The Hindu Business Line : Presentation of financial instruments

THE Institute of Chartered Accountants of India (ICAI) has issued an Exposure Draft on what could be Accounting Standard 30 — that is, Financial Instruments: Presentation. This follows on the pattern of International Accounting Standard (IAS) 32 on the same subject. The Draft suggests that the issuer of a financial instrument should classify the instrument, or its component parts, on initial recognition as a financial liability or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability and an equity instrument.

Similarly, the issuer of a non-derivative financial instrument should evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components should be classified separately as financial liabilities or equity instrument. If an enterprise reacquires (buys back) its own shares, nominal value of those shares should be deducted from share capital. No gain or loss should be recognised in the statement of profit and loss (P&L) on the purchase and cancellation of an enterprise's own shares.

Difference between the consideration paid and the nominal value of shares should be recognised directly in reserves and surplus. Interest and losses relating to a financial instrument or a component of financial instrument that is a financial liability should be recognised as expense in the P&L statement and gains relating to it should be recognised as income in the P&L statement.

Distributions to holders of an equity instrument should be recognised by the enterprise in the P&L statement after determination of net profit after tax for the current year. Transaction costs, net of any related income-tax benefit, of an equity transaction should be recognised in the P&L statement after determination of net profit after tax for the current year. A financial asset and a financial liability should be offset and the net amount presented in the balance-sheet when, and only when, an enterprise:

a) currently has a legally enforceable right to set off the recognised amounts; and

b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. In accounting for a transfer of a financial asset that does not qualify for de-recognition, the enterprise should not offset the transferred asset and the associated liability.

More importantly, the ICAI has identified issues that could arise during the implementation of the Draft, which it wants to settle before the Draft converts into an AS.

The application of the principle regarding classification of financial instruments may result into classifying preference shares that provide for mandatory redemption by the issuer for a fixed or determinable amount at a fixed or determinable future date, or give the holder the right to require the issuer to redeem the instrument at or after a particular date for a fixed or determinable amount, as a financial liability.

The Exposure Draft, however, in a footnote, recognises that, at present, Schedule VI to the Companies Act, 1956, inter alia, requires that all preference shares be disclosed as a part of the `Share Capital', irrespective of their substance. It also recognises that until Schedule VI is amended, a company classifying the preference shares as share capital, irrespective of their substance, will be considered to be complying with this Accounting Standard.

This is because, as per paragraph 4.10 of the Preface to the Statements of AS, where a requirement of an accounting standard is different from the applicable law, the law prevails. The proposed amendments to the Companies Act do not appear to suggest this, which means that the superiority of the Companies Act shall prevail.

The Exposure Draft proposes to consider the `puttable instrument' as a financial liability. For example, open-ended mutual funds, unit trusts and some co-operative entities may provide their unit-holders or members with a right to redeem their interests in the issuer at any time for cash equal to their proportionate share of the asset value of the issuer.

(The author is a Hyderabad-based chartered accountant.)

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