Mergers With Warrants – a New Accounting Headache

When I first started in Club Accounting tech support, mergers that involved cash and stock as part of the merger consideration were few and far between. This isn’t true now. There seem to be multiple mergers of this type each year. Recently, a new twist was added to this type of merger and that’s the inclusion of warrants as part of the merger consideration. This makes a mildly complex transaction into a more complex one as now the warrants must be accounted for properly. Unfortunately, how the merger is structured will change how to enter the warrants part of the merger.

In a previous article I explained the difference between an acquisition-type merger and a reorganization type. These two types have different tax consequences. In an acquisition, the merger is treated as a sale for the total value of the merger consideration. A portion of the proceeds of that “sale” are then used to “buy” the new shares received in the merger. The holding period starts at the merger (purchase) date and the cost basis of the shares received is the fair market value of the shares on the merger date.

If warrants are involved, their value is included in the merger consideration and a separate buy transaction is entered on the merger date to keep the holding period and cost basis accurate for the warrants. In a reorganization merger, the holding period is the holding period of the non-surviving company shares and the cost basis of those shares is transferred to the new shares. The cost basis must be adjusted if cash is part of the merger agreement. All or part of the cash received will be taxable as capital gain. The gain is calculated as if the old shares are sold for the value of the merger consideration. But it’s limited to the cash received. Depending on circumstances the cash received will be en­tered as a return of capital and a capital gain — or just a capital gain. These transactions will adjust the cost basis to account for the cash received in the merger consideration.

Once the transactions for the cash portion are done, a merger transaction can be entered to account for the new shares received. The merger entry will transfer the cost basis and holding period of the old shares to the new shares. This still leaves accounting for the warrants when they’re included in the merger consideration. Fortunately, a spinoff entry will do the job. This requires finding some information on the prices of the warrants and new stock on the merger date.

There are several websites that can give historical price information, such as Yahoo! Finance and BigCharts.com. Opening price, closing price or an average of the two can be used, but use the same one for each security.

In the spinoff transaction screen, the prices can be entered or the remaining basis percent. The remaining basis is calculated using the equation:

(Total value of shares received) / (Total value of shares received + Total value of warrants received)

The fractional shares should be included in the above calculation.

Warrants add complexity to a merger, but the entries needed to accurately account for them are part of the accounting software. Looking at how the merger is structured will tell you which transaction type to use for the warrants.