Accounting Standard (AS) 31
Financial Instruments: Presentation
Issued by
The Institute of Chartered Accountants of India
New Delhi
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Contents
Accounting Standard (AS) 31
Financial Instruments: Presentation
OBJECTIVE Paragraphs 1-2
SCOPE 3-6
DEFINITIONS 7-31
Financial Assets and Financial Liabilities 11-20
Equity Instruments 21-22
Derivative Financial Instruments 23-27
Contracts to Buy or Sell Non-Financial Items 28-31
PRESENTATION 32-88
Liabilities and Equity 32-57
No Contractual Obligation to Deliver Cash or Another
Financial Asset
34-47
Settlement in the Entity’s Own Equity Instruments 48-52
Contingent Settlement Provisions 53-54
Settlement Options 55-56
Treatment in Consolidated Financial Statements 57
Compound Financial Instruments 58-67
Treasury shares 68-70
Interest, Dividends, Losses and Gains 71-78
Offsetting a Financial Asset and a Financial Liability 79-88
Appendix A: Illustrative Examples
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ENTITIES SUCH AS MUTUAL FUNDS AND COOPERATIVES
WHOSE SHARE CAPITAL IS NOT EQUITY
AS DEFINED IN AS 31
A1-A2
Example 1: Entities with no equity A1
Example 2: Entities with some equity A2
ACCOUNTING FOR COMPOUND FINANCIAL
INSTRUMENTS
A3-A18
Example 3: Separation of a compound financial instrument
on initial recognition
A3-A5
Example 4: Separation of a compound financial instrument
with multiple embedded derivative features
A6-A7
Example 5: Repurchase of a convertible instrument A8-A14
Example 6: Amendment of the terms of a convertible
instrument to induce early conversion
A15-A18
Appendix B: Examples of Application of Paragraphs 40 – 46
UNCONDITIONAL RIGHT TO REFUSE REDEMPTION
(PARAGRAPH 42)
B2-B5
Example 1 B2-B3
Example 2 B4-B5
PROHIBITIONS AGAINST REDEMPTION (PARAGRAPHS
43 AND 44)
B6-19
Example 3 B6-B10
Example 4 B11-B13
Example 5 B14-B15
Example 6 B16-B17
Example 7 B18-B19
Appendix C: Comparison with IAS 32, Financial Instruments:
Presentation
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Accounting Standard (AS) 31
Financial Instruments: Presentation
(This Accounting Standard includes paragraphs set in bold italic type and plain type, which have
equal authority. Paragraphs in bold italic type indicate the main principles. This Accounting
Standard should be read in the context of its objective and the Preface to the Statements of
Accounting Standards 1.)
Accounting Standard (AS) 31, Financial Instruments: Presentation, issued by the
Council of the Institute of Chartered Accountants of India, comes into effect in respect of
accounting periods commencing on or after 1-4-2009 and will be recommendatory in nature for
an initial period of two years. This Accounting Standard will become mandatory2 in respect of
accounting periods commencing on or after 1-4-2011 for all commercial, industrial and business
entities except to a Small and Medium-sized Entity, as defined below:
(i) Whose equity or debt securities are not listed or are not in the process of listing on
any stock exchange, whether in India or outside India;
(ii) which is not a bank (including co-operative bank), financial institution or any
entity carrying on insurance business;
(iii) whose turnover (excluding other income) does not exceed rupees fifty crore in the
immediately preceding accounting year;
(iv) which does not have borrowings (including public deposits) in excess of rupees
ten crore at any time during the immediately preceding accounting year; and
(v) which is not a holding or subsidiary entity of an entity which is not a small and
medium-sized entity.
For the above purpose, an entity would qualify as a Small and Medium-sized Entity, if
the conditions mentioned therein are satisfied as at the end of the relevant accounting
period.
1 Attention is specifically drawn to paragraph 4.3 of the Preface, according to which accounting standards are
intended to apply only to items which are material.
2 This implies that, while discharging their attest function, it will be the duty of the members of the Institute to
examine whether this Accounting Standard is complied with in the presentation of financial statements covered by
their audit. In the event of any deviation from this Accounting Standard, it will be their duty to make adequate
disclosures in their audit reports so that the users of financial statements may be aware of such deviations.
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Where, in respect of an entity there is a statutory requirement for presenting any financial
instrument in a particular manner as liability or equity and/ or for presenting interest, dividend,
losses and gains relating to a financial instrument in a particular manner as income/ expense or
as distribution of profits, the entity should present that instrument and/ or interest, dividend,
losses and gains relating to the instrument in accordance with the requirements of the statute
governing the entity. Untill the relevant statute is amended, the entity presenting that instrument
and/ or interest, dividend, losses and gains relating to the instrument in accordance with the
requirements thereof will be considered to be complying with this Accounting Standard, in view
of paragraph 4.1 of the Preface to the Statements of Accounting Standards which recognises that
where a requirement of an Accounting Standard is different from the applicable law, the law
prevails3.
The following is the text of the Accounting Standard.
Objective
1. The objective of this Standard is to establish principles for presenting financial
instruments as liabilities or equity and for offsetting financial assets and financial liabilities. It
applies to the classification of financial instruments, from the perspective of the issuer, into
financial assets, financial liabilities and equity instruments; the classification of related interest,
dividends, losses and gains; and the circumstances in which financial assets and financial
liabilities should be offset.
2. The principles in this Standard complement the principles for recognising and measuring
financial assets and financial liabilities in Accounting Standard (AS) 30, Financial Instruments:
Recognition and Measurement and for disclosing information about them in Accounting
Standard (AS) 32, Financial Instruments: Disclosures4.
3 To illustrate, as per paragraph 35(a) of the Standard, a preference share that provides for mandatory redemption by
the issuer for a fixed or determinable amount at a fixed or determinable future date, or gives the holder the right to
require the issuer to redeem the instrument at or after a particular date for a fixed or determinable amount, is a
financial liability. However, at present, Schedule VI to the Companies Act, 1956, inter alia, requires that all
preference shares should be disclosed as a part of the ‘Share Capital’. Untill Schedule VI is amended, a company
classifying the preference shares as share capital will be considered to be complying with this Accounting Standard
even in a case where as per this Standard the preference shares are to be shown as a liability. In the latter case, as a
corollary to this, dividend on such preference shares treated as a distribution to holders thereof and not as an expense
will also be considered as a compliance with this Accounting Standard. Similarly, in case of a co-operative entity
those requirements of paragraphs 40 to 47 and Appendix B to the Standard would not apply which are contrary to
the law governing such an entity.
4A separate Accounting Standard (AS) 32 on Financial Instruments: Disclosures is being formulated.
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Scope
3. This Standard should be applied by all entities to all types of financial instruments
except:
(a) those interests in subsidiaries, associates and joint ventures that are accounted
for in accordance with AS 21, Consolidated Financial Statements and
Accounting for Investments in Subsidiaries in Separate Financial Statements,
AS 23, Accounting for Investments in Associates, or AS 27, Financial
Reporting of Interests in Joint Ventures. However, in some cases, AS 21, AS 23
or AS 27 permits or requires an entity to account for an interest in a subsidiary,
associate or joint venture using Accounting Standard (AS) 30, Financial
Instruments: Recognition and Measurement5; in those cases, entities should
apply the disclosure requirements in AS 21, AS 23 or AS 27 in addition to those
in this Standard. Entities should also apply this Standard to all derivatives
linked to interests in subsidiaries, associates or joint ventures.
(b) employers’ rights and obligations under employee benefit plans, to which AS
15, Employee Benefits, applies.
(c) contracts for contingent consideration in a business combination6. This
exemption applies only to the acquirer.
(d) insurance contracts as defined in the Accounting Standard on Insurance
Contracts7. However, this Standard applies to derivatives that are embedded in
insurance contracts if Accounting Standard (AS) 30, Financial Instruments:
Recognition and Measurement requires the entity to account for them
separately. Moreover, an issuer should apply this Standard to financial
guarantee contracts if the issuer applies AS 30 in recognising and measuring
the contracts, but should apply the Accounting Standard on Insurance
Contracts if the issuer elects, in accordance with the Accounting Standard on
Insurance Contracts, to apply that Standard in recognising and measuring
them.
5 It may be noted that AS 21, AS 23 and AS 27, at present, make reference to Accounting Standard (AS) 13,
Accounting for Investments, with regard to the accounting for an investment in a subsidiary, associate and joint
venture, respectively. On Accounting Standard (AS) 30, Financial Instruments: Recognition and Measurement,
becoming mandatory, AS 13 would stand withdrawn except to the extent it relates to accounting for investment
properties. In other words, accounting for investments in a subsidiary, associate and joint venture would no longer
be covered by AS 13. Keeping this in view, with the issuance of the proposed AS 30, Limited Revisions have been
made to AS 21, AS 23 and AS 27 to replace the references to AS 13 with those to AS 30. Pursuant to these Limited
Revisions, the titles of AS 21 and AS 23 are also modified.
6 ‘Business combination’ is the bringing together of separate entities or businesses into one reporting entity.
At present, Accounting Standard (AS) 14, Accounting for Amalgamations, deals with accounting for contingent
consideration in an amalgamation, which is a form of business combination.
7 A separate Accounting Standard on Insurance Contracts will specify the requirements relating to insurance
contracts.
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(e) financial instruments that are within the scope of the Accounting Standard on
Insurance Contracts8 because they contain a discretionary participation
feature. The issuer of these instruments is exempt from applying to these
features paragraphs 32-67 of this Standard regarding the distinction between
financial liabilities and equity instruments. However, these instruments are
subject to all other requirements of this Standard. Furthermore, this Standard
applies to derivatives that are embedded in these instruments (see Accounting
Standard (AS) 30, Financial Instruments: Recognition and Measurement).
(f) financial instruments, contracts and obligations under share-based payment
transactions9 except for
(i) contracts within the scope of paragraphs 4-6 of this Standard, to which this
Standard applies.
(ii) paragraphs 68, 69 and 70 of this Standard, which should be applied to
treasury shares, purchased, sold, issued or cancelled in connection with
employee share option plans, employees share purchase plans, and all other
share-based payment arrangements.
4. This Standard should be applied to those contracts to buy or sell a non-financial item
that can be settled net in cash or another financial instrument, or by exchanging financial
instruments, as if the contracts were financial instruments, with the exception of contracts that
were entered into and continue to be held for the purpose of the receipt or delivery of a nonfinancial
item in accordance with the entity’s expected purchase, sale or usage requirements.
