• Discussed at March 2005 IASB Meeting
• Discussed at April 2006 IASB Meeting
• Discussed at January 2007 IASB Meeting
• Discussed at February 2007 IASB Meeting
• Discussed at April 2007 Joint IASB-FASB Meeting
• Discussed at December 2007 IASB Meeting
• Discussed at January 2008 IASB Meeting
• Discussed at February 2008 IASB Meeting
• 28 February 2008 Discussion Paper Published – comment deadline 5 September 2008
• Discussed at July 2008 IASB Meeting
• Discussed at July 2008 IASB Meeting – added to active agenda
• Discussed at September 2008 IASB Meeting
• Discussed at October 2008 IASB Meeting
• Discussed at November 2008 IASB Meeting
• Discussed at January 2009 IASB Meeting
• Discussed at March 2009 IASB Meeting
• Discussed at May 2009 IASB Meeting
• Discussed at June 2009 IASB Meeting
• Discussed at July 2009 IASB Meeting
• Discussed at September 2009 IASB Meeting
• Discussed at October 2009 Joint IASB-FASB Meeting
• Discussed at December 2009 IASB Meeting
• Discussed at January 2010 Joint IASB-FASB Meeting
• Discussed at February 2010 Joint IASB-FASB Meeting
• Discussed at Special 3 March 2010 Joint IASB-FASB Meeting
• Discussed at July 2010 IASB Meeting
• Discussed at September 2010 IASB Meeting (jump to notes below)
• Discussed at October 2010 IASB Meeting (jump to notes below)

Timetable

• Click for IASB Project Timetable

IASB Project Insights

• A quick overview of this project is available on our IASB Project Insights page

This project addresses the distinction between liabilities and equity.

This is a joint project with the FASB.

Discussion at the March 2005 IASB Meeting

The FASB presented to the IASB the approach being developed by the FASB regarding the accounting for instruments that could potentially be classified as liabilities or equity. The PowerPoint presentation is available on the IASB's website in the observer notes section and will be posted to FASB's website in due course.

Discussion at the April 2006 IASB Meeting

FASB staff conducted an educational session to update the IASB on status of the FASB's liabilities and equity project. The objective of the project is to establish a framework for classifying and measuring instruments with characteristics of equity and liabilities under US GAAP.

Staff noted that the approach being presented today encompasses not only the single-component financial instruments, which the Board discussed at its March 2005 meeting, but also multiple-component financial instruments.

Staff presented an accounting approach called the Ownership-Settlement Approach. The approach is based on 13 principles that deal with classification, initial measurement, subsequent measurement, separate reporting within equity, and extinguishment accounting. The presentation included a comparison of the approach to current IFRS literature.

In addition to this approach, the FASB will further develop two alternative approaches:

• The Dilution Approach. A narrower view of equity that bases its classification scheme on whether an instrument will or might dilute net assets belonging to existing shareholders.
• Reassessed Expected Outcomes (REO) Approach. This approach was presented to the IASB at its June 2004 meeting. REO is a probabilistic-based approach that applies contingent claims modelling techniques to determine classification based on the current economic conditions.

After choosing one approach, the FASB to publish a Preliminary Views document in the second quarter of 2007.

No decisions were made during this session.

Discussion at the January 2007 IASB Meeting

Project proposal

(The FASB staff joined the meeting by video link for this session.)

The Board discussed the latest project plan for the Liabilities and Equity project and its interaction with other projects, in particular the steps contemplated with respect to issuing the forthcoming FASB Preliminary Views document as an IASB Discussion Paper.

The staff noted that it intended to discuss with the IASB three models for distinguishing liabilities and equity in the FASB Preliminary Views document as well as a model being developed under the auspices of the European Financial Reporting Advisory Group. Other sessions would allow for a discussion of the FASB's Preliminary Views and associated Invitation to Comment.

