IAS 32 Financial Instruments: Presentation

This standard outlines the presentation of financial instruments as either debt or equity instruments (or
a combination of both in certain situations). Disclosure requirements relating to financial instruments
are found in IFRS 7 Financial Instruments: Disclosures.
Categories: IAS 32 - Financial Instruments: Presentation (/search/?ct=IFRS-News&cat=41559034-a8cb411e-910b-456631c31857) Financial Instruments (FI) (/search/?ct=IFRS-News&cat=eeb76861-cc19-4d098941-815631957f8d)

Denitions
Accounts receivable

Amounts due from customers for goods or services which have been provided in the normal course of
business operations.
Amortised cost of nancial asset or nancial liability

The amount at which the asset or liability was measured upon initial recognition, minus principal
repayments, plus or minus the cumulative amortisation of any premium or discount, and minus any writedown for impairment or uncollectibility.
Available-for-sale nancial assets

Those non-derivative financial assets which are designated as available-for-sale or are not classified as:
loans and receivables;
held-to-maturity investments; or
financial assets at fair value through profit or loss.
Carrying amount

The amount at which an asset is presented in the statement of financial position.

Cash

Cash on hand and demand deposits with banks or other financial institutions.
Cash equivalents

Short-term, highly liquid investments that are readily convertible to known amounts of cash which are
subject to an insignificant risk of changes in value.
Compound instruments

An issued single financial instrument that contains both liability and equity (e.g. a convertible loan). Under
IAS 32 principles, such instruments are split accounted.
Control

The ability to direct the strategic, financial and operating policies of an entity so as to obtain benefits from
its activities.
Credit risk

The risk that a loss may occur from the failure of one party to a financial instrument to discharge an
obligation according to the terms of a contract.
Current assets

An asset is classified as current when it satisfies any of the following criteria:

It is expected to be realised in, or is intended for sale or consumption in, the entitys normal operating
cycle.
It is held primarily for the purpose of being traded.
It is expected to be realised within 12 months after the reporting period.
It is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at
least 12 months after the reporting period.
Derecognition

Removal of a previously recognised financial asset or liability from an entitys statement of financial
position.
Derivative

A financial instrument or other contract with all three of the following features:
Its value changes in response to changes in a specified interest rate, security price, commodity price,
foreign exchange rate, index of prices or rates, a credit rating or credit index, or other variable, provided
in the case of a non-financial variable that the variable is not specific to a party to the contract.
It requires little or no initial net investment relative to the other types of contracts that have a similar
response to changes in market conditions.
It is settled at a future date.
Eective interest method

A method of calculating the amortised cost of a financial asset or a financial liability (or group of financial
instruments) and of allocating the interest income or expense over the relevant period.
Eective interest rate

The rate that exactly discounts estimated future cash flows to the net carrying amount of the financial
instrument through the expected life of the instrument (or a shorter period, when appropriate). In
calculating the effective rate, the entity should estimate future cash flows after considering all of the
contractual terms of the financial instrument but without considering future credit losses. Fees, points paid
or received between parties to the contract, transaction costs and other premiums and discounts are also
included.
Embedded derivative

A component of a hybrid (combined) financial instrument that also includes a non-derivative host contract
with the effect that some of the cash flows of the combined instrument vary in a way similar to a
standalone derivative.
Equity instrument

Any contract that evidences a residual interest in the assets of an entity after deducting all its liabilities.

Fair value

Amount for which an asset could be exchanged, or a liability settled, between knowledgeable and willing
parties in an arms-length transaction.
Fair value through prot or loss

An option in IAS 39 Financial Instruments: Recognition and Measurement allows an entity to irrevocably
designate any financial asset or financial liability at fair value through profit or loss, but only upon its initial
recognition, as one to be measured at fair value, with changes in this fair value passing through profit or
loss.
Financial asset

Any asset that is one of the following:

Cash
An equity instrument of another entity
A contractual right:
To receive cash or another financial asset from another entity; or
To exchange financial instruments with another entity under conditions that are potentially favourable.
A contract that will be settled in the reporting entitys own equity instruments and is:
A non-derivative for which the entity is, or may be obligated, to receive a variable number of its own
equity instruments; or
A derivative that will, or may, be settled other than by the exchange of a fixed amount of cash or
another financial asset for a fixed number of the entitys own equity instruments (which excludes
puttable financial instruments classified as equity and instruments that are themselves contracts for
the future receipt or delivery of the entitys equity instruments).
Financial assets are classified as being:
at fair value through profit or loss;
available-for-sale;
held-to-maturity; and
loans and receivables.
Financial assets/liabilities carried at fair value through prot or loss

A financial instrument which is either acquired or incurred for trading (i.e. is principally for the purpose of
generating a profit from short-term fluctuations in price or dealers margin, or which is part of identified,
commonly managed financial instruments and for which there is a pattern of short-term profit-taking by
the entity, or which is a derivative unless designated for, and effective as, a hedging instrument) or upon
initial recognition is designated for carrying at fair value through profit or loss.
Fair value through prot or loss

