Preface to Fifth Edition Financial Reporting both in India and from the examination point of view has undergone a massive change, especially with Ind AS (Adoption of IFRS) implementation. Keeping in view the latest trend in the exams this thoroughly revised and enlarged edition of Financial Reporting is being presented for students aspiring for CA Final level – New Course. This book would also serve the need of other students pursuing professional courses where Ind AS would be required. We are confident that this book will serve the students with necessary number and variety of questions essential for their successful preparation of their subject of “Financial Reporting”. The difficulties which students are likely to encounter in the Exams have been presented and discussed. This edition specifically incorporates Ind AS (including differences between AS and Ind AS and carve-ins and carveouts w.r.t. IFRS), as the same has been incorporated from examination point of view. Case studies, Clarifications and Examples have been given at various places to make the reader easily understand the complexities involved in Ind AS. A separate book on practice is also available for students. We felt that there is a need to address these complicated standards in a lucid manner. An attempt has been made to make these standards easily understandable by examples, diagrams, charts, clarifications and explanations. Examples have been introduced which will help an average student to master the subject without assistance. The book has been written in a classroom style teaching, so that one is able to easily understand the concept. In this edition, a major amendments related to Ind AS-103, 116 and other amendments have also been incorporated at various places wherever applicable. The Chapter has been written based on classroom teaching experience. The questions in each topic have been carefully arranged to suit beginners as well as experts. We hope students will find this book simple and updated. Though every attempt has been made to avoid errors, in case you find any errors, please bring it to our notice. Last but not the least, we are really thankful to Taxmann Publications Pvt. Ltd. for providing us a platform to showcase the book to the students and professionals. We shall be eager to receive any suggestions, feedback for improvements. You can email us at kapileshwar.bhalla@rediffmail.com Or Contact us on: 0-989911-4735(M) New Delhi 1st August, 2021
CA. PARVEEN SHARMA CA. KAPILESHWAR BHALLA
I-5
Syllabus PAPER 1: FINANCIAL REPORTING (One paper – Three hours – 100 Marks)
Objectives: (a) To acquire the ability to integrate and solve problems in practical scenarios on Indian Accounting Standards for deciding the appropriate accounting treatment and formulating suitable accounting policies. (b 7R JDLQ WKH SURZHVV WR UHFRJQL]H DQG DSSO\ GLVFORVXUH UHTXLUHPHQWV VSHFLÀHG LQ ,QGLDQ $FFRXQWLQJ 6WDQGDUGV ZKLOH SUHSDULQJ DQG SUHVHQWLQJ WKH ÀQDQFLDO VWDWHPHQWV (c 7R GHYHORS WKH VNLOO WR SUHSDUH ÀQDQFLDO VWDWHPHQWV RI JURXS HQWLWLHV ZKLFK LQFOXGHV VXEVLGLDULHV DVVRFLDWHV DQG MRLQW arrangements based on Indian Accounting Standards. (d 7R GHYHORS DQ XQGHUVWDQGLQJ RI WKH YDULRXV IRUPV RI UHSRUWLQJ RWKHU WKDQ ÀQDQFLDO VWDWHPHQWV DQG DFFRXQWLQJ IRU special transactions, and apply such knowledge in problem solving. Contents: 1. Framework for Preparation and Presentation of Financial Statements in accordance with Indian Accounting Standards (Ind AS). 