Issued shares, or equity instruments, may be in the name of individuals or companies. Companies are required to present their accounts, and as such need to make a number of accounting and legal considerations, in order to classify and measure shares in their own name correctly on their balance sheet.
Assessment of the Underlying Reporting Framework
The first general assessment is the accounting framework applicable – is the Company preparing its financial statements under IFRS, or under GAPSME? This will eventually impact the presentation of the equity instruments on the face of the balance sheet. In some cases, this will also impact the subsequent measurement of the equity instrument held.
Consideration of Varying Degrees of Involvement
Specifically in relation to the equity instruments held, the first consideration relates to the degree of involvement that the shares represent. At one extreme, a company may hold all the shares of the investee (that is, the company in which it holds shares). At the other extreme, the Company may hold a negligible shareholding in the investee. For instance, it may have purchased a number of shares from a bank or company listed on the stock exchange, but the percentage holding is below 1%.
There are three degrees of involvement. Generally speaking, these include:
- Investees in which the investor holds at least 50% + 1 share.
- Investees in which the investor holds between 20% and 50% of shares.
- Investees in which the investor holds less than 20%.
Investments with Control over Investee
In the first category, it is presumed that the investor controls the investee. In many cases, the investor would need to also present consolidated financial statements – that is, the accounts of the group as one company. This requirement could be subject to exemptions stemming from laws or regulations. Anyhow, the separate financial statements – that is, the single entity financial statements of a parent company that consolidates under IFRS – show the subsequent measurement of an investment in subsidiary either at cost, or at the equity method, or under IFRS 9 principles.
Investments with Significant Influence over Investee
In the second category, the investor significantly influences the investee. The investor is required to account for the investment by applying the equity method. This means that the investor adjusts the investment by a share of profits. It should be mentioned that under GAPSME, there is the option to leave the investment in the associate at cost. In both cases, that is control and significant influence, the investment is subject to impairment.
Investments without Participation
In the third category, the investor’s influence over the investee is less than significant. Careful consideration of the framework and accounting standard being adopted is required.
An IFRS preparer preparing under IFRS 9 would measure the shares at fair value. Fair value changes are almost always booked through profit or loss. However, if the share is not held for trading, the investor may elect to book fair value changes through other comprehensive income.
A GAPSME preparer, on the other hand, would typically classify such shares as ‘held for trading’ or ‘available-for-sale’. Shares held for trading include, for instance, shares traded for speculation purposes. These are measured either at fair value through profit or loss, or at cost. Other shares are typically classified as ‘available-for-sale, and are measured at either fair value, with fair value movements booked through equity, or at cost. Unquoted investments in equity instruments, the fair value of which cannot be measured reliably, are measured at cost.
Investments with Joint Control over the Investee
There is also a possible scenario in which an entity holds joint control over an investee. Joint control occurs where decisions need to be taken unanimously by the investors. The measurement of joint control investments is similar to investments in which the investor has significant influence (associates). In fact, under IFRS, the equity method is used, whereas under GAPSME, there is also the cost option. GAPSME also provides the choice between the cost method and the equity method for investments in subsidiaries (at the individual company level).
The above demonstrates how the accounting for shares held is largely driven by the degree of influence of the investor in the investee. It’s important to note that the assessment of whether the investor has control, significant influence or none of these, should not be carried out solely by looking at the percentage shareholding. One needs to look at any further legal or substantial aspects that may change the picture. This includes, but is not limited to, the existence of both voting rights and potential voting rights in the investee.
What about issuers of equity instruments? What considerations need to be made?
The upcoming 4-hour course on equity instruments by ZD Academy will take a high-level, but 360 degree approach, to the discussion of equity instruments, from both the holder’s side (as above) and the issuer’s side.