Financial Instruments: Question Bank and Concept Illustration

1. Ind AS-32 : Financial Instruments – Presentation

Scope of Ind AS 32 and 109 : [Financial Guarantee contract]

Q1: [Based on Definition in Appendix A + Para No. B2.5 of Ind AS 109] : P Ltd. (parent company) has issued a comfort letter to its subsidiary company, S Ltd. S Ltd. was able to obtain funds from the banker on the basis of comfort letter issued by P Ltd.
Whether the same will be accounted for as a financial guarantee contract in accordance with Ind AS 109, Financial Instruments?
[Issue No. 3 of ITFG Clarification Ind AS Bulletin No. 12]

Ans.:
Analysis : In accordance with the above, it may be noted that a significant feature of a financial guarantee contract is the contractual obligation to make specified payment in case of default by the credit holder. As such the contract may not necessarily be called as financial guarantee contract and it may take any name or legal form, however the treatment will be same as that of a financial guarantee contract.
If a contract legally meets these requirements, then it would be accounted for as the financial guarantee contract as per Ind AS 109.
Conclusion : Accordingly, in the given case, P Ltd. will be required to evaluate as to whether it is contractually obliged to make good the loss in case S Ltd. fails to make the payment.
If yes, then such comfort letter would be considered to be a financial guarantee contract and will be accounted for in accordance with Ind AS 109.

Q2: [Based on Definition in Appendix A of Ind AS 109] : Company A Ltd., applied for a term loan from Bank B for business purposes. As per the loan agreement, the loan required a personal guarantee of one of the directors of A Ltd. to be executed. In case of default by A Ltd., the director will be required to compensate for the loss that Bank B incurs Mr. P, one of the directors had given guarantee to the bank pursuant to which the loan was sanctioned to Company A. Company A does not pay premium or fees to its director for providing this financial guarantee.
Whether Company A is required to account for the financial guarantee received from its director?
[Issue No. 2 of ITFG Clarification Ind AS Bulletin No. 13]

Ans.:
Analysis : Based on this definition, an evaluation is required to be done to ascertain whether the contract between director and Bank B qualifies as a financial guarantee contract as defined in Appendix A to Ind AS 109.
In the given case, it does qualify as a financial guarantee contract as:

• • The reference obligation is a debt instrument (term loan);
  • The holder i.e. Bank B is compensated only for a loss that it incurs (arising on account of non-repayment); and
  • The holder is not compensated for more than the actual loss incurred.

Ind AS 109 provides principles for accounting by the issuer of the guarantee. However, it does not specifically address the accounting for financial guarantees by the beneficiary. In an arm’s length transaction between unrelated parties, the beneficiary of the financial guarantee would recognize the guarantee fee or premium paid as an expense.

It is also pertinent to note that the entity needs to exercise judgment in assessing the substance of the transaction taking into consideration relevant facts and circumstances, for example whether the director is being compensated otherwise for providing guarantee. Based on such an assessment, an appropriate accounting treatment based on the principles of Ind AS should be followed.

Conclusion : In the given case, Company A Ltd., is the beneficiary of the financial guarantee and it does not pay a premium or fees to its director for providing this financial guarantee (subject to discussion above).
Accordingly, Company A will not be required to account for such financial guarantee in its financial statements considering the unit of account as being the guaranteed loan, in which case the fair value would be expected to be the face value of the loan proceeds that the Company A received.
Nonetheless, the above transaction needs to be evaluated for disclosure under paragraph 18 of Ind AS 24, Related Party Disclosures.

Further Conclusion : In the given case based on the limited facts provided, Company A will be required to make necessary disclosures of such financial guarantee in accordance with Ind AS 24.