2. Application of Indian Accounting Standards (Ind AS) with reference to General Purpose Financial Statements (i) Ind AS on First time adoption of Indian Accounting Standards (ii) Ind AS on Presentation of Items in the Financial Statements (iii) Ind AS on Measurement based on Accounting Policies (iv) Ind AS on Income Statement (v ,QG $6 RQ $VVHWV DQG /LDELOLWLHV RI WKH )LQDQFLDO 6WDWHPHQWV LQFOXGLQJ ,QGXVWU\ VSHFLÀF ,QG $6 (vi) Ind AS on Items impacting the Financial Statements (vii) Ind AS on Disclosures in the Financial Statements (viii) Other Ind AS 3. Indian Accounting Standards on Group Accounting (i) Business Combinations and Accounting for Corporate Restructuring (including demerger) (as per Ind AS) (ii) Consolidated and Separate Financial Statements (as per Ind AS) 4. Accounting and Reporting of Financial Instruments (as per Ind AS) 5. Analysis of Financial Statements 6. Integrated Reporting 7. Corporate Social Responsibility Reporting
I-7
Syllabus
I-8 Notes:
1. If either a new Indian Accounting Standard (Ind AS) or Announcements and Limited Revisions to Ind AS are issued or the earlier one are withdrawn or new Ind AS, Announcements and Limited Revisions to Ind AS are issued in place of existing Ind AS, Announcements and Limited Revisions to Ind AS, the syllabus will accordingly include/exclude such new developments in the place of the existing ones with HIIHFW IURP WKH GDWH WR EH QRWLÀHG E\ WKH ,QVWLWXWH 7KH VSHFLÀF LQFOXVLRQV H[FOXVLRQV LQ DQ\ WRSLF FRYHUHG LQ WKH V\OODEXV ZLOO EH HIIHFWHG HYHU\ \HDU E\ ZD\ of Study Guidelines. Note: Following topics are excluded from the paper “Financial Reporting” effective from November, 2019 Examination onwards as per Notification dated 24-6-2019 by the Board of Studies, ICAI. Topics excluded:
Application of existing Accounting Standards i.e., AS 15, 21, 23, 25, 27 and 28
Application of Guidance Notes issued by ICAI on specified accounting aspects
Accounting for Carbon Credits and related Guidance Note
Accounting for E-commerce Business and related Guidance Note
Human Resource Reporting
Value Added Statement
Expert Advisory Committee (EAC) Opinions
The Guidance Note on accounting for expenditure on Corporate Social Responsibility activities falling within the scope of topic 13 of Syllabus Contents continues to be applicable.
Contents PAGE
Preface to Fifth Edition
I-5
Syllabus
I-7
PART 1 Chapter 1
Framework for Preparation and Presentation of Financial Statements
Chapter 2
Ind AS on Presentation of Items in the Financial Statements
1 18 18
Unit 1
Ind AS 1: Presentation of Financial Statements
Unit 2
Ind AS 34: Interim Financial Reporting
109
Unit 3
Ind AS 7: Cash Flow Statement
126
Chapter 3
Ind AS 115: Revenue from Contracts with Customers
147
Chapter 4
Ind AS on Measurement based on Accounting Policies
257
Chapter 5
Unit 1
Ind AS 8: Accounting Policies, Changes in Accounting Estimates and Errors
257
Unit 2
Ind AS 10: Events after the Reporting Period
273
Unit 3
Ind AS 113: Fair Value Measurement
284
Unit 1 Chapter 6
307
Other Ind AS Ind AS 20: Accounting for Government Grants and Disclosure of Government Assistance
Ind AS 101: First Time Adoption of Ind AS
307 324
PART 2 Chapter 7
Ind AS on Assets of the Financial Statements
358
Unit 1
Ind AS 2: Valuation of Inventory
358
Unit 2
Ind AS 16: Property, Plant and Equipment
376
Unit 3
Ind AS 23: Borrowing Costs
451
Unit 4
Ind AS 36: Impairment of Assets
466
Unit 5
Ind AS 38: Intangible Assets
512
Unit 6
Ind AS 40: Investment Property
545
Unit 7
Ind AS 105: Non-Current Assets held for Sale and Discontinued Operations
559
I-9
Contents
I-10
PAGE
Chapter 8
Unit 1 Chapter 9
591*
,QGXVWU\ 6SHFLÀF ,QG $6 Ind AS 41: Agriculture
Ind AS on Liabilities of the Financial Statements
591* 604*
Unit 1
,QG $6 (PSOR\HH %HQHÀWV
604*
Unit 2
Ind AS 37: Provisions, Contingent Liabilities and Contingent Assets
627*
PART 3 Chapter 10
Chapter 11
Chapter 12
Ind AS on Items impacting the Financial Statements
652*
Unit 1