Board members asked whether the EFRAG model was a new approach or a variant of one of the FASB models. It was suggested that it was a variant of the 'ownership/ settlement' model. Board members suggested that it would be highly beneficial to the IASB, FASB and the EFRAG working group if the EFRAG model was discussed before the FASB finalised their Preliminary Views document. The Board asked the staff to suggest that the item be added to the April IASB/FASB joint meeting agenda, provided that the EFRAG working group had completed their work.

Interaction with the conceptual framework project

The Board also noted that there was a potential overlap between the Liabilities and Equity project and the definitions part of the conceptual framework project. Board members noted that the Boards' current efforts in the conceptual framework project had been focussed on the definition of an asset; it was almost assumed that the Liabilities and Equity project would address the conceptual issues. It was noted that the staff summary (Observer Note 12B) was a very good summary of why the Liabilities and Equity project was the appropriate context in which to consider the conceptual issues involved.

Overview of IAS 32

The Board discussed a memorandum prepared by the staff that summarised and illustrated the difficulties in applying the current distinction between liabilities and equity in IAS 32 Financial Instruments: Presentation. The paper addressed issues such as the tension between legal form and economic substance, the overlapping nature of many hybrid instruments and the challenge faced by the IASB in developing further guidance, given the diversity of opinion about what constitutes 'equity'.

The Board commended the staff's work, but asked that before issuing the summary in final form, the staff should include arguments refuting commonly-presented 'problems' (such as 'economic compulsion'). In addition, the Board suggested other issues for inclusion and discussion.

Discussion at the February 2007 IASB Meeting – Educational Session

In this first education session on this topic, the Board discussed the three models for distinguishing liabilities and equity in the FASB Preliminary Views Document, namely:

• Ownership
• Ownership–settlement
• Reassessed expected outcome (REO)

The staff provided a detailed analysis and comparison of the three models covering the following aspects:

• Definition of equity
• Linkage and separation principles
• Initial and subsequent measurement
• Other issues: substantive features principle, separate presentation in equity, consolidation, reassessment and reclassification
• Illustrative examples for the equity/liability classification of different types of common stock, preferred stock, hybrid instruments and options/forwards

Further details are available in Observer Note 4 to 4H, available on the IASB Website.

The session consisted of Board members questioning the application of the three models, and comparing them with each other. The discussion particularly focused on the definition of equity, the treatment of convertible instruments, the linkage and separation criteria, and the definition of transaction price.

No decisions were made, and no strong views were expressed at this stage.

Discussion at the April 2007 Joint IASB-FASB Meeting

The Boards discussed an alternative view of the liability and equity distinction labelled as the Loss Absorption Approach.

The approach was prepared by staff of the Accounting Standards Committee of Germany on behalf of the European Financial Reporting Advisory Group (EFRAG) and the German Accounting Standards Board (GASB) under the Pro-active Accounting Activities in Europe Initiative (PAAinE) of EFRAG and the European National Standard Setters.

The staff pointed out that the basic principle for the classification of equity and liability has been established but that all other components still represent work-in-progress.

The core principles of the Loss Absorption Approach are:

• Dichotomous approach that classifies equity and liability from an entities perspective and seeks to define the term equity rather than the term liability.
• The distinction between equity (risk capital) and liabilities is based exclusively on the ability or inability of capital to absorb losses incurred by the entity with losses being tentatively understood as accounting losses.
• Accounting losses are defined as 'net negative total recognised income and expense before conditional servicing costs and related tax impact on and remeasurements of capital provided'.
• Both capital that is fully loss-absorbing and capital that is not fully loss-absorbing classifies as (partial) equity. If an instrument is not fully loss-absorbing, the instrument is bifurcated into a fully loss-absorbing portion and a non loss-absorbing portion (split accounting). Only the fully loss-absorbing portion is allocated to equity.
• An instrument is classified solely by reference to its terms and conditions and independently of the classification of other instruments, that is, all instruments within the same class of capital and across entities will be accounted for in the same way, thereby not taking into account what other instruments had been issued or at which point in time an investment was being made.
• Classification of an instrument would has to be made at inception and will not be changed unless either its terms and conditions are changed or settlement of the instrument gives rise to a new instrument. In particular, no reclassification is made over the term of the instrument following recognition of additional instruments, derecognition of existing instruments, or passage of time. Embedded conditional features (such as the exercise of a conversion option or a condition to absorb losses only if these exceed a certain threshold) would not be considered a change to the terms and conditions of the instrument. Rather, they are conditions already implicit in the terms and conditions that may come into force and that, hence, would have to be tested for each reporting date as to whether they have actually come into force.
• Retained earnings and measurement reserves such as revaluation reserves and cash flow hedging reserves are regarded to be loss-absorbing capital.