5. There are various ways in which a contract to buy or sell a non-financial item can be
settled net in cash or another financial instrument or by exchanging financial instruments. These
include:
(a) when the terms of the contract permit either party to settle it net in cash or another
financial instrument or by exchanging financial instruments;
(b) when the ability to settle net in cash or another financial instrument, or by
exchanging financial instruments, is not explicit in the terms of the contract, but
the entity has a practice of settling similar contracts net in cash or another
financial instrument, or by exchanging financial instruments (whether with the
counterparty, by entering into offsetting contracts or by selling the contract before
its exercise or lapse);
(c) when, for similar contracts, the entity has a practice of taking delivery of the
underlying and selling it within a short period after delivery for the purpose of
generating a profit from short-term fluctuations in price or dealer’s margin; and
8 See footnote 7.
9 Employee share based payment, which is one of the share-based payment transactions, is accounted for as per the
Guidance Note on Employee Share-based Payment, issued by the ICAI. Further, some other pronouncements of the
ICAI deal with other share-based payments, e.g., AS 10, Accounting for Fixed Assets.
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(d) when the non-financial item that is the subject of the contract is readily
convertible to cash.
A contract to which (b) or (c) applies is not entered into for the purpose of the receipt or
delivery of the non-financial item in accordance with the entity’s expected purchase, sale
or usage requirements, and, accordingly, is within the scope of this Standard. Other
contracts to which paragraph 4 applies are evaluated to determine whether they were
entered into and continue to be held for the purpose of the receipt or delivery of the nonfinancial
item in accordance with the entity’s expected purchase, sale or usage
requirement, and accordingly, whether they are within the scope of this Standard.
6. A written option to buy or sell a non-financial item that can be settled net in cash or
another financial instrument, or by exchanging financial instruments, in accordance with
paragraph 5(a) or (d) is within the scope of this Standard. Such a contract cannot be entered into
for the purpose of the receipt or delivery of the non-financial item in accordance with the entity’s
expected purchase, sale or usage requirements.
Definitions
7. The following terms are used in this Standard with the meanings specified:
7.1 A financial instrument is any contract that gives rise to a financial asset of one
entity and a financial liability or equity instrument of another entity.
7.2 A financial asset is any asset that is:
(a) cash;
(b) an equity instrument of another entity;
(c) a contractual right:
(i) to receive cash or another financial asset from another entity; or
(ii) to exchange financial assets or financial liabilities with another entity
under conditions that are potentially favourable to the entity; or
(d) a contract that will or may be settled in the entity’s own equity instruments and
is:
(i) a non-derivative for which the entity is or may be obliged to receive a
variable number of the entity’s own equity instruments; or
(ii) a derivative that will or may be settled other than by the exchange of a
fixed amount of cash or another financial asset for a fixed number of the
entity’s own equity instruments. For this purpose the entity’s own equity
instruments do not include instruments that are themselves contracts for
the future receipt or delivery of the entity’s own equity instruments.
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7.3 A financial liability is any liability that is:
(a) a contractual obligation:
(i) to deliver cash or another financial asset to another entity; or
(ii) to exchange financial assets or financial liabilities with another entity
under conditions that are potentially unfavourable to the entity; or
(b) a contract that will or may be settled in the entity’s own equity instruments and
is
(i) a non-derivative for which the entity is or may be obliged to deliver a
variable number of the entity’s own equity instruments; or
(ii) a derivative that will or may be settled other than by the exchange of a
fixed amount of cash or another financial asset for a fixed number of the
entity ’s own equity instruments. For this purpose the entity’s own equity
instruments do not include instruments that are themselves contracts for
the future receipt or delivery of the entity’s own equity instruments.
7.4 An equity instrument is any contract that evidences a residual interest in the
assets of an entity after deducting all of its liabilities.
7.5 Fair value is the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arm’s length transaction.
8. The following terms are defined in paragraph 8 of Accounting Standard (AS) 30,
Financial Instruments: Recognition and Measurement and are used in this Standard with the
meaning specified in AS 30.
amortised cost of a financial asset or financial liability
available-for-sale financial assets
derecognition
derivative
effective interest method
financial asset or financial liability at fair value through profit or loss
financial guarantee contract
firm commitment
forecast transaction
hedge effectiveness
hedged item
hedging instrument
held-to-maturity investments
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loans and receivables
regular way purchase or sale
transaction costs.
9. In this Standard, ‘contract’ and ‘contractual’ refer to an agreement between two or more
parties that has clear economic consequences that the parties have little, if any, discretion to
avoid, usually because the agreement is enforceable by law. Contracts, and thus financial
instruments, may take a variety of forms and need not be in writing.
10. In this Standard, ‘entity’ includes individuals, partnerships, incorporated bodies, trusts
and government agencies.
Financial Assets and Financial Liabilities
11. Currency (cash) is a financial asset because it represents the medium of exchange and is
therefore the basis on which all transactions are measured and recognised in financial statements.
A deposit of cash with a bank or similar financial institution is a financial asset because it
represents the contractual right of the depositor to obtain cash from the institution or to draw a
cheque or similar instrument against the balance in favour of a creditor in payment of a financial
liability.
12. Common examples of financial assets representing a contractual right to receive cash in
the future and corresponding financial liabilities representing a contractual obligation to deliver
cash in the future are:
(a) trade accounts receivable and payable;
(b) bills receivable and payable;
(c) loans receivable and payable;
(d) bonds receivable and payable; and
(e) deposits and advances.
In each case, one party’s contractual right to receive (or obligation to pay) cash is
matched by the other party’s corresponding obligation to pay (or right to receive).
13. Another type of financial instrument is one for which the economic benefit to be received
or given up is a financial asset other than cash. For example, a promissory note payable in
government bonds gives the holder the contractual right to receive and the issuer the contractual
obligation to deliver government bonds, not cash. The bonds are financial assets because they
represent obligations of the issuing government to pay cash. The promissory note is, therefore, a
financial asset of the promissory note holder and a financial liability of the promissory note
issuer.
14. ‘Perpetual’ debt instruments normally provide the holder with the contractual right to
receive payments on account of interest at fixed dates extending into the indefinite future, either
with no right to receive a return of principal or a right to a return of principal under terms that
make it very unlikely or very far in the future. For example, an entity may issue a financial
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instrument requiring it to make annual payments in perpetuity equal to a stated interest rate of 8
per cent applied to a stated par or principal amount of Rs. 1,000. Assuming 8 per cent to be the
market rate of interest for the instrument when issued, the issuer assumes a contractual obligation
to make a stream of future interest payments having a fair value (present value) of Rs. 1,000 on
initial recognition. The holder and issuer of the instrument have a financial asset and a financial
liability, respectively.
15. A contractual right or contractual obligation to receive, deliver or exchange financial
instruments is itself a financial instrument. A chain of contractual rights or contractual
obligations meets the definition of a financial instrument if it will ultimately lead to the receipt or
payment of cash or to the acquisition or issue of an equity instrument.
16. The ability to exercise a contractual right or the requirement to satisfy a contractual
obligation may be absolute, or it may be contingent on the occurrence of a future event. For
example, a financial guarantee is a contractual right of the lender to receive cash from the
guarantor, and a corresponding contractual obligation of the guarantor to pay the lender, if the
borrower defaults. The contractual right and obligation exist because of a past transaction or
event (assumption of the guarantee), even though the lender’s ability to exercise its right and the
requirement for the guarantor to perform under its obligation are both contingent on a future act
of default by the borrower. A contingent right and obligation meet the definition of a financial
asset and a financial liability, even though such assets and liabilities are not always recognised in
the financial statements. Some of the contingents rights and obligations may be insurance
contracts within the scope of the Accounting Standard on Insurance Contracts10.
17. Under AS 19, Leases, a finance lease is regarded as primarily an entitlement of the lessor
to receive, and an obligation of the lessee to pay, a stream of payments that are substantially the
same as blended payments of principal and interest under a loan agreement. The lessor accounts
for its investment in the amount receivable under the lease contract rather than the leased asset
itself. An operating lease, on the other hand, is regarded as primarily an uncompleted contract
committing the lessor to provide the use of an asset in future periods in exchange for
consideration similar to a fee for a service. The lessor continues to account for the leased asset
itself rather than any amount receivable in the future under the contract. Accordingly, a finance
lease is regarded as a financial instrument and an operating lease is not regarded as a financial
instrument (except as regards individual payments currently due and payable).
18. Physical assets (such as inventories, property, plant and equipment), leased assets and
intangible assets (such as patents and trademarks) are not financial assets. Control of such
physical and intangible assets creates an opportunity to generate an inflow of cash or another
financial asset, but it does not give rise to a present right to receive cash or another financial
asset.
19. Assets (such as prepaid expenses) for which the future economic benefit is the receipt of
goods or services, rather than the right to receive cash or another financial asset, are not financial
assets. Similarly, items such as deferred revenue and most warranty obligations are not financial
10 See footnote 7.
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liabilities because the outflow of economic benefits associated with them is the delivery of goods
and services rather than a contractual obligation to pay cash or another financial asset.
20. Liabilities or assets that are not contractual (such as income taxes that are created as a
result of statutory requirements imposed by governments) are not financial liabilities or financial
assets. Accounting for income taxes is dealt with in AS 22, Accounting for Taxes on Income.
Equity Instruments
21. Examples of equity instruments include non-puttable equity shares, some types of
preference shares (see paragraphs 38 and 39) and warrants or written call options that allow the
holder to subscribe for or purchase a fixed number of non-puttable equity shares in the issuing
entity in exchange for a fixed amount of cash or another financial asset. An obligation of an
entity to issue or purchase a fixed number of its own equity instruments in exchange for a fixed
amount of cash or another financial asset is an equity instrument of the entity. However, if such a
contract contains an obligation for the entity to pay cash or another financial asset, it also gives
rise to a liability for the present value of the redemption amount (see paragraph 52(a)). An issuer
of non-puttable equity shares assumes a liability when it formally acts to make a distribution and
becomes legally obligated to the shareholders to do so. This may be the case following the
declaration of a dividend or when the entity is being wound up and any assets remaining after the
satisfaction of liabilities become distributable to shareholders.
