Purpose of Note: –
A Ltd has issued a 100,000,000, @ 10 each, 0.0001 % Redeemable Preference Shares during the year. The purpose of this note to understand how it will have impact on disclosure from standpoint of IND As 109 on financial Statement.
Brief understanding of Financial Instrument: –
Financial Instruments is any contract that gives rise to a Financial Asset of one entity and a financial liability or equity instrument of another entity.
As per Compound Financial Instruments Ind As 109 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 its liability.
Therefore, when the initial carrying amount of compound financial instruments is allocated to its equity and liability components. The equity component is assigned the residual amount i.e., Fair value of the instrument less; The amount separately determined for 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 recognizing the components of the instruments separately.
What are Compound Financial Instruments? Instruments which have features of both Financial Liability and Equity Instruments are called as “Compound Financial Instruments”. An example would be a bond that can be converted into shares. It doesn’t matter whether the bondholders will ultimately opt for conversion or not.
There are Four steps model need one need to follow.
- Identify all the components of financial instruments.
- Determine the fair value of the financial instruments as a whole
- Determine the fair value of the liability component
- Determine the value of Equity Component
For better understanding, we understand by way of following example.
A Ltd has issued 100,000,000, @ 10 each, 0.0001 % Redeemable Preference Shares having face value Rs. 10 each with mandatory dividends and mandatory conversion redemption at the end of 20 years from the date of issue.
Market rate for Preference shares with similar credit status and other features except the conversion feature is 9%p.a. The preference share has two components – (1) Contractual obligation for payment of mandatory dividend and mandatory redemption and preference shares into equity.
The first component is a financial liability because the same consist of contractual obligation to pay cash and the entity does not have an unconditional right to avoid delivering cash.
The second component is equity since there is mandatory conversion into equity shares, which, in substance, signifies that the amount for the equity is already prepended even before receiving the shares practically.
Present value of Principal payable at the end of the 20 years (Rs. 1,000,000,000 discounted at 9% for 20 years) = Rs. 178,430,890. The date of loan is 31st May 2021
Interest component on this financial liability calculated considering ROI is 9% for FY 2021-22 for 305 days is Rs. (178,430,890*9%/365*305) Rs. 13,418,981/-
Disclosure in Financial Statement: –
Balance sheet Disclosure: –
- Therefore, total financial liability is equal present value of loan amount plus interest component which amounts to Rs. 191,849,870/- (Rs. 178,430,890+ Rs. 13,418,980/-) which is required to show under borrowing as Unsecured -at amortised cost.
- Equity component is equal to total value of redeemable preference share – P.V of Obligation (Rs.1,000,000,000-Rs.1,78,430,890) = Rs. 821,569,110 is shown under other equity as equity component of compounded financial instruments.
Statement of profit and loss Disclosure: –
Statement of profit and loss account is charged with interest amortisation at 9% (ROI) on the financial liability component is Rs. 13,418,981/-and Pref dividend expense of Rs. 1,000/-
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