IFRIC 2 Members’ Shares in Co-operative Entities and Similar Instruments
Last EU endorsed/ amended on 21.01.2008
•IAS 32 Financial Instruments: Disclosure and Presentation (as revised in 2003)*
•IAS 39 Financial Instruments: Recognition and Measurement (as revised in 2003)
1Co-operatives and other similar entities are formed by groups of persons to meet common economic or social needs. National laws typically define a co-operative as a society endeavouring to promote its members’ economic advancement by way of a joint business operation (the principle of self-help). Members’ interests in a co-operative are often characterised as members’ shares, units or the like, and are referred to below as ‘members’ shares’.
2IAS 32 establishes principles for the classification of financial instruments as financial liabilities or equity. In particular, those principles apply to the classification of puttable instruments that allow the holder to put those instruments to the issuer for cash or another financial instrument. The application of those principles to members’ shares in co-operative entities and similar instruments is difficult. Some of the International Accounting Standards Board’s constituents have asked for help in understanding how the principles in IAS 32 apply to members’ shares and similar instruments that have certain features, and the circumstances in which those features affect the classification as liabilities or equity.
3This Interpretation applies to financial instruments within the scope of IAS 32, including financial instruments issued to members of co-operative entities that evidence the members’ ownership interest in the entity. This Interpretation does not apply to financial instruments that will or may be settled in the entity’s own equity instruments.
4Many financial instruments, including members’ shares, have characteristics of equity, including voting rights and rights to participate in dividend distributions. Some financial instruments give the holder the right to request redemption for cash or another financial asset, but may include or be subject to limits on whether the financial instruments will be redeemed. How should those redemption terms be evaluated in determining whether the financial instruments should be classified as liabilities or equity?
*In August 2005, IAS 32 was amended as IAS 32 Financial Instruments: Presentation. In February 2008 the IASB amended IAS 32 by requiring instruments to be classified as equity if those instruments have all the features and meet the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D of IAS 32.
5The contractual right of the holder of a financial instrument (including members’ shares in co-operative entities) to request redemption does not, in itself, require that financial instrument to be classified as a financial liability. Rather, the entity must consider all of the terms and conditions of the financial instrument in determining its classification as a financial liability or equity. Those terms and conditions include relevant local laws, regulations and the entity’s governing charter in effect at the date of classification, but not expected future amendments to those laws, regulations or charter.
6Members’ shares that would be classified as equity if the members did not have a right to request redemption are equity if either of the conditions described in paragraphs 7 and 8 is present or the members’ shares have all the features and meet the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D of IAS 32. Demand deposits, including current accounts, deposit accounts and similar contracts that arise when members act as customers are financial liabilities of the entity.
7Members’ shares are equity if the entity has an unconditional right to refuse redemption of the members’ shares.
8Local law, regulation or the entity’s governing charter can impose various types of prohibitions on the redemption of members’ shares, eg unconditional prohibitions or prohibitions based on liquidity criteria. If redemption is unconditionally prohibited by local law, regulation or the entity’s governing charter, members’ shares are equity. However, provisions in local law, regulation or the entity’s governing charter that prohibit redemption only if conditions—such as liquidity constraints—are met (or are not met) do not result in members’ shares being equity.
9An unconditional prohibition may be absolute, in that all redemptions are prohibited. An unconditional prohibition may be partial, in that it prohibits redemption of members’ shares if redemption would cause the number of members’ shares or amount of paid-in capital from members’ shares to fall below a specified level. Members’ shares in excess of the prohibition against redemption are liabilities, unless the entity has the unconditional right to refuse redemption as described in paragraph 7 or the members’ shares have all the features and meet the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D of IAS 32. In some cases, the number of shares or the amount of paid-in capital subject to a redemption prohibition may change from time to time. Such a change in the redemption prohibition leads to a transfer between financial liabilities and equity.
10At initial recognition, the entity shall measure its financial liability for redemption at fair value. In the case of members’ shares with a redemption feature, the entity measures the fair value of the financial liability for redemption at no less than the maximum amount payable under the redemption provisions of its governing charter or applicable law discounted from the first date that the amount could be required to be paid (see example 3).