Q3: V Ltd. is covered under Phase II of Ind AS roadmap and is required to apply Ind AS from financial year 2017-18. It has given financial guarantee for five years against the loan taken by its associate company, S Ltd. since 1.4.2014 and charging 1% guarantee commission.
(a) At what value will the financial guarantee contract be accounted for in the opening Ind AS balance sheet of V Ltd.
(b) Further, if on 31.3.2016, the guarantee is invoked but V Ltd. has shown it under contingent liability in financial statement of 2015 and also 2016 contesting that it is confident that liability shall not devolve on it. Whether on transition date i.e. 1.4.2016 the impairment needs to be calculated and accordingly fair value of financial guarantee need to be calculated.
[Issue No. 11 of ITFG Clarification Ind AS Bulletin No. 12]

Ans.:
(a) Assumption:
The financial guarantee given by V Ltd. meets the definition of financial guarantee contracts under Ind AS 109
Analysis and Conclusion : If the associate company S Ltd. pays the parent company V Ltd. a guarantee commission, company V Ltd. is required to determine if this commission represents the fair value of the financial guarantee contract. If the premium is equivalent to an amount that company S Ltd. would have paid to obtain a similar guarantee in a standalone arm’s length transaction, then at the initial recognition the fair value of the financial guarantee contract is likely to equal the commission received.

(b) Refer Para Nos. 4.2.1(c) and 5.5.1 of Ind AS 109;
Analysis and Conclusion : Company V Ltd. should recognise a liability for the amount of premium received and subsequently measure the financial guarantee contract at the higher of the amount of loss allowance determined in accordance with Ind AS 109 and the amount initially recognised less cumulative amount of income recognised in accordance with Ind AS 115.

In accordance with the above, at the end of each reporting period the entity shall estimate and recognise the expected loss in accordance with the provisions prescribed in the standard.
Accordingly, in the given case V Ltd. shall estimate and recognise the same in accordance with Ind AS 109.

2. Definition of Financial Instrument : [Based on Para Nos. (11 and 13)]

Q4: [Based on Para No. 11 of Ind AS 32 + Para No. 3.1.1 of Ind AS 109] : MNO Ltd. has an incentive receivable in the form of sales tax refundable from the government, under a scheme of government on complying with the certain stipulated conditions.
Whether such incentives receivable from government will fall under the definition of financial instruments under Ind AS 109 considering that there is no formal one to one contractual agreement between government and the company?
[Issue No. 3 of ITFG Clarification Ind AS Bulletin No. 15]

Ans.:
Interpretation : As per the above, a financial instrument arises as a result of contractual obligation between the parties.
Refer Para No. 13 of Ind AS 32;

Interpretation and Analysis : The above paragraph clarifies that contract need not be in writing only and may take various forms. In India, government does give incentives in the form of taxation benefits etc. to promote industry or for some other reasons as the case may be. Although under such schemes, there may not be a one to one agreement between the entity and the government as to the rights and obligations but there is an understanding between the government and the potential applicant/company that on complying the stipulated conditions attached to the scheme, the entity will be granted benefits of the scheme.

Conclusion : If in the given case, the entity has complied with the conditions attached to the scheme then it rightfully becomes entitled to the incentives attached to the scheme.
Accordingly, such incentive receivable will fall under the definition of financial instruments and will be accounted for as a financial asset per Ind AS 109.

3. Definition of Financial Liability & Equity Instrument : [Based on Para Nos. (11 and 16)]

Situation I : Non-Derivative – Application of Fixed Test : [Based on Clause (a)(i) of Financial Liability Definition]

Q5: A Ltd. (the ‘Company’) makes purchase of steel for its consumption in normal course of business. The purchase terms provide for payment of goods at 30 days credit and interest payable @ 12% per annum for any delays beyond the credit period.
Analyse the nature of this financial instrument.

Ans.: A Ltd. has entered into a contractual arrangement for purchase of goods at a fixed consideration payable to the creditor.
A contractual arrangement that provides for payment in fixed amount of cash to another entity meets the definition of financial liability.

Situation II : Non-Derivative – Application of Fixed Test : [Based on Clause (b)(i) of Financial Liability Definition]

Case I : [Fails Fixed Test]

Q6: C Ltd. issues convertible debentures to R Ltd. for a subscription amount of ` 100 crores. Those debentures are convertible after 5 years into equity shares of C Ltd. using a pre-determined formula. The formula is:

Examine the nature of the financial instrument.

