Those who keep an eye on latest trends over fund raising by Indian entities, they would have noticed that recently ICICI bank has initiated a Dollar Bond issue through its Dubai branch. Refer http://economictimes.indiatimes.com/markets/bonds/icici-raises-300-mn-through-dollar-bonds/articleshow/57434318.cms for full story. These funds will essentially be in dollar denominated and will have certain terms and conditions over which such issue has been made. If we look at the traditional accounting perspective then these Bonds will be treated as Liability i.e. debt and will be accounted accordingly without giving any other thought in general. However after the applicability of Ind-As/ IFRS the classification between these funds either Equity or Liability will not be that simple and straightforward.
Here the objective of taking this recent ICICI Bond issue is just to provide an approach to all readers about the classification of such Instruments (considering various scenarios) and to conclude whether it will be treated as Equity or Liability. The overall terms and conditions will be assumed here to illustrate the concept only so that all readers/ users can develop an approach while dealing with these kinds of Instruments.
Under current accounting which generally goes with its normal nature (not in substance) as a whole and accordingly such accounting treatment is being done. However as per Ind-As-32– “Financial Instruments- Presentation” talks about some fundamental differences which will be used to conclude whether any Instrument is Equity or Liability?. Let’s have some references from the relevant accounting standard for the ease of our discussion further-
As per Ind-As-32 para
“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………………………….”
“An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities”
Para -19 – “If an entity does not have an unconditional right to avoid delivering cash or another financial asset to settle a contractual obligation, the obligation meets the definition of a financial liability ………………………….”
Now,
Let’s understand classification of such Bonds after assuming different scenarios and try to develop a sense for how it can be used on any Instrument that our reader will come across –
Scenario -1
Terms of the Bonds – a) Bond is having a period of 10 years after which its principal value will mandatorily be redeemed,
b) Interest rate as defined in the offer letter will required to be paid based on the dates as mentioned in the offer letter,
Approach towards classification– There is a contractual obligation for an issuer to pay Interest payments as per the due dates defined in the offer letter and it can not be avoided hence Interest payments will be treated as Financial Liability. In case of Principal part of the Bond which is mandatorily be redeemed will also be classified as Financial Liability being its redemption can not be avoided or there is no unconditional right to avoid such payment and hence will be treated as Financial Liability.
Scenario -2
Terms of the Bonds – a) Bond is having a period of 10 years after which it is at the discretion of the issuer to decide its redemption or in other words there is no fixed or final date,
b) Interest rate as defined in the offer letter will required to be paid based on the dates as mentioned in the offer letter
Approach towards classification– Refer para AG 6 of Ind-As 32 which also has given an example where perpetuity bond has been issued and there is a fixed stream of payment which is to be paid over the years. Since we all know that the fair value of such perpetuity bonds will be determined based on its Interest payments only i.e. value of bond will be (“Periodic Interest payments/ Market interest rate) hence entire bond will be treated/ classified as Financial Liability.
Scenario -3
Terms of the Bonds – a) Bond is having a period of 10 years after which it is at the discretion of the issuer to decide its redemption or in other words there is no fixed or final date,
b) Interest on these Bonds will be paid as per the discretion of the Issuer and solely based on the election by the Issuer which will not be treated as event of default, there is further mentioned that if an issuer will not make any payment to such Bond holder then it will not distribute any income to Ordinary shares as well,
Approach towards classification
Now, There is an unconditional right to avoid payment of Principal as well as Its Interest as per the terms mentioned above and hence entire Instrument will be classified as Equity.
Scenario -4
Suppose the terms states that there is no periodic Interest payment will be applicable however a final payment will be made at the end of term of the Bond. The Bond was issued at discounted value (similar to Zero coupon bonds).
Approach towards classification
Since there is no Unconditional right to avoid payment of such bonds and contractual obligation exists and hence entire Instrument will be classified as Financial Liability.
Now,
One important thing to note that if the instruments as mentioned above will be classified as Equity then all issue related expenses will directly be deducted from the equity value and nothing will go to the Profit & Loss account.
The illustration about ICICI bank bonds has been used to explain the concept only by linking current developments in the market with its possible accounting impacts to develop a habit using/ applying Ind-As/ IFRS.
A reader 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 IFRS advisor & corporate trainer. He can be reached via email at [email protected] or whatsapp +91-9634706933)
Author Bio
I have just got one question from Mr. Anil- Nagpur who wanted to know in case there is a clause which allows issuer to defer dividend payments upto perpetuity however there is a history of paying dividends on each year is available. Now, The standard says assessment of classification should be done based on substance of the Instrument which does not mean one has to look beyond contractual agreement. Hence even if history is to pay dividends on these Instruments, it will still be classified as equity being there is no contractual obligation to deliver cash/ financial assets. Hope this will add more clarity to other users as well..thanks