The session was held in form of an educational session with the Boards questioning the application of the model.

The discussion particularly focused on the following issues:

• The definition of accounting loss and the potential circularity in this definition
• The definition of loss absorption
• The treatment of convertible instruments and derivatives, in particular, the point in time at which these instruments fulfil the criterion of loss-absorbing capital
• The impact of the approach on the classification of puttable instruments
• The Boards identified various weaknesses in the approach and thought that, overall it was not superior to the approaches discussed by them so far. However, they noted that the Loss Absorption Approach was a 'work in progress' and encouraged the PAAinE/GASC group to continue its work. If there was a workable solution to one of accounting's most intractable problems, the Boards wanted to know about it.

No decisions were made.

Discussion at the December 2007 IASB Meeting

This project is part of the Memorandum of Understanding between the FASB and the IASB. On 30 November 2007, the FASB published for comment a preliminary views document. The document can be downloaded from the FASB's Website.

This session was split in two parts:

• The Board's strategy for the project
• An education session conducted by FASB staff members on the preliminary views document issued by the FASB

Strategy

The staff informed the Board that it plans to present a comprehensive analysis of the differences between the FASB's preliminary views and the current approach under IFRSs as set out in IAS 32 at the Board meeting in January or February (including a draft IASB Discussion Paper (DP) inviting comment on FASB's preliminary views). Staff noted that if the Board does issue amendments to IAS 32 regarding instruments puttable at fair value, that would be included in the analysis. The focus will be on the 'basic ownership' and 'ownership-settlement' approaches. The next step would be the publication of the IASB DP in March 2008. The DP would incorporate FASB's preliminary views document, possibly with additional material or questions, and invite public comments.

The Board agreed to the proposed schedule.

Education session

This was an education session and accordingly no decisions were made. The full presentation can be downloaded from the IASB's Website (Agenda Paper 4B).

The main topics of the presentation were:

• The FASB's preference is a basic ownership approach. A basic ownership instrument is the most subordinate class of claims that provides for a share of the assets after all other claims are satisfied – settlement would not be relevant for classification. In this approach (like in the other approaches) equity is defined first – liabilities are the residual.

  The FASB staff highlighted the reduction of accounting arbitrage opportunities and its simplicity as the main advantages of this approach. Additionally, substance and linkage tests would be reduced. The major disadvantages are the greater impact on the income statement and the changes in accounting for convertible debt (especially compared to the current IAS 32 model) and stock options.

• The ownership-settlement approach seems less favourable, but still a feasible approach.

• The reassessed expected outcomes approach was found to be complex and hard to communicate to constituents. The FASB staff made clear that they would prefer not to analyse this approach any further as none of the FASB members voted in favour of it.

The Board discussed some types of instruments, especially those with put features, in the light of the previous discussions it had on the proposed puttable instruments amendments to IAS 32. Also, it discussed some types of preference shares. The FASB staff noted that the preliminary views document is not supposed to be close to a standard but more a discussion of the broader principles from which a standard could be developed.

One participant mentioned the possible impact of the equity definition on distributable profits if distributable profits are based on equity as measured in accordance with IFRSs.

