Hi,
We have invested via convertible preference shares with contractual PIK dividends convertible at our discretion at any time. Shares are non-voting and would give me c. 14% shareholding once converted. We have a Board seat (one of six), Board observer and effective veto rights over many aspects of operating and financial policy. We have assessed we have a significant influence.
So we've gained significant influence via instrument which returns are currently not similar to ordinary share returns. On that count, equity method doesn't seem right to be applied. My question is, does the fact I can convert at any time affects the assessment of applicability of equity method? Shall I then equity-account for my preference shares rather than treat the investment as long-term interest in an associate to be fair valued in line with IFRS 9?
Any views?
Equity method - convertible preference shares
Re: Equity method - convertible preference shares
From your entity's separate FS's perspective, you can account for the instrument as an investment in the subs either at cost, under IFRS 9 or under equity method.
If you are applying the equity method, then you can have a look at IAS 28.14, which says IFRS 9 doesn't apply to entities accounted under the equity method (under certain circumstances). This means that you can not apply IFRS 9 and follow the accounting under the equity method. But this is under the provision of IAS 28.13.
So have a look at IAS 28.13&14.
If you are applying the equity method, then you can have a look at IAS 28.14, which says IFRS 9 doesn't apply to entities accounted under the equity method (under certain circumstances). This means that you can not apply IFRS 9 and follow the accounting under the equity method. But this is under the provision of IAS 28.13.
So have a look at IAS 28.13&14.
Re: Equity method - convertible preference shares
@Leo,
What I'm asking for is the judgement to be applied to the fact pattern, namely if my preference shares should be accounted for under equity method as their can be converted at any time and provide returns aligned with ordinary shares or rather should they be treated as a long term interests accounted for under IFRS 9. I'm not asking about the choice between cost, IFRS 9 or equity method. I'm preparing 'economic interest' financial statements in which associates are generally accounted for at equity method but only if the instrument I'm investing in lends itself to equity method of accounting (f.e ordinary shares). The fact I've gained significant influence via convertible preference shares (as per the fact pattern) leaves it to the debate if equity method or IFRS 9 measurement applies.
"When instruments containing potential voting rights in substance currently give access to the returns associated with an ownership interest in an associate or a joint venture, the instruments are not subject to IFRS 9. In all other cases, instruments containing potential voting rights in an associate, or a joint venture are accounted for in accordance with IFRS 9 (IAS 28.14)." - this is the judgement I need to make regarding my investment, namely does the right to convert at any time is equivalent to 'giving access to the returns associated with an ownership interest'. I hope it's clearer now.
What I'm asking for is the judgement to be applied to the fact pattern, namely if my preference shares should be accounted for under equity method as their can be converted at any time and provide returns aligned with ordinary shares or rather should they be treated as a long term interests accounted for under IFRS 9. I'm not asking about the choice between cost, IFRS 9 or equity method. I'm preparing 'economic interest' financial statements in which associates are generally accounted for at equity method but only if the instrument I'm investing in lends itself to equity method of accounting (f.e ordinary shares). The fact I've gained significant influence via convertible preference shares (as per the fact pattern) leaves it to the debate if equity method or IFRS 9 measurement applies.
"When instruments containing potential voting rights in substance currently give access to the returns associated with an ownership interest in an associate or a joint venture, the instruments are not subject to IFRS 9. In all other cases, instruments containing potential voting rights in an associate, or a joint venture are accounted for in accordance with IFRS 9 (IAS 28.14)." - this is the judgement I need to make regarding my investment, namely does the right to convert at any time is equivalent to 'giving access to the returns associated with an ownership interest'. I hope it's clearer now.
Re: Equity method - convertible preference shares
I think the presence of a dividend could be interpreted as a return associated with an ownership interest. Ultimately it's a judgement you need to make.
Re: Equity method - convertible preference shares
Tough judgement to make! I'd also refer to IAS 28.12 which says the interest in an associate is determined solely on the basis of existing ownership interests and does not reflect the possible exercise or conversion of potential voting rights. It appears that these convertible preference shares don't give you an existing ownership interest.
Re: Equity method - convertible preference shares
Just to clarify,
If you are preparing group accounts, than, the only option would be account for the prefs as per IFRS 9 or under IAS 28.
If you are preparing separate FS, than, you can either account for the investment as a receivable under IFRS 9 or as an investment under IAS 27.10. If the instrument is an equity instrument, than, it's unlikely to account it as a receivable.
If you are preparing group accounts, than, the only option would be account for the prefs as per IFRS 9 or under IAS 28.
If you are preparing separate FS, than, you can either account for the investment as a receivable under IFRS 9 or as an investment under IAS 27.10. If the instrument is an equity instrument, than, it's unlikely to account it as a receivable.
Re: Equity method - convertible preference shares
Leo, you don't understand the question being asked I'm afraid...
Re: Equity method - convertible preference shares
Thanks Marek,
What I was thinking is: isn't the fact I can convert into ordinary shares basically any time, say tomorrow, give me 'existing ownership interest' or is equivalent to having 'existing ownership interest'. You're right though, it's a tough judgment to make!
What I was thinking is: isn't the fact I can convert into ordinary shares basically any time, say tomorrow, give me 'existing ownership interest' or is equivalent to having 'existing ownership interest'. You're right though, it's a tough judgment to make!
Re: Equity method - convertible preference shares
Well, there must be a reason why you haven't converted into ordinary shares yet. For example, to what extent does the yield on these preference shares depend on investee's results? What are the current voting rights attaching to them? What are the conversion terms?
Re: Equity method - convertible preference shares
Yeap, I could use this reasoning I think. We wouldn't never convert into ordinary shares just for the sake of getting dividends or being shareholders. We would only do it once there's a sizeable upside available, meaning sale to 3rd party, IPO, etc.
Re: Equity method - convertible preference shares
I think it really depends on the voting rights you get if you convert the pref shares and accumulated PIK dividends. If those voting rights give you access to the same returns as those of ordinary shareholders, then you should account for the instruments using the equity method, according to paragraph 14 (provided that you can exercise that option at any time, as you've indicated).