22. A purchased call option or other similar contract acquired by an entity that gives it the
right to reacquire a fixed number of its own equity instruments in exchange for delivering a fixed
amount of cash or another financial asset is not a financial asset of the entity. Instead, any
consideration paid for such a contract is deducted from equity.
Derivative Financial Instruments
23. Financial instruments include primary instruments (such as receivables, payables and
equity instruments) and derivative financial instruments (such as financial options, futures and
forwards, interest rate swaps and currency swaps). Derivative financial instruments meet the
definition of a financial instrument and, accordingly, are within the scope of this Standard.
24. Derivative financial instruments create rights and obligations that have the effect of
transferring between the parties to the instrument one or more of the financial risks inherent in an
underlying primary financial instrument. On inception, derivative financial instruments give one
party a contractual right to exchange financial assets or financial liabilities with another party
under conditions that are potentially favourable, or a contractual obligation to exchange financial
assets or financial liabilities with another party under conditions that are potentially
unfavourable. However, they generally11 do not result in a transfer of the underlying primary
11 This is true of most, but not all derivatives, e.g. in some cross-currency interest rate swaps principal is exchanged
on inception (and re-exchanged on maturity).
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financial instrument on inception of the contract, nor does such a transfer necessarily take place
on maturity of the contract. Some instruments embody both a right and an obligation to make an
exchange. Because the terms of the exchange are determined on inception of the derivative
instrument, as prices in financial markets change those terms may become either favourable or
unfavourable.
25. A put or call option to exchange financial assets or financial liabilities (i.e. financial
instruments other than an entity’s own equity instruments) gives the holder a right to obtain
potential future economic benefits associated with changes in the fair value of the financial
instrument underlying the contract. Conversely, the writer of an option assumes an obligation to
forgo potential future economic benefits or bear potential losses of economic benefits associated
with changes in the fair value of the underlying financial instrument. The contractual right of the
holder and obligation of the writer meet the definition of a financial asset and a financial
liability, respectively. The financial instrument underlying an option contract may be any
financial asset, including shares in other entities and interest-bearing instruments. An option may
require the writer to issue a debt instrument, rather than transfer a financial asset, but the
instrument underlying the option would constitute a financial asset of the holder if the option
were exercised. The option-holder’s right to exchange the financial asset under potentially
favourable conditions and the writer’s obligation to exchange the financial asset under
potentially unfavourable conditions are distinct from the underlying financial asset to be
exchanged upon exercise of the option. The nature of the holder’s right and of the writer’s
obligation are not affected by the likelihood that the option will be exercised.
26. Another example of a derivative financial instrument is a forward contract to be settled in
six months’ time in which one party (the purchaser) promises to deliver Rs. 1,000,000 cash in
exchange for Rs. 1,000,000 face amount of fixed rate government bonds, and the other party (the
seller) promises to deliver Rs. 1,000,000 face amount of fixed rate government bonds in
exchange for Rs. 1,000,000 cash. During the six months, both parties have a contractual right and
a contractual obligation to exchange financial instruments. If the market price of the government
bonds rises above Rs. 1,000,000, the conditions will be favourable to the purchaser and
unfavourable to the seller; if the market price falls below Rs. 1,000,000, the effect will be the
opposite. The purchaser has a contractual right (a financial asset) similar to the right under a call
option held and a contractual obligation (a financial liability) similar to the obligation under a put
option written; the seller has a contractual right (a financial asset) similar to the right under a put
option held and a contractual obligation (a financial liability) similar to the obligation under a
call option written. As with options, these contractual rights and obligations constitute financial
assets and financial liabilities separate and distinct from the underlying financial instruments (the
bonds and cash to be exchanged). Both parties to a forward contract have an obligation to
perform at the agreed time, whereas performance under an option contract occurs only if and
when the holder of the option chooses to exercise it.
27. Many other types of derivative instruments embody a right or obligation to make a future
exchange, including interest rate and currency swaps, interest rate caps, collars and floors, loan
commitments12, and letters of credit. An interest rate swap contract may be viewed as a variation
12 Loan commitment is firm commitment of an entity to provide credit under pre-specified terms and conditions.
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of a forward contract in which the parties agree to make a series of future exchanges of cash
amounts, one amount calculated with reference to a floating interest rate and the other with
reference to a fixed interest rate. Futures contracts are another variation of forward contracts,
differing primarily in that the contracts are standardised and traded on an exchange.
Contracts to Buy or Sell Non-Financial Items
28. Contracts to buy or sell non-financial items do not meet the definition of a financial
instrument because the contractual right of one party to receive a non-financial asset or service
and the corresponding obligation of the other party do not establish a present right or obligation
of either party to receive, deliver or exchange a financial asset. For example, contracts that
provide for settlement only by the receipt or delivery of a non-financial item (e.g. an option,
futures or forward contract on silver) are not financial instruments. Many commodity contracts
are of this type. Some are standardised in form and traded on organised markets in much the
same fashion as some derivative financial instruments. For example, a commodity futures
contract may be bought and sold readily for cash because it is listed for trading on an exchange
and may change hands many times. However, the parties buying and selling the contract are, in
effect, trading the underlying commodity. The ability to buy or sell a commodity contract for
cash, the ease with which it may be bought or sold and the possibility of negotiating a cash
settlement of the obligation to receive or deliver the commodity do not alter the fundamental
character of the contract in a way that creates a financial instrument. Nevertheless, some
contracts to buy or sell non-financial items that can be settled net or by exchanging financial
instruments, or in which the non-financial item is readily convertible to cash, are within the
scope of the Standard as if they were financial instruments (see paragraph 4).
29. A contract that involves the receipt or delivery of physical assets does not give rise to a
financial asset of one party and a financial liability of the other party unless any corresponding
payment is deferred past the date on which the physical assets are transferred. Such is the case
with the purchase or sale of goods on trade credit.
30. Some contracts are commodity-linked, but do not involve settlement through the physical
receipt or delivery of a commodity. They specify settlement through cash payments that are
determined according to a formula in the contract, rather than through payment of fixed amounts.
For example, the principal amount of a bond may be calculated by applying the market price of
oil prevailing at the maturity of the bond to a fixed quantity of oil. The principal is indexed by
reference to a commodity price, but is settled only in cash. Such a contract constitutes a financial
instrument.
31. The definition of a financial instrument also encompasses a contract that gives rise to a
non-financial asset or non-financial liability in addition to a financial asset or financial liability.
Such financial instruments often give one party an option to exchange a financial asset for a nonfinancial
asset. For example, an oil-linked bond may give the holder the right to receive a stream
of fixed periodic interest payments and a fixed amount of cash on maturity, with the option to
exchange the principal amount for a fixed quantity of oil. The desirability of exercising this
option will vary from time to time depending on the fair value of oil relative to the exchange
ratio of cash for oil (the exchange price) inherent in the bond. The intentions of the bondholder
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concerning the exercise of the option do not affect the substance of the component assets. The
financial asset of the holder and the financial liability of the issuer make the bond a financial
instrument, regardless of the other types of assets and liabilities also created.
Presentation
Liabilities and Equity
32. The issuer of a financial instrument should classify the instrument, or its component
parts, on initial recognition as a financial liability, a financial asset or an equity instrument in
accordance with the substance of the contractual arrangement and the definitions of a
financial liability, a financial asset and an equity instrument.
33. When an issuer applies the definitions in paragraph 7 to determine whether a financial
instrument is an equity instrument rather than a financial liability, the instrument is an equity
instrument if, and only if, both conditions (a) and (b) below are met.
(a) The instrument includes no contractual obligation:
(i) to deliver cash or another financial asset to another entity; or
(ii) to exchange financial assets or financial liabilities with another entity
under conditions that are potentially unfavourable to the issuer.
(b) If the instrument will or may be settled in the issuer’s own equity instruments, it is
(i) a non-derivative that includes no contractual obligation for the issuer to
deliver a variable number of its own equity instruments; or
(ii) a derivative that will be settled only by the issuer exchanging a fixed
amount of cash or another financial asset for a fixed number of its own
equity instruments. For this purpose the issuer’s own equity instruments
do not include instruments that are themselves contracts for the future
receipt or delivery of the issuer’s own equity instruments.
A contractual obligation, including one arising from a derivative financial instrument that will or
may result in the future receipt or delivery of the issuer’s own equity instruments, but does not
meet conditions (a) and (b) above, is not an equity instrument.
No Contractual Obligation to Deliver Cash or Another Financial Asset (paragraph 33(a))
34. A critical feature in differentiating a financial liability from an equity instrument is the
existence of a contractual obligation of one party to the financial instrument (the issuer) either to
deliver cash or another financial asset to the other party (the holder) or to exchange financial
assets or financial liabilities with the holder under conditions that are potentially unfavourable to
the issuer. Although the holder of an equity instrument may be entitled to receive a pro rata share
of any dividends or other distributions of equity, the issuer does not have a contractual obligation
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to make such distributions because it cannot be required to deliver cash or another financial asset
to another party.
35. The substance of a financial instrument, rather than its legal form, governs its
classification on the entity’s balance sheet. Substance and legal form are commonly consistent,
but not always. Some financial instruments take the legal form of equity but are liabilities in
substance and others may combine features associated with equity instruments and features
associated with financial liabilities. For example:
(a) a preference share that provides for mandatory redemption by the issuer for a
fixed or determinable amount at a fixed or determinable future date, or gives the
holder the right to require the issuer to redeem the instrument at or after a
particular date for a fixed or determinable amount, is a financial liability.
(b) a financial instrument that gives the holder the right to put it back to the issuer for
cash or another financial asset (a ‘puttable instrument’) is a financial liability.
This is so even when the amount of cash or other financial assets is determined on
the basis of an index or other item that has the potential to increase or decrease, or
when the legal form of the puttable instrument gives the holder a right to a
residual interest in the assets of an issuer. The existence of an option for the
holder to put the instrument back to the issuer for cash or another financial asset
means that the puttable instrument meets the definition of a financial liability. For
example, open-ended mutual funds, unit trusts and some co-operative entities may
provide their unitholders 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. However, classification as a financial liability does not preclude the use
of descriptors such as ‘net asset value attributable to unitholders’ and ‘change in
net asset value attributable to unitholders’ on the face of the financial statements
of an entity that has no equity capital (such as some mutual funds and unit trusts,
see Illustrative Example 1 of Appendix A) or the use of additional disclosure to
show that total members’ interests comprise items such as reserves that meet the
definition of equity and puttable instruments that do not (see Illustrative Example
2 of Appendix A).
