SPAC Accounting: Technical Issues and Considerations

A Special Purpose Acquisition Company, or SPAC, is a publicly-traded company created to raise capital for acquiring an existing private company, allowing the target to go public without a traditional Initial Public Offering (IPO). Sponsors form the SPAC and raise funds from public investors, which are then held in a trust. The sponsors have 18 to 24 months to find a suitable company to acquire in a merger, often called a “de-SPAC” transaction. If a merger is not completed within this period, the SPAC is liquidated, and the funds are returned to investors. This lifecycle introduces unique accounting and financial reporting complexities.

Initial Public Offering and Pre-Combination Accounting

A SPAC’s accounting begins with its IPO, where its main activity is raising capital. Costs directly related to the IPO, like underwriting and legal fees, are not immediately expensed. Instead, these costs are deferred and recorded as an asset on the balance sheet.

After a successful IPO, these deferred costs are offset against the proceeds, reducing the capital recorded in shareholders’ equity. Any costs from an aborted offering cannot be deferred and must be expensed as incurred.

The majority of IPO proceeds are placed into a trust account until a merger is completed or the SPAC is liquidated. Interest earned on these funds is recorded on the SPAC’s income statement as it accrues and is one of the few revenue sources for the company during its search phase.

Public shares sold in the IPO include a redemption feature, allowing shareholders to reclaim their investment if they disapprove of a proposed merger. Because the redemption decision is outside the company’s control, these shares have a specific balance sheet presentation. Under SEC guidance in ASC 480-10-S99, redeemable shares must be classified as temporary or “mezzanine” equity, presented separately between liabilities and permanent equity.

Accounting for the De-SPAC Transaction

The de-SPAC transaction, or the merger with a private operating company, is accounted for as a “reverse merger.” Although the SPAC is the legal acquirer, the private operating company is identified as the accounting acquirer. This is because the target company’s former owners usually hold control of the combined entity.

Based on business combination accounting in ASC 805, the target company’s historical financial statements become the continuing financial statements of the combined entity. The transaction is treated as the private company issuing stock to raise capital and get a public listing. The private company’s assets and liabilities remain at their historical carrying values, and no goodwill is recorded from the merger.

Consideration transferred in the merger is measured at fair value, including the equity issued by the SPAC. The primary asset acquired by the target company is the SPAC’s cash in trust. The difference between the fair value of the equity issued and the fair value of the SPAC’s net assets is treated as a listing expense, representing the cost of going public.

Transaction costs for the merger, like advisory and legal fees, are expensed as incurred. However, costs for related financing activities are handled differently. For example, in a Private Investment in Public Equity (PIPE) financing, the incremental costs of raising this new capital are recorded as a reduction of the proceeds.

Complex Financial Instruments and Their Treatment

SPACs use financial instruments that create accounting challenges, especially warrants. Warrants give the holder the right to buy more shares at a set price and are issued to public investors and sponsors. Their accounting depends on their classification as either equity or liabilities, a distinction that has received increased SEC scrutiny.

While many SPACs historically classified warrants as equity, certain features can require liability treatment. If a warrant agreement has a provision that could force a cash settlement under circumstances outside the company’s control, it cannot be classified as equity. The SEC has clarified that some tender offer provisions require liability classification.

Warrants classified as liabilities must be measured at fair value each reporting period through mark-to-market accounting. Changes in fair value are recorded as a gain or loss on the income statement. This can cause earnings volatility, as warrant value fluctuates with the company’s stock price and other market factors.

Other instruments also require careful accounting, such as founder shares issued to sponsors. De-SPAC transactions also include earnout provisions, a form of contingent consideration. These grant additional shares to the target’s former owners if performance milestones are met. Earnout arrangements are classified as liabilities and must be re-measured at fair value each reporting period, with changes in value affecting earnings.

Post-Combination Financial Reporting

After the de-SPAC transaction, the combined entity becomes a standard public operating company. It must then fulfill all SEC financial reporting obligations, including filing quarterly reports on Form 10-Q and annual reports on Form 10-K.

In the alternative scenario of a forward merger where the SPAC is the accounting acquirer, a new basis of accounting is established. This requires recognizing the target’s assets and liabilities at fair value, which can result in identifying new intangible assets and goodwill. These intangible assets are then amortized, and goodwill is tested annually for impairment.

An operational challenge for the new company is implementing internal controls over financial reporting. The Sarbanes-Oxley Act (SOX) requires public companies to maintain these controls to ensure financial statement accuracy. Because the target company was private, it may lack formal processes, requiring it to design and implement a control framework that meets public company standards.