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Redeemable preference shares are equity
December, 05th 2008
Corporate houses that have issued redeemable preference shares will have to continue treating them as equity capital. The Institute of Chartered Accountants of India (ICAI) which frames accounting rules had suggested in its standards on financial instruments that companies treat them as long-term liability. The change would have impacted the bottomlines of companies negatively. If a redeemable preference share is treated as equity, the returns to those holding the instrument would be in the nature of dividend. On the other hand, if it is treated as long-term liability, the same would be interest, which would be an expense that would lower profits. The governments latest attempt at making schedule six of the Companies Act compatible with ICAI norms and the international standards has not addressed the contentious issue of classifying financial instruments. India has committed to classifying them as per their substance and not form, accounting experts said. For instance, redeemable preference shares are in the nature of debt, yet they continue to be classified as equity in India. So, the fact that they are called shares has been the reason for clubbing them with equity. The revision of schedule six of the Companies Act proposed last month makes it mandatory for companies to make more relevant disclosures, particularly of foreign exchange losses and gains. The revision, for which suggestions will be accepted till December 22, aims at attaining compatibility and convergence with the International Accounting Standards and practices and at removing ambiguity in application of rules. It, however, does not harmonise the norms relating to how various financial instruments are classified in the company law with those in the international standards. The proposed revision is only a step towards harmonisation, ICAI sources said. ICAIs standards on financial instruments, prepared as per international standards, too classify redeemable preference shares as long-term liability. As per the International Financial Reporting Standards (IFRS), redeemable preference shares should be shown under the head long-term financial liability on the liability side. The company law, in contrast, requires them to be classified as equity capital on the liability side. Classifying such shares under long-term financial liability will have an impact on the net profit of the company because it will change the way dividend paid on such shares is accounted for. The proposed amendments to schedule six of the Companies Act does not imply that companies have to start classifying redeemable preference shares as per IFRS. For that, company law itself needs to be amended, ICAI president Ved Jain said. The proposed schedule six is framed in such a way that once the law is amended, there is no need to further amend the schedule, Mr Jain added.
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