36. If an entity does not have an unconditional right to avoid delivering cash or another
financial asset to settle a contractual obligation, the obligation meets the definition of a financial
liability. For example:
(a) a restriction on the ability of an entity to satisfy a contractual obligation, such as
lack of access to foreign currency or the need to obtain approval for payment from
a regulatory authority, does not negate the entity’s contractual obligation or the
holder’s contractual right under the instrument.
(b) a contractual obligation that is conditional on a counterparty exercising its right to
redeem is a financial liability because the entity does not have the unconditional
right to avoid delivering cash or another financial asset.
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37. A financial instrument that does not explicitly establish a contractual obligation to deliver
cash or another financial asset may establish an obligation indirectly through its terms and
conditions. For example:
(a) a financial instrument may contain a non-financial obligation that must be settled
if, and only if, the entity fails to make distributions or to redeem the instrument. If
the entity can avoid a transfer of cash or another financial asset only by settling
the non-financial obligation, the financial instrument is a financial liability.
(b) a financial instrument is a financial liability if it provides that on settlement the
entity will deliver either:
(i) cash or another financial asset; or
(ii) its own shares whose value is determined to exceed substantially the value
of the cash or other financial asset.
Although the entity does not have an explicit contractual obligation to deliver
cash or another financial asset, the value of the share settlement alternative is such
that the entity will settle in cash. In any event, the holder has in substance been
guaranteed receipt of an amount that is at least equal to the cash settlement option
(see paragraph 53).
38. Preference shares may be issued with various rights. In determining whether a preference
share is a financial liability or an equity instrument, an issuer assesses the particular rights
attaching to the share to determine whether it exhibits the fundamental characteristic of a
financial liability. For example, a preference share that provides for redemption on a specific
date or at the option of the holder contains a financial liability because the issuer has an
obligation to transfer financial assets to the holder of the share. The potential inability of an
issuer to satisfy an obligation to redeem a preference share when contractually required to do so,
whether because of a lack of funds, a statutory restriction or insufficient profits or reserves, does
not negate the obligation. An option of the issuer to redeem the shares for cash does not satisfy
the definition of a financial liability because the issuer does not have a present obligation to
transfer financial assets to the shareholders. In this case, redemption of the shares is solely at the
discretion of the issuer. An obligation may arise, however, when the issuer of the shares
exercises its option, usually by formally notifying the shareholders of an intention to redeem the
shares.
39. When preference shares are non-redeemable, the appropriate classification is determined
by the other rights that attach to them. Classification is based on an assessment of the substance
of the contractual arrangements and the definitions of a financial liability and an equity
instrument. When distributions to holders of the preference shares, whether cumulative or noncumulative,
are at the discretion of the issuer, the shares are equity instruments. The
classification of a preference share as an equity instrument or a financial liability is not affected
by, for example:
(a) a history of making distributions;
(b) an intention to make distributions in the future;
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(c) a possible negative impact on the price of equity shares of the issuer if
distributions are not made (because of restrictions on paying dividends on the
equity shares if dividends are not paid on the preference shares);
(d) the amount of the issuer’s reserves;
(e) an issuer’s expectation of a profit or loss for a period; or
(f) an ability or inability of the issuer to influence the amount of its profit or loss for
the period.
40. The contractual right of the holder of a financial instrument (including members’ shares
in co-operative entities) to request redemption does not, in itself, require that financial instrument
to be classified as a financial liability. Rather, the entity must consider all of the terms and
conditions of the financial instrument in determining its classification as a financial liability or
equity. Those terms and conditions include relevant laws, regulations and the governing rules or
bye-laws of the entity in effect at the date of classification, but not expected future amendments
to those laws, regulations or bye-laws.
41. Members’ shares in co-operative entities that would be classified as equity if the
members did not have a right to request redemption are equity if either of the conditions
described in paragraphs 42 and 43 is present. Demand deposits, including current accounts,
deposit accounts and similar contracts that arise when members act as customers are financial
liabilities of the entity.
42. Members’ shares are equity if the entity has an unconditional right to refuse redemption
of the members’ shares.
43. Law, regulation or the governing rules or bye-laws of the entity can impose various types
of prohibitions on the redemption of members’ shares, e.g., unconditional prohibitions or
prohibitions based on liquidity criteria. If redemption is unconditionally prohibited by law,
regulation or the governing rules or bye-laws of the entity, members’ shares are equity.
However, provisions in law, regulation or the governing rules or bye-laws of the entity that
prohibit redemption only if conditions — such as liquidity constraints — are met (or are not met)
do not result in members’ shares being equity.
44. An unconditional prohibition may be absolute, in that all redemptions are prohibited. An
unconditional prohibition may be partial, in that it prohibits redemption of members’ shares if
redemption would cause the number of members’ shares or amount of paid-up capital from
members’ shares to fall below a specified level. Members’ shares in excess of the prohibition
against redemption are liabilities, unless the entity has the unconditional right to refuse
redemption as described in paragraph 42. In some cases, the number of shares or the amount of
paid-up capital subject to a redemption prohibition may change from time to time. Such a
change in the redemption prohibition leads to a transfer between financial liabilities and equity.
In such a case, the entity should disclose separately the amount, timing and reason for the
transfer.
45. Equity is the residual interest in the assets after deducting all liabilities. Therefore, at
initial recognition, the entity should measure the equity component in the member’s shares at the
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residual amount after deducting from the total amount of the shares as a whole the value
separately determined for its financial liabilities for redemption. The entity measures its financial
liability for redemption at fair value. In the case of members’ shares with a redemption feature,
the fair value of the financial liability for redemption is measured at no less than the maximum
amount payable under the redemption provisions of its governing bye-laws or applicable law
discounted from the first date that the amount could be required to be paid (see Example 3 of
Appendix B).
46. As required by paragraph 71, distributions to holders of equity instruments (net of any
income tax benefits) are recognised directly in the revenue reserves and surplus. Interest,
dividends and other returns relating to financial instruments classified as financial liabilities are
expenses, regardless of whether those amounts paid are legally characterised as dividends,
interest or otherwise.
47. Appendix B, which is an integral part of the Standard, illustrates the application of
paragraphs 40 to 46.
Settlement in the Entity’s Own Equity Instruments (paragraph 33(b))
48. A contract is not an equity instrument solely because it may result in the receipt or
delivery of the entity’s own equity instruments. An entity may have a contractual right or
obligation to receive or deliver a number of its own shares or other equity instruments that varies
so that the fair value of the entity’s own equity instruments to be received or delivered equals the
amount of the contractual right or obligation. Such a contractual right or obligation may be for a
fixed amount or an amount that fluctuates in part or in full in response to changes in a variable
other than the market price of the entity’s own equity instruments (e.g. an interest rate, a
commodity price or a financial instrument price). Two examples are (a) a contract to deliver as
many of the entity’s own equity instruments as are equal in value to Rs.100, and (b) a contract to
deliver as many of the entity’s own equity instruments as are equal in value to the value of 100
grams of gold. Such a contract is a financial liability of the entity even though the entity must or
can settle it by delivering its own equity instruments. It is not an equity instrument because the
entity uses a variable number of its own equity instruments as a means to settle the contract.
Accordingly, the contract does not evidence a residual interest in the entity’s assets after
deducting all of its liabilities.
49. A contract that will be settled by the entity (receiving or) delivering a fixed number of its
own equity instruments in exchange for a fixed amount of cash or another financial asset is an
equity instrument. For example, an issued share option that gives the counterparty a right to buy
a fixed number of the entity’s shares for a fixed price or for a fixed stated principal amount of a
bond is an equity instrument. Changes in the fair value of a contract arising from variations in
market interest rates that do not affect the amount of cash or other financial assets to be paid or
received, or the number of equity instruments to be received or delivered, on settlement of the
contract do not preclude the contract from being an equity instrument. Any consideration
received (such as the premium received for a written option or warrant on the entity’s own
shares) is added directly to equity in an appropriate account. Any consideration paid (such as the
premium paid for a purchased option) is deducted directly from an appropriate equity account.
Changes in the fair value of an equity instrument are not recognised in the financial statements.
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50. A contract that contains an obligation for an entity to purchase its own equity instruments
for cash or another financial asset gives rise to a financial liability for the present value of the
redemption amount (for example, for the present value of the forward repurchase price, option
exercise price or other redemption amount). This is the case even if the contract itself is an equity
instrument. One example is an entity’s obligation under a forward contract to purchase its own
equity instruments for cash. When the financial liability is recognised initially under AS 30, its
fair value (the present value of the redemption amount) is reclassified from equity.
Subsequently, the financial liability is measured in accordance with AS 30. If the contract
expires without delivery, the carrying amount of the financial liability is reclassified to equity.
An entity’s contractual obligation to purchase its own equity instruments gives rise to a financial
liability for the present value of the redemption amount even if the obligation to purchase is
conditional on the counterparty exercising a right to redeem (eg a written put option that gives
the counterparty the right to sell an entity’s own equity instruments to the entity for a fixed
price).
51. A contract that will be settled by the entity delivering or receiving a fixed number of its
own equity instruments in exchange for a variable amount of cash or another financial asset is a
financial asset or financial liability. An example is a contract for the entity to deliver 100 of its
own equity instruments in return for an amount of cash calculated to equal the value of 100
grams of gold.
52. The following examples illustrate how to classify different types of contracts on an
entity’s own equity instruments:
(a) A contract that will be settled by the entity receiving or delivering a fixed number
of its own shares for no future consideration, or exchanging a fixed number of its
own shares for a fixed amount of cash or another financial asset, is an equity
instrument. Accordingly, any consideration received or paid for such a contract is
added directly to or deducted directly from equity. One example is an issued share
option that gives the counterparty a right to buy a fixed number of the entity ’s
shares for a fixed amount of cash. However, if the contract requires the entity to
purchase (redeem) its own shares for cash or another financial asset at a fixed or
determinable date or on demand, the entity also recognises a financial liability for
the present value of the redemption amount. One example is an entity’ s
obligation under a forward contract to repurchase a fixed number of its own
shares for a fixed amount of cash.
(b) An entity’ s obligation to purchase its own shares for cash gives rise to a financial
liability for the present value of the redemption amount even if the number of
shares that the entity is obliged to repurchase is not fixed or if the obligation is
conditional on the counterparty exercising a right to redeem. One example of a
conditional obligation is an issued option that requires the entity to repurchase its
own shares for cash if the counterparty exercises the option.
