Potential voting rights – An investor may hold instruments that (if exercised or converted), give the investor power to direct the relevant activities. These are called ‘potential voting rights’ and may be held through ownership of the following types of instrument:
- share options and warrants Potential voting rights
- convertible bonds Potential voting rights
- convertible preference shares. Potential voting rights
Potential voting rights can contribute to control of an investee in combination with current voting rights, or even confer control on their own. However, IFRS 10 requires an assessment to determine whether potential voting rights are substantive. IFRS 10 has no bright lines and so judgment will be required.
IFRS 10’s ‘substantive’ assessment takes into account both:
- the general guidance consisting of: Potential voting rights
- the purpose and design of the instrument – including its terms and conditions, and the investor’s apparent expectations, motives and reasons for agreeing to them.
Some of the factors referred to above are normally more relevant than others, although any could be relevant in some situations. The following flowchart summarises the factors that are most commonly of practical relevance: Potential voting rights
|Investor’s current voting rights|
|Investor’s potential voting rights under criteria||=||Investor’s voting rights for assessing control/power|
Criteria to determine whether potential voting rights contribute to control
An enterprise may own share warrants, share call options, debt or equity instruments that are convertible into ordinary shares, or other similar instruments that have the potential, if exercised or converted, to give the enterprise voting power or reduce another party’s voting power over the financial and operating policies of another enterprise (potential voting rights).
- A and B own 80% and 20% respectively of the voting shares of C
- A sells a 50% interest to D and buys call options from D that are exercisable at any • time at a premium to the market price on issue.
The resulting structure is as follows:
Additional information about the call option:
- If exercised, A would recover its original 80% interest and voting rights
- The exercise price has economic substance and is not set deliberately high
- The option is slightly out of the money at the reporting date
Is the call option substantive?
The options held by A are at a premium to the market price upon issue and are slightly out of the money at the reporting date. However, it is necessary to consider whether A benefits for other reasons from the exercise of the options (for example, protection of interests, acquisition of assets). If that is the case, the options may be substantive, and A should consolidate C.
A, B and C own 40%, 30% and 30% respectively of D’s voting shares.
A also owns call options that:
- are exercisable at any time at the fair value of the underlying shares; and
- if exercised, would give A an additional 20% of D’s voting rights and reduce B’s and C’s interests to 20% each.
The following diagram illustrates this arrangement:
Is the call option substantive?
The call options are exercisable at fair value. As such, they are neither in nor out of the money. A would have to consider the other factors in illustration 7 in order to determine whether the options are substantive.
If the options are substantive, A would have to consider the factors in illustration 14 (for example, purpose and design of the option instrument) to assess whether the options provide A with power
And yes another example
- A, B and C each own 33% of D’s voting shares. •
- A, B and C each have the right to appoint two directors to the board of D. •
- A owns call options that are exercisable at a fixed price at any time and if exercised would • give it all of the voting rights in D.
- A’s management does not intend to exercise the call options even if B and C do not vote in • the same manner as A.
- The options are in the money at both issue date and reporting date
Are the call options substantive?
The call options appear to be substantive as they are in the money and there are no other countervailing factors. Management’s intent does not affect the assessment of whether the options are substantive unless this intention is caused by barriers or other practical difficulties.
If the options are substantive. A would have to consider: substantive rights, purpose and design of instrument and involvement and/or other voting or decision rights (for example, purpose and design of the option instrument) to assess whether the options provide A with power over D.
See also: The IFRS Foundation