11As required by paragraph 35 of IAS 32, distributions to holders of equity instruments are recognised in other comprehensive income, net of any income tax benefits. Interest, dividends and other returns relating to financial instruments classified as financial liabilities are expenses, regardless of whether those amounts paid are legally characterised as dividends, interest or otherwise.
12The Appendix, which is an integral part of the consensus, provides examples of the application of this consensus.
13When a change in the redemption prohibition leads to a transfer between financial liabilities and equity, the entity shall disclose separately the amount, timing and reason for the transfer.
14 The effective date and transition requirements of this Interpretation are the same as those for IAS 32 (as revised in 2003). An entity shall apply this Interpretation for annual periods beginning on or after 1 January 2005. If an entity applies this Interpretation for a period beginning before 1 January 2005, it shall disclose that fact. This Interpretation shall be applied retrospectively.
14A An entity shall apply the amendments in paragraphs 6, 9, A1 and A12 for annual periods beginning on or after 1 January 2009. If an entity applies Puttable Financial Instruments and Obligations Arising on Liquidation (Amendments to IAS 32 and IAS 1), issued in February 2008, for an earlier period, the amendments in paragraphs 6, 9, A1 and A12 shall be applied for that earlier period.
Examples of application of the consensus
This appendix is an integral part of the Interpretation.
A1 This appendix sets out seven examples of the application of the IFRIC consensus. The examples do not constitute an exhaustive list; other fact patterns are possible. Each example assumes that there are no conditions other than those set out in the facts of the example that would require the financial instrument to be classified as a financial liability and that the financial instrument does not have all the features or does not meet the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D of IAS 32.
Unconditional right to refuse redemption (paragraph 7)
A2 The entity’s charter states that redemptions are made at the sole discretion of the entity. The charter does not provide further elaboration or limitation on that discretion. In its history, the entity has never refused to redeem members’ shares, although the governing board has the right to do so.
A3 The entity has the unconditional right to refuse redemption and the members’ shares are equity. IAS 32 establishes principles for classification that are based on the terms of the financial instrument and notes that a history of, or intention to make, discretionary payments does not trigger liability classification. Paragraph AG26 of IAS 32 states:
When preference shares are non-redeemable, the appropriate classification is determined by the other rights that attach to them. Classification is based on an assessment of the substance of the contractual arrangements and the definitions of a financial liability and an equity instrument. When distributions to holders of the preference shares, whether cumulative or non-cumulative, are at the discretion of the issuer, the shares are equity instruments. The classification of a preference share as an equity instrument or a financial liability is not affected by, for example:
(a)a history of making distributions;
(b)an intention to make distributions in the future;
(c)a possible negative impact on the price of ordinary shares of the issuer if distributions are not made (because of restrictions on paying dividends on the ordinary shares if dividends are not paid on the preference shares);
(d)the amount of the issuer’s reserves;
(e)an issuer’s expectation of a profit or loss for a period; or
(f)an ability or inability of the issuer to influence the amount of its profit or loss for the period.
|A4||The entity’s charter states that redemptions are made at the sole discretion of the entity. However, the charter|
|further states that approval of a redemption request is automatic unless the entity is unable to make payments|
|without violating local regulations regarding liquidity or reserves.|
|A5||The entity does not have the unconditional right to refuse redemption and the members’ shares are a financial|
|liability. The restrictions described above are based on the entity’s ability to settle its liability. They restrict|
|redemptions only if the liquidity or reserve requirements are not met and then only until such time as they are|
|met. Hence, they do not, under the principles established in IAS 32, result in the classification of the financial|
|instrument as equity. Paragraph AG25 of IAS 32 states:|
|Preference shares may be issued with various rights. In determining whether a preference share is a financial liability or an equity|
|instrument, an issuer assesses the particular rights attaching to the share to determine whether it exhibits the fundamental|
|characteristic of a financial liability. For example, a preference share that provides for redemption on a specific date or at the|
|option of the holder contains a financial liability because the issuer has an obligation to transfer financial assets to the holder of|