(c) A contract that will be settled in cash or another financial asset is a financial asset
or financial liability even if the amount of cash or another financial asset that will
be received or delivered is based on changes in the market price of the entity’s
own equity. One example is a net cash-settled share option.
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(d) A contract that will be settled in a variable number of the entity’s own shares
whose value equals a fixed amount or an amount based on changes in an
underlying variable (eg a commodity price) is a financial asset or a financial
liability. An example is a written option to buy gold that, if exercised, is settled
net in the entity’s own instruments by the entity delivering as many of those
instruments as are equal to the value of the option contract. Such a contract is a
financial asset or financial liability even if the underlying variable is the entity’s
own share price rather than gold. Similarly, a contract that will be settled in a
fixed number of the entity’s own shares, but the rights attaching to those shares
will be varied so that the settlement value equals a fixed amount or an amount
based on changes in an underlying variable, is a financial asset or a financial
liability.
Contingent Settlement Provisions
53. A financial instrument may require the entity to deliver cash or another financial asset, or
otherwise to settle it in such a way that it would be a financial liability, in the event of the
occurrence or non-occurrence of uncertain future events (or on the outcome of uncertain
circumstances) that are beyond the control of both the issuer and the holder of the instrument,
such as a change in a stock market index, consumer price index, interest rate or taxation
requirements, or the issuer’s future revenues, net income or debt-to-equity ratio). The issuer of
such an instrument does not have the unconditional right to avoid delivering cash or another
financial asset (or otherwise to settle it in such a way that it would be a financial liability).
Therefore, it is a financial liability of the issuer unless:
(a) the part of the contingent settlement provision that could require settlement in
cash or another financial asset (or otherwise in such a way that it would be a
financial liability) is not genuine; or
(b) the issuer can be required to settle the obligation in cash or another financial asset
(or otherwise to settle it in such a way that it would be a financial liability) only in
the event of liquidation of the issuer.
54. Paragraph 53 requires that if a part of a contingent settlement provision that could require
settlement in cash or another financial asset (or in another way that would result in the
instrument being a financial liability) is not genuine, the settlement provision does not affect the
classification of a financial instrument. Thus, a contract that requires settlement in cash or a
variable number of the entity’s own shares only on the occurrence of an event that is extremely
rare, highly abnormal and very unlikely to occur is an equity instrument. Similarly, settlement in
a fixed number of an entity’s own shares may be contractually precluded in circumstances that
are outside the control of the entity, but if these circumstances have no genuine possibility of
occurring, classification as an equity instrument is appropriate.
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Settlement Options
55. When a derivative financial instrument gives one party a choice over how it is settled
(eg the issuer or the holder can choose settlement net in cash or by exchanging shares for
cash), it is a financial asset or a financial liability unless all of the settlement alternatives
would result in it being an equity instrument.
56. An example of a derivative financial instrument with a settlement option that is a
financial liability is a share option that the issuer can decide to settle net in cash or by
exchanging its own shares for cash. Similarly, some contracts to buy or sell a non-financial item
in exchange for the entity’ s own equity instruments are within the scope of this Standard
because they can be settled either by delivery of the non-financial item or net in cash or another
financial instrument (see paragraphs 4-6). Such contracts are financial assets or financial
liabilities and not equity instruments.
Treatment in Consolidated Financial Statements
57. In consolidated financial statements, an entity presents minority interests - i.e. the
interests of other parties in the equity and income of its subsidiaries in accordance with AS 1
(revised)13, Presentation of Financial Statements, and AS 21, Consolidated Financial Statements
and Accounting for Investments in Subsidiaries in Separate Financial Statements14. When
classifying a financial instrument (or a component of it) in consolidated financial statements, an
entity considers all terms and conditions agreed between members of the group and the holders
of the instrument in determining whether the group as a whole has an obligation to deliver cash
or another financial asset in respect of the instrument or to settle it in a manner that results in
liability classification. When a subsidiary in a group issues a financial instrument and a parent or
other group entity agrees additional terms directly with the holders of the instrument (e.g. a
guarantee), the group may not have discretion over distributions or redemption. Although the
subsidiary may appropriately classify the instrument without regard to these additional terms in
its individual financial statements, the effect of other agreements between members of the group
and the holders of the instrument is considered in order to ensure that consolidated financial
statements reflect the contracts and transactions entered into by the group as a whole. To the
extent that there is such an obligation or settlement provision, the instrument (or the component
of it that is subject to the obligation) is classified as a financial liability in consolidated financial
statements.
13 AS 1 is presently under revision.
14 A limited revision has been made to AS 21 with the issuance of the Accounting Standard (AS) 30, Financial
Instruments: Recognition and Measurement. Pursuant to the limited revision, the title of AS 21 is also modified.
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Compound Financial Instruments
(see also Illustrative Examples 3-6 of Appendix A)
58. 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
instruments in accordance with paragraph 32.
59. Paragraph 58 applies only to issuers of non-derivative compound financial instruments.
Paragraph 58 does not deal with compound financial instruments from the perspective of holders.
Accounting Standard (AS) 30, Financial Instruments: Recognition and Measurement deals with
the separation of embedded derivatives from the perspective of holders of compound financial
instruments that contain debt and equity features.
60. An entity recognises separately the components of a financial instrument that (a) creates a
financial liability of the entity and (b) grants an option to the holder of the instrument to convert
it into an equity instrument of the entity. For example, a debenture or similar instrument
convertible by the holder into a fixed number of equity shares of the entity is a compound
financial instrument. From the perspective of the entity, such an instrument comprises two
components: a financial liability (a contractual arrangement to deliver cash or another financial
asset) and an equity instrument (a call option granting the holder the right, for a specified period
of time, to convert it into a fixed number of equity shares of the entity). The economic effect of
issuing such an instrument is substantially the same as issuing simultaneously a debt instrument
with an early settlement provision and warrants to purchase equity shares, or issuing a debt
instrument with detachable share purchase warrants. Accordingly, in all cases, the entity presents
the liability and equity components separately on its balance sheet.
61. Classification of the liability and equity components of a convertible instrument is not
revised as a result of a change in the likelihood that a conversion option will be exercised, even
when exercise of the option may appear to have become economically advantageous to some
holders. Holders may not always act in the way that might be expected because, for example, the
tax consequences resulting from conversion may differ among holders. Furthermore, the
likelihood of conversion will change from time to time. The entity’s contractual obligation to
make future payments remains outstanding until it is extinguished through conversion, maturity
of the instrument or some other transaction.
62. Accounting Standard (AS) 30, Financial Instruments: Recognition and Measurement
deals with the measurement of financial assets and financial liabilities. Equity instruments are
instruments that evidence a residual interest in the assets of an entity after deducting all of its
liabilities. Therefore, when the initial carrying amount of a compound financial instrument is
allocated to its equity and liability components, the equity component is assigned the residual
amount after deducting from the fair value of the instrument as a whole the amount separately
determined for the liability component. The value of any derivative features (such as a call
option) embedded in the compound financial instrument other than the equity component (such
as an equity conversion option) is included in the liability component. The sum of the carrying
amounts assigned to the liability and equity components on initial recognition is always equal to
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the fair value that would be ascribed to the instrument as a whole. No gain or loss arises from
initially recognising the components of the instrument separately.
63. A common form of compound financial instrument is a debt instrument with an
embedded conversion option, such as a debenture convertible into equity shares of the issuer, and
without any other embedded derivative features. Paragraph 58 requires the issuer of such a
financial instrument to present the liability component and the equity component separately on
the balance sheet, as follows:
(a) The issuer’s obligation to make scheduled payments of interest and principal is a
financial liability that exists as long as the instrument is not converted.
Accordingly, the issuer of a debenture convertible into equity shares first
determines the carrying amount of the liability component by measuring the fair
value of a similar liability (including any embedded non-equity derivative
features) that does not have an associated equity component. Thus, on initial
recognition, the fair value of the liability component is the present value of the
contractually determined stream of future cash flows discounted at the rate of
interest applied at that time by the market to instruments of comparable credit
status and providing substantially the same cash flows, on the same terms, but
without the conversion option.
(b) The equity instrument is an embedded option to convert the liability into equity of
the issuer. The fair value of the option comprises its time value and its intrinsic
value, if any. This option has value on initial recognition even when it is out of
the money. The carrying amount of the equity instrument represented by such
option is determined by deducting the fair value of the financial liability from the
fair value of the compound financial instrument as a whole.
64. On conversion of a convertible instrument at maturity, the entity derecognises the
liability component and recognises it as equity. The original equity component remains as equity
(although it may be transferred from one line item within equity to another). There is no gain or
loss on conversion at maturity.
65. When an entity extinguishes a convertible instrument before maturity through an early
redemption or repurchase in which the original conversion privileges are unchanged, the entity
allocates the consideration paid and any transaction costs for the repurchase or redemption to the
liability and equity components of the instrument at the date of the transaction. The method used
in allocating the consideration paid and transaction costs to the separate components is consistent
with that used in the original allocation to the separate components of the proceeds received by
the entity when the convertible instrument was issued, in accordance with paragraphs 58-63.
66. Once the allocation of the consideration is made, any resulting gain or loss is treated in
accordance with accounting principles applicable to the related component, as follows:
(a) the amount of gain or loss relating to the liability component is recognised in the
statement of profit and loss; and
Page26
(b) the amount of consideration relating to the equity component is adjusted in equity
against the original equity component and the balance, if any, against the reserves
and surplus.
67. An entity may amend the terms of a convertible instrument to induce early conversion,
for example by offering a more favourable conversion ratio or paying other additional
consideration in the event of conversion before a specified date. The difference, at the date the
terms are amended, between the fair value of the consideration the holder receives on conversion
of the instrument under the revised terms and the fair value of the consideration the holder would
have received under the original terms is recognised as a loss in the statement of profit and loss.
Treasury shares
68. If an entity reacquires its own equity instruments, those instruments (‘treasury shares’)
should be deducted from equity. No gain or loss should be recognised in statement of profit
and loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments.
Such treasury shares may be acquired and held by the entity or by other members of the
consolidated group. Consideration paid or received should be recognised directly in equity.