Some Board members raised concerns that the proposed approach to distinguish liabilities and equity will not be in line with the current IASB Framework and asked if the FASB and IASB staff are communicating with the Framework's project team. It was noted that staff must ensure that both projects are aligned so that the liabilities/equity project does not present outcomes that contradict the results from the Framework project.

Discussion at the January 2008 IASB Meeting

At the December 2007 Board meeting the IASB decided to issue a Discussion Paper on Financial Instruments with Characteristics of Equity.

The objective of this session was to:

• Discuss the content of the staff draft of the IASB Invitation to Comment to be included in the Discussion Paper
• Discuss the questions for respondents included in the IASB Invitation to Comment
• Provide the Board with an oral summary of the FIWG discussions.

The staff informed the Board that the overall response from the FIWG was positive. The only area of concern was communication of the timeline of the project and the interaction if the IASB project with the progress of the FASB project. One Board member pointed out that, at this stage, this project is not on the active agenda of the IASB and that the Board will deliberate adding it to its agenda in due course. However, it would be welcomed that both Boards will move in tandem when they come to exposure draft stage. Another concern was that respondents should be asked about the interaction with other IASB projects.

The Board members seemed not to support this proposal. They saw it as the Board's duty to ensure proper interaction between Board projects.

While the Board agreed to the main body of the staff paper, except for some drafting proposals, the questions to respondents that were proposed in addition to the questions from the FASB document in Appendix B seemed to be more controversial. Two questions in the staff draft will be dropped:

• B1.b: How important is it that the IASB develops a common, high quality standard used in both US and IFRS jurisdictions in the short to medium term?
• B3: How would you address the interaction between this project and the IASB's other projects on the conceptual framework, financial instruments, and financial statement presentation? Are certain projects precedential?

It was also agreed that the question on the appropriateness of the principles set out for all types of entities and jurisdictions (B5) should be expanded to cover all approaches mentioned in the document. One Board member noted that respondents could also be asked if 'economic compulsion' should also be a principle and whether this should be addressed. The staff informed the Board that they will prepare a pre-ballot draft based on the outcome of this meeting.

Discussion at the February 2008 IASB Meeting

The staff asked the Board whether there was agreement on acknowledging in the IASB's forthcoming discussion paper that the European Financial Reporting Advisory Group (EFRAG) had also issued a discussion paper on the distinction between equity and liabilities. Most Board Members disagreed with the staff's proposed wording and emphasised that the IASB should make it clear that it had not deliberated the final version of the EFRAG document, had therefore reached no final position on its merits and that the acknowledgement of the existence of the EFRAG paper should not be seen as the IASB endorsing the positions taken therein. It was decided to take the staff proposals offline to agree a suitable wording.

February 2008: Discussion Paper on how to define equity instruments

On 28 February 2008, the IASB published for comment a Discussion Paper (DP) on Financial Instruments with Characteristics of Equity. The DP has two parts – an Invitation to Comment and, as a separate document, the FASB's November 2007 Preliminary Views Financial Instruments with Characteristics of Equity. The IASB's Invitation to Comment includes background information and invites responses to the questions already included in the FASB document and to a number of additional questions raised by the IASB. IAS 32 is the current IASB standard that addresses the distinction between liabilities and equity. The DP notes two broad types of problems with IAS 32 – uncertainties on how the principles in IAS 32 should be applied and, perhaps more significantly, whether application of those principles results in an appropriate distinction between equity instruments and non-equity instruments.

The FASB document describes three approaches to distinguish equity instruments and non-equity instruments:

• basic ownership,
• ownership-settlement, and
• reassessed expected outcomes.

The FASB has reached a preliminary view that the basic ownership approach is the appropriate approach for determining which instruments should be classified as equity. The IASB has not deliberated any of the three approaches, or any other approaches, to distinguishing equity instruments and non-equity, and does not have any preliminary view.

The IASB's DP describes some implications of the three approaches in the FASB document for IFRSs. For instance:

• Significantly fewer instruments would be classified as equity under the basic ownership approach than under IAS 32.
• The ownership-settlement approach would be broadly consistent with the classifications achieved in IAS 32. However, under the ownership-settlement approach, more instruments would be separated into components and fewer derivative instruments would be classified as equity.

