Subscription receipts – not quite so simple?

Here’s another fact pattern recently considered by CPA Canada’s IFRS Discussion Group, relating to a form of financing that’s becoming more common in Canada

  • On December 15, 20X2, Company A completed a public offering of 1 million subscription receipts for gross proceeds of CAD$1 million (for simplicity, this example ignores transaction costs). Company A raised funds to complete an acquisition of a target company before January 31, 20X3 (the deadline). Company A’s functional currency is CAD and its fiscal year end is December 31, 20X2.
  • As at December 31, 20X2, the completion of the business combination was subject to closing conditions, compliance with which is outside Company A’s control. In other words, completion of the business combination is not entirely within Company A’s control.
  • As part of the terms of the subscription receipts, the gross proceeds were placed into escrow and will be released to Company A upon closing of the acquisition. The holder of each subscription receipt is entitled to receive one common share at closing of the acquisition. The common shares are neither puttable by the holder nor of the type described in paragraph 16C of IAS 32 Financial Instruments: Presentation.
  • If any one of the following events occurs, the escrowed proceeds, together with any interest earned thereon, will be returned on a pro-rata basis to holders of the subscription receipts: a) the acquisition does not close by the deadline; b) the acquisition agreement is terminated before the deadline; or c) Company A announces its intention not to proceed with the acquisition before the deadline.
  • While held in escrow, the funds will be invested in various permitted investments specified by the subscription receipts agreement (e.g., GICs). Company A has assessed and concluded that it controls the cash held in escrow and receives the benefits from such cash. Therefore, the cash held in escrow meets the definition of an asset because Company A: (i) has discretion in investing the cash held in escrow within the applicable parameters; and (ii) retains the funds and the interest earned on the escrowed funds upon the successful completion of the acquisition.
  • Company A also concluded it incurs an obligation: (i) to pay to the subscription receipt holders the funds held in escrow in the event the transaction does not occur; and (ii) to pay any shortfall between the amount owed to subscription receipt holders as described above and the funds held in escrow.
  • On January 5, 20X3, Company A completes the acquisition of the target company, the funds are released from escrow and Company A issues the common shares to the holders of the subscription receipts in exchange thereof.

The group agreed that at inception of the instrument, Company A allocates the initial proceeds of CAD $1 million between a liability component (because the company doesn’t have the unconditional right to avoid delivering cash) and an equity component (given that the number of shares to be issued in settlement of the subscription receipts is fixed). It initially recognizes the liability component at its fair value, allocating any difference to the equity component. Given the short time frame between the initial issuance of the subscription receipts and when the contingency is resolved, it’s reasonable to expect that most of the proceeds would be allocated to the fair value of the liability component (in the circumstances one can probably see the appeal of assessing the equity component as being immaterial so that the amount can be presented as a single line item – this has often been seen in practice). Certain changes in the fact pattern (for example, to denominate the subscription receipts and the amount to be potentially returned to investors in US dollars – that is, not in the entity’s functional currency – might cause the equity component to be analyzed instead as an embedded derivative.

The group discussed whether the proceeds should be classified as cash and cash equivalents in the cash flow statement, with most of them judging this to be a matter where an accounting policy choice exists: “because cash will only be held in escrow for a short time until the uncertainty is resolved, this could support the assessment that the funds meet the definition of cash equivalents  Alternatively… members considered that the funds held in escrow are held for acquiring an entity, not for short-term cash commitments. Therefore, this could support that the funds do not qualify as “cash equivalents”. (Group members) highlighted the importance of clear disclosure of this accounting policy and the intended use of the funds so that financial statement users have relevant information regarding these funds.” For companies not treating them as cash and cash equivalents, a further accounting policy choice then exists, between treating the transaction as a corresponding investing and financing activity (this would probably be my own preference), and excluding them from the cash flow statement altogether.

The group concluded that the receipts don’t impact on basic and diluted earnings per share for the year ended December 31, 20X2; however, some members thought the company should consider providing information about the anticipated future dilution event and forecasted impact on EPS in its MD&A. As so often, that’s perhaps the most important point of all, that the limits of financial statement requirements don’t prevent providing a broader forward-looking perspective elsewhere…

The opinions expressed are solely those of the author

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