Accounting for Venture Capital and Investment Trusts
Accounting for Venture Capital and Investment Trusts
Distinguishing between revenue and capital profits is not always straightforward. In this article we consider one area of complexity, being the classification of income received in the form of additional shares, also known as scrip dividends.
What are Scrip Dividends?
Scrip dividends are a method where companies offer shareholders new shares to the value of the alternative cash dividend, effectively increasing the shareholders’ investment in the company while allowing the company to retain cash.Enhanced scrip dividends offer shareholders new shares, or other equity enhancements, to a value greater than the alternative cash dividends, to act as an incentive for the shareholders to opt for shares rather than cash.
Accounting for scrip dividends under the SORP
Regular scrip dividends are presented in the revenue column of the income statement because they represent a normal return on an investment, that the company has chosen to receive in shares rather than cash. The same amount will be recognised as an increase in its investment.However, enhanced scrip dividends, include a component that increases the value of the company’s investments. The excess of the scrip dividend above the cash alternative is not a normal return on the investment. Consequently, only the portion matching the value of the cash dividend is presented as revenue income while the excess is presented as capital income.
Transaction costs in respect of investments
Transaction costs incurred in investment purchases and sales encompass various expenses associated with acquiring and disposing of financial assets, including brokerage fees, commissions, taxes, and other charges.Accounting for transaction costs
Accounting standards require that any transaction costs incurred when acquiring investments should be expensed to the income statement, if those investments will be measured at fair value through profit or loss. Under the SORP, these costs should be presented as a deduction from capital income as they relate to increases in investments rather than the management of returns on those investments. This contrasts with other assets that will be measured at cost, when the transaction costs are capitalised as part of the cost of investment.
However, we have observed some investment trusts and venture capital trusts capitalising the transaction costs into the cost of investments upon initial recognition. This practice is primarily attributed to limitations within trading systems, which often fail to segregate transaction costs at the time of acquisition of investments carried at fair value through profit or loss.
Such accounting will ultimately result in the transactions costs being presented in the capital column of the income statement which, if considered in isolation, is consistent with the SORP. However, this only arises as part of the movement in fair value, reducing any fair value gain and increase any fair value loss. It is also not compliant with FRS 102 (or corresponding IFRS requirements) and distorts the true mark to market movements. It may also distort distributable reserves, particularly in cases where changes in the fair value of investments are not distributable.
Investors in investment trust companies and venture capital trusts are interested in the performance of underlying investments (the revenue return they generate) and the buy, hold and sell decisions of management (the generation of capital returns). For this reason, it is important that management carefully consider, properly classify and transparently disclose the components of revenue and capital returns.
If you would like to discuss your business’ position, or have any questions on accounting for scrip dividends, please get in touch with our team, who will be happy to help.