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Thread: 31 Accounting Standard 31 Financial Instruments: Presentation - AS 31

  1. #11
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    Default Presentation Liabilities and Equity of Accounting Standard (AS 31) – Financial Instruments Presentation

    Presentation Liabilities and Equity of Accounting Standard (AS 31) – Financial Instruments: Presentation


    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 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.

    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;
    (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 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.

  2. #12
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    Default Settlement in the Entity’s Own Equity Instruments of Accounting Standard (AS 31) – Financial Instruments: Presentation

    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.

    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.

    (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.

  3. #13
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    Default Contingent Settlement Provisions of Accounting Standard (AS 31) – Financial Instruments Presentation

    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.

  4. #14
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    Default Settlement Options of Accounting Standard (AS 31) – Financial Instruments Presentation

    Settlement Options of Accounting Standard (AS 31) – Financial Instruments Presentation

    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), Presentation of Financial Statements, and AS 21, Consolidated Financial Statements and Accounting for Investments in Subsidiaries in Separate Financial Statements. 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.

  5. #15
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    Default Compound Financial Instruments of Accounting Standard (AS 31) – Financial Instruments: Presentation

    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 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

    (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.

  6. #16
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    Default Treasury shares of Accounting Standard (AS 31) – Financial Instruments Presentation

    Treasury shares of Accounting Standard (AS 31) – Financial Instruments Presentation

    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.

  7. #17
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    Default Interest, Dividends, Losses and Gains of Accounting Standard (AS 31) – Financial Instruments Presentation

    Interest, Dividends, Losses and Gains of Accounting Standard (AS 31) – Financial Instruments: Presentation


    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 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).

    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:

    Disclosures.

    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 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.

  8. #18
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    Default Offsetting a Financial Asset and a Financial Liability of Accounting Standard (AS 31) – Financial Instruments: Presentation

    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 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: Disclosures.

    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 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: Disclosures.

    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.

  9. #19
    AAS
    Guest

    Default Appendix A of Accounting Standard (AS 31) – Financial Instruments: Presentation

    Appendix A of Accounting Standard (AS 31) – Financial Instruments: Presentation

    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
    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



    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.

    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).

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