Indian Accounting Standard (Ind AS) 32 deals with the presentation of Financial Instruments. The principles of Ind AS 32 also complement the principles for recognising and measuring financial assets and financial liabilities in Ind AS 109 and for disclosing information about them in Ind AS 107.
From the perspective of the issuer, financial instruments are classified under this Ind AS-32 into financial assets, financial liabilities and equity instruments. Accordingly, 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. These classification shall be in accordance with the definitions of a financial asset, a financial liability and an equity instrument and the substance of the contractual arrangement.
Objective of Ind AS 32 Financial Instruments: Presentation
Ind AS-32 Financial Instruments: Presentation has come with objective to establish principles for:
i) Presenting financial instruments as liabilities or equity;
ii) Offsetting financial assets and financial liabilities.
Accordingly, Ind AS-32 applies to:
i) The classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments;
ii) The classification of related interest, dividends, losses and gains; and
iii) The circumstances in which financial assets and financial liabilities should be offset.
Scope of Ind AS-32 Financial Instruments: Presentation
Ind AS-32 Financial Instruments: Presentation shall be applicable to all entities and for all types of financial instruments. Note that the term “Entity” includes individuals, partnerships, incorporated bodies, trusts and government agencies.
Exclusion: Ind AS-32 shall not applied for
(1) Those interests in subsidiaries, associates and joint ventures (Refer Ind AS 27, 28, 109 and 110).
(2) Employer’s rights and obligations under employee benefit plans (Refer Ind AS 19).
(3) Financial instruments, contracts and obligations under share-based payment transactions (Refer Ind AS 102).
(4) Rights and obligations under insurance contracts (Refer Ind AS 104).
Inclusion: Ind AS-32 shall applied to
(1) Those contracts to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments.
Examples of non-financial items are
i) Commodities such as gold, oil and wheat;
ii) Aircraft; and
iii) Real estate etc.
(2) Those contracts that an entity designates as measured at fair value through profit or loss as per Ind AS 109.
(3) All derivatives linked to interests in subsidiaries, associates or joint ventures.
(4) All derivatives that are embedded in insurance contracts if Ind AS 109 requires the entity to account for them separately.
(5) All derivatives that are embedded in financial instruments which contain a discretionary participation feature in accordance with Ind AS 109.
(6) All financial guarantee contracts if the issuer applies Ind AS 109 in recognising and measuring the contracts.
Meanings of various terms as per Ind AS-32 Financial Instruments: Presentation:
Financial Instruments, Financial Assets, Financial Liabilities and Equity Instruments has been defined in Ind AS-32 Financial Instruments: Presentation which has been depicted as under:
Financial Instruments:
A financial instrument is any contract that gives rise to both:
- a financial asset of one entity and
- a financial liability or equity instrument of another entity.
Financial Asset:
A financial asset is any asset that is:
(a) Cash;
That means cash (currency) in hand as well as deposit of cash with a bank or similar financial institution is a financial asset.
(b) An equity instrument of another entity;
Thus, an investment in equity shares of another company shall be treated as financial asset.
(c) A contractual right
i) to receive cash.
Common examples of financial assets representing a contractual right to receive cash in the future are:
(a) trade accounts receivable and payable;
(b) notes receivable and payable;
(c) loans receivable and payable; and
(d) bonds receivable and payable.
(ii) to receive another financial asset from another entity.
A note payable in government bonds is a financial asset of the note holder this is because it gives the holder the contractual right to receive government bonds, not cash.
(iii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
(d) 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 receive 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.
Note that the entity’s own equity instruments do not include:
– puttable financial instruments.
– 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.
– instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.
Examples of Financial Assets:
1) Cash and Cash Equivalents
2) Bank Balance
3) Deposits given
4) Trade and other Receivables
5) Bills Receivable
6) Investments in Equity Shares
7) Investment in Debentures
8) Promissory Note to receive Government bonds
9) Perpetual Debt instrument held.
Physical Assets and Intangible Assets:
Physical assets (such as inventories, property, plant and equipment), leased assets and intangible assets (such as patents and trademarks) are not financial assets. Control of such physical and intangible assets creates an opportunity to generate an inflow of cash or another financial asset, but it does not give rise to a present right to receive cash or another financial asset.
Prepaid Expenses:
Prepaid expenses for which the future economic benefit is the receipt of goods or services, rather than the right to receive cash or another financial asset, are not financial assets.
Call Option:
A purchased call option or other similar contract acquired by an entity that gives it the right to reacquire a fixed number of its own equity instruments in exchange for delivering a fixed amount of cash or another financial asset is not a financial asset of the entity.
Financial Liability:
A financial liability is any liability that is:
(a) a contractual obligation:
(i) to deliver cash;
(ii) to deliver another financial asset to another entity; or
(iii) 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.