Ind AS 12: Income Taxes
652*
Unit 2
Ind AS 21: The Effects of Changes in Foreign Exchange Rates
700*
Ind AS on Disclosures in the Financial Statements
731*
Unit 1
Ind AS 24: Related Party Disclosures
731*
Unit 2
Ind AS 33: Earnings Per Share
745*
Unit 3
Ind AS 108: Operating Segments
783*
Accounting and Reporting of Financial Instruments
805*
Unit 1
Ind AS 32: Financial Instruments (Presentation)
805*
Unit 2
Ind AS 109: Financial Instruments - Recognition and Measurement
865*
Unit 3
Ind AS 107: Financial Instruments - Disclosures
1000*
PART 4 Chapter 13
Accounting for Share Based Payment
1005*
Chapter 14
Business Combinations and Corporate Restructuring
1041*
Ind AS 103 Chapter 15
Business Combinations
1041*
Consolidated and Separate Financial Statements
1135*
Ind AS 110
Consolidated Financial Statements
1135*
Ind AS 111
Joint Arrangements
1200*
Ind AS 112
Disclosure of Interests in Other Entities
1221*
Ind AS 28
Investments in Associates and Joint Ventures
1226*
Ind AS 27
Separate Financial Statements
1246*
PART 5 Chapter 16
Integrated Reporting
1261*
Chapter 17
Corporate Social Responsibility Reporting
1277*
Chapter 18
Ind AS 116 : Leases
1287*
SOLVED PAPER - MAY 2019 (NEW SYLLABUS) (GUIDELINE ANSWERS)
1383*
SOLVED PAPER - NOV. 2019 (NEW SYLLABUS) (GUIDELINE ANSWERS)
1405*
SOLVED PAPER - NOV. 2020 (NEW SYLLABUS) (GUIDELINE ANSWERS)
1419*
SOLVED PAPER - JAN. 2021 (NEW SYLLABUS) (GUIDELINE ANSWERS)
1439*
SOLVED PAPER - JULY 2021 (NEW SYLLABUS) (GUIDELINE ANSWERS)
1462*
E M U L O 6
*See
CONTENTS % ' ! 0
CHAPTER
Ind AS-1 : Presentation of Financial Statements
CHAPTER
55
8
Ind AS-20 : Accounting for Government Grants and Disclosure of Government Assistance
CHAPTER
52
7
Ind AS-113 : Fair Value Measurement
CHAPTER
50
6
Ind AS-10 : Events after Reporting Period
CHAPTER
26
5
Ind AS-8 : Accounting Policies, Changes in Accounting Estimates and Errors
CHAPTER
18
4
Ind AS-115 : Revenue from Contracts with Customers
CHAPTER
14
3
Ind AS-7 : Cash Flow Statement
CHAPTER
1
2
Ind AS-34 : Interim Financial Reporting
CHAPTER
1
58
9
Ind AS-102 : Share Based Payments I-5
74
CHAPTER
155
19
Ind AS-41 : Agriculture
CHAPTER
150
18
Ind AS-105 : Non-Current Assets held for sale and Discontinued Operations
CHAPTER
146
17
Ind AS-40 : Investment Property
CHAPTER
137
16
Ind AS-38 : Intangible Assets
CHAPTER
114
15
Ind AS-36 : Impairment of Assets
CHAPTER
102
14
Ind AS-23 : Borrowing Costs
CHAPTER
96
13
Ind AS-116 : Leases
CHAPTER
87
12
Ind AS-16 : Property, Plant and Equipment
CHAPTER
81
11
Ind AS-2 : Inventories
CHAPTER
10
Ind AS-101 : First-Time Adoption of Ind AS
CHAPTER
% ' ! 0
3 4 . % 4 . / #
I-6
181
20
Ind AS-19 : Employee Benefits
187
256
29
Ind AS-110 : Consolidated Financial Statements
CHAPTER
238
28
Ind AS-103 : Business Combination
CHAPTER
231
27
Ind AS-32 and 109 : Financial Instruments
CHAPTER
225
26
Ind AS-108 : Operating Segments
CHAPTER
223
25
Ind AS-33 : Earnings per Share
CHAPTER
219
24
Ind AS-24 : Related Party Disclosures
CHAPTER
205
23
Ind AS-21 : Effects of Changes in Foreign Exchange Rates
CHAPTER
200
22
Ind AS-12 : Income Taxes
CHAPTER
21
Ind AS-37: Provisions, Contingent Liabilities and Contingent Assets
CHAPTER
% ' ! 0
3 4 . % 4 . / #
CHAPTER
I-7
267
30
Ind AS-111 : Joint Arrangements
290
CHAPTER
328
34
Integrated reporting
CHAPTER
325
33
Corporate Social Responsibility
CHAPTER
308
32
Ind AS-27 : Separate Financial Statements
CHAPTER
31
Ind AS-28 : Investment in Associates and Joint Ventures
CHAPTER
% ' ! 0
3 4 . % 4 . / #
I-8
331
35
Analysis of Financial Statements
333
SAMPLE CHAPTER Chapter 12 Accounting and Reporting of Financial Instruments Unit 1 Ind AS 32: Financial Instruments (Presentation) There are 3 Ind AS dealing with Financial Instruments. 1. 2. 3.
