Solution

B Limited has issued CCPS which provide for:

a)    Conversion into fixed number of equity shares, i.e., one equity share for every CCPS

b)    Non-cumulative dividends.

Applying the definition of ‘equity’ under IAS 32:

a)    There is no contractual obligation to deliver cash or other financial asset. Dividends are payable only when declared and hence, at the discretion of the Issuer – B Limited, thereby resulting in no contractual obligation over B Limited.

b)    Conversion is into a fixed number of equity shares.

Hence, it meets definition of equity instrument and shall be classified as such in books of B Limited.

In the given scenario, A Limited has invested in compulsorily convertible preference shares (CCPS) issued by its subsidiary B Limited. The CCPS have a face value of $10 and a premium of $990, with a total value of $1,000 each. The CCPS carry a dividend of 12% per annum, payable only when declared by B Limited. The CCPS are compulsorily convertible into one equity share of B Limited at the end of 5 years.

To analyze the nature of this instrument, we need to consider the definition of financial instrument under IAS 32. A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.

In this case, A Limited has invested in CCPS issued by B Limited. The CCPS are a financial asset for A Limited as they give the right to receive a fixed dividend and are convertible into equity shares of B Limited at the end of 5 years. The conversion feature of the CCPS indicates that the CCPS are a non-derivative contract to be settled in own equity instruments of B Limited.

As per the definition of equity instrument, an instrument meets the definition of equity if it contains no contractual obligation to pay cash and will be settled only by the issue of a fixed number of shares or a derivative contract that will be settled by the issue of a fixed number of shares for a fixed amount of cash.

In this case, the CCPS have no contractual obligation to pay cash, and they will be settled by the issue of a fixed number of equity shares of B Limited upon conversion. Therefore, the CCPS meet the definition of equity instrument in the books of B Limited.

Overall, the CCPS issued by B Limited and held by A Limited are a financial asset and a non-derivative contract to be settled in own equity instruments of B Limited, meeting the definition of equity instrument.

The CCPS issued by B Limited meets the definition of equity instrument as per IAS 32 since it contains no contractual obligation to deliver cash or other financial asset and conversion is into a fixed number of equity shares. The fact that dividends are payable only when declared and at the discretion of B Limited does not create a contractual obligation to pay cash, which is a characteristic of equity instruments. Therefore, the CCPS should be classified as equity in the books of B Limited.

In summary, the CCPS meet the definition of both a financial asset and a financial liability, and their classification will depend on the specific circumstances of the investment.