FRSC Issues Invitation to Comment on Amendments on Financial Instruments Puttable at Fair Value and Obligations arising on Liquidation

In line with the continuing convergence of Philippine accounting standards with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB), the Financial Reporting Standards Council (FRSC) (successor to the Accounting Standards Council) issued an Invitation to Comment on the IASB Proposed Amendments to IAS 32, Financial Instruments: Presentation, and IAS 1, Presentation of Financial Statements — Financial Instruments
Puttable at Fair Value and Obligations Arising on Liquidation.

The proposals to amend IAS 32 and IAS 1 are the result of a short-term, limited scope project to improve the financial reporting of financial instruments puttable at fair value and instruments with obligations arising on liquidation that have characteristics similar to ordinary (common) shares, pending the outcome of the IASB’s long-term project on liabilities and equity.

Under IAS 32, a financial instrument that gives the holder the right to put it back to (i.e., redeem it from) the issuer for cash or another financial asset (‘a puttable instrument’) is a financial liability.

Some entities have issued financial instruments puttable at fair value that have characteristics similar to ordinary (common) shares (e.g., they give the holder a residual interest in the net assets of the entity). The effect of applying IAS 32 to financial instruments puttable at fair value can result in the entire market capitalization of an entity being recognized as a liability.

Similar issues also apply to the classification of ordinary (common) shares in a limited life entity, which is obliged to liquidate because it has a limited life. IAS 32 requires these shares to be classified as financial liabilities because the entity has an obligation to transfer cash to its shareholders. Hence, a limited life entity would have no equity. Similar issues also apply to some partnerships that are required to liquidate upon the exit of a partner (e.g., on retirement or death).

The proposed amendments would require:

1. a financial instrument puttable at fair value to be classified as equity, provided specified criteria are met;
2. an instrument that imposes an obligation to deliver to another entity a pro rata share of the net assets of the entity upon its liquidation to be classified as equity, provided specified criteria are met;
3. disclosures about financial instruments puttable at fair value classified as equity, including the fair values of these instruments; and the reclassification of financial instruments puttable at fair value and instruments with obligations arising on liquidation between financial liabilities and equity.

The FRSC invites comments to the IASB Exposure Draft by October 9, 2006.