AS 32 Financial Instruments: Presentation

Objective of IAS 32
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.
Scope
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 15-32 and AG25-35 (analysing debt and equity components) but
are subject to all other IAS 32 requirements
contracts and obligations under share-based payment transactions
(see IFRS 2 Share-based Payment) with the following exceptions:
- this standard applies to contracts within the scope of IAS 32.8-10 (see
below)

paragraphs 33-34 apply when accounting for treasury shares purchased,

sold, issued or cancelled by employee share option plans or similar
arrangements

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
non-financial item in accordance with the entity's expected purchase, sale or usage
requirements. [IAS 32.8]
Key definitions
Financial instrument: a 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
an equity instrument of another entity
a contractual right
- 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 non-derivative 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

Financial liability: any liability that is:

a contractual obligation:
- to deliver cash or another financial asset to another entity; or
- 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 non-derivative 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
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.
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.
Classification as liability or equity
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]
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 non-derivative 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]

Illustration 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, 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. 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.
Illustration issuance of fixed monetary amount of equity instruments

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]
Illustration one party has a choice over how an instrument is settled
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]
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 32.16A
and 16B for puttable instruments [IAS 32.25]

Puttable instruments and obligations arising on liquidation

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 32.16A-D]
Classifications of rights issues
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.
Compound financial instruments
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 32.29-30]
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]
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]
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.
Treasury shares
The cost of an entity's own equity instruments that it has reacquired ('treasury
shares') is deducted from equity. 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]
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]

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]

Costs of issuing or reacquiring equity 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]
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.