The goal of the Discussion Paper is to solicit views on whether FASB's proposals are a suitable starting point for the IASB's deliberations. If the project is added to the IASB's active agenda, the IASB intends to undertake it jointly with the FASB. The IASB requests responses to the DP by 5 September 2008. Click for Press Release PDF 52k).

Discussion at the July 2008 IASB Meeting – EFRAG-PAAinE Working Group Education Session

General remarks

The EFRAG representatives highlighted that some issues have to be addressed before comparing any approaches to distinguish between liabilities and equity (for example, who are the users, what is the perspective – reporting entity vs. issuing entity, etc.) and others, although important, do not (measurement, disclosure and income statement classification). It was also noted that there is a high number of cross-cutting issues like the Framework project. The representatives made clear that the characteristics of liabilities and equity are multi-dimensional, which made the dichotomous distinction difficult. Any selection of criteria was considered somewhat arbitrary.

Some Board members expressed their concern that some instruments, particularly puttable instruments with a fixed repayment amount, are considered loss absorbing under the loss absorption approach as developed in the EFRAG Discussion Paper. It was noted that some might interpret loss absorption capability as far reaching, that is even trade payables could be deemed loss absorbing in some scenarios. The Board and the EFRAG representatives had a lengthy debate on this issue.

Principle of loss absorption

The EFRAG representatives then continued to explain the principle of loss absorption. It was noted that one of the key features of equity instruments was considered to be the loss buffer function, in this case loss as defined by the accounting framework. It was also noted that the loss absorption approach would provide for reclassification when the terms change or certain triggers are met and split accounting for instrument not fully loss absorbing.

The Board discussed certain aspects of the loss absorption approach in depth. One Board member made a general remark that it would have helped the Discussion Paper of EFRAG if it had also covered measurement and disclosure issues.

Another Board member again expressed concern with loss absorbing capabilities being the distinguishing criterion, as at least on (involuntary) liquidation all instruments on the equity/liability section of the balance sheet would participate in losses – whether this was part of the contractual agreement or not. This Board member also noted that the EFRAG presentation explained that loss absorption clauses must be 'operational', but it was not clear what it means, and that he considered the existence of an obligation more fundamental for the distinction.

Some Board members asked how the loss absorption approach would avoid structuring opportunities. In response to that, another Board member explained that there will always be structuring, but that the incentive to do so could be mitigated by requiring certain measurement attributes and/or disclosures. It was also mentioned that a major issue were hybrid instruments and what would be the answer provided by the loss absorption approach.

Application within a group context

The EFRAG representative very briefly presented what the view to be taken was when the classification is made – an entity view or a proprietary view? The Board shortly discussed this issue in the light of both the EFRAG and the FASB's preferred approach.

The Board then returned to the discussion of what were the defining features of equity and what features would be covered under both the loss absorption and the basic ownership approach.

The Chairman wrapped up the session and asked the EFRAG representatives to develop a comparison between the loss absorption approach and the basic ownership approach in the light of the features highlighted in the EFRAG presentation and bring it back at a later point.

Discussion at the July 2008 IASB Meeting

The Board voted to add the project to its active agenda.

Discussion at the September 2008 IASB Meeting

FASB staff joined by video conference.

Representatives of the European Association of Co-operative Banks gave a presentation on principles and mechanisms of co-operatives and the impact of the proposals set out in the Discussion Paper Financial Instruments with the Characteristics of Equity. As this was an education session, no decisions were made.

The representatives informed the Board about the following topics:

• General information about co-operatives
• Shares of co-operatives and share purchases
• Dividends
• Retained earnings
• Redemption of shares
• Liquidation

After this introduction into the mechanisms of co-operatives, the representatives highlighted their current treatment of co-operatives' interests under IFRS, especially in Europe. It was noted that many entities inserted a 'right to refuse redemption' clause in their statutes to be covered by IFRIC 2 Members' Shares in Co-operative Entities and Similar Instruments.

