L7. IAS 32 - Financial Instruments

3/28/2016
Overview
IAS 32 Financial Instruments: Presentation outlines the
accounting requirements for the presentation of
financial instruments, particularly as to the
classification of such instruments into financial assets,
financial liabilities and equity instruments
IAS32 FinancialInstruments:
Presentation
The standard also provide guidance on the

classification of related interest, dividends and
gains/losses, and when financial assets and financial
liabilities can be offset
ByKendhoo
IAS 32 was reissued in December 2003 and applies to

annual periods beginning on or after 1 January 2005
MNUBusinessSchool/ACC235/2016S1/Kendhoo
Scope
ObjectiveofIAS32
The stated objective of IAS 32 is to establish principles for

presenting financial instruments as liabilities or equity and for
offsetting financial assets and liabilities. [IAS 32.1]
IAS 32 addresses this in a number of ways:
clarifying the classification of a financial instrument issued by an entity
as a liability or as equity
prescribing the accounting for treasury shares (an entity's own
repurchased shares)
prescribing strict conditions under which assets and liabilities may be
offset in the balance sheet
IAS 32 is a companion to IAS 39 Financial Instruments: Recognition

and Measurement and IFRS 9 Financial Instruments. IAS 39 deals
with, among other things, initial recognition of financial assets and
liabilities, measurement subsequent to initial recognition,
impairment, derecognition, and hedge accounting. IAS 39 is
progressively being replaced by IFRS 9 as the IASB completes the
various phases of its financial instruments project
IAS 32 applies in presenting and disclosing information about all types of

financial instruments with the following exceptions: [IAS 32.4]
interests in subsidiaries, associates and joint ventures that are accounted for
under IAS 27 Consolidated and Separate Financial Statements, IAS 28
Investments in Associates or IAS 31 Interests in Joint Ventures (or, for annual
periods beginning on or after 1 January 2013, IFRS 10 Consolidated Financial
Statements, IAS 27 Separate Financial Statements and IAS 28 Investments in
Associates and Joint Ventures). However, IAS 32 applies to all derivatives on
interests in subsidiaries, associates, or joint ventures
employers' rights and obligations under employee benefit plans (see IAS 19
Employee Benefits)
insurance contracts(see IFRS 4 Insurance Contracts). However, IAS 32 applies
to derivatives that are embedded in insurance contracts if they are required to
be accounted separately by IAS 39
financial instruments that are within the scope of IFRS 4 because they contain
a discretionary participation feature are only exempt from applying
paragraphs 1532 and AG2535 (analysing debt and equity components) but
are subject to all other IAS 32 requirements
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Scope
IAS 32 applies in presenting and disclosing information
about all types of financial instruments with the following
exceptions: [IAS 32.4] (Continued)
contracts and obligations under sharebased payment
transactions (see IFRS 2 Sharebased Payment) with the
following exceptions:
this standard applies to contracts within the scope of IAS 32.810 (see
below)
paragraphs 3334 apply when accounting for treasury shares
purchased, sold, issued or cancelled by employee share option plans
or similar arrangements
Keydefinitions[IAS32.11]
Financial instrument: a contract that gives rise
to a financial asset of one entity and a
financial liability or equity instrument of
another entity
IAS 32 applies to those contracts to buy or sell a non

financial item that can be settled net in cash or another
financial instrument, except for contracts that were entered
into and continue to be held for the purpose of the receipt
or delivery of a nonfinancial item in accordance with the
entity's expected purchase, sale or usage requirements.
[IAS 32.8]
Financial asset: any asset that is:

cash
an equity instrument of another entity
a contractual right
Financial liability: any liability that is:
a contractual obligation:
to deliver cash or another financial asset to another entity; or
to receive cash or another financial asset from another entity; or

to exchange financial assets or financial liabilities with another entity
under conditions that are potentially favourable to the entity; or
a contract that will or may be settled in the entity's own equity

