ACCOUNTING

TR-29 CARRY-OVER-TRANSACTIONS (COT) THE ISSUE

The Karachi Stock Exchange (Guarantee) Limited (KSE) had enforced Carry-Over Tra nsactions Regulations ( the Regulations ) with effect from 11 January 1993. These re gulations were introduced to enhance the stock market liquidity and parallel reg ulations were also enforced by the other stock exchanges of the country. Followi ng paragraphs summarise the mechanism of COT along with its accounting treatment generally being followed.a 1. Carry over transaction, as defined in section 2(e) of the R egulations, means the combination of two transactions taking place simultaneousl y and settled in two clearings in sequence. According to section 4(iii) of the r egulations, the buyer of shares in current clearing period ( the first transaction ) would become seller of the same shares in the immediate next clearing period ( th e second transaction ) and the seller of shares in current clearing period ( the fir st transaction ) would become buyer of the same shares in the immediate next clear ing period ( the second transaction ). 2. Buyer / Seller enters into the first transaction on Friday after normal trading hours and its settlement takes place on succeeding Wednesda y through Clearing House of KSE along with settlements of normal transactions. S imultaneously, seller / buyer enters into the second transaction on the same Fri day and its settlement takes place through Clearing House but on succeeding seco nd Wednesday. However, the contract ticket of the second transaction (which is p repared on Friday) bears the date of succeeding Monday, not of Friday. Share Pri ce of the second transaction is marked-up and generally does not match with the prevailing market quotes of the succeeding Monday. The marking-up of second tran saction is dependent on demand and supply of funds in the Carry-Over Market. 3. Paragraph 10 of International Accounting Standard 39 Financi al Instruments: Recognition and Measurement defines repurchase agreement (Repo) as an agreement to transfer a financial asset to another party in exchange for cas h or other consideration and a concurrent obligation to reacquire the financial asset at a future date for an amount equal to the cash or other consideration ex changed plus interest . If we consider the series of above two Carry-Over-Transact ions as a whole, its commercial effect takes form of a Repo in which lending / b orrowing of funds against pledge of shares takes place for one week i.e. from We dnesday to Wednesday. 4. Paragraph 13 of the IAS 18 Revenue states that the revenue rec ognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without re ference to the series of transactions as a whole . Paragraph 13 further gives an e xample of an enterprise that may sell goods and at the same time enter into a se parate agreement to repurchase the goods at a later date thus negating the subs tantive effect of the transaction; in such a case the two transactions are dealt with together . However, dealing with first and second transactions separate ly, revenue / expense from COT is generally accounted for as capital gain / loss and not as interest income / expense. 5. Paragraph 27 of IAS 39 states that an enterprise should reco gnise a financial asset or financial liability on its balance sheet when, and o nly when, it becomes a party to the contractual provisions of the instrument . In the case of first transaction COT, generally the buyer recognises purchase of sh ares as investment in its balance sheet (and not recognise a lending) without co nsidering the second transaction. However, simultaneousness of the second transa ction of COT does not constitute the buyer in substance a party to the contractu al provisions of the equity instrument. 6. Paragraph 35 of IAS 39 states that an enterprise should dere

cognise a financial asset or a portion of a financial asset when, and only when, the enterprise loses control of the contractual rights that comprise the financ ial asset (or a portion of the financial asset). Further, paragraphs 38 & 39 stat e that a transferor has not lost control of a transferred financial asset and, t herefore the asset is not derecognised if the transferor has the right to reacqu ire the transferred asset unless either (i) the asset is readily obtainable in t he market or (ii) the reacquisition price is fair value at the time of reacquisi tion. In the case of first transaction of COT, generally the seller de-recognise s the investment in shares from its balance sheet (and not recognising a borrowi ng) without considering the second transaction. However, simultaneousness of the second transaction of COT gives the seller a right to repurchase the shares at a fixed price. Further, the respective shares are not readily obtainable in the market on succeeding Monday because their prices are fixed in advance i.e. on Fr iday. Keeping in view the above practise and the form as well as substance of CO T a question has arisen whether COT is a Repo or not? TECHNICAL COMMITTEE RECOMMENDATIONS The appropriate Committee of the Institute has examined all aspects of the query regarding Carry-Over-Transactions (COT) and is of the opinion that a Carry-Over -Transaction is a Repo transaction as the substance of the transaction and not i ts form should be considered and accordingly it should be treated as a financing transaction. in the books of accounts. The aforesaid clarification provides th e accounting treatment for Carry-Over-Transactions under International Accountin g Standards. However for the purposes of other statutes, the transaction would h ave the effect according to the relevant provisions of that law.