Impact of Redeemable Preference Shares on Financial Statements under IND AS 109

Understanding the Impact of Redeemable Preference Shares under IND AS 109

This note aims to clarify how A Ltd's issuance of redeemable preference shares, specifically 100,000,000 shares at ₹10 each with a dividend rate of 0.0001%, affects financial statement disclosures in accordance with IND AS 109.

Financial Instruments Overview

A financial instrument is defined as any contract that results in a financial asset for one entity and a financial liability or equity instrument for another. IND AS 109 specifically addresses the measurement of these financial assets and liabilities, categorizing equity instruments as those that reflect a residual interest in an entity's assets after all liabilities have been settled.

When accounting for compound financial instruments, the initial carrying amount is divided into equity and liability components. The equity component represents the residual value, calculated as the fair value of the instrument minus the assessed value of the liability component.

The total carrying amounts of both components upon initial recognition must equal the total fair value assigned to the instrument overall. It is important to note that recognizing these components separately does not result in any gain or loss.

Definition and Calculation of Compound Financial Instruments

Compound financial instruments possess features of both financial liabilities and equity instruments. A common example is a convertible bond, which can be exchanged for shares, regardless of whether bondholders ultimately choose to convert.

To assess a compound financial instrument, follow these four steps:

Identify all components of the financial instrument.
Determine the fair value of the entire financial instrument.
Assess the fair value of the liability component.
Calculate the value of the equity component.

Example: A Ltd's Redeemable Preference Shares

Consider A Ltd's issuance of 100,000,000 redeemable preference shares at ₹10 each, featuring a mandatory dividend and mandatory conversion at the end of 20 years. The relevant market rate for similar preference shares, excluding the conversion feature, is 9% p.a.

This preference share consists of two components:

Contractual Obligation: The obligation to pay dividends and redeem the shares, considered a financial liability as the entity lacks an unconditional right to avoid cash payments.
Equity Component: Due to the mandatory conversion, this signifies that the related equity value is established even before the shares are issued.

To calculate the present value of the principal payable at the end of 20 years (discounted at 9%):

Present Value = ₹1,000,000,000 / (1 + 0.09)^20 = ₹178,430,890.

For the fiscal year 2021-22, the interest component on this liability, calculated over 305 days, is:

[ \text{Interest} = \left( ₹178,430,890 \times \frac{9%}{365} \times 305 \right) = ₹13,418,981. ]

Disclosure in Financial Statements

Balance Sheet Disclosure

The total financial liability comprises the present value of the loan amount plus the interest component, amounting to ₹191,849,870 (i.e., ₹178,430,890 + ₹13,418,980). This total should be reported under borrowings as "Unsecured at Amortised Cost."

The equity component reflects the total value of the redeemable preference shares minus the present value of obligations:

[ \text{Equity Component} = ₹1,000,000,000 - ₹178,430,890 = ₹821,569,110, ]

which should be classified under "Other Equity" as part of the equity component of compound financial instruments.

Statement of Profit and Loss Disclosure

In the profit and loss statement, the interest amortization at a 9% return on investment relating to the financial liability component amounts to ₹13,418,981. Additionally, a preference dividend expense of ₹1,000 should also be recorded.

Conclusion

The issuance of redeemable preference shares entails significant implications for financial statement disclosures under IND AS 109.