Financial Instruments – Presentation. Financial Instruments – Recognition and Measurement. Financial Instruments – Disclosures.
We shall deal with them one by one.
Definitions: Ind AS 32 – Financial Instruments (Presentation) What is a ‘Financial Instrument’? Paragraph 11 of Ind AS 32 defines: 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. Author’s commentary: The key words in the definition are: Presence of a ‘contract’ – A contract would essentially be between 2 parties. Where, ‘Contract’ and ‘contractual’ refers 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. Note: Contracts need not be in writing.
Unit 1: Ind AS 32: Financial Instruments (Presentation)
806
Chapter 12
Example 1: M 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? Answer: A 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. 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 as per Ind AS 109. In case of Financial Instruments, the two parties are called: (a) Issuer of an instrument who presents it on the Liability side of the Balance Sheet as per Schedule III – Division II. (b) Holder of an instrument who presents it on the Asset side of the Balance Sheet as per Schedule III – Division II. Ind AS 32 deals with the presentation of Financial instrument in the Balance Sheet. Typically, it is the Issuer who needs to decide whether the instrument is to be presented as financial liability or equity instrument. Irrespective the holder would always present it as financial asset. Let us now make some deep analysis which will help us in appreciating the need for Ind AS 32 which focuses on Financial Instrument – Presentation. An analysis of Schedule III – Division II gives us an insight as under: 1. 2.
Assets segregated into non-current and current; further segregated in terms of non-financial and financial in nature. Liability side segregated into Equity and Liability; liabilities are split in terms of non-current and current; and further segregated in terms of non-financial and financial in nature.
Unit 1: Ind AS 32: Financial Instruments (Presentation)
Chapter 12
807
We can summarize this as under:
NonCurrent Asset side
Current
NonFinancial Financial NonFinancial Financial
Balance Sheet
Liability side
Equity
NonCurrent
Liabilities Current
NonFinancial Financial NonFinancial Financial
Let us analyse which Ind AS would apply for which aspect. S.No.
Particulars
Applicable Ind AS
1.
Assets segregated into Current and Non-current
1
2.
Liabilities segregated into Current and Non-current
1
3.
Financial or Non-Financial Asset
32
4.
Financial or Non-Financial Liability
32
5.
Equity Instrument or Financial Liability
32
Once an issuer has decided that a Financial Instrument is an Equity Instrument or Financial Liability as per Ind AS 32 it would focus as under: Ind AS 109 – For Recognition and Measurement. Ind AS 107 – For Disclosures. Also, the holder has to apply the above standards for the same purpose i.e. for Financial Assets; Ind AS 109 – For Recognition and Measurement. Ind AS 107 – For Disclosures. Now the most important terms we need to understand before we fully understand the definition of Financial Instrument are: 1. 2. 3.
Financial Liability. Financial Asset. Equity Instruments.
Unit 1: Ind AS 32: Financial Instruments (Presentation)
808
Chapter 12
Let's take, these terms one by one. What is a ‘Financial Liability’? Paragraph 11 of Ind AS 32 defines: 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, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. Apart from the aforesaid, 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. Also, for these purposes the entity’s own equity instruments do not include puttable financial instruments that are classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments. As an exception, an instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D. Author’s commentary: To understand the above definition first of all let us see the different aspects of this definition with the help of a diagram and then we shall discuss each aspect separately.
