Equity or Liability - will it be clearer now?

The effects of relevant laws or regulations

Do laws and regulations impact the contractual terms of a financial instrument, and if so, to what extent?

Only enforceable contractual terms that give rise to rights and obligations in addition to those established by law are considered in classifying a financial instrument (or its component parts).

Contractual terms shall be considered in their entirety i.e., contractual and non-contractual are not separated.

Settlement in an entity’s own equity instruments

Can variations/adjustments be made to the amount of cash/number of equity instruments without failing the ‘fixed-for-fixed’ (fixed amount of cash or other financial asset for a fixed number of the entity’s own equity instruments) condition.

Clarified that the ‘fixed-for-fixed’ condition is met if:

ü  Amount to be exchanged is denominated in the entity’s functional currency; and is either:

ü  Fixed; or

ü  Varies solely…

• To preserve the relative economic interests of future shareholders to an equal/lesser extent than current shareholders
• For passage-of-time adjustments that:
  • are predetermined
  • vary only with passage of time
  • effectively fix the present value of the amount per equity instrument up front

Derivatives giving a party a choice of settlement between classes of equity must be considered for each class.

Obligations to purchase an entity’s own equity instruments

How to account for obligations over own equity settled in a variable number of own equity.

Clarify that the entity must recognise a financial liability for the present value of the redemption amount (which equity component the liability is removed from and how to measure the liability is clarified)

How should these obligations be subsequently measured?

Initial + subsequent measurement of the liability = same approach

• Ignore the probability and estimated timing of the holder exercising the option

The accounting treatment on expiry of a written put option on an own equity instruments without delivery.

• Financial liability reclassified to the same equity component from which it was reclassified on initial recognition
• Cumulative amount in retained earnings from remeasurement can be reclassified to another equity component

Contingent settlement provisions

Whether financial instruments with contingent settlement features can be compound instruments

If so, how should these be recognised and measured if they are compound instruments?

How should financial instruments with contingent settlement provisions be subsequently measured?

Clarify that financial instruments with contingent settlement provisions can be compound instruments.

If liability component could require immediate settlement on occurrence of a contingent event

• Measure at the full amount of conditional obligation

Payments at the discretion of the issuer

• Always equity

Initial + subsequent measurement of the liability = same approach

• Ignore the probability and estimated timing of the holder exercising the option

Shareholder discretion

Whether settlement at shareholder discretion gives the entity an unconditional right to avoid settlement.

Specifically...

Whether shareholder decisions are part of the entity’s operating and governance process,

or

Whether shareholders are acting in their individual capacity.

Judgement to be applied to facts and circumstances where shareholders discretion arises. 

Proposed factors to consider:

• Is it a routine decision typically made in ordinary course of business?
• Does the decision relate to an action/transaction that would be initiated/proposed by management?
• Would different classes of shareholders benefit differently?
• Is the shareholder able to make a decision requiring the entity to redeem/pay a return on the shares in cash or another financial asset?

The IASB also proposes to provide guidance on applying the above.

Reclassification of financial liabilities and equity instruments

IAS 32 has no requirements on whether/when to reclassify between financial liabilities and equity.

The substance of a contractual arrangement may change without a modification to the contractual terms. This raises questions in practice:

• Are these reclassifications required or allowed?

• If so, how are these accounted for?

Reclassifications are only permitted when:

ü  The substance of the contractual terms change (without any modification to the contract)

ü  arising from changes in circumstances outside the contract (examples to be provided)

Reclassification date = the date of the change in circumstance; prospectively.

Financial liability reclassified from equity:

• measure at fair value of the liability on date of reclassification
• difference recognised in equity

Equity reclassified from a financial liability:

• measure at the carrying value of the financial liability at that date (no gain or loss)

Transition

Subsidiaries without public accountability

Presentation and disclosure

Objective expanded

Information to allow users to understand:

• how an entity is financed; and
• its ownership structure; including
• potential dilution to ownership structure

Scope

• Remove reference to “derivatives that meet the definition of an equity instrument”

• Paragraphs 80A and 136A move from IAS 1 into IFRS 7

• Require separate disclosure of gains/losses on financial liabilities with a contractual obligation to make payments based on the entity’s performance/change in net assets.

• Add disclosure requirements for compound financial instruments.

Disclose information about…

• Nature and priority of claims on liquidation.
• Terms and conditions of financial instruments:
• with financial liability and equity features
• that become/stop being effective due to passage of time
  • Potential dilution of ordinary shares.
  • Obligations to purchase own equity instruments.

Why? To make it clear which amounts are attributable to ordinary shareholders

How? Separate presentation for amounts attributable to ordinary shareholders from that to other owners of the parent:

• Statement of financial position: Issued capital and reserves
• Statement of comprehensive income: Allocation of profit/loss and comprehensive income
• Statement of changes in equity: Each class of ordinary share capital and each class of other contributed equity
• Dividend amounts