In continuation of previous articles “Double-double test, Caps & Floor & Call/Put/ Prepayments – Embedded Derivatives as per Ind-As/ IFRS”, Foreign currency denominated bonds/debts are very common in practice and these are being issued for payments into some foreign currency either for Principal or Interest related payments.
Issues comes whether these kind of derivative which converts one currency into another embedded with some host require to be separated.
Standards objective was to provide a guidance which could be applicable to all such type of options mentioned in any debt instrument and accordingly separation will not be required to avoid any conflict in accounting.
Let’s have a quick reference of the standard which talks about such call, put or prepayment options within debt instrument and to guide if separation is required-
Ind-As 109 – “Financial Instruments”
Para -B-4.3.8 (c) – “An embedded foreign currency derivative that provides a stream of principal or interest payments that are denominated in a foreign currency and is embedded in a host debt instrument (for example, a dual currency bond) is closely related to the host debt instrument. Such a derivative is not separated from the host instrument because Ind AS 21 The Effects of Changes in Foreign Exchange Rates requires foreign currency gains and losses on monetary items to be recognised in profit or loss.”
Ind-As 21– “The Effects of Changes in Foreign Exchange Rates”
Para -8– “Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency”.
Para -23– “……a) foreign currency monetary items shall be translated using the closing Rate………”
Let’s take an example to understand the overall objective of the standards and its related guidance’s –
Company A which operates in India and its functional currency as per Ind-As -21 has been defined as INR issues some bonds in its functional currency i.e. INR in which it pays semi-annual Interest payments in USD and after the period of 10 years it will be repaid back in INR. Whether the derivative which changes INR interest payment in USD requires separation?
Suggested approach –
These kind of Bonds where either principal or interest are being paid in some foreign currency are known as Dual Currency Bonds. It is nothing but provide an interest rate swap to the investor in which the Investor will be able to convert its INR interest payments into USD.
Since the Bond will have certain life and will be settled into determinable currency hence it is classified as Monetary item as per Ind-As -21 (definition mentioned above) and at the each year end its will value will be re-measure at the rate of closing prices.
As per the definition para- B.4.3.8. -( c) since the Bond foreign currency part is being re-measured at the each Balance Sheet date and resulting changes will be debited to PL, hence these kind of foreign currency bonds/ debt will be considered as closely related to its host.
An interesting scenario to be noted here that where an entity whose functional currency is USD issues Bond in USD and which are to be settled in USD only but if holder wants, it can be settled in EURO(fixed amount) as well then this kind of BOND will not fall under this para because the debt was issued in functional currency with an option to get repaid in a foreign currency hence the loan will not be covered under Ind-As- 21 (does not require re-measurement at closing rates) and will required to be separated from host debt.
Readers will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Readers are requested not to take this article as any kind of advice (it is not exhaustive in nature) and should evaluate all relevant factors of each individual cases separately.
(Author of this article is an experienced chartered accountant who has specialization on various GAAP conversions assignments covering different industries around different part of the world including acting as an Independent IFRS Advisor & Corporate Trainer. He can be reached via email at email@example.com or Whatsapp +91-9634706933)