On April 12, 2021, the Securities and Exchange Commission (SEC) published its perspective on accounting for warrants that are typically issued during the creation of a Special Purpose Acquisition Company (SPAC). The SPAC subsequently carries these warrants into the new company upon acquisition of the operating company (i.e., a de-SPAC). As a result, a vast majority of these warrants will need to be classified as liability (versus equity under the prior practice) with changes in fair value recorded in earnings in each reporting period.
Impacted companies (which are most pre-SPACs, SPACs and de-SPACs) are required to address the issue immediately.
This typically will involve the following steps:
- Perform a technical accounting assessment of the terms of warrants to determine if they result in liability accounting in accordance with Accounting Standards Codification (ASC) 480 / ASC 815.
- Perform a valuation of the warrants to determine fair value at issuance and at the end of each reporting period.
- Perform a quantitative and qualitative assessment in accordance with SEC Staff Accounting Bulletin (SAB) Topics 1.M/ 1.N (previously referred to as SAB 99/ SAB 108) to determine whether the changes are material to the financial statements.
- In accordance with ASC 250, correct financial statements in one of three ways:
- Currently – When the error is not material to current or prior periods; in this case, no disclosures or changes in prior periods are required.
- Revision – When the error is not material to prior periods, but if it is recorded in the current period, it significantly misstates the results; in this case, the prior period information will be revised in the current year comparative to the financial statements and adding disclosure will be included.
- Restatement – When the error is material to prior periods; in this case, previously issued financial statements will be restated and reissued to reflect the correction of the error in those financial statements.
- Assess the impact on internal controls over financial reporting (ICFR) and determine whether the errors represent a control deficiency, significant deficiency, or a material weakness. In cases where a restatement is required, a material weakness would most likely also be identified. This will require considering SEC Regulation S-K 307 / 308, which entails evaluating whether previously issued filings need to be revised to reflect changes in ICFR or the effectiveness of management’s evaluation of ICFR.
- Facilitate an independent audit firm review of management’s conclusion on these matters, which would likely require consultations between the audit team and the audit firm’s National and Risk management organizations.
- Perform other required communications (i.e., filing of an 8-K, communicating with the audit committee, pre-clearing with SEC, etc.).
These steps may be complex and require judgment. Generally robust documentation related to this process would need to be prepared and retained.