ACCOUNTANCY: Classification conundrum
Anonymous. Businessline. Chennai: Dec 11, 2008.
Abstract (Summary)
Redeemable Preference Shares The Institute of Chartered Accountants of India (ICAI) advises that redeemable preference shares be classified as long-term liabilities. Schedule VI of the Companies Act, 1956 - which appears more powerful that accounting regulations - mandates that this be reflected as equity. The impact would be immense if treated as equity, payouts to these shareholders would be reflected below-the-line, but when treated as long-term liabilities, payments to the shareholders would hit the profit and loss account as interest, thereby impacting the bottom-line.
A financial instrument, other than an outstanding share, that, at inception, embodies an obligation to repurchase the issuer's equity shares, or is indexed to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets (for example, a forward purchase contract or written put option on the issuer's equity shares that is to be physically settled or net cash settled).
A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares, if, at inception, the monetary value of the obligation is based solely or predominantly on certain prescribed standards.
from BUSINESS LINE, December 11, 2008 There is a quote that says that "An accountant is a person who knows the cost of everything and the value of nothing". With the global move now from cost to market-value accounting, accountants would in future be regarded more as valuers than as conservative accountants.
Although attempts are being made globally to make accountants speak the same language, the very task of accounting creates divides due to multifarious accounting regulations. One such stand-off that could impact the bottom-line of entities is the classification of redeemable preference shares.
Redeemable Preference Shares The Institute of Chartered Accountants of India (ICAI) advises that redeemable preference shares be classified as long-term liabilities. Schedule VI of the Companies Act, 1956 - which appears more powerful that accounting regulations - mandates that this be reflected as equity. The impact would be immense if treated as equity, payouts to these shareholders would be reflected below-the-line, but when treated as long-term liabilities, payments to the shareholders would hit the profit and loss account as interest, thereby impacting the bottom-line.
The recent proposed amendment to the Companies Act is silent on this point. When in doubt, we have always looked upon international accounting standards for guidance. A combination of IAS 39 and IFRS 7 on Financial Instruments confirm the view that such instruments need to be classified as liabilities. Statement No. 150 issued by the Financial Accounting Standards Board in the US emulated other US GAAP standards by being extremely rule-based.
Statement No. 150 This Statement requires an issuer to classify the following instruments as liabilities: A financial instrument issued in the form of shares that is mandatorily redeemable - that embodies an unconditional obligation requiring the issuer to redeem it by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur. Redeemable preference would squarely fit into this category.
A financial instrument, other than an outstanding share, that, at inception, embodies an obligation to repurchase the issuer's equity shares, or is indexed to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets (for example, a forward purchase contract or written put option on the issuer's equity shares that is to be physically settled or net cash settled).
A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares, if, at inception, the monetary value of the obligation is based solely or predominantly on certain prescribed standards.
This Statement does not apply to features that are embedded in a financial instrument that is not a derivative in its entirety. For example, it does not change the accounting treatment of conversion features, conditional redemption features, or other features embedded in financial instruments that are not derivatives in their entirety. It also does not affect the classification or measurement of convertible bonds, puttable stock, or other outstanding shares that are conditionally redeemable.
Way to go The road to a seamless transition to IFRS would be filled with such challenges. There do exist such significant differences between the Companies Act in its present form and the IFRS as well as US GAAP norms.
Since companies in India are statutorily bound by the Companies Act, an amendment to that Act should be the first priority. The ICAI has done its role by issuing standards and revising existing standards. One of the major questions being asked is whether any deductions due to the concept of mark-to-market valuation as prescribed by international standards would be allowed as a deduction under the Income-Tax Act, 1961. While it would be unreasonable to expect either the Companies Act or accounting standards to prescribe this, as the situation is at present, the entity would have to treat the transaction as an extraordinary item - for example a material change in the depreciation policy - and use his convincing skills with the tax officer.
Redeemable Preference Shares The Institute of Chartered Accountants of India (ICAI) advises that redeemable preference shares be classified as long-term liabilities. Schedule VI of the Companies Act, 1956 - which appears more powerful that accounting regulations - mandates that this be reflected as equity. The impact would be immense if treated as equity, payouts to these shareholders would be reflected below-the-line, but when treated as long-term liabilities, payments to the shareholders would hit the profit and loss account as interest, thereby impacting the bottom-line.
A financial instrument, other than an outstanding share, that, at inception, embodies an obligation to repurchase the issuer's equity shares, or is indexed to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets (for example, a forward purchase contract or written put option on the issuer's equity shares that is to be physically settled or net cash settled).
A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares, if, at inception, the monetary value of the obligation is based solely or predominantly on certain prescribed standards.
from BUSINESS LINE, December 11, 2008 There is a quote that says that "An accountant is a person who knows the cost of everything and the value of nothing". With the global move now from cost to market-value accounting, accountants would in future be regarded more as valuers than as conservative accountants.
Although attempts are being made globally to make accountants speak the same language, the very task of accounting creates divides due to multifarious accounting regulations. One such stand-off that could impact the bottom-line of entities is the classification of redeemable preference shares.
Redeemable Preference Shares The Institute of Chartered Accountants of India (ICAI) advises that redeemable preference shares be classified as long-term liabilities. Schedule VI of the Companies Act, 1956 - which appears more powerful that accounting regulations - mandates that this be reflected as equity. The impact would be immense if treated as equity, payouts to these shareholders would be reflected below-the-line, but when treated as long-term liabilities, payments to the shareholders would hit the profit and loss account as interest, thereby impacting the bottom-line.
The recent proposed amendment to the Companies Act is silent on this point. When in doubt, we have always looked upon international accounting standards for guidance. A combination of IAS 39 and IFRS 7 on Financial Instruments confirm the view that such instruments need to be classified as liabilities. Statement No. 150 issued by the Financial Accounting Standards Board in the US emulated other US GAAP standards by being extremely rule-based.
Statement No. 150 This Statement requires an issuer to classify the following instruments as liabilities: A financial instrument issued in the form of shares that is mandatorily redeemable - that embodies an unconditional obligation requiring the issuer to redeem it by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur. Redeemable preference would squarely fit into this category.
A financial instrument, other than an outstanding share, that, at inception, embodies an obligation to repurchase the issuer's equity shares, or is indexed to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets (for example, a forward purchase contract or written put option on the issuer's equity shares that is to be physically settled or net cash settled).
A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares, if, at inception, the monetary value of the obligation is based solely or predominantly on certain prescribed standards.
This Statement does not apply to features that are embedded in a financial instrument that is not a derivative in its entirety. For example, it does not change the accounting treatment of conversion features, conditional redemption features, or other features embedded in financial instruments that are not derivatives in their entirety. It also does not affect the classification or measurement of convertible bonds, puttable stock, or other outstanding shares that are conditionally redeemable.
Way to go The road to a seamless transition to IFRS would be filled with such challenges. There do exist such significant differences between the Companies Act in its present form and the IFRS as well as US GAAP norms.
Since companies in India are statutorily bound by the Companies Act, an amendment to that Act should be the first priority. The ICAI has done its role by issuing standards and revising existing standards. One of the major questions being asked is whether any deductions due to the concept of mark-to-market valuation as prescribed by international standards would be allowed as a deduction under the Income-Tax Act, 1961. While it would be unreasonable to expect either the Companies Act or accounting standards to prescribe this, as the situation is at present, the entity would have to treat the transaction as an extraordinary item - for example a material change in the depreciation policy - and use his convincing skills with the tax officer.
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