Examples of Financial Liability:
1) Finance Lease
2) Promissory Note payable in Government Bonds
3) Loans including Bank Loan
4) Bills Payable
5) Trade and other Payables
6) Deposits received
Deferred Revenue:
Deferred revenue and most warranty obligations are not financial liabilities because the outflow of economic benefits associated with them is the delivery of goods and services rather than a contractual obligation to pay cash or another financial asset.
Equity Instrument:
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Equity instruments include
- Non-puttable Ordinary Shares.
- Some puttable instruments (If not financial liabilities and specific conditions are met).
- Some 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.
- Some types of preference shares, and warrants or written call options that allow the holder to subscribe for or purchase a fixed number of non-puttable ordinary shares in the issuing entity in exchange for a fixed amount of cash or another financial asset.
Puttable Instrument:
A puttable instrument is a financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset or is automatically put back to the issuer on the occurrence of an uncertain future event or the death or retirement of the instrument holder.
In other words, you may say that a puttable financial instrument includes a contractual obligation for the issuer to repurchase or redeem that instrument for cash or another financial asset on exercise of the put. Therefore, it is a financial liability.
However, as an exception, such an instrument is classified as an equity instrument if it satisfied both conditions viz. Instrument specific conditions as well as Issuer Specific Conditions as described hereunder:
A) Instrument specific conditions:
(1) It entitles the holder to a pro rata share of the entity‘s net assets in the event of the entity‘s liquidation. The entity‘s net assets are those assets that remain after deducting all other claims on its assets.
A pro rata share is determined by:
= (Entity’s net assets on liquidation ÷ Number of units) × Number of the units held by the financial instrument holder
(2) The instrument is in the class of instruments that is subordinate to all other classes of instruments.
The following conditions must be fulfilled to be in such a class the instrument:
(a) Has no priority over other claims to the assets of the entity on liquidation, and
(b) Does not need to be converted into another instrument before it is in the class of instruments that is subordinate to all other classes of instruments.
(3) All financial instruments in the class of instruments that is subordinate to all other classes of instruments shall have identical features.
(4) Apart from the contractual obligation for the issuer to repurchase or redeem the instrument for cash or another financial asset, the instrument does not include any contractual obligation to deliver cash or another financial asset to another entity, or to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity, and it is not a contract that will or may be settled in the entity’s own equity instruments.
(5) The total expected cash flows attributable to the instrument over the life of the instrument are based substantially on:
(i) The profit or loss
(ii) The change in the recognised net assets or
(iii) The change in the fair value of the recognised and unrecognised net assets of the entity over the life of the instrument (excluding any effects of the instrument).
B) Issuer Specific Conditions
In addition to the instrument having all the above features, the issuer must have no other financial instrument or contract that has:
(1) Total cash flows based substantially on
(i) The profit or loss
(ii) The change in the recognised net assets or
(iii) The change in the fair value of the recognised and unrecognised net assets of the entity (excluding any effects of such instrument or contract)
(2) The effect of substantially restricting or fixing the residual return to the puttable instrument holders
Therefore, if all the above conditions (Instrument and Issuer specific) are satisfied, the puttable instrument is classified as an equity instrument. On the other hand, if an Entity cannot carry out the above 2 tests, the puttable instrument is classified as a Financial Liability.
Settlement Options:
When a derivative financial instrument gives one party a choice over how it is settled (e.g. the issuer or the holder can choose settlement net in cash or by exchanging shares for cash), it is a financial asset or a financial liability unless all of the settlement alternatives would result in it being an equity instrument.
Derivative Financial Instruments:
Financial instruments include primary instruments (such as receivables, payables and equity instruments) and derivative financial instruments (such as financial options, futures and forwards, interest rate swaps and currency swaps). Derivative financial instruments meet the definition of a financial instrument and, accordingly, are within the scope of Ind AS-32.
Compound Financial Instruments:
A common form of compound financial instrument is a debt instrument with an embedded conversion option, such as a bond convertible into ordinary shares of the issuer, and without any other embedded derivative features.
The issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components shall be classified separately as financial liabilities, financial assets or equity instruments.
Treasury Shares:
An entity’s own equity instruments are not recognised as a financial asset regardless of the reason for which they are reacquired. Therefore, if an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be deducted from equity.
No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received shall be recognised directly in equity.
However, when an entity holds its own equity on behalf of others, e.g. a financial institution holding its own equity on behalf of a client, there is an agency relationship and as a result those holdings are not included in the entity’s balance sheet.
Interest, Dividends, Losses and Gains:
Interest, dividends, losses and gains relating to a financial instrument or a component that is a financial liability shall be recognised as income or expense in profit or loss. Distributions to holders of an equity instrument shall be recognised by the entity directly in equity. Transaction costs of an equity transaction shall be accounted for as a deduction from equity.
Offsetting a financial asset and a financial liability:
A financial asset and a financial liability shall be offset and the net amount presented in the balance sheet when, and only when, an entity:
(a) currently has a legally enforceable right to set off the recognised amounts; and
(b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.
In accounting for a transfer of a financial asset that does not qualify for derecognition, the entity shall not offset the transferred asset and the associated liability.