Treatment of exploration costs in presenting pro forma net assets

Public documents issued to shareholders and potential investors, such as IPO prospectuses and documents seeking shareholder approval for a proposed acquisition or other transaction – will usually include a pro forma statement of net assets, in order to illustrate the impact of the proposed transaction on the company’s financial position.

Under ASIC’s Regulatory Guide 230, such pro forma information should be prepared “as a minimum” on the basis of the company’s most recent statutory statement of financial position – typically from the full year (audited) or half-year (reviewed) financial statements. 

We are frequently asked about the treatment of exploration costs which have been incurred after the balance sheet date.

For an IPO, the pro forma statement will typically include adjustments for the gross proceeds and costs of the offer, and also commonly includes, for example, the issue of options to directors and advisors and the conversion of convertible notes (or other liabilities) into equity.   It will also include events which have occurred subsequent to the balance sheet date – for example, pre-IPO dividends and financing transactions, such as the issue of shares or convertible notes.  

It is generally accepted that the pro forma statement should not include adjustments for trading income or operational expenditure incurred since the balance sheet date, since it is intended to show the balance sheet as if all the transactions had occurred as at that date (eg. 31 December 2019).  It is not intended to show a forecast balance sheet or cash position on completion of the transaction(s).

We generally recommend the inclusion of a note beneath the pro forma statement, stating that, for example “the pro forma statement of net assets does not include adjustments for exploration or other operational expenditure incurred since 31 December 2019”. 

However, where the company has incurred substantial exploration costs since the date of the last financial statements, this can present a concern, as the pro forma cash position shown may be significantly higher than the expected cash position following completion of the IPO and/or other transaction(s), and there is a risk that this could be considered misleading in the absence of additional disclosure.

Where the exploration costs incurred are significantly higher than in previous periods, or include material one-off amounts, in our view:

• the note to the pro forma statement should state the amount of the costs incurred between the balance sheet date and the closest practicable date to the date of issue of the public document, and;
• in a capital raising, the “Use of Funds” table should start from a more current cash position, and show clearly the amount of the funds to be applied to future exploration activities.

On rare occasions, where the expenditure is so material that the pro forma statement would itself be potentially misleading in the absence of an adjustment (having regard to other disclosures elsewhere in the document), it may be appropriate to include an adjustment.

As an alternative

We have seen occasional cases where the directors have chosen to present the pro forma statement at a more recent balance sheet date (eg. 31 March) which does not align with its financial reporting requirements.  However, this will usually result in additional cost as the balance sheet will not previously have been reviewed by the company’s auditors.

How can RSM help?

We would always encourage early discussion with your investigating accountants in relation to this and other matters arising in connection with the preparation of pro forma financial information. If you have any questions or require assistance please contact your local RSM adviser today.