instruments and is:
a nonderivative for which the entity is or may be obliged to receive a
variable number of the entity's own equity instruments
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 entity's own equity instruments. For this purpose the entity's own
equity instruments do not include instruments that are themselves
contracts for the future receipt or delivery of the entity's own equity
instruments
puttable instruments classified as equity or certain liabilities arising on
liquidation classified by IAS 32 as equity instruments
to exchange financial assets or financial liabilities with another entity under

conditions that are potentially unfavourable to the entity; or
a contract that will or may be settled in the entity's own equity

instruments and is
a nonderivative for which the entity is or may be obliged to deliver a variable
number of the entity's 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 entity's
own equity instruments. For this purpose the entity's own equity instruments
do not include: instruments that are themselves contracts for the future
receipt or delivery of the entity's own equity instruments; puttable
instruments classified as equity or certain liabilities arising on liquidation
classified by IAS 32 as equity instruments
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Equity instrument: Any contract that

evidences a residual interest in the assets of
an entity after deducting all of its liabilities
Fair value: the amount for which an asset

could be exchanged, or a liability settled,
between knowledgeable, willing parties in an
arm's length transaction
10
The definition of financial instrument used in

IAS 32 is the same as that in IAS 39
Puttable instrument: a financial instrument

that gives the holder the right to put the
instrument back to the issuer for cash or
another financial asset or is automatically put
back to the issuer on occurrence of an
uncertain future event or the death or
retirement of the instrument holder
11
12
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Classificationasliabilityorequity
Classificationasliabilityorequity
The fundamental principle of IAS 32 is that a financial
instrument should be classified as either a financial liability
or an equity instrument according to the substance of the
contract, not its legal form, and the definitions of financial
liability and equity instrument
Two exceptions from this principle are certain puttable
instruments meeting specific criteria and certain
obligations arising on liquidation (see below)
The entity must make the decision at the time the
instrument is initially recognised. The classification is not
subsequently changed based on changed circumstances.
[IAS 32.15]
13
Illustration preferenceshares
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, should be recognised as a liability. [IAS
32.18(a)]
In contrast, preference shares that do not have a fixed
maturity, and where the issuer does not have a
contractual obligation to make any payment are equity
A financial instrument is an equity instrument

only if
(a) the instrument includes no contractual obligation
to deliver cash or another financial asset to another
entity and
(b) if the instrument will or may be settled in the
issuer's own equity instruments, it is either:
a nonderivative that includes no contractual obligation for
the issuer to deliver a variable number of its own equity
instruments; or
a derivative that will be settled only by the issuer exchanging
a fixed amount of cash or another financial asset for a fixed
number of its own equity instruments. [IAS 32.16]
14
Illustration issuanceoffixedmonetary
amountofequityinstruments
A contractual right or obligation to receive or
deliver a number of its own shares or other
equity instruments that varies so that the fair
value of the entity's own equity instruments
to be received or delivered equals the fixed
monetary amount of the contractual right or
obligation is a financial liability. [IAS 32.20]
In this example even though both instruments are

legally termed preference shares they have different
contractual terms and one is a financial liability while
the other is equity
15
16
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Illustration onepartyhasachoice
overhowaninstrumentissettled
Contingentsettlementprovisions
When a derivative financial instrument gives

one party a choice over how it is settled (for
instance, the issuer or the holder can choose
settlement net in cash or by exchanging shares
for cash), it is a financial asset or a financial
liability unless all of the settlement
alternatives would result in it being an equity
instrument. [IAS 32.26]
17
Puttable instrumentsandobligations
arisingonliquidation
In February 2008, the IASB amended IAS 32 and
IAS 1 Presentation of Financial Statements with
respect to the balance sheet classification of
puttable financial instruments and obligations
arising only on liquidation
As a result of the amendments, some financial
instruments that currently meet the definition of
a financial liability will be classified as equity
because they represent the residual interest in
the net assets of the entity. [IAS 32.16AD]
19
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 32.16A and 16B for puttable
instruments [IAS 32.25]
18
Classificationsofrightsissues
In October 2009, the IASB issued an amendment to IAS
32 on the classification of rights issues
For rights issues offered for a fixed amount of foreign
currency current practice appears to require such
issues to be accounted for as derivative liabilities
The amendment states that if such rights are issued pro
rata to an entity's all existing shareholders in the same
class for a fixed amount of currency, they should be
classified as equity regardless of the currency in which
the exercise price is denominated
20
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Compoundfinancialinstruments
Some financial instruments sometimes called
compound instruments have both a liability and an
equity component from the issuer's perspective
In that case, IAS 32 requires that the component parts
be accounted for and presented separately according
to their substance based on the definitions of liability
and equity
The split is made at issuance and not revised for
subsequent changes in market interest rates, share
prices, or other event that changes the likelihood that
the conversion option will be exercised. [IAS 32.2930]
21
To illustrate, a convertible bond contains two components

