Accounting challenges ahead
Company finances at risk due to perpetual bonds being reclassified as debt in 2020, PwC Thailand warns
Changes in the way financial instruments are classified under the new Thai Accounting Standards (TAS 32) may result in perpetual bonds being reclassified from equity to liabilities in financial statements, PwC Thailand has warned.
This may increase the debt-to-equity (D/E) ratio for issuers, potentially leading to a breach of debt covenants, and ultimately prompting banks to call in all outstanding loans.
As of Sept 30, 2019, eight listed companies in Thailand had perpetual bonds worth 80 billion baht in outstanding principal. Reclassification may cause short-term volatility in share prices and affect the overall capital market. While relief from reclassification for a certain period is possible, it is not guaranteed, said Chanchai Chaiprasit, assurance leader and partner at PwC Thailand.
“All businesses will face challenges as we dive deeper into the digital era, catching up with new technologies and abiding by rules and regulations that follow them,” he said at PwC Thailand’s Symposium 2019.
Several new accounting standards and principles will come into effect in 2020, including TFRS 9, TAS 32 and TFRIC 23. They will affect how listed companies report their finances. In
TAS 32, a financial instrument presentation standard, areas that were once ambiguous are addressed with much more clarity.
Changes in perpetual bond classification may worsen key financial ratios such as D/E. This might result in liquidity issues and also lead to higher finance costs as it indicates higher credit risk.
TWO KEY FEATURES
Perpetual bonds have two key features. First, there are no repayments of principal so the holder has no right to redeem the bonds. The right to redeem lies with the issuer. Second, although there’s a clear interest payment schedule, the issuer has the right to defer those payments indefinitely.
Most perpetual bonds trigger principal and/or interest settlement provisions in extraordinary circumstances such as liquidation, bankruptcy, rehabilitation and going into absolute receivership.
TAS 32 provides clear guidance on the classification of debt and equity, highlighting control as the key consideration. Where the entity cannot control the situation that triggers repayments (such as where cumulative deficits result in an equity balance of less than 50% of registered share capital), the bonds are classified as a liability.
Given that rehabilitation and absolute receivership would lead to a settlement provision of the bonds, the instrument is then considered to have a contractual obligation to repay, and so it becomes a liability. If the issuer can defer settlements indefinitely, apart from repayments upon voluntary liquidation or forced liquidation (such as bankruptcy by court order), the bond is classified as equity.
Perpetual bonds satisfy the need for capital while mitigating high D/E ratios and higher credit risks without borrowing or increasing share capital, making them attractive to many businesses.
There are two ways to handle the new requirements imposed by TAS 32. The issuer can either revise the term of perpetual bonds or redeem and reissue new perpetual bonds. Either way will be costly and time-consuming. As TAS 32 comes into effect on Jan 1, many may not have enough time, said Mr Chanchai.
“While reclassification is impending, the final verdict on whether issued and outstanding bonds may be relieved from reclassification for a certain period has not been announced by the Federation of Accounting Professions,” he said.
TAX UNCERTAINTY
Meanwhile, the new reporting standard TFRIC 23, similar to FIN 48 in the US, addresses income tax uncertainty. It requires entities to recognise provisions or liability arising from income tax uncertainties and report them in financial statements.
Conventionally, companies estimate deductible expenses and income tax liabilities on the assumption that they have a certain obligation to pay taxes. Any unclear or incorrect tax treatments are left out of statements.
A common practice was to recognise income tax relating to those unclear items would be finalised postinspection if the Revenue Department required any clarification. This requirement may affect the financial position and performance of many companies in the short and long term.
“All businesses must assess all uncertain tax items to determine any tax obligations. The assessment should be based on facts, rules and regulations to determine if and how much you’ll need to pay in taxes,” said Mr Chanchai.
“When it’s deemed more likely [50% or higher] that you have an obligation to pay and can reliably estimate the amount, present that amount as income tax expense and related liabilities at the time they arise. Work with the assumption the Revenue Department has full visibility of your transactions and put this into practice at all times, even if not inspected.”
As companies navigate the increasingly complex nature of business transactions, keep in mind the Thailand Revenue Code and the Financial Reporting Standards are based on different sets of principles.
This disparity, combined with the lack of clarity, guidance and interpretation from the tax authorities, means management needs to make its best estimations to comply with both standards.
A good understanding of tax laws and their interpretation enables companies to mitigate risk and take an appropriate position on tax returns, he said.
Work with the assumption the Revenue Department has full visibility of your transactions and put this into practice at all times. CHANCHAI CHAIPRASIT Assurance leader and partner, PwC Thailand