CRITICAL THINKING QUESTION Please read the case study below on the differences b
ID: 2332589 • Letter: C
Question
CRITICAL THINKING QUESTION Please read the case study below on the differences between equity and liabilities. Decide whether the Class A common (ie, ordinary) shares may be disclosed as part of shareholders' equity. Explain the application of relevant passages from AASB 132 and the Conceptual Framework to the Class A Common Shares, making specific connections between wording in in the standards and framework with the features of the shares. Using the AREA framework, do you agree or disagree with the classification of the Class A shares as equity? In your answer refer to relevant accounting standards. ANALYSE: (30-50 words) Identify the issue and why it matters. Determine what you need to find out. RESEARCH: (200-250 words) Present relevant facts and evidence, or issues. EVALUATE & ANSWER: (200-250 words) Provide your opinion of the themes or issues you have identified, justified by the evidence you have gathered and evaluated.Explanation / Answer
Analysis
We are given a case study where Extua Corporation (The Issuer) wants to report the Class A Shares issued by them in the Equity section in their Balance Sheet. We are required to peruse the AASB and identify whether the disclosure is as per the AASB - 132 and the applicable conceptual framework related to the Class - A Shares in the instant case study.
Research
Upon a careful perusal of the AASB - 132, we arrive at the following:
1. Equity Instrument: Any contract that evidences a residual interest in the assets of any Company after deducting all its liabilities.
An instrument can be called an Equity Instrument if and only if it meets the criteria set out in Para 16 A-D of the AASB 132.
AASB 132 states the Following:
15: That the recognition is to be made as a financial liability or a financial asset or equity instrument based on the substance of the contractual arrangement and the respective definitions
16: This paragraph prescribes the basic criteria that need to be satisfied for the instrument to be classified as an Equity Instrument. It goes on to state that an instrument bears no contractual obligation for delivery of cash or any other financial asset or for an exchange of financial asset or liability on terms prejudicial to the interest of the Company. Where Entity's shares are being issued, then it is non-derivative and there be no contractual obligation for the issuer to deliver a variable number of its own equity instruments or a derivative that will be settled only by delivery of cash or other financial Asset.
!6 A-D: Puttable Instruments: Any Instrument including an obligation for the issuer to repurchase or redeem that instrument for cash or any other Financial Asset on the exercise of the Put. 16 A-D specifies certain conditions which are presented briefly below (not verbatim):
16A: Holder should have a pro-rata share in the net assets of the Company. Such instrument belongs to a class that is subordinate to all other classes of the Instruments. All the Financial instruments in the subordinate class have identical features. Apart from the obligation to repurchase or redeem, it doesn't contain any other contractual obligations prejudicial to the interests of the Company and that the overall cash flows attributable to the Instrument are through Profit/ loss or change in recognised net assets or change in the fair value of the unrecognised net assets over the life of the instrument.
16B: There must be no other financial instrument that has cash flows reliant on the Profit/ loss or change in recognised net assets or change in the fair value of the unrecognised net assets of the Company thus in effect restricting the residual return to the holders of the puttable instruments
16C and 16D talk about instruments that have an obligation to deliver to another party a share of the net assets of the Company on Liquidation.
Evaluation
In the instant case, the Company has two classes of Equity Shares:
100,000 Class - A shares of $ 50 each which are redeemable at an identical rate (the rate which has been arrived using the same method) and have no right over dividend and no voting right and
One Hundred Million Class - C shares which give the holder a vote per share at the General Meeting, a right to dividend and are freely transferable and are actively traded on the Australian Stock Exchanges
The Company wants to Classify the Class A Shares in the Shareholders Equity section of the Balance sheet.
Considering the definitions presented above, it is seen that the Shares of Class A are financial instruments that have an on par right to the net assets of the Company and also that there is no contractual obligation to settle in cash or other financial asset or exchange or any other means. There is also the condition to redeem. Thus the shares can be classified as Puttable Instruments as per Para 16A of the AASB 132.
Since the AASB grants the right to classify certain instruments as equity instruments provided all the prescribed conditions are satisfied and the Company satisfies all the requisite conditions, the Class A shares may be reported under the Shareholders' Equity Section in the Balance Sheet.
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