One is a financial liability, namely the issuer's contractual
obligation to pay cash, and the other is an equity
instrument, namely the holder's option to convert into
common shares
Another example is debt issued with detachable share
purchase warrants
When the initial carrying amount of a compound financial
instrument is required to be allocated to its equity and
liability components, the equity component is assigned the
residual amount after deducting from the fair value of the
instrument as a whole the amount separately determined
for the liability component. [IAS 32.32]
22
Treasuryshares
Interest, dividends, gains, and losses relating to an

instrument classified as a liability should be reported in
profit or loss. This means that dividend payments on
preferred shares classified as liabilities are treated as
expenses. On the other hand, distributions (such as
dividends) to holders of a financial instrument
classified as equity should be charged directly against
equity, not against earnings. [IAS 32.35]
The cost of an entity's own equity instruments

that it has reacquired ('treasury shares') is
deducted from equity
Transaction costs of an equity transaction are deducted

from equity. Transaction costs related to an issue of a
compound financial instrument are allocated to the
liability and equity components in proportion to the
allocation of proceeds
23
Gain or loss is not recognised on the purchase,

sale, issue, or cancellation of treasury shares.
Treasury shares may be acquired and held by the
entity or by other members of the consolidated
group
Consideration paid or received is recognised
directly in equity. [IAS 32.33]
24
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Offsetting
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: [IAS
32.42]
Costsofissuingorreacquiringequity
instruments
Costs of issuing or reacquiring equity
instruments (other than in a business
combination) are accounted for as a
deduction from equity, net of any related
income tax benefit. [IAS 32.35]
has a legally enforceable right to set off the

amounts; and
intends either to settle on a net basis, or to realise
the asset and settle the liability simultaneously.
[IAS 32.48]
25
26
Disclosures
Financial instruments disclosures are in IFRS 7
Financial Instruments: Disclosures, and no
longer in IAS 32
The disclosures relating to treasury shares are
in IAS 1 Presentation of Financial Statements
and IAS 24 Related Parties for share
repurchases from related parties. [IAS 32.34
and 39]
27

L7. IAS 32 - Financial Instruments

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L7. IAS 32 - Financial Instruments

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3/28/2016

The standard also provide guidance on the

IAS 32 was reissued in December 2003 and applies to

The stated objective of IAS 32 is to establish principles for

IAS 32 is a companion to IAS 39 Financial Instruments: Recognition

IAS 32 applies in presenting and disclosing information about all types of

IAS 32 applies to those contracts to buy or sell a non

Financial asset: any asset that is:

Financial liability: any liability that is:

to receive cash or another financial asset from another entity; or

a contract that will or may be settled in the entity's own equity

to exchange financial assets or financial liabilities with another entity under

a contract that will or may be settled in the entity's own equity

Equity instrument: Any contract that

Fair value: the amount for which an asset

The definition of financial instrument used in

Puttable instrument: a financial instrument

A financial instrument is an equity instrument

In this example even though both instruments are

When a derivative financial instrument gives

If, as a result of contingent settlement provisions,

To illustrate, a convertible bond contains two components

Interest, dividends, gains, and losses relating to an

The cost of an entity's own equity instruments

Transaction costs of an equity transaction are deducted

Gain or loss is not recognised on the purchase,

has a legally enforceable right to set off the

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