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Instruments Puttable at Fair Value

Date recorded:

The Board was asked to confirm proposed amendments to IAS 32, as a correct reflection of the Board's decisions at its September 2005 meeting (the proposals are set out in the observer notes).

The Board debated how best to narrow the amendment so as to ensure that the return over a period of time is the same for all instrument holders within the most subordinated class. The concern raised by some Board members related to the fact that the entry price of acquiring the instrument could be manipulated by adding premiums or discounts that could distort the return to individual holders. The staff was asked to add a condition to this effect along the lines of requiring entry and exit from the most subordinated class of equity at fair value.

In order to apply the proposed amendments, the staff noted that an entity must determine fair value in accordance with the IAS 39 application guidance. Partnerships or non-public companies, which calculate the fair value of the redemption price of the puttable instruments using a proxy measure (for example, book values or a pre-set formula based on book values), might not be able to apply the proposed amendments. This is because such proxy measures might not be consistent with the measurement of fair value under IAS 39, paragraphs AG69 to AG82. The Board agreed to allow the use of the proposed amendment in the above instances only where the share is not listed and the formula or proxy measure is an approximation of fair value.

The Board reiterated that the objective here is to reach fair value at entry and exit and that a formula designed to penalise early exit may not qualify as a fair value proxy.

The Board asked the staff to consider supplementary disclosures (as well as presentation issues) regarding the fair values of instruments captured by these amendments even though they are classified as equity. The rationale for supplementary disclosure requirements being that such instruments have potential claims on assets. Limited life entities The Board agreed to include within the proposed amendments to IAS 32, the issue of classification of instruments puttable at fair value in limited life entities. The Board also agreed to include a table of examples in the guidance clarifying that for limited life entities, the instruments are not puttable.

Liquidation at the option of the holder

The proposed amendments would allow equity classification of instruments that contain an obligation entitling the holder to a pro rata share of the net assets of the entity upon liquidation of the entity, including instruments that give the holder the option to require the entity to liquidate. Therefore, partnership interests that include a condition that requires the partnership to liquidate upon the exit of any partner will be classified as equity, if it has the required characteristics.

The Board discussed whether the requirements to liquidate upon the withdrawal of a partner are substantive. The concern was raised because in practice, the effect of a partner withdrawing would result in mere book entries.

The Board also registered concerns about extending the requirements to any instrument that allows the holder the ability to liquidate if that holder feels aggrieved in any way. The Board seemed to agree that the answer to this issue was to require that all the parties should have the same ability to require liquidation, therefore in the case of a partnership, every partner must be able to put to the partnership, his/her interest.

Consolidated financial statements

The Board considered the consequences of its decisions for consolidated financial statements. The Board agreed that the non-controlling interests must be regarded as being not in the most subordinated class of instruments from the group's perspective. The rationale for this view is that the claims of non-controlling interests to the net assets of the subsidiary have to be satisfied first, before the parent's share of the net assets of the subsidiary could be distributed to the parent's residual interest holders. Hence, non-controlling interests are not in the most subordinated class of instruments at the group level.

For limited life entities, the Board agreed that at the group level, non-controlling interests in a limited life subsidiary will be classified as financial liabilities. This is because the proposed amendments are based on the view that non-controlling interests are not in the most subordinated class of instruments at the group level. The Board also came to a similar view on the issue of obligations arising on liquidation when liquidation is at the option of the holder.

In considering the entire package of proposed amendments, the Board agreed by vote to proceed with the amendments with some Board members dissenting on the basis that these amendments were merely an exception to the principles of IAS 32 designed to address the specific concerns of certain constituents and as a consequence, sets a bad precedent.

Correction list for hyphenation

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