Ans.:

Nature of contract	Clause No.	Which Test will apply?	Status
Non-derivative	(b)(i)	Fixed Test	Fails

 

Analysis and Conclusion : The above contract is a financial liability of the entity even though the entity 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.

The underlying thought behind this conclusion is that the entity is using its own equity instruments ‘as currency’.

Q7: Target Ltd. took a borrowing from Z Ltd. for ` 10,00,000. Z Ltd. enters into an arrangement with Target Ltd. for settlement of the loan against issue of a certain number of equity shares of Target Ltd. whose value equals ` 10,00,000. For this purpose, fair value per share (to determine total number of equity shares to be issued) shall be determined based on the market price of the shares of Target Ltd. at a future date, upon settlement of the contract.

Evaluate this under definition of financial instrument.

Ans.:

Nature of contract	Clause No.	Which Test will apply?	Status
Non-derivative	(b)(i)	Fixed Test	Fails

 

Analysis and Conclusion : Target Ltd. is under an obligation to issue variable number of equity shares equal to a total consideration of ` 10,00,000.

Hence, equity shares are used as currency for purpose of settlement of an amount payable by Target Ltd.

Since this is variable number of shares to be issued in a non-derivative contract for fixed amount of cash, it tantamount to use of equity shares as ‘currency’ and hence, this contract meets definition of financial liability in books of Target Ltd.

Case II : [Passes Fixed Test]

Q8: D Ltd. issues convertible debentures to J Ltd. for a subscription amount of ` 100 crores. Those debentures are convertible after 5 years into 15 crore equity shares of ` 10 each.

Examine the nature of the financial instrument.

Ans.:

 

Nature of contract	Clause No.	Which Test will apply?	Status
Non-derivative	(b)(i)	Fixed Test	Passes

 

Analysis and Conclusion : This contract is an equity instrument because changes in the fair value of equity shares arising from market related factors 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.

Situation III : Derivative – Application of Fixed for Fixed Test : [Based on Clause (b)(ii) of Financial Liability Definition]

 

Case I : [Passes Fixed for Fixed Test]

Q9: A Ltd. issues warrants to all existing shareholders entitling them to purchase additional equity shares of A Ltd. (with face value of ` 100 per share) at an issue price of ` 150 per share.

Evaluate whether this constitutes an equity instrument or a financial liability?

Ans.:

Nature of contract	Clause No.	Which Test will apply?	Status
Derivative	(b)(ii)	Fixed for Fixed Test	Passes

 

Step I : Proof of being a Derivative : Let us evaluate this contract under definition of derivative:

Parameter 1 : The value of warrant changes in response to change in value of underlying equity shares.

Parameter 2 : This involves no initial net investment

Parameter 3 : It shall be settled at a future date.

Hence, this warrant meets the definition of derivative.

Step II : Evaluation of Fixed for Fixed Test : Company A Ltd. has issued warrants entitling the shareholders to purchase equity shares of the Company at a fixed price. Hence, it constitutes a contractual arrangement for issuance of fixed number of shares against fixed amount of cash.

Step III : Analysis and Conclusion : Applying definition of equity under Ind AS 32, a derivative contract that will be settled by exchange of fixed number of equity shares for fixed amount of cash meets definition of equity instrument.

The above contract is derivative contract that will be settled by issue of fixed number of own equity instruments by A Ltd. for fixed amount of cash and hence, meets definition of equity instrument.

Situation IV : Derivative Financial Liability : [Based on Clause (a)(ii) of Financial Liability Definition]

Q10: Entity – B Ltd. writes an option contract for sale of shares of Target Ltd. at a fixed price of ` 100 per share to C Ltd. This option is exercisable anytime for a period of 90 days (‘American option’). Evaluate this under definition of financial instrument.

Ans.:

Nature of contract	Clause No.	Which Test will apply?	Status
Derivative	(a)(ii)	Exchange under conditions potentially unfavourable	Passes

 

Step I:

Proof of being a Derivative : Let us evaluate this contract under definition of derivative:

Parameter 1 : The value of option changes based on change in market price of equity share

Parameter 2 : This involves no initial net investment

Parameter 3 : It shall be settled at a future date (anytime in 90 days).