69. The amount of treasury shares held is disclosed separately either on the face of the
balance sheet or in the notes, in accordance with AS 115 (Revised), Presentation of Financial
Statements. An entity provides disclosure in accordance with AS 18, Related Party Disclosures,
if the entity reacquires its own equity instruments from related parties.
70. An entity’s own equity instruments are not recognised as a financial asset regardless of
the reason for which they are reacquired. Paragraph 68 requires an entity that reacquires its own
equity instruments to deduct those equity instruments from equity. However, when an entity
holds its own equity on behalf of others, eg, a financial institution holding its own equity on
behalf of a client, there is an agency relationship and as a result those holdings are not included
in the entity’s balance sheet.
Interest, Dividends, Losses and Gains
71. Interest, dividends, losses and gains relating to a financial instrument or a component
of financial instrument that is a financial liability should be recognised as income or expense
in the statement of profit and loss. Distributions to holders of an equity instrument should be
debited by the entity directly to an appropriate equity account, net of any related income tax
benefit. Transaction costs of an equity transaction should be accounted for as a deduction
from equity net of any related income tax benefit.
72. The classification of a financial instrument as a financial liability or an equity instrument
determines whether interest, dividends, losses and gains relating to that instrument are
recognised as expense or income in the statement of profit and loss or are recognised directly in
15 See footnote 13.
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the revenue reserves and surplus. Thus, dividend payments on shares wholly recognised as
liabilities are recognised as expenses in the same way as interest on a bond/ debenture. Similarly,
gains and losses associated with redemptions or refinancings of financial liabilities are
recognised in the statement of profit and loss, whereas redemptions or refinancings of equity
instruments are recognised as changes in equity. Changes in the fair value of an equity
instrument are not recognised in the financial statements.
73. An entity typically incurs various costs in issuing or acquiring its own equity instruments.
Those costs might include regulatory fees, amounts paid to legal, accounting and other
professional advisers, printing costs and stamp duties. The transaction costs (net of any related
income tax benefit) of an equity transaction are recognised directly in the appropriate equity
account to the extent they are incremental costs directly attributable to the equity transaction that
otherwise would have been avoided. The costs of an equity transaction that is abandoned are
recognised as an expense.
74. Transaction costs that relate to the issue of a compound financial instrument are allocated
to the liability and equity components of the instrument in proportion to the allocation of
proceeds. Transaction costs that relate jointly to more than one transaction are allocated to those
transactions using a basis of allocation that is rational and consistent with similar transactions.
75. The amount of transaction costs recognised in the revenue reserves and surplus is
disclosed separately under AS 1 (revised)16.
76. The following example illustrates the application of paragraph 71 to a compound
financial instrument. Assume that a non-cumulative preference share is mandatorily redeemable
for cash in five years, but that dividends are payable at the discretion of the entity before the
redemption date. Such an instrument is a compound financial instrument, with the liability
component being the present value of the redemption amount. The unwinding of the discount on
this component is recognised in statement of profit and loss and classified as interest expense.
Any dividends paid relate to the equity component and, accordingly, are recognised directly in
the revenue reserves and surplus. A similar treatment would apply if the redemption was not
mandatory but at the option of the holder, or if the share was mandatorily convertible into a
variable number of equity shares calculated to equal a fixed amount or an amount based on
changes in an underlying variable (e.g., commodity). However, if any unpaid dividends are
added to the redemption amount, the entire instrument is a liability. In such a case, any dividends
are classified as interest expense.
77. Dividends classified as an expense are presented in the statement of profit and loss as a
separate item. In addition to the requirements of this Standard, disclosure of interest and
dividends is subject to the requirements of AS 1 (revised)17 and Accounting Standard (AS) 32,
Financial Instruments: Disclosures18.
78. Gains and losses related to changes in the carrying amount of a financial liability are
recognised as income or expense in the statement of profit and loss even when they relate to an
16 See footnote 13.
17 See footnote 13.
18 See footnote 4.
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instrument that includes a right to the residual interest in the assets of the entity in exchange for
cash or another financial asset (see paragraph 35(b)). Under AS 1 (revised)19, the entity presents
any gain or loss arising from remeasurement of such an instrument separately on the face of the
statement of profit and loss when it is relevant in explaining the entity’s performance.
Offsetting a Financial Asset and a Financial Liability
79. A financial asset and a financial liability should be offset and the net amount
presented in the balance sheet when, and only when, an entity:
(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 derecognition,
the entity should not offset the transferred asset and the associated liability (see
Accounting Standard (AS) 30, Financial Instruments: Recognition and Measurement).
80. This Standard requires the presentation of financial assets and financial liabilities on a net
basis when doing so reflects an entity’s expected future cash flows from settling two or more
separate financial instruments. When an entity has the right to receive or pay a single net amount
and intends to do so, it has, in effect, only a single financial asset or financial liability. In other
circumstances, financial assets and financial liabilities are presented separately from each other
consistently with their characteristics as resources or obligations of the entity.
81. Offsetting a recognised financial asset and a recognised financial liability and presenting
the net amount differs from the derecognition of a financial asset or a financial liability.
Although offsetting does not give rise to recognition of a gain or loss, the derecognition of a
financial instrument not only results in the removal of the previously recognised item from the
balance sheet but also may result in recognition of a gain or loss.
82. A right of set-off is a debtor’s legal right, by contract or otherwise, to settle or otherwise
eliminate all or a portion of an amount due to a creditor by applying against that amount an
amount due from the creditor. In unusual circumstances, a debtor may have a legal right to apply
an amount due from a third party against the amount due to a creditor provided that there is an
agreement between the three parties that clearly establishes the debtor’s right of set-off. Because
the right of set-off is a legal right, the conditions supporting the right may vary from one legal
jurisdiction to another and the laws applicable to the relationships between the parties need to be
considered.
83. The existence of an enforceable right to set off a financial asset and a financial liability
affects the rights and obligations associated with a financial asset and a financial liability and
may affect an entity’s exposure to credit and liquidity risk. However, the existence of the right,
by itself, is not a sufficient basis for offsetting. In the absence of an intention to exercise the right
or to settle simultaneously, the amount and timing of an entity’s future cash flows are not
19 See footnote 13.
Page29
affected. When an entity intends to exercise the right or to settle simultaneously, presentation of
the asset and liability on a net basis reflects more appropriately the amounts and timing of the
expected future cash flows, as well as the risks to which those cash flows are exposed. An
intention by one or both parties to settle on a net basis without the legal right to do so is not
sufficient to justify offsetting because the rights and obligations associated with the individual
financial asset and financial liability remain unaltered.
84. An entity’s intentions with respect to settlement of particular assets and liabilities may be
influenced by its normal business practices, the requirements of the financial markets and other
circumstances that may limit the ability to settle net or to settle simultaneously. When an entity
has a right of set-off, but does not intend to settle net or to realise the asset and settle the liability
simultaneously, the effect of the right on the entity’s credit risk exposure is disclosed in
accordance with Accounting Standard (AS) 32, Financial Instruments: Disclosures20.
85. Simultaneous settlement of two financial instruments may occur through, for example,
the operation of a clearing house in an organised financial market or a face-to-face exchange. In
these circumstances the cash flows are, in effect, equivalent to a single net amount and there is
no exposure to credit or liquidity risk. In other circumstances, an entity may settle two
instruments by receiving and paying separate amounts, becoming exposed to credit risk for the
full amount of the asset or liquidity risk for the full amount of the liability. Such risk exposures
may be significant even though relatively brief. Accordingly, realisation of a financial asset and
settlement of a financial liability are treated as simultaneous only when the transactions occur at
the same moment.
86. The conditions set out in paragraph 79 are generally not satisfied and offsetting is usually
inappropriate when:
(a) several different financial instruments are used to emulate the features of a single
financial instrument (a ‘synthetic instrument’);
(b) financial assets and financial liabilities arise from financial instruments having the
same primary risk exposure (for example, assets and liabilities within a portfolio
of forward contracts or other derivative instruments) but involve different
counterparties;
(c) financial or other assets are pledged as collateral for non-recourse financial
liabilities;
(d) financial assets are set aside in trust by a debtor for the purpose of discharging an
obligation without those assets having been accepted by the creditor in settlement
of the obligation (for example, a sinking fund arrangement); or
(e) obligations incurred as a result of events giving rise to losses are expected to be
recovered from a third party by virtue of a claim made under an insurance
contract.
87. To offset a financial asset and a financial liability, an entity must have a currently
enforceable legal right to set off the recognised amounts. An entity may have a conditional right
20See footnote 4.
Page30
to set off recognised amounts. An entity that undertakes a number of financial instrument
transactions with a single counterparty may enter into a ‘master netting arrangement’ with that
counterparty. Such an agreement provides for a single net settlement of all financial instruments
covered by the agreement in the event of default on, or termination of, any one contract. These
arrangements are commonly used by financial institutions to provide protection against loss in
the event of bankruptcy or other circumstances that result in a counterparty being unable to meet
its obligations. A master netting arrangement commonly creates a right of set-off that becomes
enforceable and affects the realisation or settlement of individual financial assets and financial
liabilities only following a specified event of default or in other circumstances not expected to
arise in the normal course of business. A master netting arrangement does not provide a basis for
offsetting unless both of the criteria in paragraph 79 are satisfied. When financial assets and
financial liabilities subject to a master netting arrangement are not offset, the effect of the
arrangement on an entity’s exposure to credit risk is disclosed in accordance with Accounting
Standard (AS) 32, Financial Instruments: Disclosures21.
88. The Standard does not provide special treatment for so-called ‘synthetic instruments’,
which are groups of separate financial instruments acquired and held to emulate the
characteristics of another instrument. For example, a floating rate long-term debt combined with
an interest rate swap that involves receiving floating payments and making fixed payments
synthesises a fixed rate long-term debt. Each of the individual financial instruments that together
constitute a ‘synthetic instrument’ represents a contractual right or obligation with its own terms
and conditions and each may be transferred or settled separately. Each financial instrument is
exposed to risks that may differ from the risks to which other financial instruments are exposed.
Accordingly, when one financial instrument in a ‘synthetic instrument’ is an asset and another is
a liability, they are not offset and presented on an entity’s balance sheet on a net basis unless
they meet the criteria for offsetting in paragraph 79.
21 See footnote 4.
Page31
Appendix A
Illustrative Examples
These examples accompany, but are not part of the Accounting Standard (AS) 31, Financial
Instruments: Presentation.