|the share. The potential inability of an issuer to satisfy an obligation to redeem a preference share when contractually required to|
|do so, whether because of a lack of funds, a statutory restriction or insufficient profits or reserves, does not negate the obligation.|
Prohibitions against redemption (paragraphs 8 and 9)
|A6||A co-operative entity has issued shares to its members at different dates and for different amounts in the past|
|(a)||1 January 20X1 100,000 shares at CU10 each (CU1,000,000);|
|(b)||1 January 20X2 100,000 shares at CU20 each (a further CU2,000,000, so that the total for shares|
|issued is CU3,000,000).|
|Shares are redeemable on demand at the amount for which they were issued.|
|A7||The entity’s charter states that cumulative redemptions cannot exceed 20 per cent of the highest number of its|
|members’ shares ever outstanding. At 31 December 20X2 the entity has 200,000 of outstanding shares,|
|which is the highest number of members’ shares ever outstanding and no shares have been redeemed in the|
|past. On 1 January 20X3 the entity amends its governing charter and increases the permitted level of|
|cumulative redemptions to 25 per cent of the highest number of its members’ shares ever outstanding.|
|Before the governing charter is amended|
|A8||Members’ shares in excess of the prohibition against redemption are financial liabilities. The co-operative|
|entity measures this financial liability at fair value at initial recognition. Because these shares are redeemable|
|on demand, the co-operative entity determines the fair value of such financial liabilities as required by|
|paragraph 49 of IAS 39, which states: ‘The fair value of a financial liability with a demand feature (eg a|
|demand deposit) is not less than the amount payable on demand …’ Accordingly, the co-operative entity|
|classifies as financial liabilities the maximum amount payable on demand under the redemption provisions.|
|A9||On 1 January 20X1 the maximum amount payable under the redemption provisions is 20,000 shares at CU10|
|each and accordingly the entity classifies CU200,000 as financial liability and CU800,000 as equity.|
|However, on 1 January 20X2 because of the new issue of shares at CU20, the maximum amount payable|
|under the redemption provisions increases to 40,000 shares at CU20 each. The issue of additional shares at|
|CU20 creates a new liability that is measured on initial recognition at fair value. The liability after these|
|shares have been issued is 20 per cent of the total shares in issue (200,000), measured at CU20, or|
|CU800,000. This requires recognition of an additional liability of CU600,000. In this example no gain or loss|
|is recognised. Accordingly the entity now classifies CU800,000 as financial liabilities and CU2,200,000 as|
|equity. This example assumes these amounts are not changed between 1 January 20X1 and 31 December|
|After the governing charter is amended|
|A10||Following the change in its governing charter the co-operative entity can now be required to redeem a|
|maximum of 25 per cent of its outstanding shares or a maximum of||50,000 shares at CU20 each.|
|Accordingly, on 1 January 20X3 the co-operative entity classifies as financial liabilities an amount of|
|CU1,000,000 being the maximum amount payable on demand under the redemption provisions, as|
|determined in accordance with paragraph 49 of IAS 39. It therefore transfers on 1 January 20X3 from equity|
|to financial liabilities an amount of CU200,000, leaving CU2,000,000 classified as equity. In this example|
|the entity does not recognise a gain or loss on the transfer.|
|A11||Local law governing the operations of co-operatives, or the terms of the entity’s governing charter, prohibit|
|an entity from redeeming members’ shares if, by redeeming them, it would reduce paid-in capital from|
|members’ shares below 75 per cent of the highest amount of paid-in||capital from members’ shares.|
|The highest amount for a particular co-operative is CU1,000,000. At the end of the reporting period the|
|balance of paid-in capital is CU900,000.|
|A12||In this case, CU750,000 would be classified as equity and CU150,000 would be classified as financial|
|liabilities. In addition to the paragraphs already cited, paragraph 18(b) of IAS 32 states in part:|
|… a financial instrument that gives the holder the right to put it back to the issuer for cash or another financial asset (a|
|puttable instrument) is a financial liability, except for those instruments classified as equity instruments in accordance|
|with paragraphs 16A and 16B or paragraphs 16C and 16D.. The financial instrument is a financial liability even when|
|the amount of cash or other financial assets is determined on the basis of an index or other item that has the potential to|
|increase or decrease. The existence of an option for the holder to put the instrument back to the issuer for cash or|
|another financial asset means that the puttable instrument meets the definition of a financial liability, except for those|
|instruments classified as equity instruments in accordance with paragraphs 16A and 16B or paragraphs 16C and 16D.|