Hence, this warrant meets the definition of derivative.

Step II:

Evaluation of Exchange under potentially unfavourable conditions : B Ltd. has written an option, which if exercised by C Ltd. will result in B Ltd. selling equity shares of Target Ltd. for fixed cash of ` 100 per share.

Such option will be exercised by C Ltd. only if the market price of shares of Target Ltd. increases beyond ` 100, thereby resulting in contractual obligation over B Ltd. to settle the contract under potential unfavourable terms.

In the above case, if the market price is already ` 120 which means that if option is exercised by C Ltd., then B Ltd. shall buy shares from the market at ` 120 per share and sell at ` 100, thereby resulting in a loss or exchange at unfavourable terms to B Ltd.

Hence, it meets the definition of financial liability in books of B Ltd.

Step III:

Analysis and Conclusion : Thus, based on steps 1 and 2 we can conclude that it meets the definition of derivative financial liability in books of B Ltd.

Situation IVA : Non-Derivative Financial Liability : [Based on Clause (a)(ii) of Financial Liability Definition]

Q11: A Ltd. (the ‘Company’) makes a borrowing for ` 10 lacs from RBC Bank, with bullet repayment of ` 10 lacs and an annual interest rate of 12% per annum. Now, Company defaults at the end of 5th year and consequently, a rescheduling of the payment schedule is made beginning 6th year onwards. The Company is required to pay ` 13,00,000 at the end of 6th year for one-time settlement, in lieu of defaults in payments made earlier.

   (a)   Does the above instrument meet definition of financial liability? Please explain.

   (b)   Analyze the differential amount to be exchanged for one-time settlement.

Ans.:

Nature of contract	Clause No.	Which Test will apply?	Status
Non-Derivative	(a)(ii)	Exchange under conditions potentially unfavourable	Passes

 

Analysis and Conclusion to Part (a) : A Ltd. has entered into an arrangement wherein against the borrowing, A Ltd. has contractual obligation to make stream of payments (including interest and principal). This meets definition of financial liability.

Analysis and Conclusion to Part (b) : Let’s compute the amount required to be settled and any differential arising upon one-time settlement at the end of 6th year;

Loan principal amount = ` 10,00,000

Amount payable at the end of 6th year = ` 12,54,400

[10,00,000 * 1.12 * 1.12 (Interest for 5th & 6th year in default plus principal amount)]

One-time settlement = ` 13,00,000

Thus,

Additional amount payable = ` 45,600

The above represents a contractual obligation to pay cash against settlement of a financial liability under conditions that are unfavourable to A Ltd. (owing to additional amount payable in comparison to amount that would have been paid without one-time settlement).

Hence, the rescheduled arrangement meets definition of ‘financial liability’.

4. Special Issue: Carve out of Ind AS 32 vis-à-vis IAS 32 : [Based on Clause (b)(ii) of Financial Liability Definition]

Q12: Entity A issues a bond with face value of USD 100 and carrying a fixed coupon rate of 6% p.a. Each bond is convertible into 1,000 equity shares of the issuer.

Examine the nature of the financial instrument.

Ans.:

Analysis and Conclusion : While the number of equity shares is fixed, the amount of cash is not.

The variability in cash arises on account of fluctuation in exchange rate of ` -USD. Such a foreign currency convertible bond (FCCB) will qualify the definition of “financial liability”.

However, Ind AS 32.11 provides, “the equity conversion option embedded in a convertible bond denominated in foreign currency to acquire a fixed number of the entity’s own equity instruments is an equity instrument if the exercise price is fixed in any currency.”

Accordingly, FCCB will be treated as an “equity instrument”.

5. Equity Instrument : [Based on Para No. 16]

Q13: A holding company H Ltd., which is covered under phase II of Ind AS has a subsidiary S Ltd. H Ltd. is holding 57% of equity in S Ltd. The subsidiary S Ltd., has issued 1.5% optionally convertible preference shares (OCPS) to its holding company, which are non-cumulative. All preference shares are issued to holding company. The subsidiary company has the option to convert or redeem the stated preference shares. H Limited does not have any right for the redemption of such preference shares.

