Ind AS Transition Facilitation Group (ITFG) Clarification Bulletin 15
'Ind AS Transition Facilitation Group' (ITFG) of Ind AS Implementation Group has been constituted for providing clarifications on timely basis on various issues related to the applicability and /or implementation of Ind AS under the Companies (Indian\ Accounting Standards) Rules, 2015, raised by preparers, users and other stakeholders. Ind AS Transition Facilitation Group (ITFG) considered some issues received from members and decided to issue following clarifications1 on April 4, 2018:
Issue 1: Company PQR Ltd is required to comply with Ind AS from financial year 2017-18. It had issued Foreign Currency Convertible Bonds (FCCB) at the rate of 6% interest rate on April 26, 2013 to a foreign Investor (bondholder). The tenure of the FCCB is five years and one day. As per the terms and conditions, the FCCB would be converted into equity on April 26, 2018 at the option of the holder On the settlement day, the Company will issue the fixed number of shares, e.g. 100,000 shares. Interest on the FCCB is payable on a half-yearly basis, which has been paid on regular basis.
To comply with the relevant RBI norms, the FCCB issued by the company were at the maximum permissible interest rate on the date of issuance, say, 6%.
However, based on the guidance under Ind AS company has assessed that the applicable rate after considering, currency, time period, credit status and without conversion option for borrowing would have been, assuming 7.5%.
What should be the rate of interest at which the liability portion of the FCCB be discounted to determine the present value of financial liability at initial recognition?
Response: As per paragraph 28 of Ind AS 32, Financial Instruments, Presentation, “The issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components shall be classified separately as financial liabilities, financial assets or equity instruments in accordance with paragraph 15.
Paragraph 29 inter-alia states that, An entity recognizes 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 bond or similar instrument convertible by the holder into a fixed number of ordinary 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 ordinary shares of the entity).
As per the requirements of Ind AS 32, FCCB is a compound financial instrument (fixed for fixed met as per Ind AS requirement) and the issuer of the compound financial instruments is required to split the instrument into two components i.e. one as liability and other as equity component on initial recognition. It may be noted that in accordance with paragraph 11(b) (ii) of Ind AS 32, 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 with the exercise price is fixed in any currency.
Paragraph AG31 of Ind AS 32 states as follows:
AG31 A common form of compound financial instrument is a debt instrument with an embedded conversion option, such as a bond convertible into ordinary shares of the issuer, and without any other embedded derivative features. Paragraph 28 requires the issuer of such a financial instrument to present the liability component and the equity component separately in 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. 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. This option has value on initial recognition even when it is out of the money.
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