.

It’s pretty clear that IFRIC 17 isn’t addressing the accounting by SpinCo, so you might conclude that the accounting within the new entity should reflect the carrying values within the old one. This would place the main emphasis on the fact that the shareholders have the same ownership interest in the asset before and after the transaction, and therefore reflect their “continuity of interest.” Alternatively, you might think it would make most sense for SpinCo to mirror the accounting in ParentCo, by recognizing the asset at that same value (and as a corresponding contribution to equity). This would put more weight on the absence of a controlling party or parties before and after the transaction. Or you might conclude it’s something on which the entity can make an accounting policy choice.

An overlapping issue is that of “carve-out statements.” In the Canadian context, National Instrument 51-102 discusses situations where:

  • no separate financial records for a business activity are maintained; they are simply consolidated with the parent’s records. In these cases, if the parent’s financial records are sufficiently detailed, it is possible to extract or “carve-out” the information specific to the business activity in order to prepare separate financial statements of that business.  Financial statements prepared in this manner are commonly referred to as “carve-out” financial statements.

Such statements would clearly be relevant to users where, for instance, the business activity in question is being launched as a separate entity. In this case, the fact pattern specifies that the assets in question don’t constitute a business, so the relevance isn’t necessarily clear. Still, with attention perhaps to the fact that regulators may sometimes have different ideas on whether something constitutes a business, the group discussed that issue as well, setting out different possible conclusions on whether carve-out statements would be required.

On both these issues, there’s perhaps a bit of artful misdirection in the fact pattern. The group’s view was that the more relevant standard from SpinCo’s perspective is IFRS 2, Share-based Payment, because SpinCo acquired the asset through the issuance of its shares; therefore the shares would generally be measured by reference to the fair value of the asset received in accordance with that standard (there may be examples where this wasn’t done, perhaps because of confusion over the scope of IFRS 2). On the other issue, the meeting summary carefully notes: “If SpinCo needs to produce historical information about the asset to fulfill securities law requirements, the entity could prepare financial statements on a carve-out basis” (my emphasis). However, if it’s truly just an asset, then such statements often shouldn’t be required. The CSA presence at the meeting emphasized that “useful information (should) be provided to investors…to convey what activity has occurred to develop the mineral property,” but plainly, financial statements aren’t the only (or even likely the best) way of accomplishing that. Still, the discussion creates some awareness of the possible issues…

The opinions expressed are solely those of the author

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