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Financial Instruments Puttable at Fair Value and Obligations Arising on Liquidation

Date recorded:

In May 2007, the Board tentatively decided that for a puttable instrument to qualify for equity classification, the instrument must, among other requirements, participate fully in the performance of the issuing entity in the period the instrument is outstanding (hereafter referred to as 'the Requirement'). The Board tentatively agreed that the full participation in the performance of the issuer can be best demonstrated when the instrument is issued and puttable at the fair value of the instrument.


Demand for an exception to the Requirement

Some constituents noted that the Requirement makes the scope of the proposed amendment too narrow because, in many situations, the issue price and/or the strike price of the put option of a puttable instrument is not simply defined as the fair value of the instrument. Instead those prices are the result of applying a formula or some other method, for example, the result of negotiation between the interested parties. They argue that if there is no exception to the Requirement, the proposed amendment will affect only a very limited number of entities.

In the view of those constituents, 'something less than full economic participation' would be sufficient for a puttable instrument to qualify for equity classification - for instance, participation based on a formula.

The Board decided that any exception should be within the boundaries of paragraph AG 14A of the ED, that is, any exception would not apply to publicly listed companies and entities that hold assets in fiduciary capacity.


Scope of an exception to the Requirement

The Board then discussed what level of participation in the performance of the entity should be demonstrated by the formula to qualify for equity classification.

The staff presented various alternatives, but stated a preference for an approach under which full participation in the accounting performance of the entity (that is, the effect of items that are not recognised for accounting purposes are not taken into consideration) would be required for a puttable instrument to qualify for equity classification should the exception to the Requirement apply, as follows:

  • 1. Instrument is both issued and redeemed at the pro rata share of the book value of the entity (as calculated under IFRS).
  • 2. Instrument is issued at a fixed price, the comprehensive income of the entity is distributed in its entirety annually, or if not distributed allocated to the partners' or shareholders' capital account (that is, full profit sharing), and the instrument is redeemed at the same fixed price as it was issued at. (If losses have been incurred in excess of other reserves over the period the instrument is outstanding the fixed redemption price would be adjusted accordingly).
  • 3. Instrument is both issued and redeemed at the pro rata share of the book value, however that book value is not calculated under IFRS, but instead under local law or local GAAP as dictated by the charter or the instruments terms and conditions.

The Board had a lengthy discussion without concluding on a preferred approach. Some Board members were concerned about widening the scope at all. Others were reluctant to allow book values under local law or GAAP (alternative 3 above). Finally, the staff was directed to try to find a reasonable scope of exceptions taking into account staff views and the statements made at this meeting. If it would not be possible to find a solution the Board intends to release the amendments as as currently drafted.

This issue will be discussed again at the September meeting.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.