Start with the issuer’s contractual obligations
Under Ind AS 32, classify the instrument or its components on initial recognition according to the substance of the contractual arrangement. Check the signed instrument and related agreements for mandatory cash payments, redemption rights, guarantees, settlement alternatives and contingent triggers. Legal labels such as preference share or debenture do not decide the presentation. An equity instrument evidences a residual interest in assets after liabilities. Subject to specific exceptions, equity classification requires no contractual obligation to deliver cash or another financial asset or exchange financial instruments on potentially unfavourable terms, and the applicable own-share settlement conditions must be met.
For a non-derivative settled in the issuer’s own equity instruments, check whether the issuer is obliged to deliver a variable number. For a derivative, the general rule requires exchange of a fixed amount for a fixed number of own equity instruments, subject to Ind AS 32 exceptions. Analyse all reset and anti-dilution clauses. A proportionate adjustment for a share split can differ in substance from a down-round ratchet; avoid classifying either from its name alone. Paragraphs 11 and 16(b)(ii) contain an Indian provision for a conversion option embedded in a foreign currency convertible bond that acquires a fixed number of the issuer’s own equity instruments where the exercise price is fixed in any currency. Assess the option and the host separately; do not apply this exception to every foreign currency contract. The standard also has a separate pro-rata rights issue exception.
| Instrument and terms | Issuer analysis |
|---|---|
| Preference shares redeemable for cash at a fixed date or at the holder’s option | Cash redemption creates a liability component. Mandatory coupons generally also form part of the liability. Examine whether discretionary distributions create a separate equity component; AG37 illustrates such a case. |
| Compulsorily convertible preference shares (CCPS) with a fixed ratio | Equity can result if settlement is in a fixed number of eligible own shares and the issuer has no cash obligation or other disqualifying term. Discretionary distributions on an equity instrument are recognised directly in equity. |
| CCPS with value-linked share settlement | A variable number of shares used to deliver a monetary value normally fails equity classification. Apply Ind AS 109 to determine the measurement and any separate embedded derivative. |
| Compulsorily convertible debentures (CCDs) | Fixed-share settlement with no other liability obligation may be equity. A mandatory cash coupon alongside qualifying fixed-share settlement creates a liability for the coupons and a residual equity component. |
| Optional conversion with cash redemption if not converted | Recognise the cash liability. Split out an equity conversion option only if it qualifies as equity; otherwise consider applicable derivative and liability requirements. |
| Perpetual instruments | Absence of principal maturity does not remove an obligation to pay coupons. If the issuer can unconditionally avoid cash payments and no other liability terms apply, equity classification may be appropriate. |
Section 55 of the Companies Act, 2013 prohibits irredeemable preference shares and generally limits the redemption period to 20 years, subject to the rule 10 exception for specified infrastructure projects: a term above 20 and up to 30 years, with the prescribed minimum annual redemption from year 21 or earlier on the stated terms. The legal requirements and accounting classification are separate. Do not equate reported accounting equity with a statutory or contractual net-worth definition; reconcile them before concluding on covenants, borrowing limits or filings.
Split and measure a compound instrument
Under paragraphs 28–32, first measure the fair value of the liability, including relevant non-equity derivative features, then attribute the residual of the instrument’s initial fair value to equity. No gain or loss arises merely from the initial split. Where appropriate, discount the contractual cash obligations using a market yield for comparable debt without the equity feature. Under paragraph 38 allocate eligible issue costs in proportion to the initial allocation of proceeds. Apply Ind AS 109 to the liability subsequently; amortised cost and the effective interest method apply when required. The equity component is not remeasured. Interest and distributions are presented according to the classification of the related component.