Unit 1: Ind AS 32: Financial Instruments (Presentation)
Chapter 12
809
The entire definition of ‘financial liability’ has been set up as under in Paragraph 11 of Ind AS 32:
Definition of Financial Liability Point (a) Clause (i)
To deliver cash/another Financial Asset
Clause (ii)
Exchange under conditions potentially unfavourable
Point (b) Clause (i) NonDerivative Failure of 'Fixed Test'
Clause (ii)
Derivative Failure of 'Fixed for Fixed Test'
Clarifications: Clarification I Rights, option, warrants Clarification II (Carve out) FCCB (Foreign currency convertible bonds) Clarification III Equity Instruments not to include 'Deemed Equity Instruments'
Aspect 1: Any Liability: It will include: 1. 2. 3. 4.
Actual liability. Contingent liability. (Though there is Ind AS 37 dealing with the same; See discussion in scope later for more understanding) Derivative liability. Non-derivative liability.
Aspect 2: Contractual obligation: There has to be an obligation which is contractual in nature. For example: Income tax to be paid to government is an obligation but not contractual in nature. It is statutory in nature; therefore, would not be a financial liability. Aspect 3: Ways in which the contractual obligation is discharged:
Unit 1: Ind AS 32: Financial Instruments (Presentation)
810
Chapter 12
Note: Not all ways have been discussed at this stage. 1. 2.
Point (a)(i) of the definition: Cash (includes through bank and cash and cash equivalents) or another Financial Asset Point (b)(i) of the definition: Own equity instruments (but variable in number)
Special Issues: (Discussed separately) Point (a) (ii) – Exchange Point (b) (ii) - Derivative Ind AS 32 recognizes the use of own equity instruments as a medium of settlement of an obligation. This concept is called in case of non-derivative “Fixed Test”. In simple words, If an entity issues Fixed no. of equity instruments it passes the Fixed Test and the instrument is not a financial liability in that case. If an entity issues Variable no. of equity instruments it fails the Fixed Test and the instrument is a financial liability in that case. Let us put the above discussion in the form of a step chart to make our thought process clear.
Step 1: Is there a contractual obligation?
No
Yes
Stop
Go to Step 2
Step 2: How will the contractual obligation be discharged?
Cash/Bank/Cash and Cash equivalents/Another Financial Asset
Financial Liability
Equity Instruments
Variable No.
Fixed No.
Financial Liability
Not a Financial Liability
Chapter 12
Unit 1: Ind AS 32: Financial Instruments (Presentation)
811
Let us take some examples to make the above concept absolutely clear especially when we use own equity instruments as a medium for settlement. Example 2: X Ltd. issues convertible debentures to Y Ltd. for a subscription amount of Rs. 250 crores. Those debentures are convertible after 5 years into equity shares of X Ltd. using a pre-determined formula. The formula is: 100 crores × (1 + 10%) ^5 Fair value on date of conversion Examine the nature of the financial instrument. Answer: Such a contract is a financial liability of the entity where the entity is using own equity instruments as a medium (currency) to settle the transaction. 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. (It fails the Fixed Test) Example 3: A Ltd., issues convertible debentures to B Ltd. for a subscription amount of Rs. 340 crores. Those debentures are convertible after 5 years into 40 crore equity shares of Rs. 10 each. Examine the nature of the financial instrument. Answer: This contract is an equity instrument because number of equity instruments to be received or delivered is fixed. (It passes the Fixed Test) Test your knowledge: A Ltd. took a borrowing from Z Ltd. for Rs. 20,00,000. Z Ltd. enters into an arrangement with A Ltd. for settlement of the loan against issue of a certain number of equity shares of A Ltd. whose value equals Rs. 20,00,000. 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 A Ltd. at a future date, upon settlement of the contract. Evaluate the nature of financial instrument? Answer: A Ltd. is under an obligation to issue variable number of Equity shares equal to a total consideration of Rs. 20,00,000. Hence, equity shares are used as currency for purpose of settlement of an amount payable by A Ltd. Since this is variable number of shares are to be issued in a non-derivative contract, it implies the use of equity shares as ‘currency’ and hence, this contract meets definition of financial liability in books of A Ltd. (It fails the Fixed Test) Special Issue 1: Exchange: Point (a) (ii): “To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity”
Unit 1: Ind AS 32: Financial Instruments (Presentation)
812
Chapter 12
Example 4: P Ltd. takes a short position in a call option with A Ltd. (long position) to subscribe to P Ltd.’s equity shares at a price of Rs. 200 per share. The call option is to be settled on a ‘net’ basis i.e. without physical delivery of shares. Analysis: If on the balance sheet date, market value of equity share of P Ltd. is Rs. 210 per share, P Ltd. will be obliged to pay Rs. 10 to settle the option. Such a condition is potentially unfavourable to P Ltd. and hence Rs. 10 represents a financial liability for P Ltd. Special Issue 2: Derivative: Point (b) (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.” Look at the italicized words carefully. You can see the words – Fixed for Fixed. This concept is called in case of derivative “Fixed for Fixed Test”. In simple words,
