Section 230-45 financial arrangements
A financial arrangement is defined in section 230-45, which provides that an entity has a financial arrangement if it has, under an arrangement, a cash settlable legal or equitable right to receive or obligation to provide a financial benefit, or a combination of one or more such rights and obligations.
However, the arrangement will not be a financial arrangement if under the same arrangement the entity also has a not insignificant right or obligation that is either to provide or receive something that is:
- not a financial benefit
- not cash settlable.
The definition of a financial arrangement draws on, and closely corresponds with, the definitions of financial instruments in the accounting principles as defined in subsection 995-1(1), but does not align completely with those definitions.
Cash settlable right or obligation
Under subsection 230-45(2), a right to receive or an obligation to provide a financial benefit is cash settlable if one of the following applies:
- The benefit is money or money equivalent.
- In the case of a right, the entity intends to satisfy or settle it by receiving money or a money equivalent, or by starting to have or ceasing to have another financial arrangement, other than an equity interest.
- In the case of an obligation, the entity intends to satisfy or settle it by providing money or a money equivalent, or by starting to have or ceasing to have another financial arrangement, other than an equity interest.
- The entity has a practice of satisfying or settling similar rights or obligations by money or money equivalent.
- The entity deals with the right or obligation to generate a profit from short-term fluctuations in price or from a dealers margin.
- The financial benefit can be converted readily into money or money equivalent, there is a highly liquid market for the financial benefit, and either of the following apply
- for the recipient of the financial benefit, the money or money equivalent is not subject to a substantial risk of substantial decrease in value
- a purpose of the entity for entering into the arrangement is to receive or deliver the financial benefit to raise or provide finance or so that it may be converted or liquidated into money or a money equivalent (other than as part of expected purchase, sale or usage requirements).
- The entity can settle the right or obligation, whether or not it intends to satisfy the right or obligation in that way, and its sole or dominant purpose for entering into the arrangement is not the purpose of receiving or providing delivering the financial benefit as part of its expected purchase, sale or usage requirements.
Example 1: Deferral of payment for the acquisition of goods
On 1 April 2011, Archie Co enters into an arrangement with Luke Co. Under this arrangement, Luke Co will supply Archie Co with a handcrafted wooden desk for $10,000. The desk is due to be completed and delivered on 1 December 2011, with full payment to be made by Archie Co on that day.
By entering into this arrangement, Archie Co has both:
- an obligation to pay $10,000
- a right to receive a non-monetary financial benefit – that is, the desk.
Archie Co's non-monetary financial benefit is not insignificant when compared to its obligation to pay $10,000. As a result, this arrangement is not a financial arrangement under section 230-45.
Example 2: Deferred purchase agreements
AEHR Co pays $10,000 to enter into an investment product, commonly referred to as a deferred purchase agreement, issued by Big Bank, on 1 July 2011. Under the agreement, AEHR Co is entitled to receive an unspecified number of shares in Edward Finance Co, deliverable on 30 June 2015.
AEHR Co will receive at least 95% of the initial investment (the $10,000) in the form of Edward Finance Co shares. This is the basis of the capital protection. AEHR Co is entitled to a further amount, the value of which is contingent on changes in the level of a nominated market index over the term of the agreement. Thus AEHR Co receives shares in Edward Finance Co at least equal in value to $9,500.
The requirements in subparagraph 230-45(2)(f) are satisfied for both AEHR Co and Big Bank. The Edward Finance Co shares are readily convertible into money, highly liquid and the financial benefits that the recipient (AEHR Co) is entitled to receive under the arrangement are not subject to a substantial risk of substantial decrease in value. As such, AEHR Co's right to receive, and Big Bank's obligation to provide, the Edward Finance Co shares are cash settlable rights and obligations.
End of example
When does a financial arrangement start?
Generally, whether an arrangement is a financial arrangement is determined at the time that arrangement comes into existence or starts to be held. The legislation does not specify a point in time at which a financial arrangement comes into being; rather, it provides that one exists when the entity holds relevant rights and obligations or assets (section 230-45, section 230-50 and Subdivision 230-J).
As there can be many rights and obligations under an arrangement, including future rights or obligations and contingent rights or obligations, various rights and obligations can start or cease at different times.
For example, an arrangement may not be a financial arrangement at one point in time due to the existence of a right or obligation that is both:
- not cash settlable or relates to something that is not a financial benefit
- not insignificant in comparison to the other cash settlable rights and obligations.
However, the same arrangement may become a financial arrangement at a later point in time – for instance, when there are no longer any not insignificant non-cash settlable rights and obligations under the arrangement.
It can become necessary to reassess whether an arrangement is a financial arrangement. This is the case when an arrangement moves from having some not insignificant non-cash settlable rights or obligations (or rights or obligations to things that are not financial benefits) to an arrangement consisting only of cash settlable rights or obligations. This can also be the case when the arrangement between the parties has not changed and there is no new agreement.
Example: Starting to have a financial arrangement
Vin Co enters into an agreement on 1 July 2010 to sell a truck to Just Co for $100,000. At the time of the agreement, Vin Co has:
- a right to receive a monetary financial benefit – that is, $100,000
- an obligation to provide something that is not cash settlable – that is, the truck.
As Vin Co's obligation to provide the truck is not insignificant when compared to its right to receive payment from Just Co, the arrangement is not a financial arrangement on 1 July 2010.
The arrangement may later become a financial arrangement if payment for the truck to Vin Co remains outstanding more than 12 months after it is delivered. Once the truck has been delivered, the only subsisting rights and or obligations under the arrangement will be Vin Co's (cash settlable) right to receive payment from Just Co, so the arrangement will be a financial arrangement at the time Vin Co delivers the truck. The financial arrangement will comprise Vin Co's right to receive $100,000.
End of example