Entities such as Mutual Funds and Co-operatives whose Share Capital is not
Equity as defined in AS 31
Example 1: Entities with no equity
A1. The following example illustrates a statement of profit and loss and balance sheet format
that may be used by entities such as mutual funds that do not have equity as defined in AS 31.
Other formats are possible.
Statement of profit and loss for the year ended 31 March 20x6
20x5-20x6 20x4-20x5
Rs. Rs.
Revenue 2,956 1,718
Expenses (appropriately classified) (644) (614)
Profit from operating activities 2,312 1,104
Finance costs -distributions to unitholders (47) (47)
- other finance costs (50) (50)
Change in net assets attributable to unitholders 2,215 1,007
Balance sheet at 31 March 20x6
20x5-20x6 20x4-20x5
Rs. Rs Rs Rs
ASSETS
Non-current assets
(appropriately classified) 91,374 78,484
Total non-current assets 91,374 78,484
Current assets
(appropriately classified) 1,422 1,769
Total current assets 1,422 1,769
Total assets 92,796 80,253
Page32
LIABILITIES
Current liabilities
(appropriately classified) 647 66
Total current liabilities (647) (66)
Non-current liabilities excluding net
assets attributable to unitholders
(appropriately classified) 280 136
(280) (136)
Net assets attributable to unitholders 91,869 80,051
Example 2: Entities with some equity
A2. The following example illustrates a statement of profit and loss and balance sheet format
that may be used by entities whose share capital is not equity as defined in AS 31, because the
entity has an obligation to repay the share capital on demand. Other formats are possible.
Statement of profit and loss for the year ended 31 March 20x6
20x5-20x6 20x4-20x5
Rs. Rs.
Revenue 472 498
Expenses (appropriately classified) (367) (396)
Profit from operating activities 105 102
Finance costs – distributions to members (50) (50)
– other finance costs (4) (4)
Change in net assets attributable to members 51 48
Balance sheet at 31 March 20x6
20x5-20x6 20x4-
20x5
Rs. Rs. Rs. Rs.
ASSETS
Non-current assets
(appropriately classified) 908 830
Total non-current assets 908 830
Current assets
(appropriately classified) 383 350
Total current assets 383 350
Page33
Total assets 1,291 1,180
LIABILITIES
Current liabilities
(appropriately classified) 372 338
Share capital repayable on demand 202 161
Total current liabilities (574) (499)
Total assets less current liabilities 717 681
Non-current liabilities
(appropriately classified) 187 196
187 196
RESERVES22
Reserves e.g. revaluation reserve, retained earnings
etc
530 485
530 485
717 681
MEMORANDUM NOTE - TOTAL MEMBERS’ INTERESTS
Share capital repayable on demand 202 161
Reserves 530 485
732 646
Accounting for Compound Financial Instruments
Example 3: Separation of a compound financial instrument on initial recognition
A3. Paragraph 58 describes how the components of a compound financial instrument are
separated by the entity on initial recognition. The following example illustrates how such a
separation is made.
A4. An entity issues 2,000 convertible debentures at the start of year 1. The debentures have a
three-year term, and are issued at par with a face value of Rs. 1,000 per debenture, giving total
proceeds of Rs. 2,000,000. Interest is payable annually in arrears at a nominal annual interest rate
of 6 per cent. Each debenture is convertible at any time up to maturity into 250 equity shares.
When the debentures are issued, the prevailing market interest rate for similar debt without
conversion options is 9 per cent.
22 In this example, the entity has no obligation to deliver a share of its reserves to its members.
Page34
A5. The liability component is measured first, and the difference between the proceeds of the
debenture issue and the fair value of the liability is assigned to the equity component. The
present value of the liability component is calculated using a discount rate of 9 per cent, the
market interest rate for similar debentures having no conversion rights, as shown below.
Rs.
Present value of the principal - Rs.
2,000,000 payable at the end of three years 1,544,367
Present value of the interest – Rs. 120,000
payable annually in arrears for three years 303,755
Total liability component 1,848,122
Equity component (balancing figure) 151,878
Proceeds of the debenture issue 2,000,000
Example 4: Separation of a compound financial instrument with multiple embedded
derivative features
A6. The following example illustrates the application of paragraph 62 to the separation of the
liability and equity components of a compound financial instrument with multiple embedded
derivative features.
A7. Assume that the proceeds received on the issue of a callable convertible debenture are Rs.
60. The value of a similar debenture without a call or equity conversion option is Rs. 57. Based
on an option pricing model, it is determined that the value to the entity of the embedded call
feature in a similar debenture without an equity conversion option is Rs. 2. In this case, the value
allocated to the liability component under paragraph 62 is Rs. 55 (Rs. 57 – Rs. 2) and the value
allocated to the equity component is Rs. 5 (Rs. 60 – Rs. 55).
Example 5: Repurchase of a convertible instrument
A8. The following example illustrates how an entity accounts for a repurchase of a
convertible instrument. For simplicity, at inception, the face amount of the instrument is assumed
to be equal to the aggregate carrying amount of its liability and equity components in the
financial statements, i.e. no original issue premium or discount exists. Also, for simplicity, tax
considerations have been omitted from the example.
A9. On 1 January 1999, Entity A issued a 10 per cent convertible debenture with a face value
of Rs. 1,000 maturing on 31 December 2008. The debenture is convertible into equity shares of
Entity A at a conversion price of Rs.25 per share. Interest is payable half-yearly in cash. At the
date of issue, Entity A could have issued non-convertible debt with a ten-year term bearing a
coupon interest rate of 11 per cent.
A10. In the financial statements of Entity A the carrying amount of the debenture was allocated
on issue as follows:
Page35
Rs.
Liability component
Present value of 20 half-yearly interest payments of Rs. 50,
Discounted at 11% 597
Present value of Rs. 1,000 due in 10 years, discounted at 11%,
Compounded half-yearly 343
940
Equity component
(Difference between Rs. 1,000 total proceeds and Rs. 940
allocated above) 60
Total proceeds 1,000
A11. On 1 January 2004, the convertible debenture has a fair value of Rs. 1,700.
A12. Entity A makes a tender offer to the holder of the debenture to repurchase the debenture
for Rs. 1,700, which the holder accepts. At the date of repurchase, Entity A could have issued
non-convertible debt with a five-year term bearing a coupon interest rate of 8 per cent.
A13. The repurchase price is allocated as follows:
Carrying
Value
Fair
Value
Difference
Liability component: Rs. Rs. Rs.
Present value of 10 remaining half-yearly interest
Payments of Rs. 50, discounted at 11% and 8%,
Respectively 377 405
Present value of Rs. 1,000 due in 5 years,
discounted at 11% and 8%, compounded halfyearly,
respectively 585 676
962 1,081 (119)
Equity component 60 61923 (559)
Total 1,022 1,700 (678)
A14. Entity A recognises the repurchase of the debenture as follows:
Dr Liability component Rs. 962
Dr Debt settlement expense (statement of
profit and loss)
Rs. 119
Cr Cash Rs. 1,081
To recognise the repurchase of the liability component.
23 This amount represents the difference between the fair value amount allocated to the liability component and the
repurchase price of Rs. 1,700.
Page36
Dr Equity component Rs. 60
Dr. Reserves and Surplus Rs. 559
Cr Cash Rs. 619
To recognise the cash paid for the equity component.
Example 6: Amendment of the terms of a convertible instrument to induce early
conversion
A15. The following example illustrates how an entity accounts for the additional consideration
paid when the terms of a convertible instrument are amended to induce early conversion.
A16. On 1 January 2005, Entity A issued a 10 per cent convertible debenture with a face value
of Rs. 1,000 with the same terms as described in Example 5. On 1 January 2006, to induce the
holder to convert the convertible debenture promptly, Entity A reduces the conversion price to
Rs.20 if the debenture is converted before 1 March 2006 (i.e. within 60 days).
A17. Assume the market price of Entity A’s equity shares on the date the terms are amended is
Rs.40 per share. The fair value of the incremental consideration paid by Entity A is calculated as
follows:
Number of equity shares to be issued to debenture holders under amended conversion
terms:
Face amount Rs. 1,000
New conversion price /Rs. 20 per share
Number of equity shares to be issued on conversion 50 shares
Number of equity shares to be issued to debenture holders under original conversion
terms:
Face amount Rs. 1,000
Original conversion price /Rs.25 per share
Number of equity shares issued upon conversion 40 shares
Number of incremental equity shares issued upon conversion 10 Shares
Value of incremental equity shares issued upon conversion
Rs.40 per share x 10 incremental shares Rs.400
Page37
A18. The incremental consideration of Rs. 400 is recognised as a loss in the statement of profit
and loss.
Page38
Appendix B
Examples of Application of Paragraphs 40-46
This appendix is an integral part of AS 31.
B1. This appendix sets out seven examples of the application of paragraphs 40-46. The
examples do not constitute an exhaustive list; other fact patterns are possible. Each example
assumes that there are no conditions other than those set out in the facts of the example that
would require the financial instrument to be classified as a financial liability.
Unconditional Right to Refuse Redemption (Paragraph 42)
Example 1
Facts
B2. The governing bye-laws of the entity state that redemptions are made at the sole
discretion of the entity. The bye-laws do not provide further elaboration or limitation on that
discretion. In its history, the entity has never refused to redeem members’ shares, although the
governing board of the entity has the right to do so.
Classification
B3. The entity has the unconditional right to refuse redemption and the members’ shares are
equity. The Standard establishes principles for classification that are based on the terms of the
financial instrument and notes that a history of, or intention to make, discretionary payments
does not trigger liability classification. Paragraph 39 of the Standard states:
“When preference shares are non-redeemable, the appropriate classification is determined
by the other rights that attach to them. Classification is based on an assessment of the
substance of the contractual arrangements and the definitions of a financial liability and
an equity instrument. When distributions to holders of the preference shares, whether
cumulative or non-cumulative, are at the discretion of the issuer, the shares are equity
instruments. The classification of a preference share as an equity instrument or a financial
liability is not affected by, for example:
(a) a history of making distributions;
(b) an intention to make distributions in the future;
Page39
(c) a possible negative impact on the price of equity shares of the issuer if
distributions are not made (because of restrictions on paying dividends on the
equity shares if dividends are not paid on the preference shares);
(d) the amount of the issuer’s reserves;
(e) an issuer’s expectation of a profit or loss for a period; or
(f) an ability or inability of the issuer to influence the amount of its profit or loss for
the period.”
