Written put options on non-controlling interests – read this for the answer!

02 February 2015

Guest blogger: Gary Berchowitz, follow him on LinkedIn 


The blogger’s views are his own; please share your thoughts, comments and reactions. Comments are moderated before being posted. 

OK, so if you are reading this, you are probably part of the elite 5% of the accounting world who actually (a) know what the headline of this blog means and (b) probably have a pretty strong view on this. But for those brave souls who are just reading this because it’s late at night and you are trying to fall asleep, let me outline the problem by way of a ‘brief’ example.

Company A buys 75% of the shares of a target company. As part of the acquisition,  the remaining 25% shareholders receive an option to sell their shares to Company A after a 3 year period for the fair value of the shares at that time. Company A will potentially acquire the shares for fair value after 3 years, so there is no economic risk to Company A, no problem, right? Wrong. IAS 32 tells us that Company A’s group accounts need to include this option on a gross basis! In other words, Company A needs to recognise a liability on the date of the acquisition equal to 25% of the fair value of the target (pause as everyone scratches their head trying to make sense of that). But wait, it gets worse, changes in the fair value of the 25% stake need to be recognised in the income statement. So that means over the 3 years, if the target’s value goes up (which is good news, right?), Company A will need to take an expense in its income statement because the fair value of the liability goes up (hmm, that sounds like bad news). Confused? So is the rest of the world.

Now this problem isn’t new, between the Interpretations Committee and the Board, the IASB have been battling with how to get the accounting for these types of transactions “right” for about 3 years now. The way I see it, this is where the tension lies:

  • The gross liability gives investors insight into the ‘liquidity’ risk (i.e. future cash flow problems). This is because, if the minority shareholders exercise their right to sell their shares back to the company, the group needs to have sufficient cash reserves on hand to settle the repurchase of shares;
  • However, from an economic or shareholder value perspective, the majority shareholders are indifferent if the cash leaves the group. Their value per share will remain unchanged if the group buys the shares back for fair value. Therefore it makes no sense that remeasurements on the liability are recognised in the income statement.

The answer to this problem (drumroll, wait for it…). Why not recognize the liability gross, but take movements in the liability through equity? That way, the tension is resolved. Investors would still see the liquidity risk on the balance sheet, but at the same time, they would not be misled by gains/losses on the remeasurement of that liability in the income statement.

There is already some mileage in arguing that in substance, this continues to be a transaction among shareholders, and so IFRS 10’s principle that no gain/loss should be recognised on shareholder transactions makes sense.

What can I say, I’m just a simple man, so maybe my simple solution is flawed. But it does seem that we could solve this with a simple clarification that IFRS 10 applies to the remeasurement of the liability. Or we could call on the collective intelligence of the world to reconsider the debt equity debate…and then just sit and wait.

What do you think about a simple answer to a not-so-simple problem?



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Two obvious reasons spring to mind:

1) The conceptual definitions of income and expense and
2) The resulting conflict with the requirements of IFRS 3.

1) The conceptual framework defines a change in the measurement of a liability as income/expense. IAS 1 requires all income and expense to be recognised in profit/loss or OCI. So your 'solution' violates a main principle of the 2007 changes to IAS 1.

2) In the example given the transaction is effectively contingent consideration. IFRS 3 already requires that contingent consideration is at fair value through profit or loss. Allowing changes to go to equity when the contingent consideration is in the form of an NCI put overrides this, and results in the legal form (an NCI put) overriding the accounting for the economic form (contingent consideration).


Does the problem not originate from the fact that 'minority shareholders' are considered part of equity ? It makes sense to do so as IFRS 3 and IFRS 10 explain. However when these 'minorities' become third party debt holders because they can force the entity to pay them out, then the trouble starts as a liability has to be recognised. It can become even more confusing when the accounting of this debt is done versus the majority shareholders interest leaving the minority shareholders interest presented as a non controlling interest unaffected (put is at the then current fair value at exercise date leaving the fair value risk to the NCI shareholder). In this scenario the minority interest is twice presented: once as NCI and a second time as a debt. This presentation can be justified by the two roles the minorities play but I am afraid that this is understandable only for the 'happy few' who have written the related IFRS standards and those who have spent a major part of their professional life time trying to understand what the standard setters have tried to achieve.

I think it would have been easier to understand when the NCI would not have been part of equity and thus part of the debts. Writing a put would then only have effected the measurement of this debt in accordance with IAS39/IFRS9. Unfortunately the Boards have decided differently and consequently introduced a high level of complexity. May be they reconsider as part of the post implementation review of IFRS 3. Let's hope....

Lets assume that "Company A" and the "target company" are both banks in a Basel III jurisdiction, and, in line with your suggestion, Company A recognizes the the liability gross and takes movements in the liability through equity.

What would the treatment be for CET1 purposes - I assume that there would be no adjustment to neutralize the negative equity reserve?

Good afternoon Gary

Ideally the fair value of the deferred consideration should not vary too much if the acquirer did a good job of estimating the amount that it expected to pay in 3 years.

The acquirer is allowed to factor in its wonderful yet reasonable growth plans resulting from synergies for the target in the calculation of the fair value of the amount that will be paid in 3 years. Any deviation from this discounted amount will be (knock on wood) minimal. Any gain on the liability because synergies did not happen will likely be offset by a impairment on the goodwill or other assets.

If the 25% of the target is valued using a current period's revenue, EBITDA, net income, AUM, etc. times a multiple, then yes there could be a significant variation between the amount recorded as consideration and the amount that will be paid. This is more of a failure to estimate what will be paid in three years.

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