Under the ownership approach proposed in the Discussion Paper, it was pointed out that the redemption formula would not approximate fair value as shares of co-operatives were usually redeemed at face value.

Board members asked questions to get a better picture about the problems co-operatives would face under the proposals. At the end of the session, the project staff highlighted a possible issue as the proposals have a substance (of terms and conditions of the contract) notion and as the right to refuse redemption could be deemed as non-substantive this could prevent equity classification under the ownership approach.

The Chairman thanked the representatives for the presentation and closed the session.

Discussion at the October 2008 IASB Meeting

Discussion Paper comment letter analysis

The purpose of this session was to provide Board members with an overview of the main issues raised by constituents in the comment letters on the Discussion Paper Financial Instruments with Characteristics of Equity. The staff noted that it plans to come back with more detailed analyses of certain questions at future meetings. Furthermore, the staff explained to the Board that, at the session scheduled for 16 October 2008, it plans to identify possible candidates within the approaches that could be used as a starting point for future deliberations and that a final decision would have to be made at the Joint Board meeting later in October. At this session the staff asked for any questions on the significant comments and issues.

Significant comments and issues from the comment letters were:

• General support for the objective of the project
• General concern of the interaction with the concurrent Framework project
• IAS 32 Financial Instruments: Presentation could be used as a starting point
• The majority of commentators did not support the basic ownership approach (as preferred by the FASB)
• The majority of commentators objected to a classification of a perpetual instrument as a liability
• Classification under the basic ownership approach based on priority at liquidation contradicts the going concern assumption
• Concerns over the classification of subsidiary basic ownership instruments in consolidated financial statements
• The requirements for instruments with redemption requirements are not clear and not operational
• Classification of cooperative shares compared to IFRIC 2 would be different for some instruments
• Scope of FASB document is too narrow

One Board member asked the staff to clarify that the reassessed expected outcomes (REO) approach was mainly discarded because the elements recognised in the financial statements under this approach would not represent assets and liabilities under the Framework. This Board member also encouraged the staff to liaise with the derecognition project team on this issue as one of the proposed approaches of the derecognition project team would be an overriding the asset/ liability definition in the framework.

Preparation for 20-21 October 2008 Joint IASB-FASB Meeting

The staff noted that this part of the session aimed to prepare Board members for and to facilitate the discussion to be held at the joint meeting of the Board and the FASB on 20-21 October 2008. No decisions were requested.

The staff noted that in order to complete the project by 2011, as contemplated by the project plan discussed by the IASB and the FASB in June, a decision was required at the joint IASB/FASB meeting regarding which approach the boards want to pursue.

The staff explained that of the approaches outlined in the IASB's Discussion Paper Financial Instruments with the Characteristics of Equity, as well as others suggested by constituents (including the PAAinE 'loss absorption approach'), the staff preferred what had been labelled the 'Perpetual approach'. The Perpetual approach would classify an instrument as equity if it (a) lacks a settlement requirement and (b) entitles the holder to a share of the entity's net assets in liquidation. The staff explained that this approach was similar to the classification approach in IAS 32 except that derivatives over an entity's own equity would not be classified by the issuer as equity. The FASB had discussed the paper presented in a public education session and none of the FASB members had expressed opposition to the approach at that meeting.

One Board member expressed concern that the loss absorption approach seemed to be dismissed somewhat summarily in the staff paper. However, another Board member noted that the Board had held two sessions dedicated to the model and most Board members remained unconvinced that something that looks like commercial paper should be classified as equity.

Most Board members expressed support for the staff recommendation. A common thread in the discussion was that the perpetual approach was superior to the basic ownership approach advocated in the Discussion Paper, although inconsistencies between IAS 32 and the IASB Framework and FAS 150 and the FASB's Concept Statements were acknowledged.

