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A. Facts of the Case
1. A private limited company is engaged in the business of
construction and development of real estate. The company has, during the year ended 31st March, 2008, issued ‘Compulsorily’
Convertible Debentures to a large International Bank under a
Foreign Direct Investment Regime under the Foreign Exchange
Management Act, 1999. The key features of the debentures issued
are as below (emphasis supplied by the querist):
(i) The debentures issued are compulsorily convertible into
equity shares after a tenure of 39 months from the date
of issue. The querist has emphasised that the debentures
so issued are mandatorily convertible in order to be
subscribed by an International Bank from foreign funds
under the Foreign Exchange Management (Transfer or
Issue of Security by a Person Resident outside India)
(Amendment) Regulations, 2000, read with Press Note
No. 2 of 2005 issued by the Ministry of Commerce &
Industry, Government of India.
(ii) Till the date of conversion, interest is payable @ 13.65%
on quarterly basis.
(iii) The debentures are unsecured.
2. The company has not yet adopted Accounting Standard (AS)
30, ‘Financial Instruments: Recognition and Measurement’, and
Accounting Standard (AS) 31, ‘Financial Instruments: Presentation’
issued by the Institute of Chartered Accountants of India, and is
debiting interest payable on such debentures to the profit and loss
account.
3. The querist has stated that in the balance sheet of the company
for the year ended 31st March, 2008, the amount received on
issue of convertible debentures is classified under the head
‘unsecured loans’, as the auditors are of the view that till such a
debenture is converted into equity, it continues to be a debt, and
therefore, to be classified under ‘Loan Funds’.
4. According to the querist, in the view of the management of
the company, such amounts received are not repayable and are
convertible into equity shares. In substance, it is capital of the
company, and therefore, should be classified under the head ‘share
capital’ under ‘shareholders’ fund’. In this regard, the querist has drawn the attention of the Committee to the Framework for the
Preparation and Presentation of Financial Statements issued by
the Institute of Chartered Accountants of India. As per the querist,
this Framework enunciates the underlying concepts in the
preparation and presentation of financial statements. The
Framework defines ‘liability’ as a present obligation of the enterprise
arising from past events, the settlement of which is expected to
result in an outflow from the enterprise of resources embodying
economic benefits. The Framework defines ‘equity’ as the residual
interest in the assets of the enterprise after deducting all its liabilities.
Based on the above, the management is of the view that since the
result is not an outflow from the enterprise of resources, the
compulsorily convertible debentures could not be a liability, and,
therefore, could be classified as equity.
B. Query
5. The querist has sought the opinion of the Expert Advisory
Committee on the correctness of the view held by the management
of the company that the compulsorily convertible debentures should
be classified as equity. If the answer is in the negative, whether it
could be shown in any other way under ‘shareholders’ funds’, i.e.,
as a separate item between shareholders’ funds and loan funds
as is being done in the case of share application money.
C. Points considered by the Committee
6. The Committee notes from the Facts of the Case that the
debentures issued by the company carry an interest @ 13.65% on
quarterly basis till the date of conversion. Accordingly, the
Committee is of the view that till the date of conversion the
debentures are of the nature of loans.
7. The Committee also notes that the company under
consideration is a private limited company and, therefore, the
provisions of Schedule VI to the Companies Act, 1956 would apply
with respect to the form of balance sheet of the company. The
Committee notes that Schedule VI to the Companies Act, 1956
requires debentures to be classified under the head ‘secured loans’
and that the disclosure is required to be made with respect to the
terms of redemption or conversion (if any) of debentures issued to be stated together with earliest date of redemption or conversion.
The Committee further notes that the debentures issued by the
company are unsecured. Accordingly, the Committee is of the
view that the same should be classified under the head ‘unsecured
loans’ in the balance sheet of the company.
D. Opinion
8. On the basis of the above, the Committee is of the opinion
that the compulsorily convertible debentures cannot be classified
as share capital/shareholders’ funds/equity till the conversion
thereof. Such debentures also cannot be shown as a separate
item between shareholders’ funds and loan funds. Such debentures
should be classified under the head ‘unsecured loans’ with
appropriate disclosures with respect to the term of conversion
along with the earliest date of conversion in accordance with the
requirements of Schedule VI to the Companies Act, 1956.
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