Objective: IAS 32 establishes principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities.
- Applies to all types of financial instruments except those covered by other standards
- Focuses on classification as debt vs equity and presentation in financial statements
- Works with IFRS 9 (recognition/measurement) and IFRS 7 (disclosures)
Financial Instrument: Any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
Financial Asset: Any asset that is cash, equity instrument of another entity, or contractual right to receive cash/another financial asset.
Financial Liability: Any liability that is a contractual obligation to deliver cash/another financial asset.
Equity Instrument: Any contract that evidences a residual interest in the assets of an entity after deducting all its liabilities.
1. Does instrument contain contractual obligation?
• YES → Financial liability
• NO → Proceed to 2
2. Is instrument residual interest?
• YES → Equity instrument
• NO → Re-evaluate substance
| Feature | Debt | Equity |
|---|---|---|
| Obligation | Contractual obligation exists | No contractual obligation |
| Settlement | Fixed or determinable | At issuer's discretion |
| Returns | Mandatory payments | Discretionary distributions |
| Priority | Senior to equity | Residual interest |
Compound Instruments: Contain both liability and equity components that must be separated.
- Examples: Convertible bonds, bonds with warrants
- Separation Method: Allocate proceeds between liability and equity components
- Liability Component: Present value of contractual cash flows
- Equity Component: Residual amount after deducting liability component
- No gain/loss recognized on separation
Treasury Shares: An entity's own equity instruments that have been issued and subsequently reacquired.
- Deducted from equity (not recognized as financial asset)
- No gain/loss recognized on purchase, sale, or cancellation
- Consideration paid/received recognized directly in equity
- Disclosure required of shares held as treasury shares
Scenario: Company issues $1,000,000 convertible bonds
Similar Debt Without Conversion: Would yield 8%
Present Value of Cash Flows: $900,000 (liability component)
Equity Component: $100,000 ($1,000,000 - $900,000)
Accounting Entry:
Dr Cash $1,000,000
Cr Financial Liability $900,000
Cr Equity $100,000
| Payment Type | Classification | Accounting Treatment |
|---|---|---|
| Interest on Debt | Expense | Recognized in profit or loss |
| Dividends on Equity | Distribution | Recognized directly in equity |
| Transaction Costs | Allocated | Based on debt/equity classification |
Transaction Costs: Allocated between liability and equity components in proportion to allocation of proceeds.
Offsetting Criteria: Financial asset and liability can be offset only when there is:
- Legally enforceable right to set off
- Intention to settle net or simultaneously
- Master Netting Agreements: Common in derivatives trading
- Disclosure Required: Even if offsetting criteria not met
- Not Permitted: When only intention exists without legal right
| Instrument | Classification | Reasoning |
|---|---|---|
| Preference Shares (mandatory redemption) | Liability | Contractual obligation to redeem |
| Preference Shares (discretionary dividends) | Equity | No contractual obligation |
| Puttable Instruments | Equity (with exceptions) | Specific criteria must be met |
| Contingent Settlement Provisions | Liability | Outside entity's control |
- Classification: Basis for classifying instruments as debt/equity
- Compound Instruments: Terms, conditions, and separation methodology
- Treasury Shares: Number and carrying amount held
- Default & Breaches: Details of any defaults on liabilities
- Offsetting: Information about offsetting rights and arrangements
- Risk Management: How financial instruments are used for risk management
- Distinguishing between debt and equity for complex instruments
- Applying substance over form principle
- Valuing equity components of compound instruments
- Determining legal enforceability of offsetting rights
- Accounting for instruments with contingent features
- Managing presentation of treasury share transactions