Fixed Consideration
Fixed No. of Equity Instruments to be issued in settlement
Fixed for Fixed Test
Example 5: S Ltd. purchases an option from T Ltd. entitling the holder to subscribe to equity shares of issuer at a fixed exercise price of Rs. 60 per share at any time during a period of 3 months. Holder paid an initial premium of Rs. 5 per option. Examine how will the financial instrument will be classified? Answer: For the issuer A Ltd., this option is an equity instrument as it will be settled by the exchange of a fixed amount of cash for a fixed number of its own equity instruments. (It passes the Fixed for Fixed Test) We can summarize the concept of both ‘Fixed Test’ and ‘Fixed for Fixed Test’ as under: S. No.
Particulars
Remarks
Logic
1.
Non-Derivative Passes Fixed Test
Equity Instruments
Fixed no. of equity instruments is being issued.
2.
Non-Derivative Fails Fixed Test
Financial Liability
Variable no. of equity instruments is being issued.
3.
Derivative Passes Fixed for Fixed Test
Equity Instruments
Issuer does not have an obligation to pay cash. Holder is not exposed to variability.
Unit 1: Ind AS 32: Financial Instruments (Presentation)
Chapter 12 S. No.
Particulars
Remarks
Logic
4.
Derivative Passes Fixed for Variable Test
Financial Liability
Own variable equity instruments are used to settle obligation for fixed amount.
5.
Derivative Passes Variable for Fixed Test
Financial Liability
Issuer does not have an obligation to pay cash. Holder is exposed to variability.
6.
Derivative Passes Variable for Variable Test
Financial Liability
Both parties (issuer and holder) are exposed to variability.
813
Aspect 4: Rights, options or warrants: Point (b) (ii): ‘Rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments.’ Aspect 5: Equity conversion option embedded in a convertible bond denominated in foreign currency (simply called FCCB): Point (b) (ii): ‘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.’ The position in Ind AS is different from IFRS. Let us pin point the Carve-out on this issue: As per IFRS (i.e. IAS 32): As per accounting treatment prescribed under IAS 32: Equity conversion option In case of foreign currency denominated convertible bonds (FCCBs) Is considered a derivative liability which is embedded in the bond Gains or losses arising on account of change in fair value of the derivative need to be recognised in the Statement of profit and loss as per IAS 32. Carve out (Based on Ind AS 32): In Ind AS 32, an exception has been included to the definition of “Financial liability᪃ in Paragraph 11(b) (ii), whereby: Conversion option In a convertible bond denominated o
In foreign currency
To acquire a fixed number of entity’s own equity instruments Is classified as an equity instrument o
If the exercise price is fixed in any currency
Reasons for the carve-out: The treatment as per IAS 32 is not appropriate in instruments, such as, FCCB’s since the number of
Unit 1: Ind AS 32: Financial Instruments (Presentation)
814
Chapter 12
shares convertible on the exercise of the option remains fixed and the amount at which the option is to be exercised in terms of foreign currency is also fixed; (Merely the difference in the currency should not affect the nature of derivative, i.e., the option.) Further, the fair value of the option is based on the fair value of the share prices of the company. If there is decrease in the share price, the fair value of derivative liability would also decrease which would result in recognition of gain in the statement of profit and loss. This would bring unintended volatility in the statement of profit and loss due to volatility in share prices. This will also not give a true and fair view of the liability as in this situation, when the share prices fall, the option will not be exercised. However, it has been considered that if such option is classified as equity, fair value changes would not be required to be recognised. Accordingly, the exception has been made in definition of financial liability in Ind AS 32. Example 6: Entity A issues a bond with face value of USD 1000 and carrying a fixed coupon rate of 6% p.a. Each bond is convertible into 10,000 equity shares of the issuer. Examine the nature of the financial instrument. Analysis: 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 INR-USD. Such a foreign currency convertible bond (FCCB) will as per IFRS i.e. IAS 32 qualifies the definition of financial liability. However, Ind AS 32 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. Aspect 6: Entity’s own equity instruments do not include…. Point (b) (ii): ‘Also, for these purposes the entity’s own equity instruments do not include puttable financial instruments that are classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.’