How will these instruments be accounted for in the following financial statements?

    (i)   Standalone financial statements of S Ltd.

   (ii)   Standalone financial statements of H Ltd. and

(iii)   Consolidated financial statements of the Group.

           [Issue No. 7 of ITFG Clarification Ind AS Bulletin No. 14]

Ans.:

Note : This Question should be read after getting a basic understanding of Para Nos. AG25 and AG26 of Ind AS 32.

Assumption : It has been assumed that S Ltd. has an option to convert the instrument into a fixed number of its own shares and dividend payment is discretionary.

Analysis and Conclusion:

S. No.	Financial Statements	Classification of the Instruments
(i)	Standalone FS of S Ltd.	Provided the conversion feature is considered substantive, the instrument can be viewed as an equity instrument, because the issuer has the ability to convert the instrument into a fixed number of its own shares at any time. The issuer, therefore, has the ability to avoid making a cash payment or settling the instrument in a variable number of its own shares. Any feature that might have been considered to be an embedded derivative would not meet the definition of a derivative on a stand-alone basis, given the ability to avoid payment. Hence, the issuer’s conversion and redemption options would not be separated, and the entire instrument would be classified as equity in the separate financial statements of S Ltd.
(ii)	Standalone FS of H Ltd	In the separate financial statements of H Limited, the investment should be considered to be an investment in subsidiary and therefore would be excluded from the scope of Ind AS 109 unless H Ltd. has elected otherwise. Paragraph 10 of Ind AS 27, Separate Financial Statements, states that when an entity prepares separate financial statements, it shall account for investments in subsidiaries, joint ventures and associates either:    (a)   at cost, or    (b)   in accordance with Ind AS 109. In view of the above assuming that the company H Ltd. has not elected to account for its investment in accordance with Ind AS 109, it would account for it at cost.
(iii)	Consolidated FS of the Group	In the consolidated financial statements of the Group, these transactions will be eliminated, being intra-group transactions in accordance with Ind AS 110.

6. Definition of Financial Asset & Financial Liability : [Based on Para Nos. AG6 to AG12 of Appendix A to Ind AS 32]

Q14: [Based on Para No. AG6 of Ind AS 32] : A Ltd. issues a bond at principal amount of CU 1000 per bond. The terms of bond require annual payments in perpetuity at a stated interest rate of 8 per cent applied to the principal amount of CU 1000. Assuming 8 per cent to be the market rate of interest for the instrument when it was issued, the issuer assumes a contractual obligation to make a stream of future interest payments having a fair value (present value) of CU1,000 on initial recognition.

Evaluate the financial instrument in the hands of both the holder and the issuer.

Ans.: Analysis and Conclusion:

Point of View	Classification	Reason
Holder	Financial Asset	Right to receive cash in future.
Issuer	Financial Liability	Contractual obligation to pay cash in future.

 

Q15: [Based on Para No. 2 of Ind AS 2 + Para Nos. 11 and AG10 of Ind AS 32] : A share broking company is dealing in sale/purchase of shares for its own account and therefore is having inventory of shares purchased by it for trading. The company is covered under Phase II of Ind AS roadmap.

What will be the accounting treatment of such shares held as stock-in trade in accordance with Ind AS?

                                [Issue No. 5 of ITFG Clarification Ind AS Bulletin No. 14]

Ans.:

Interpretation : Ind AS 109 applies to all types of financial instruments with certain exceptions as envisaged in paragraph 2 of Ind AS 109.

Accordingly, the principles of recognizing and measuring financial instruments are governed by Ind AS 109, its presentation is governed by Ind AS 32 and disclosures about them are in Ind AS 107, Financial Instruments: Disclosures, even if these instruments are held as stock-in trade by a company.

Further Ind AS 101, First-time Adoption of Indian Accounting Standards does not provide any transitional relief from the application of the above standards.

