Recent news on approving merger of Vodafone & Idea at their board level has given many questions related to its accounting under the new framework i.e. Ind-As. The same can be referenced by using the link http://economictimes.indiatimes.com/markets/stocks/news/idea-cellular-approves-merger-with-vodafone-india-stock-rallies-nearly-15/articleshow/57726511.cms
Many of our readers have sent their queries to know about the below situation and to know its treatment under Ind-As. The below approach has been mentioned by assuming some hypothetical data and it will purely be treated for illustration purposes only. The queries are-
1) Merged entity (Combined entity) has given an option to one of counterparty (i.e Idea) to buy some fixed number of shares in merged entity at an agreed price of INR 130 (assumed only) and this option is valid for next 3 years (assumed only), how this will be treated in the books of Merged entity?
2) Suppose there is an option to settle in Cash OR Shares considering all other conditions are same as above with a fixed maturity date of this option e.g. 01.01.2018?
Let’s build an example to understand the approach about the queries above-
Merged entity has written this option to allow one of the counterparty to buy fixed number of shares (assume 1 million shares) at the price of INR 130/- in next 3 years. Fair value of premium of this call option at inception is INR 10,000 (which has been added in purchase consideration)
Let’s refer first para 22 of Ind-As 32 – Financial Instruments- Presentation
“………………………………, a contract that will be settled by the entity (receiving or) delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash or another financial asset is an equity instrument. For example, an issued share option that gives the counterparty a right to buy a fixed number of the entity’s shares for a fixed price or for a fixed stated principal amount of a bond is an equity instrument. Changes in the fair value of a contract arising from variations in market interest rates that do not affect the amount of cash or other financial assets to be paid or received, or the number of equity instruments to be received or delivered, on settlement of the contract do not preclude the contract from being an equity instrument. Any consideration received (such as the premium received for a written option or warrant on the entity’s own shares) is added directly to equity. Any consideration paid (such as the premium paid for a purchased option) is deducted directly from equity. Changes in the fair value of an equity instrument are not recognised in the financial statements”
Answering to first bullet point-
Since the number of shares which will required to be issued are fixed i.e. 1 million shares (given above) and price at which it will be issued is also fixed then it will be classified as EQUITY.
1) Fair value of the option given to the counterparty is INR 10,000 (given above) will be accounted as below-
Cash Dr 10,000
To Equity Cr 10,000
2) Since it has given for three years, any change in fair value of these options given will not affect any entry and hence no entry will be passed till its actual exercise of option
3) Let’ s assume at any time during the 3 years, the option is exercised then the below entry will be passed by crediting equity with an amount of cash received on 1 million shares at the rate of 130/- each –
Cash Dr 130,000,000
To Equity Cr 130,000,000
4) If there is any expenses related to this proceed then it will directly be debited to Equity only
5) In case there is no exercise of this option then initial equity entry will remain and no further entry will be passed
Answering to second bullet point-
1) Now, if there is an option to settle either in cash or in shares then it will be classified as derivative instrument and will be accounted at its fair value at inception, e.g. fair value of this option is INR 20,000 then entry will follow as below –
Cash Dr 20,000
To Option obligation Cr 20,000
2) All fair value changes in the options will be accounted in Profit and loss of that period, assume there was a overall reduction in marked to market fair value of option and it has now reduced to INR 12,000 (it mean INR 8,000 has been debited to PL over the periods)
3) If the option is exercised in CASH or in EQUITY then will be accounted as below-
a) Cash settled – Being the fair value of option has been settled by payment of INR 12K-
Option obligation Dr 12,000
To Cash Cr 12,000
b) Equity settled – Being value of INR 12,000 equivalent value for shares price of 130/- will be issued as Equity –
Option obligation Dr 12,000
To Equity Cr 12,000
(Issue of approx 92.30 shares)
The above approach is given to readers for them to navigate the requirement of these new standards and accordingly correct accounting treatment can be suggested/ implemented. It is further to note that the above analysis is purely for illustration purposes and does not reflect any facts about the Vodafone- Idea merger deal.
The accounting for step-up in investment will be done based on its classification from the point of view of Investor i.e. Idea. It has been assumed there is no control of any of the entity on merged Company.
A reader will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Readers are requested not to take this article as any kind of advice (it is not exhaustive in nature) and should evaluate all relevant factors of each individual cases separately.
(Author of this article is an experienced chartered accountant who has specialization on various GAAP conversions assignments covering different industries around different part of the world including acting as an Independent IFRS Advisor & Corporate Trainer. He can be reached via email at firstname.lastname@example.org or Whatsapp +91-9634706933)