Here’s the background to another issue recently discussed by Canada’s IFRS Discussion Group:
- An entity may acquire an asset or a group of assets that do not comprise a business by issuing multiple financial instruments. Careful analysis is required to determine whether these instruments are in scope of IFRS 2 Share-based Payments. This standard can impact how the instruments are classified and measured both on initial recognition and subsequent measurement. The Group is asked to consider a scenario where a company issues multiple financial instruments in exchange for assets of another company that do not comprise a business and to discuss whether any of the financial instruments issued are in scope of IFRS 2. The Group is then asked to consider whether a contingent payment should be considered as part of the cost of the assets acquired.
The simplest item considered was a future issuance of common shares of Entity A with the number of shares determined by reference to the performance of the assets acquired. Regardless of the exact terms, this falls within IFRS 2 as the issuer receives goods in an arrangement which entitles the counterparty to receive its equity instruments. Another example consists of share purchase warrants giving Entity B the right to purchase common shares of Entity A; the exercise price will be adjusted if Entity A issues common shares at a price that is lower than the initial exercise price on issuance. Regardless of the adjustment feature, the warrants are clearly equity interests, again falling within the scope of IFRS 2.
The importance of this determination is that it may trigger a different basis for measuring the item. You’ll recall that IFRS 2 generally requires measuring the goods or services received in an equity-settled share-based payment transaction directly at the fair value of the goods or services received. If the above instruments fall under IFRS 2 then, their fair value might be indicated by a valuation report on the acquired assets or suchlike. Otherwise, their fair value would be determined with reference to IFRS 13, which would likely require applying some other form of valuation technique.
Here’s another example:
- A future issuance of common shares of Entity A. However, if Entity A does not complete an initial public offering (IPO) before the date that the shares become issuable, then Entity A is instead required to make a cash payment of a fixed amount.
The majority of the group took the view that this isn’t classified as an equity-settled share-based payment as it may require settlement in cash, and also isn’t considered a cash-settled share-based payment as the amount that Entity A may be required to pay isn’t based on the price of Entity A’s equity instruments. One member disagreed with this though, taking the view that the IPO feature isn’t sufficiently significant to exclude the instrument from IFRS 2. Although IFRS 2 doesn’t specifically address that fact pattern, it does address the presumably more common case of an equity-settled share-based payment that clearly does fall within IFRS 2, but which may or not vest based on successfully achieving a future IPO. Anyway, the main point there is that some analysis may sometimes be required even in determining the scope of IFRS 2, let alone its more detailed application matters.
A few years ago, IFRIC considered the accounting for variable payments to be made for the purchase of an item of property, plant and equipment or an intangible asset that isn’t part of a business combination, noting that it was “unable to reach a consensus on whether an entity (the purchaser) recognizes a liability at the date of purchasing the asset for variable payments that depend on its future activity or, instead, recognizes such a liability only when the related activity occurs.” However, in conjunction with the discussion above, the IFRS discussion group underlined that there’s no ambiguity about the accounting for share-based payments issued in such circumstances. So in the following example:
- Entity A acquires from Entity B a group of assets that do not comprise a business. The consideration Entity A paid is:
- (a) shares of Entity A issuable on the date when control of the assets is transferred;
- (b) a future cash payment in one year equal to the increase in value of the Entity A shares issued since the acquisition date; and
- (c) additional Entity A shares with the number of shares determined based on the performance of the assets acquired from Entity B.
…these are all share-based payments of one kind or another, and therefore all within the scope of IFRS 2, entailing that they’re all measured at the time of the acquisition. As noted, for payments based on future milestones that fall outside the scope of IFRS 2, no consensus exists. We speculated in the past that the most appropriate treatment might depend in part on the degree of economic compulsion attaching to the milestones – that is, whether it would be practical to avoid them (if, for instance, significant penalties exist). But that was only speculation…
The opinions expressed are solely those of the author