Example 2
Facts
B4. The governing bye-laws of the entity state that redemptions are made at the sole
discretion of the entity. However, the bye-laws further state that approval of a redemption
request is automatic unless the entity is unable to make payments without violating regulations
regarding liquidity or reserves.
Classification
B5. The entity does not have the unconditional right to refuse redemption and the members’
shares are a financial liability. The restrictions described above are based on the entity’s ability
to settle its liability. They restrict redemptions only if the liquidity or reserve requirements are
not met and then only until such time as they are met. Hence, they do not, under the principles
established in the Standard, result in the classification of the financial instrument as equity.
Paragraph 38 of the Standard states:
“Preference shares may be issued with various rights. In determining whether a
preference share is a financial liability or an equity instrument, an issuer assesses the
particular rights attaching to the share to determine whether it exhibits the fundamental
characteristic of a financial liability. For example, a preference share that provides for
redemption on a specific date or at the option of the holder is a financial liability because
the issuer has an obligation to transfer financial assets to the holder of the share. The
potential inability of an issuer to satisfy an obligation to redeem a preference share when
contractually required to do so, whether because of a lack of funds, a statutory restriction
or insufficient profits or reserves, does not negate the obligation. [Emphasis added]”
Prohibitions Against Redemption (Paragraphs 43 and 44)
Example 3
Facts
B6. A co-operative entity has issued shares to its members at different dates and for different
amounts in the past as follows:
Page40
(a) 1 January 20X1: 100,000 shares at Rs. 10 each (Rs. 1,000,000);
(b) 1 January 20X2: 100,000 shares at Rs. 20 each (a further Rs. 2,000,000, so that
the total for shares issued is Rs. 3,000,000).
Shares are redeemable on demand at the amount for which they were issued.
B7. The governing bye-laws of the entity state that cumulative redemptions cannot exceed 20
per cent of the highest number of its members’ shares ever outstanding. At 31 December 20X2,
the entity has 200,000 of outstanding shares, which is the highest number of members’ shares
ever outstanding and no shares have been redeemed in the past. On 1 January 20X3, the entity
amends its governing bye-laws and increases the permitted level of cumulative redemptions to
25 per cent of the highest number of its members’ shares ever outstanding.
Classification
Before the governing bye-laws are amended
B8. Members’ shares in excess of the prohibition against redemption are financial liabilities.
The co-operative entity measures this financial liability at fair value at initial recognition.
Because these shares are redeemable on demand, the co-operative entity determines the fair
value of such financial liabilities as required by paragraph 55 of AS 30, which states: ‘The fair
value of a financial liability with a demand feature (e.g., a demand deposit) is not less than the
amount payable on demand…’. Accordingly, the co-operative entity classifies as financial
liabilities the maximum amount payable on demand under the redemption provisions.
B9. On 1 January 20X1, the maximum amount payable under the redemption provisions is
20,000 shares at Rs. 10 each and, accordingly, the entity classifies Rs. 200,000 as financial
liability and Rs. 800,000 as equity. However, on 1 January 20X2, because of the new issue of
shares at Rs. 20, the maximum amount payable under the redemption provisions increases to
40,000 shares at Rs. 20 each. The issue of additional shares at Rs. 20 creates a new liability that
is measured on initial recognition at fair value. The liability after these shares have been issued is
20 per cent of the total shares in issue (200,000), measured at Rs. 20, or Rs. 800,000. This
requires recognition of an additional liability of Rs. 600,000. In this example no gain or loss is
recognised. Accordingly, the entity now classifies Rs. 800,000 as financial liabilities and Rs.
2,200,000 as equity. This example assumes these amounts are not changed between 1 January
20X1 and 31 December 20X2.
After the governing bye-laws are amended
B10. Following the change in its governing bye-laws, the co-operative entity can now be
required to redeem a maximum of 25 per cent of its outstanding shares or a maximum of 50,000
shares at Rs. 20 each. Accordingly, on 1 January 20X3, the co-operative entity classifies as
financial liabilities an amount of Rs. 1,000,000 being the maximum amount payable on demand
under the redemption provisions, as determined in accordance with paragraph 55 of AS 30. It,
therefore, transfers on 1 January 20X3 from equity to financial liabilities an amount of Rs.
Page41
200,000, leaving Rs. 2,000,000 classified as equity. In this example, the entity does not recognise
a gain or loss on the transfer.
Example 4
Facts
B11. Law governing the operations of co-operatives, or the terms of the governing bye-laws of
the entity, prohibit an entity from redeeming members’ shares if, by redeeming them, it would
reduce paid-in capital from members’ shares below 75 per cent of the highest amount of paid-in
capital from members’ shares. The highest amount for a particular co-operative is Rs. 1,000,000.
At the balance sheet date, the balance of paid-in capital is Rs. 900,000.
Classification
B12. In this case, Rs. 750,000 would be classified as equity and Rs. 150,000 would be
classified as financial liabilities. In addition to the paragraphs already cited, paragraph 35(b) of
the Standard states in part:
“…a financial instrument that gives the holder the right to put it back to the issuer for
cash or another financial asset (a ‘puttable instrument’) is a financial liability. This is so
even when the amount of cash or other financial assets is determined on the basis of an
index or other item that has the potential to increase or decrease, or when the legal form
of the puttable instrument gives the holder a right to a residual interest in the assets of an
issuer. The existence of an option for the holder to put the instrument back to the issuer
for cash or another financial asset means that the puttable instrument meets the definition
of a financial liability. …”
B13. The redemption prohibition described in this example is different from the restrictions
described in paragraphs 36 and 38 of the Standard. Those restrictions are limitations on the
ability of the entity to pay the amount due on a financial liability, i.e., they prevent payment of
the liability only if specified conditions are met. In contrast, this example describes an
unconditional prohibition on redemptions beyond a specified amount, regardless of the entity’s
ability to redeem members’ shares (e.g., given its cash resources, profits or distributable
reserves). In effect, the prohibition against redemption prevents the entity from incurring any
financial liability to redeem more than a specified amount of paid-up capital. Therefore, the
portion of shares subject to the redemption prohibition is not a financial liability. While each
member’s shares may be redeemable individually, a portion of the total shares outstanding is not
redeemable in any circumstances other than liquidation of the entity.
Example 5
Facts
B14. The facts of this example are as stated in example 4. In addition, at the balance sheet date,
liquidity requirements imposed in the jurisdiction prevent the entity from redeeming any
Page42
members’ shares unless its holdings of cash and short-term investments are greater than a
specified amount. The effect of these liquidity requirements at the balance sheet date is that the
entity cannot pay more than Rs. 50,000 to redeem the members’ shares.
Classification
B15. As in example 4, the entity classifies Rs. 750,000 as equity and Rs. 150,000 as a financial
liability. This is because the amount classified as a liability is based on the entity’s unconditional
right to refuse redemption and not on conditional restrictions that prevent redemption only if
liquidity or other conditions are not met and then only until such time as they are met. The
provisions of paragraphs 36 and 38 of the Standard apply in this case.
Example 6
Facts
B16. The governing bye-laws of the entity prohibit it from redeeming members’ shares, except
to the extent of proceeds received from the issue of additional members’ shares to new or
existing members during the preceding three years. Proceeds from issuing members’ shares must
be applied to redeem shares for which members have requested redemption. During the three
preceding years, the proceeds from issuing members’ shares have been Rs. 12,000 and no
member’s shares have been redeemed.
Classification
B17. The entity classifies Rs. 12,000 of the members’ shares as financial liabilities.
Consistently with the conclusions described in example 4, members’ shares subject to an
unconditional prohibition against redemption are not financial liabilities. Such an unconditional
prohibition applies to an amount equal to the proceeds of shares issued before the preceding
three years, and accordingly, this amount is classified as equity. However, an amount equal to
the proceeds from any shares issued in the preceding three years is not subject to an
unconditional prohibition on redemption. Accordingly, proceeds from the issue of members’
shares in the preceding three years give rise to financial liabilities until they are no longer
available for redemption of members’ shares. As a result the entity has a financial liability equal
to the proceeds of shares issued during the three preceding years, net of any redemptions during
that period.
Example 7
Facts
B18. The bye-laws governing the operations of a co-operative entity state that atleast 50 per
cent of the entity’s total ‘outstanding liabilities’ (a term defined in the byelaws to include
members’ share accounts) has to be in the form of members’ paid-up capital. The effect of the
bye-laws is that if all of a co-operative’s outstanding liabilities are in the form of members’
Page43
shares, it is able to redeem them all. On 31 December 20X1, the entity has total outstanding
liabilities of Rs. 200,000, of which Rs. 125,000 represent members’ share accounts. The terms of
the members’ share accounts permit the holder to redeem them on demand and there are no
limitations on redemption in the governing byelaws of the entity.
Classification
B19. In this example, members’ shares are classified as financial liabilities. The redemption
prohibition is similar to the restrictions described in paragraphs 36 and 38 of the Standard. The
restriction is a conditional limitation on the ability of the entity to pay the amount due on a
financial liability, i.e., they prevent payment of the liability only if specified conditions are met.
More specifically, the entity could be required to redeem the entire amount of members’ shares
(Rs. 125,000) if it repaid all of its other liabilities (Rs. 75,000). Consequently, the prohibition
against redemption does not prevent the entity from incurring a financial liability to redeem more
than a specified number of members’ shares or amount of paid-in capital. It allows the entity
only to defer redemption until a condition is met, i.e., the repayment of other liabilities.
Members’ shares in this example are not subject to an unconditional prohibition against
redemption and are therefore classified as financial liabilities.
Page44
Appendix C
Comparison with IAS 32, Financial Instruments: Presentation
Note: This Appendix is not a part of Accounting Standard (AS) 31, Financial Instruments:
Presentation. The purpose of this appendix is only to bring out the major differences between AS
31 and the corresponding International Accounting Standard (IAS) 32.
Comparison with IAS 32, Financial Instruments: Presentation
The Accounting Standard is based on International Accounting Standard (IAS) 32, Financial
Instruments: Presentation and incorporates IFRIC 2, Members’ Shares in Co-operative Entities
and Similar Instruments (Re. IAS 32, Financial Instruments: Presentation), issued by the
International Financial Reporting Interpretation Committee (IFRIC) of the International
Accounting Standards Board (IASB). There is no major difference between AS 31, and IAS 32
and IFRIC 2.
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