Revised Guidance on Classifying Financial Liabilities From Convertible Instruments

1. Introduction

The recent amendment of Ind AS 1, Presentation of Financial Statements has also highlighted the classification of financial liability arising out of issuance of optionally converted financial instruments. Ind AS 1 previously used to state that, “the terms of liability that could at the option of the counterparty, result in the settlement by the issuance of equity instrument do not affect its classification”. However, there was no clarity over the classification of financial liability arising out of such optional conversion. The revised Ind AS 1 has now brought clarity over the classification of such liability.

2. Ind AS 32

Ind AS 32, Financial Instruments: Presentation clearly depicts that financial instruments shall be recognized as “financial liability”, “financial asset” or “equity instrument” as per the substance of the contractual agreement.

The paragraph 16 of Ind AS 32 states that “the financial instruments shall be recognised as equity instrument if the settlement of such instrument takes place by issuance of fixed number of its own equity instrument”.

Furthermore, the paragraph 11 of Ind AS 32 states that “the financial instruments shall be recognised as financial liability if such instrument is settled by entity’s own equity instrument which is a non-derivative for which the entity is obliged to deliver variable number of own equity instrument”.

3. Pre Amendment Scenario

The terms of liability that could at the option of counterparty result in the settlement by the issue of equity instrument do not affect its classification. It means that the holder’s right to demand early conversion into equity was ignored when deciding current versus non-current classification.

Example

Moonlight Private Limited hereinafter referred to as “the company” has issued 10,000 optionally converted preference share on 10th April 2024. The shares will be converted into variable number of equity shares of the company based on the fair value of equity shares at the time of conversion. The conversion shall take place at the option of holderor mandatorily after 5 years.

In the extant case the financial instrument shall be converted into the variable number of equity instrument based on its fair value. Thus, as per Ind AS 32, this optionally converted preference share shall be recognized as “financial liability”. As per Ind AS 1, since the settlement is taking place by issuance of equity instrument, the holder’s right to demand early conversion is ignored while determining the classification of liability.Hence, the liability shall classified as “non-current” from the year 1 to 4 despite the holder having right of conversion.

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