1. Reclassification of Items
Enquiry:
Please advise if trade receivables are netted with advances from customers and reported as a single net balance in prior year because it pertains to two different branches of same customer and customer used to pay on branch behalf and sometimes branches pays themselves (they have legally enforceable right to setoff) and in current year these are reported separately as an asset and liability on the balance sheet and consequently comparative figures have been restated/ reclassified. In the prior year the amount was off-set as:
- the customer paid extra amount at one branch to settle amount owed by them at another branch.
- the net credit balance from the customer, if any, was presented as a liability.
- advance amount (if a receivable of equal or more exists with another branch) did not entitle the customer to further goods. Further, customer is only entitled to future supply of good for net credit balance only.
Please advise whether the change in presentation is a reclassification or not? It involves material amounts and also offsetting of assets and liabilities last time was in accordance with IFRS. As affirmative reply means reclassification disclosure has to be presented (if material).
Opinion:
In context of the information submitted by the enquirer, we understand that the company settled the trade receivable and customer advance balances on a net basis. Consequently, the amount of net receivable is a financial asset, while any net credit balance, being a customer advance, is a financial liability as cash will be refunded to customer.
In accordance with IAS 1, Presentation of Financial Statements, the assets and liabilities can be offset, if permitted or required by International Financial Reporting Standard.
Offsetting, in accounting, is the presentation of financial assets and financial liabilities on a net basis in the financial statements. The offsetting of financial instruments is required under IAS 32, Financial Instruments: Presentation, and the underlying principle outlined in paragraph 42 of IAS 32 is mentioned below: (Emphasis is ours)
“A financial asset and a financial liability shall be offset and the net amount presented in the statement of financial position when, and only when, an entity:
(a) currently has a legally enforceable right to set off the recognized amounts; and
(b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.”
Further, Paragraph 43 of IAS 32, clarifies that “When an entity has the right to receive or pay a single net amount and intends to do so, it has, in effect, only a single financial asset or financial liability”. (Emphasis is ours)
In view of the above discussion, offsetting is required when there is both a right and intention to offset because doing so reflects an entity’s expected future cash flows from settling two or more financial instruments. The view is that offsetting in such situations, in effect, represents in the balance sheet that the entity has a single financial asset or financial liability. In other circumstances and conditions, the financial assets and liabilities are presented separately at their gross amounts in accordance with their characteristics as resources or obligations of the entity.
IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, defines accounting policies as specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. Further, the change in accounting policy requires restatement. However, application of accounting policy for new transactions, events or conditions that differ in substance from those previously occurring is not a change in the accounting policy.
IAS 1, Presentation of Financial Statements, requires consistent presentation and classification of items in the financial statements from one period to the next unless a change is justified either by a change in circumstances or a requirement of a new IFRS. Further, the entity shall reclassify the comparative amounts in case of change in the presentation or classification of items, unless reclassification is impracticable.
Based on the information contained in the enquiry, the Committee understands that off-setting of financial assets (trade debtor) and financial liability (customer advance) relating to the same counterparty, in the prior period/s, must be on the basis of the above principle of IAS 32. Any change in the presentation can only be made if there is change in the terms and conditions which don’t meet the off-setting criteria discussed in the preceding paragraphs.
(March 27, 2017)
2. Query on TR – 32 ‘Director’s Loan’
Enquiry:
An entity had a loan from directors amounting to Rs. 100 as at December 31, 2014. It was classified as long term loan and with repayable terms of 5 years and it was interest free. It was discounted using effective interest rate method, resultantly; difference between present value and cash received was made part of equity. The same treatment has been mentioned in TR 32 para 3.1.
Share Capital and Reserves
Equity Reserve 20
Long term Loans
Loan from Directors 80
As on January 31, 2015 the terms were changed and it was decided that entity can pay the same on its own discretion and whenever they deem fit. (the same treatment has been mentioned in Para 3.3 of TR 32). Now question is what will be the settlement accounting, whether I will only reclassify whole amount of 100 to equity or only reclassify 80. Whether there will be any consideration regarding restatement or no?
Opinion:
The Committee considered your query and response to your queries are as follows:
- Since Rs. 20 is already in equity as of Dec 31, 2014, therefore, on Jan 31, 2015, Rs. 80 should be further transferred to equity. The entity can report the full amount of Rs. 100 as equity contribution as a separate line item on balance sheet and in a separate column in statement of changes in equity and provide appropriate disclosure.
(2) Restatement would not be appropriate because the terms of the loan changed after Dec 31, 2014.
(April 18, 2016)
3. Share Deposit Money
Enquiry:
One of our clients a listed company received contribution from its three directors in 1993 as share deposit money and classified it as part of equity and is still appearing as sub classification of equity. Other brief facts are as under:
1) The Company has to date not initiated any process for right issue.
2) The Company has shown its intentions in the form of written representations to issue shares against this amount (classified as share deposit money) in the future at an appropriate time.
3) the contributors (directors) of have given their written representation to have shares of the Company against this amount as and when Company will issue right shares in future, and not to ask for repayment
4) IFRS framework defines equity as the residual interest (assets less liabilities) and exemplifies contributions from shareholders as sub classification of equity.
It is purely management decision for not issuing the right shares after a lapse of 17th year and further in directors’ opinion, continuous problems faced by the textile industry and turbulence in Stock Exchanges prevailing at various point of times did not make it feasible.
The need to seek an opinion after such a long period has arisen as the standards (IASs and IFRSs) and disclosure requirements have undergone immense changes and the professional judgments exercised previously may not be appropriate in the current scenario. Furthermore, the IFRS framework and the Companies Ordinance 1984 also do not clearly describe the treatment of share deposit money when the shares have not been issued and the management has not been required to pay back the amount by the contributories.
It is pertinent to note that the directors have given an undertaking that they would not withdraw the amount and the company has not received any show cause from SECP yet in this regard.
Keeping in view the above facts, we seek your advice about the classification of the amount received from directors (share deposit money) as equity or liability.
Opinion:
The Committee is of the view that Section 86 of The Companies Ordinance, 1984 “Ordinance” provides a framework for further issue of capital where directors of the company decide to increase the capital by issuing further shares. However, the Ordinance is silent on the matter of receiving funds in advance for shares to be issued in future. The Fourth Schedule of the Ordinance also does not provide any such category under the headings of Share Capital and Reserves.
However, the Committee would like to draw your attention to the following para of IAS 32’ Financial Instruments: Presentation’ which may be relevant in the instant matter:
Para 11 of the standard define the “Financial Instrument” as follows:
“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.”
15 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.
16 When an issuer applies the definitions in paragraph 11 to determine whether a financial instrument is an equity instrument rather than a financial liability, the instrument is an equity instrument if, and only if, both conditions (a) and (b) below are met.
(a) The instrument includes no 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 unfavorable to the issuer.
(b) If the instrument will or may be settled in the issuer’s own equity instruments, it is:
(i) a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments; or
(ii) a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its 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…….
18 The substance of a financial instrument, rather than its legal form,governs its classification in the entity’s statement of financial position. Substance and legal form are commonly consistent, but not always.Some financial instruments take the legal form of equity but are liabilities in substance and others may combine features associated with equity instruments and features associated with financial liabilities.
The Committee is of the view that the substance of the contractual arrangements shall guide the company (issuer of financial instrument) to classify such instrument as equity or liability. However, at the time of issue of shares the applicable legal requirements have to be complied with.
Further the Committee is also of the view that proper disclosure required under paragraph 112 of IAS 1 and paragraph 21 of IFRS 7 should be given in the financial statements.
(July 8, 2010)