Conclusion : Accordingly, in the given case the relevant requirements of Ind AS 109, Ind AS 32 and Ind AS 107 shall be applied retrospectively unless otherwise exempted under Ind AS 101.

7. Preference Shares : [Based on Para Nos. AG25 to AG26 of Appendix A]

Q16: Silver Ltd. issued irredeemable preference shares with face value of ` 10 each and premium of ` 90. These shares carry dividend @ 8% per annum; however, dividend is paid only when Silver Ltd. declares dividend on equity shares.

Analyse the nature of this instrument.

Ans.: Evaluation Chart:

S. No.	Parameters	Analysis	Remarks
1.	Principal Amount	Preference share are irredeemable. Face value is not redeemable (except in case of liquidation).	Equity Instrument
2.	Returns (Dividend)	Preference shares carry dividend, which is payable only when Company declares dividend on equity shares. Since dividend on equity shares is discretionary and the Company can choose not to pay, Company has an unconditional right to avoid payment of cash on preference shares also.	Equity Instrument
Overall Conclusion			Equity Instrument

 

Q17: A Ltd. invests in compulsorily convertible preference shares (CCPS) issued by its subsidiary – B Ltd. at ` 1,000 each (` 10 face value + ` 990 premium). Under the terms of the instrument, each CCPS is compulsorily convertible into one equity share of B Ltd. at the end of 5 year. Such CCPS carry dividend @ 12% per annum, payable only when declared at the discretion of B Ltd. Evaluate this under definition of financial instrument.

Ans.: Evaluation Chart:

S. No.	Parameters	Analysis	Remarks
1.	Principal Amount	Conversion into fixed number of equity shares, i.e., one equity share, for every CCPS. [Meets the Fixed Test]	Equity Instrument
2.	Returns (Dividend)	Non-cumulative dividends. Dividends are payable only when declared and hence, at the discretion of the Issuer – B Ltd., thereby resulting in no contractual obligation over B Ltd.	Equity Instrument
Overall Conclusion			Equity Instrument

 

Q18: A Ltd. (issuer) issues preference shares to B Ltd. (holder). Those preference shares are redeemable at the end of 10 years from the date of issue and entitle the holder to a cumulative dividend of 15% p.a. The rate of dividend is commensurate with the credit risk profile of the issuer.

Examine the nature of the financial instrument.

Ans.: Evaluation Chart:

S. No.	Parameters	Analysis	Remarks
1.	Principal Amount	This instrument provides for mandatory redemption by the issuer for a fixed amount at a fixed future date. Since there is a contractual obligation to deliver cash to the preference shareholder that cannot be avoided, the instrument is a financial liability.	Financial Liability
2.	Returns (Dividend)	This instrument provides for mandatory fixed dividend payments by the issuer for a fixed amount at a fixed future date. Since there is a contractual obligation to deliver cash to the preference shareholder that cannot be avoided, the instrument is a financial liability.	Financial Liability
Overall Conclusion			Financial Liability

 

Q19: LMN Ltd. issues preference shares to PQR Ltd. These preference shares are redeemable at the end of 5 years from the date of issue.

The instrument also provides a settlement alternative to the issuer whereby it can transfer a particular commercial building to the holder, whose value is estimated to be significantly higher than the cash settlement amount.

Examine the nature of the financial instrument.

Ans.: Evaluation Chart:

S. No.	Parameters	Analysis	Remarks
1.	Principal Amount	These preference shares are redeemable at the end of 5 years from the date of issue.	Financial Liability
2.	Returns (Dividend)	No Information. Thus, assume to be FL.	Financial Liability
Overall Conclusion			Financial Liability

 

Note : The entity can avoid a transfer of cash or another financial asset only by settling by transfer of non-financial asset (building). This would not impact the analysis.

Q20: A Ltd. issued compulsorily convertible preference shares (CCPS) at ` 100 each (` 10 face value + ` 90 premium per share) for ` 10,00,000. These are convertible into equity shares at the end of 10 years, where the number of equity shares to be issued shall be determined based on fair value per equity share to be determined at the time of conversion.

