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IAS 32 Financial Instruments: Members' Shares in Co-operative Entities

Go To List of IFRIC Issues Issue Description: Should members' shares in co-operative banks and similar co-operative entities be classified as liabilities or as equity under IAS 32? Discussion at the IFRIC Meeting February 2004 Three representatives of the European Association of Co-operative Banks made a presentation to IFRIC expressing the concern of that association that members' shares in co-operative banks may be considered liabilities in accordance with the revised IAS 32. They detailing their reasons for believing the members shares should be treated as equity. The IFRIC agreed that absent the existence of a redemption provision, the members' shares as described should be classified as equity. In reaching this conclusion, the IFRIC considered the voting, dividend, and liquidation rights typically associated with these instruments. The IFRIC considered the circumstances in which the redemption provision causes the members' shares to be classified as liabilities and agreed that where the redemption of shares is at the discretion of the issuer, the instruments should generally be classified as equity. However the IFRIC noted the importance of providing very clear guidance on this matter to ensure that when applied by analogy the guidance is not misinterpreted. The IFRIC agreed that a considerable portion of the next meeting should be dedicated to resolving this issue. Discussion at the IFRIC Meeting March 2004 Three representatives of the European Association of Co-operative Banks attended the IFRIC meeting to assist in the discussions. The IFRIC agreed to amend the scope to clarify that the interpretation applies to all entities applying the December 2003 version of IAS 32. Amending the scope in this manner will enable the IFRIC to include a paragraph clarifying that members' current accounts held in a relationship with them as customers or suppliers should be treated as liabilities. The IFRIC agreed that members' shares should be treated as equity in two broad situations: where the entity has an unconditional right to refuse redemption; and where the entity has an obligation (such as a statutory obligation) to refuse redemption. The IFRIC discussed the inclusion of a paragraph specifying that, when the members' shares are considered equity, periodic payments are treated as dividends, and where they are classified as liabilities such payments are treated as expenses. The IFRIC agreed this inclusion was conceptually correct, albeit potentially redundant. The IFRIC also agreed that where the treatment results in the reclassification of items between liabilities and equity, gain or loss should not be recognised on such reclassification. The IFRIC discussed transition issues, particularly in relation to European Co-operative Banks. The bank representatives noted that their current constitutions would result in a classification as liability, but that they would be unwilling to attempt to amend their constitutions until the IFRIC Interpretation is finalised. As the only general meeting in which such changes for a co-operative bank could be approved is held in May or June each year, they noted that on transition their members' shares will be treated as a liability, until such time as the constitution can be amended. The IFRIC agreed that this issue is best addressed by disclosure by the co-operative banks, as this best reflects the fact that for a time, for accounting purposes, these items should be treated as liabilities, and there is not any guarantee that members will agree to the changes in their constitutions. The IFRIC agreed to include an example showing the accounting in a situation where an entity is prohibited from ever redeeming a members share unless there is a new shareholder coming in. Discussion at the May 2004 IFRIC Meeting The IFRIC was presented with, and voted unanimously in favour of issuing, a draft interpretation on the classification of members' shares in cooperative banks and similar entities under revised IAS 32. The IFRIC noted that redemption amounts may be different depending on the class of shares purchased and noted concern about measuring the liability and equity components when some of shares are liabilities and some shares are equity. The IFRIC concluded that when this is the case, the liability should be measured at the highest amount that could legally be redeemed. The IFRIC confirmed its earlier decision to allow shares to be reclassified from liability to equity and vice versa as deemed appropriate under IAS 32. There was general concern about the classification change being created by self-imposed restrictions. However, the IFRIC noted that this exists when an entity writes forwards on its own shares. The IFRIC discussed the measurement of the liabilities that have been reclassified and whether they should be discounted. The IFRIC concluded that this was an IAS 37 issue generally, but indicated the shares should be measured at their nominal amount to avoid gains or losses on reclassification. The IFRIC discussed a fact pattern in which 5% of the shares could be redeemed in any given year. The IFRIC noted that if 5% were redeemed each year, in 20 years nearly all the shares would be redeemed. Therefore, the IFRIC concluded that in this fact pattern, all shares would be considered liabilities. That is, if the concern is not whether the shares will be exercised, but when, then the shares should be classified as liabilities since the passage of time is a certainty. The IFRIC noted that the effective date should be the same for as an entity applying IAS 32. Therefore, the exception from applying IAS 32 retrospectively for first-time adopters would also apply here. The IFRIC discussed further editorial comments and requested the staff finalise a draft for final IFRIC review and approval. Draft Interpretation D8 On 30 June 2004 IFRIC issued Draft Interpretation D8 for public comment. Comment deadline is 13 September 2004. Discussion at the November 2004 IFRIC Meeting Title On the issue of the title of the draft Interpretation, IFRIC agreed to a title that reads: "Members Shares in Co-operative Entities and Similar Instruments" so as to allow analogous reference as well as clear functioning of the hierarchy in IAS 8 but still making it obvious that the only issue dealt with specifically by IFRIC was that of members' shares in co-operative entities. Clarification of the application of the prohibition on redemption Certain constituents have raised concerns that the interpretation could have the unintended consequence of classifying certain members' accounts, when members' act as customers, as equity instead of liabilities. In particular UK building societies are subject to regulations ('nature limits') that require broadly that at least 50% of a society's borrowings are in the form of member share deposits. In all other respects, member share deposits behave as chequing accounts in a bank. However, application of D8 could inadvertently lead to the classification of such members' accounts as equity. To address this issue, IFRIC agreed with the Staff recommendation that the application of the prohibition on redemption be clarified by distinguishing between: conditional restrictions that prevent redemption only if a condition is met, and even then only until the condition is not met. These do not prevent a liability coming into existence and therefore do not lead to equity classification of members' shares, and unconditional restrictions that prevent redemption in all circumstances. These prevent a liability coming into existence and therefore lead to equity classification of members' shares; Staff brought to IFRIC's attention, suggestions by certain constituents to consider a concept of restrictions or prohibitions based on their permanence. IFRIC concurred with the Staff view that this would be difficult to achieve as this concept is not dealt with in IAS 32. Subsequent measurement of the liability for redemption of members' shares IFRIC agreed not to deal with this issue in the D8 project. Distinction between 'reclassification' and 'extinguishment' IFRIC agreed with the Staff recommendation to remove BC17 but to make other drafting changes to clarify this issue. Use of portfolio approach IFRIC discussed the concern raised by some commentators regarding the applicability of the portfolio approach and agreed to clarify by way of example, that the portfolio approach would be applicable. Transition IFRIC underscored its decision to retain the proposed effective date of 1 January 2005 after discussing some suggestions from commentators which included staggered implementation and deferral. It was re-affirmed that the co-operative groups had no problems with the proposed transitional requirements of D8. In conclusion, staff indicated that D8, subject to certain drafting changes, would be forwarded to IASB members for a final vote at the Board's December meeting. Discussion by the IASB at its November 2004 Meeting The Board considered and approved the following Interpretation for issue: IFRIC 2 Members' Shares in Co-operative Entities and Similar Instruments. November 2004: IFRIC 3 Issued On 25 November 2004, the IFRIC issued IFRIC 2 Members' Shares in Co-operative Entities and Similar Instruments.