Ind AS 32 in the definition of Financial liability gives us 3 instruments which are not considered as equity instruments for settlement of financial liability; though they are regarded as “deemed equity instruments” (see Aspect 7 below). 1. 2.
3.
Puttable financial instruments. (Classified as equity instruments if all conditions of paragraphs 16A and 16B are met – Discussed in detail later.) Instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation. (Classified as equity instruments if all conditions of paragraphs 16C and 16D are met – Discussed in detail later.) Instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.
Chapter 12
Unit 1: Ind AS 32: Financial Instruments (Presentation)
815
Aspect 7: Exception: (Clarification at the end of the definition) “As an exception, an instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D.” These are technically called “Deemed equity instruments”. (Discussed in detail later) They are ‘Financial liabilities’ but treated as ‘Equity Instruments’ if certain conditions are met. At this stage we can only keep one simple concept in mind. Case I: Financial Liability
Deemed Equity Instruments All conditions of Paragraphs 16A & 16B are met Case II: Financial Liability
Deemed Equity Instruments All conditions of Paragraphs 16C & 16D are met
Let’s recall; These equity instruments are not considered as equity instruments for settlement of Financial Liability. See Aspect 6 above.
Unit 1: Ind AS 32: Financial Instruments (Presentation)
816
Chapter 12
Though we are yet to see the definition of ‘Equity Instruments’ but we can create a super summary chart covering major aspects we have discussed above. Step 1: Is there a contractual obligation?
Yes
No
Step 2:
Not a Financial Instrument
Is there an obligation to deliver cash or another financial asset?
(apply applicable Ind AS )
Yes
No
Financial Liability
Is there an obligation to exchange financial assets or liabilities under potentially unfavourable conditions ?
Step 3:
No
Yes
Step 4: Is there an obligation to issue own equity instruments AND
Financial Liability
Either of the consideration received/receivable or number of equity instruments is VARIABLE
# No means: (a) Obligation to issue own equity instruments. AND
Yes
No
Financial Liability
Equity Instruments #
FINANCIAL REPORTING Set of 2 Volumes Author :
PARVEEN SHARMA, KAPILESHWAR BHALLA
Publisher: TAXMANN Edition :
5th Edition
ISBN No.: 9789391596309 Date of Publication: August 2021
Rs. 1995 | USD 79
Description: Taxmann's Financial Reporting is prepared exclusively for the Final Level of Chartered Accountancy Examination requirement. It covers the entire revised syllabus as per ICAI. This book serves as a guide for students & professionals, and the objectives of this book are as follows: It helps the reader acquire the ability to integrate & solve problems in practical scenarios on Indian Accounting Standards (Ind AS). It also assists the reader in deciding the appropriate accounting treatment and formulation of suitable accounting policies While preparing and presenting the financial statements, this book helps in the ability to recognize and apply disclosure requirements specified in Ind AS Acquiring/developing the skill to prepare financial statements of group entities based on Ind AS Develop an understanding of the various forms of reporting (other than financial statements) and accounting for special transactions, and apply such knowledge in problem-solving
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