Evaluate if this is financial liability or equity?

What if the conversion ratio was fixed at the time of issue of such preference shares?

Note : This Question should be done after getting basic understanding of Ind AS 109.

Ans.: Evaluation Chart – Part I:

S. No.	Parameters	Analysis	Remarks
1.	Principal Amount	Non-derivative contracts which will be settled against issue of variable number of own equity shares meet the definition of financial liability. [i.e. Fails Fixed Test] In this case, A Ltd. has issued CCPS which are convertible into variable number of shares. Hence, it is akin to use of own equity shares as currency for settlement of the liability of CCPS issued. Accordingly, it meets the definition of financial liability.	Financial Liability
2.	Returns (Dividend)	Assumed payable with the principal in the end in the form of equity shares.	Financial Liability
Overall Conclusion			Financial Liability

 

Measurement:

Initial measurement : This shall be measured at fair value on date of transaction. Since A Ltd. shall give shares worth ` 10 lacs at the end of 10 years which is equal to the amount borrowed on day 1, the liability is recognized at fair value, determined by discounting future settlement of the borrowed amount.

For difference arising on day 1 between amount borrowed and that recognized as liability using level 3 inputs, it is deferred and recognized on a systematic basis over the period of liability.

Subsequent measurement : Such liability shall be carried at fair value through profit or loss (FVTPL).

Evaluation Chart – Part I:

S. No.	Parameters	Analysis	Remarks
1.	Principal Amount	A non-derivative contract that involves issue of fixed number of equity shares shall be classified as equity. [Passes Fixed Test] In this case, if the conversion of CCPS was into a fixed number of equity shares at the end of 10 years, then it meets the definition of equity and hence, shall be classified as ‘equity instrument’.	Equity Instrument
2.	Returns (Dividend)	Assumed payable with the principal in the end in the form of equity shares.	Equity Instrument
Overall Conclusion			Equity Instrument

 

Measurement:

Initial measurement : An equity instrument is carried at cost.

Subsequent measurement : No further adjustments made to its’ carrying value after initial recognition.

Q21: [Based on Para No. AG26] : Does the lack of access to foreign currency or the need to obtain approval for payment from a regulatory authority, will lead to contractual obligation?

Ans.: 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.

Q22: Company P has been making losses in the past years and hence did not pay dividend to its cumulative preference shareholder Prior to transition to Ind ASs, the Company was showing the accumulated arrears of cumulative preference dividend as ‘contingent liability’ in the notes to its financial statements. On transition to Ind ASs, the cumulative preference shares are assessed to meet the requirements for classification as a financial liability in their entirety under Ind AS 32 Financial Instruments: Presentation.

    (i)   Whether the accumulated arrears of preference dividend, earlier shown as ‘contingent liability’, be recognized in the books of account as interest expense by applying the effective interest method?

   (ii)   If yes, then whether the entire amount needs to be amortized or recognized as interest expense in the first Ind AS reporting period?

           [Issue No. 3 of ITFG Clarification Ind AS Bulletin No. 20]

Note : This Question should be done after getting basic understanding of Ind AS 109.

Ans.:

Ind AS 32, Financial Instruments: Presentation, establishes, inter alia, principles for presentation of financial instruments as liabilities or equity. The application of these principles may result in a financial instrument being classified as a financial liability in entirety (e.g. a typical redeemable debenture that carries a periodic coupon rate and is redeemable at a fixed date for a fixed amount), or as equity in entirety (e.g. a typical equity share of an entity), or partly as a financial liability and partly as equity (e.g. a typical optionally convertible debenture that is convertible into a fixed number of equity shares).

Conclusion : As per the facts of the case, the preference shares under reference are assessed to meet the requirements for classification as a financial liability in entirety. This implies, inter alia, that the covenants of the terms of issue of preference shares relating to dividends represent a contractual obligation of the issuer (Company P) to pay such dividends.

Analysis : Preference shares that are classified in entirety as a financial liability are accounted for under Ind AS 109 in the same manner as a redeemable debenture or a typical loan.