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:
- the Company has to date not initiated any process for right issue.
- 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.
- 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
- 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.
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)