A. Facts of the case
Indian Entities have issued Foreign Currency Compulsory Convertible Bonds / Compulsory convertible debentures. How should the same be classified under revised Schedule VI?
B. Revised Schedule VI – Excerpt from Guidance Note
The Ministry of Corporate Affairs (MCA) has issued a revised form of Schedule VI on February 28, 2011. As per the notification 2/6/2008-C.L-V, dated 30-3-2011, the Schedule applies to all companies for the Financial Statements to be prepared for the financial year commencing on or after April 1, 2011. (para 3.1.)
Where compliance with the requirements of the Act including Accounting Standards as applicable to the companies require any change in treatment or disclosure including addition, amendment, substitution or deletion in the head/sub-head or any changes inter se, in the Financial Statements or statements forming part thereof, the same shall be made and the requirements of the Schedule VI shall stand modified accordingly.
As per ICAI Guidance Note on Terms Used in Financial Statements, ‘Capital’ refers “to the amount invested in an enterprise by its owners e.g. paid-up share capital in a corporate enterprise. It is also used to refer to the interest of owners in the assets of an enterprise.” (para 184.108.40.206.)
The said Guidance Note defines ‘Share Capital’ as the “aggregate amount of money paid or credited as paid on the shares and/or stocks of a corporate enterprise.” (para 220.127.116.11.)
In respect of disclosure requirements for Share Capital, the Revised Schedule VI states that “different classes of preference share capital to be treated separately”. A question arises whether the preference shares should be presented as share capital only or does it mean that a company compulsorily needs to decide whether preference shares are liability or equity based on its economic substance using AS 31 Financial Instruments: Presentation principles and present the same accordingly. The Revised Schedule VI deals only with presentation and disclosure requirements. Accounting for various items is governed by the applicable Accounting Standards. However, since Accounting Standards AS 30 Financial Instruments : Recognition and Measurement, AS 31 and AS 32 Financial Instruments: Disclosures are yet to be notified and Section 85(1) of the Act refers to Preference Shares as a kind of share capital, Preference Shares will have to be classified as Share Capital. (para 18.104.22.168.)
Standards Notified by Ministry of Corporate Affairs
Institute of Chartered Accountants of India (ICAI) has issued 29 Indian Accounting standards before the Convergence to IFRS road map was laid. All these 29 accounting standards are notified by Ministry of Company Affairs (MCA).
As a part of alignment to International Standards, ICAI had issued by the applicable Accounting Standards, AS 30 Financial Instruments: Recognition and Measurement, AS 31 and AS 32 Financial Instruments: Disclosures. However these standards are not notified considering the convergence road map to IFRS.
The MCA has further notified 35 Indian IFRS standards (known as “Ind-AS’), without announcing the applicability date. In its press release dated February 25, 2011, the MCA has stated that Ind-AS will be applied in a phased manner, to ensure smooth transition for all stakeholders.
D. Accounting under Ind AS 32
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
When an issuer applies the definitions in paragraph 11 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, 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.
Objective of Revised Schedule VI is to align the Statutory Format of Financial Statements with that of the Regulatory Framework laid by the Institute of Chartered Accountants of India (ICAI).
As part of the Guidance note issued by ICAI, we can visualize the intent being in line with the Convergence to IFRS framework.
It is understood from the exposure draft of the guidance note to Revised Schedule VI read with the guidance issued by ICAS in April 2011 for adoption of AS 30, 31 and 32, that the entity can classify a Redeemable Preference Shares as “Liability” if the entity follows the measurement and classification requirements of AS 30, 31, and 32 so far that they do not over rule the requirements of existing accounting standards.
However, the final version of guidance note came out with a caveat of notification and thus AS 30 principles would not apply while presenting balance sheet under Revised Schedule VI.
It is to be noted that on one side AS 30, 31 and 32 are not notified but Ind AS 32 and 39 are notified by the MCA on February 25, 2011.
Adopting the principles of Ind AS which are notified standards under MCA, would be in line with the intent of the final draft satisfying the criteria of being notified by MCA and thus reporting the substance.
Entities may reclassify them from liabilities and bring it with Shareholders' funds after Reserves & Surplus".
Alternatively, the same can be separately classified on the face sheet below Shareholders Funds and before Non current liabilities.
Since Revised Schedule VI is not a rigid format, an appropriate disclosure along with complete note justifying such substance of equity may well be considered.
Note: These are personal views and not of any firm or organisation.