Ind AS 32 | Perpetual Loan – Financial Liability vs Equity

1. Question

A wholly owned Government company(hereinafter referred to as “the company”) engaged in the construction and repair of ships and submarines received a financial restructuring package of ₹824.90 crore in FY 2010-11 to clear legacy liabilities. Out of this, ₹452.68 crore was given as aid for settling dues, while an existing government loan of ₹372.22 crore including accrued interest and guarantee fees was converted into a perpetual, interest-free loan.

The company followed IGAAP till FY 2023-24 and is now transitioning to Ind AS from FY 2024-25, preparing its opening balance sheet as on April 1, 2023.

The question arises whether the perpetual loan should be treated as a financial liability or classified as equity under Ind AS. If classified as equity, what would be the recognition criteria, classification, and presentation requirements in accordance with the Ind AS framework?

2. Relevant Provisions

2.1 Ind AS 32 – “Financial Instruments: Presentation”

Para 11 of Ind AS 32

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.”

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

(b) a contract that will or may be settled in the entity’s own equity instruments and is:

(i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or

(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. Apart from the aforesaid, 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 if the exercise price is fixed in any currency. Also, for these purposes the entity’s own equity instruments do not include puttable financial instruments that are classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.

As an exception, an instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D.

An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.”

Para 15 of Ind AS 32

The issuer of a financial instrument shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument.

2.2 Guidance Note on Division II- Ind AS Schedule III

Ind AS 32 defines an equity instrument as “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities”. The accounting definition of ‘Equity’ is principle based as compared to the legal definition of ‘Equity’ or ‘Share’, such that any contract that evidences residual interest in an entity’s net asset is termed as ‘Equity’ irrespective of whether it is legally recognized as a ‘Share’ or not. Accordingly, all instruments (including convertible preference shares and convertible debentures) that meet the definition of ‘Equity’ as per Ind AS 32 in its entirety and when they do not have any component of liability, should be considered as having the nature of ‘Equity’ for the purpose of Ind AS Schedule III. Such instruments shall be termed as ‘Instruments entirely equity in nature’.”

Instruments entirely equity in nature, may be presented as a separate line item on the face of the Balance Sheet under ‘Equity’ after ‘Equity Share Capital’ but before ‘Other Equity’.

Click Here To Read The Full Story