IAS 39 allows an entity to irrevocably designate any financial asset or liability, upon its initial recognition, as
one to be measured at fair value with changes in that fair value being taken to profit or loss.
Financial instrument

Any contract which gives rise to both a financial asset of one entity and a financial liability or equity
instrument of another entity.
Financial liability

Any liability which meets either of the following criteria:

A contractual obligation:
to deliver cash or another financial asset to another entity; or
to exchange financial instruments with another entity under conditions which are potentially
unfavourable to the entity.
A contract that will, or may, be settled in the entitys own equity instruments and is:
a non-derivative for which the entity is, or may, be obligated to deliver a variable number of its own
equity instruments; or
a derivative that will, or may, be settled other than by the exchange of a fixed amount of cash or
another financial asset for a fixed number of the entitys own equity instruments (which excludes
puttable financial instruments classified as equity and instruments that are themselves contracts for
the future receipt or delivery of the entitys equity instruments).
Hedging

Designating one or more hedging instruments such that the change in fair value or cash flows of the
hedging instrument is an offset, in whole or part, to the change in fair value or cash flows of the hedged
item. The objective is to ensure that the gain or loss on the hedging instrument is recognised in profit or
loss in the same period that the hedged item affects profit or loss. The types of hedges are:
fair value hedge;
cash flow hedge; and
net investment in a foreign operation.
Hedging instrument

For hedge accounting purposes, a designated derivative or (for a hedge of the risk of changes in foreign
currency exchange rates only) a designated non-derivative financial asset or non-derivative financial liability
whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated
hedged item.
Held-to-maturity investments

Non-derivative financial assets with fixed or determinable payments and fixed maturities that the entity has
the positive intent and ability to hold to maturity, except for:
those at fair value through profit or loss;
those designated as available-for-sale; and
loans and receivables.
An entity should not classify any financial assets as held-to-maturity if the entity has, during the current
financial year, or during the two preceding financial years, sold or reclassified more than an insignificant
amount (in relation to the total amount of held-to-maturity investments) of held-to-maturity investments
before maturity (these are referred to as the tainting rules).

Liquidity risk

The risk that an entity may encounter difficulty in meeting obligations associated with financial liabilities.
Loans and receivables

Non-derivative financial assets with fixed or determinable payments that are not quoted in an active
market, other than:
those at fair value through profit or loss;
those designated as available-for-sale; and
those which the holder may not recover substantially all of its initial investment.
Market risk

The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in
market prices. There are three types of market risk:
currency risk;
interest rate risk; and
other price risk.
Market value

An amount obtainable from a sale, or payable on acquisition, of a financial instrument in an active market.
Other price risk

The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in
market prices (other than those arising from interest rate risk or currency risk), whether those changes are
caused by factors specific to the individual financial instrument or its issuer, or factors affecting all similar
financial instruments traded in the market.
Transaction costs

Incremental costs directly attributable to the acquisition or disposal of a financial asset or liability.

Recognition and measurement nancial assets

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability
of another entity. They can be financial assets, financial liabilities or equity instruments.
Financial assets are classified as either:
Available-for-sale

These are non-derivative financial assets which are not classified as financial assets at fair value through
profit or loss, held-to-maturity investments or loans and receivables. The available-for-sale category is
essentially a default category for those financial instruments which cannot be classified as fair value
through profit or loss, held-to-maturity investments or loans and receivables.
Financial assets at fair value through prot or loss

These are carried at fair value with changes in the instruments fair value being recognised in profit or loss.
In order to be able to recognise a financial asset through profit or loss, it has to meet one of the following
conditions:
the financial asset is classed as held-for-trading (ie the entity plans to sell it within a short period of time
usually within one year); and
upon initial recognition, the financial asset was designated at fair value through profit or loss.
Held-to-maturity investments

These are non-derivative fixed-term investments that the entity intends to hold on to until they mature and
must be quoted in an active market. Strict tainting rules in IAS 39 say that if a company sells or reclassifies
a significant amount of held-to-maturity investments, it must reclassify the entire portfolio of held-tomaturity investments to the available-for-sale category.
Loans and receivables

These are non-derivative financial assets which have fixed or determinable payments, are not quoted in an
active market, are not held-for-trading and upon initial recognition have not been recognised as assets at
fair value through profit or loss. An example of such an asset would be a loan to another entity or a sale to
a customer on credit terms.
A summary of the accounting for financial assets in the financial statements is as follows:
Financial asset

Statement of financial
position

Gains or losses recognised

in

Fair value through profit or

loss

Fair value

Statement of comprehensive
income

Available-for-sale*

Fair value

In equity until derecognition,

then recycled through the
statement of comprehensive
income

Held-to-maturity*

At amortised cost

Not applicable

Loans and receivables

At amortised cost

Not applicable

*It is to be noted that under the new IFRS 9 Financial Instruments, there is no classification of held-tomaturity or available-for-sale financial assets.