|A13||The redemption prohibition described in this example is different from the restrictions described in|
|paragraphs 19 and AG25 of IAS 32. Those restrictions are limitations on the ability of the entity to pay the|
|amount due on a financial liability, ie they prevent payment of the liability only if specified conditions are|
|met. In contrast, this example describes an unconditional prohibition on redemptions beyond a specified|
|amount, regardless of the entity’s ability to redeem members’ shares (eg given its cash resources, profits or|
|distributable reserves). In effect, the prohibition against redemption prevents the entity from incurring any|
|financial liability to redeem more than a specified amount of paid-in capital. Therefore, the portion of shares|
|subject to the redemption prohibition is not a financial liability. While each member’s shares may be|
|redeemable individually, a portion of the total shares outstanding is not redeemable in any circumstances|
|other than liquidation of the entity.|
|A14||The facts of this example are as stated in example 4. In addition, at the end of the reporting period, liquidity|
|requirements imposed in the local jurisdiction prevent the entity from redeeming any members’ shares unless|
|its holdings of cash and short-term investments are greater than a specified amount. The effect of these|
|liquidity requirements at the end of the reporting period is that the entity cannot pay more than CU50,000 to|
|redeem the members’ shares.|
|A15||As in example 4, the entity classifies CU750,000 as equity and CU150,000 as a financial liability. This is|
|because the amount classified as a liability is based on the entity’s unconditional right to refuse redemption|
|and not on conditional restrictions that prevent redemption only if liquidity or other conditions are not met|
|and then only until such time as they are met. The provisions of paragraphs 19 and AG25 of IAS 32 apply in|
|A16||The entity’s governing charter prohibits it from redeeming members’ shares, except to the extent of proceeds|
|received from the issue of additional members’ shares to new or existing members during the preceding three|
|years. Proceeds from issuing members’ shares must be applied to redeem shares for which members have|
|requested redemption. During the three preceding years, the proceeds from issuing members’ shares have|
|been CU12,000 and no member’s shares have been redeemed.|
|A17||The entity classifies CU12,000 of the members’ shares as financial liabilities. Consistently with the|
|conclusions described in example 4, members’ shares subject to an unconditional prohibition against|
|redemption are not financial liabilities. Such an unconditional prohibition applies to an amount equal to the|
|proceeds of shares issued before the preceding three years, and accordingly, this amount is classified as|
|equity. However, an amount equal to the proceeds from any shares issued in the preceding three years is not|
|subject to an unconditional prohibition on redemption. Accordingly, proceeds from the issue of members’|
|shares in the preceding three years give rise to financial liabilities until they are no longer available for|
|redemption of members’ shares. As a result the entity has a financial liability equal to the proceeds of shares|
|issued during the three preceding years, net of any redemptions during that period.|
|A18||The entity is a co-operative bank. Local law governing the operations of co-operative banks state that at least|
|50 per cent of the entity’s total ‘outstanding liabilities’ (a term defined in the regulations to include members’|
|share accounts) has to be in the form of members’ paid-in capital. The effect of the regulation is that if all of|
|a co-operative’s outstanding liabilities are in the form of members’ shares, it is able to redeem them all. On|
|31 December 20X1 the entity has total outstanding liabilities of CU200,000, of which CU125,000 represent|
|members’ share accounts. The terms of the members’ share accounts permit the holder to redeem them on|
|demand and there are no limitations on redemption in the entity’s charter.|
|A19||In this example members’ shares are classified as financial liabilities. The redemption prohibition is similar|
|to the restrictions described in paragraphs 19 and AG25 of IAS 32. The restriction is a conditional limitation|
|on the ability of the entity to pay the amount due on a financial liability, ie they prevent payment of the|
|liability only if specified conditions are met. More specifically, the entity could be required to redeem the|
|entire amount of members’ shares (CU125,000) if it repaid all of its other liabilities (CU75,000).|
|Consequently, the prohibition against redemption does not prevent the entity from incurring a financial|
|liability to redeem more than a specified number of members’ shares or amount of paid-in capital. It allows|
|the entity only to defer redemption until a condition is met, ie the repayment of other liabilities. Members’|
|shares in this example are not subject to an unconditional prohibition against redemption and are therefore|
|classified as financial liabilities.|