Six worked examples
1. Fixed-share CCD with mandatory cash coupons
On 1 April 2024 a company issues 1,00,000 CCDs of ₹100 each for ₹1 crore. It must pay 8% cash coupons annually on 31 March for three years. Each instrument converts into two equity shares on 31 March 2027, with no cash redemption or other liability term. Assume the initial fair value equals proceeds and 12% is the comparable yield for the cash obligations. Discount the three ₹8 lakh coupons at 12% using unrounded factors. Rounded to rupees, initial liability is ₹19,21,465 and residual equity is ₹80,78,535. The two amounts sum to ₹1 crore.
| Year ended 31 March | Opening liability (₹) | Effective interest (₹) | Coupon (₹) | Closing liability (₹) |
|---|---|---|---|---|
| 2025 | 19,21,465 | 2,30,576 | 8,00,000 | 13,52,041 |
| 2026 | 13,52,041 | 1,62,245 | 8,00,000 | 7,14,286 |
| 2027 | 7,14,286 | 85,714 | 8,00,000 | 0 |
The last coupon extinguishes the cash obligation. The conversion issues 2,00,000 shares. Any allocation within equity to share capital and premium follows the share terms and applicable legal requirements; do not invent a face value for the new shares.
2. Redeemable preference shares with mandatory dividends
On 1 April 2024 the issuer sells 50,00,000 preference shares at ₹10, giving ₹5 crore of proceeds. It must pay 9% annually and redeem all shares for ₹5 crore on 31 March 2029. Assume both obligations are unconditional, the comparable market yield is 9%, and there are no costs. Initial liability is ₹5 crore, and ₹45 lakh annual cash dividend is finance cost for this liability. Check current or non-current presentation at each reporting date; accounting treatment does not itself determine the instrument’s corporate-law or tax status.
3. Down-round ratchet on CCPS
For ₹10 crore of CCPS proceeds, assume a formula based on a fixed rupee amount converts at ₹100 per share initially, or 10,00,000 shares. If a qualifying down-round resets that price to ₹80, the same formula delivers 12,50,000 shares. The variable share count on these facts fails equity classification. Review the complete contract and Ind AS 109 before concluding whether the whole liability is at fair value through profit or loss or a derivative must be accounted for separately. The direction of a remeasurement cannot be inferred simply from an increase in issuer valuation.
4. Allocate directly attributable compound issue costs
Initial proceeds of ₹20 crore split into ₹16 crore liability and ₹4 crore equity, an 80:20 ratio. If ₹50 lakh represents eligible incremental issue costs, allocate ₹40 lakh to the liability and ₹10 lakh to equity. For an amortised-cost liability, the initial net amounts are ₹15.60 crore liability and ₹3.90 crore equity. Compute the resulting effective yield from the actual cash flows rather than assuming an amount.
5. Repurchase before maturity
Assume the issuer pays ₹12 crore to repurchase a compound instrument before maturity with unchanged original conversion privileges and no transaction costs. At that date the debt carrying amount is ₹9.50 crore, the equivalent non-convertible debt fair value ₹10.20 crore, and the original equity amount ₹2 crore. Under AG33–AG34 allocate ₹10.20 crore to the liability, giving a ₹70 lakh loss in profit or loss. Allocate the remaining ₹1.80 crore consideration to equity. Any ₹20 lakh difference from the original equity amount may be moved within equity; it is not an extinguishment gain in profit or loss.
6. A perpetual instrument with cancellable distributions
A company raises ₹25 crore with no maturity or holder put. The stated 10% distribution would be ₹2.50 crore for a full year if paid. Assume the issuer has an unconditional right to cancel it without accumulation, default or other contractual cash consequence, and no other term creates a liability. The instrument is equity on those facts, with any declared distribution recorded directly in equity. A contractual requirement to pay perpetual interest would change the analysis.
Practical questions
Does accounting reclassification alter the legal status or tax treatment of preference shares?
No change follows automatically. Evaluate corporate filings, voting, redemption restrictions and applicable tax withholding under their own legal rules and the period concerned. An expense caption in the financial statements does not make a legal dividend interest for tax purposes.
What happens to an equity conversion option when it expires?
It remains within equity; a transfer between equity captions may be appropriate. Settle the liability separately under its terms and measurement basis. No gain or loss arises merely from expiry of the equity component.
Can the whole instrument be designated at fair value through profit or loss to avoid separation?
No. A liability designation under Ind AS 109 does not subsume a component that is equity under Ind AS 32. Different rules may apply to a hybrid contract that contains no equity component.
What should the accounting file show?
Keep the terms and settlement analysis, comparable yield and cash-flow model, split and transaction-cost workings, and a covenant bridge where relevant. Assess Ind AS 107 risk and instrument disclosures and applicable capital-management disclosures under Ind AS 1.