Recognition and measurement nancial liabilities

Financial liabilities can be complex items to account for. In essence, however, when an entity wishes to
raise finance it may do so from a varying degree of sources such as a share issue or a loan. Under the
provisions in IAS 32, there are generally two options to accounting for financial liabilities:
recognise the instrument as debt; or
recognise the instrument as equity.

Financial liabilities can be measured as:

at fair value through profit or loss; or
at amortised cost using the effective interest method.
IAS 32 looks at the substance of the transaction where financial liabilities are concerned and in particular
looks at whether (or not) the financial instrument entitles the holder to receive cash, or if the financial
liability contains any form of redemption feature. If the financial instrument does not entitle the holder to
receive cash, nor contains any redemption feature, the financial instrument is classified as equity. If, on the
other hand, the financial instrument entitles the holder to receive cash, or if the instrument contains a
redemption feature, the instrument is classified as debt.
Equity instruments

An equity instrument is any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.
If a financial instrument does not have a redemption feature, or does not contain any obligation to pay
cash to the holder, it is recognised as equity.
If an entity reacquires its own equity instruments, they are deducted from equity. No gain or loss is
recognised in profit or loss on the purchase, sale or cancellation of an entitys own equity instruments. Any
consideration paid or received must be recognised directly in equity.
Any interest payments, dividends, losses and gains relating to financial instruments or a component of a
financial instrument that has been recognised as a financial liability must be recognised as income or
expense in profit or loss.
Preference shares

If an entity issues preference (preferred) shares that pay a fixed rate of dividend and that have a mandatory
redemption feature at a future date, the substance is that they are a contractual obligation to deliver cash
and, therefore they should be recognised as a liability. Where preference shares do not have a fixed
maturity, and where the issuer does not have a contractual obligation to make any payment, they are
recognised as equity.
Compound nancial instruments

Compound financial instruments are financial instruments that contain a mixture of both debt and equity.
The most common instrument which is classified as a compound financial instrument is a loan whereby the
loan note holders have the option when the loan notes mature to either convert the capital amount into
shares of the entity, or receive cash in settlement (often referred to as convertible debt). In these
situations part of the instrument will be recognised in debt, with the other part being recognised in equity.
Example Compound financial instrument
On 1 April 2014, an 8% convertible loan with a nominal value of $600,000 was issued at par. It is
redeemable on 31 March 2017 also at par. Alternatively, it may be converted into equity shares of the
entity on the basis of 100 new shares for every $200 of loan note.

An equivalent loan note without the conversion option would carry interest at 10%. Interest of $48,000 has
already been paid to the loan note holder and has been included as finance costs in the statement of profit
or loss.
Present value rates are as follows:
End of year Present Value

8%

10%

0.93

0.91

0.86

0.83

0.79

0.75

0.73

0.68

As there is an option to convert the shares into equity, there is clearly an obligation to transfer economic
benefits. Elements of both debt and equity are present. The debt component here is the obligation to pay
cash (the interest at 8% per annum) and a redemption amount. The equity component is the loan note
holders option to convert.
The way to calculate the debt and equity components is to first discount the cash flows to present day
values. The difference between the discounted amount and the proceeds received is the equity component
of the instrument.

8% interest

($600,000 x 8%) Factor at a rate of 10% Present value

(rounded down)
Year 1 2014

48,000

0.91

43,600

Year 2 2015

48,000

0.83

39,800

Year 3 2016

48,000

0.75

36,000

119,400

648,000

0.68

440,600

Year 4 2017
Amount recognised as a liability

560,000

Initial proceeds

(600,000)

Amount recognised as equity

40,000

The next step is to consider the interest charge that has been recognised as a finance cost. The example
shows that $48,000 has already been paid to the loan note holders, which has been debited to finance
costs in the statement of profit or loss. This represents 8% of the loan. However, it has to be recognised
that an equivalent loan without the option to convert the capital element into shares would carry interest at
a rate of 10% and therefore it is necessary to reflect this.
The present value of the debt component is $560,000 and therefore this would be charged interest of
$56,000 ($560,000 x 10%). $48,000 has already been charged to the statement of profit or loss and so the
difference of $8,000 ($56,000 less $48,000) is also charged to finance costs as this is essentially the rolled
up interest in the loan.
Contingent settlement provisions

If as a result of contingent settlement provisions, the issuer does not have an unconditional right to avoid
settlement by delivery of cash or other financial instrument (or otherwise to settle in a way that it would be
a financial liability) the instrument is a financial liability of the issuer, unless:
the contingent settlement provision is not genuine; or
the issuer can only be required to settle the obligation in the event of the issuer's liquidation; or
the instrument has all the features and meets the conditions of IAS 32 for puttable instruments.
Osetting

IAS 32 also prescribes rules for the offsetting of financial assets and financial liabilities. It specifies that a
financial asset and a financial liability should be offset and the net amount reported when, and only when,
an entity:
has a legally enforceable right to set off the amounts; and
it intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.
Disclosures

The disclosures relating to financial instruments are contained in IFRS 7 Financial Instruments: Disclosures.