Some Board members noted that they would not support any approach that permitted an entity to write a put on its own equity and treat that equity as treasury or repurchased shares. In their view, the equity was still in issue and the entity had written a derivative which should be subject to normal derivative accounting.

Some Board members retained a preference for the basic ownership approach, because it provides a cleaner answer when compared with that in the perpetual approach for such instruments as puttable shares and instruments subject to 'economic compulsion'. Some Board members acknowledged these difficulties and suggested that the superior answer to the puttable share debate was to treat the shares as equity and account for the put separately as a derivative.

Another common thread in the discussion was that Board members were unwilling to develop an approach knowing at the outset that they would have to provide exceptions from the basic principles. They saw the perpetual approach as the best opportunity to avoid such exceptions.

Discussion at the November 2008 IASB Meeting

(FASB staff joined the meeting by videolink.)

At the Joint Board meeting in October, the boards decided to begin deliberations on their project financial instruments with characteristics of equity using the principles underlying the perpetual approach (that is, no settlement feature and entitlement to pro-rata share on liquidation of the issuing entity) and the basic ownership approach (that is, most subordinated instrument and entitlement to percentage of net assets).

The staff explained that the Agenda Paper divided the seven previously identified classification issues into two parts, as follows:

• Part 1: Issues that could potentially be resolved at this meeting
  • Should perpetual basic ownership instruments be classified as equity?
  • Should other perpetual instruments be classified as equity?
  • Should derivatives held or issued by an entity be classified as equity if the underlying is the entity's own equity instruments?
• Part 2: Issues that likely would require further analysis and deliberations at future meetings
  • Which hybrid instruments should be separated into equity and non-equity components?
  • How should redeemable ownership instruments be reported?
  • Should instruments that are classified as equity in the financial statements of a subsidiary retain that classification in the consolidated financial statements?
  • How do the Boards want to address income statement presentation (especially disaggregation of gains and losses on derivatives and hybrid instruments)?

On the Part 2 issues, the staff sought initial reactions to confirm that these were the right issues to be analysed.

Part 1: Issues that could potentially be resolved at this meeting

Should perpetual basic ownership instruments be classified as equity?

The staff asked the Board whether it considered perpetual basic ownership instruments as equity. One of the Board members questioned whether the notion of 'ultimate risks and ultimate rewards' used in the Agenda Paper was the characteristic that made the staff believe it is equity. The staff answered that the definition of a basic ownership instrument as defined in the discussion paper was the driver for this conclusion.

In the end, the Board agreed that perpetual basic ownership instruments are equity.

Should other perpetual instruments be classified as equity?

The staff continued to explain that FASB prior to issuance of its preliminary views debated whether perpetual instruments with preference to dividend or in liquidation should be classified as equity. It was noted that finally the FASB decided to classify them as a financial liability because it was not able to resolve the issue of economic compulsion. One Board member questioned whether economic compulsion creates a present obligation and hence, whether an perpetual instrument where the features created economic compulsion met the definition of a liability under the Framework.

After a brief discussion, the Board agreed with the staff proposal to treat such perpetual instruments with dividend or liquidation preference as equity.

Should derivatives held or issued by an entity be classified as equity if the underlying is the entity's own equity instruments?

The staff reminded the Board of the two approaches to accounting for derivatives over own equity instruments it previously focussed on:

• Classify indirect ownership instruments settled with equity instruments as equity
• Classify all derivatives over own equity as assets or liabilities

It was noted that FASB decided that such instruments should not be accounted for as equity leaving the issue of accounting for employee stock options open. Staff informed the Board that the decision whether employee stock options are within this scope of this project would be deferred to a future meeting. Some Board members saw no different characteristic in employee stock option that would justify a different accounting treatment. One Board member noted that classification as liability or asset would be in line with the concept of basic ownership instruments, but that this treatment would violate the Framework. Another Board member noted that this is true only for the current definition.

The Board agreed by majority vote that derivatives over an issuer's own equity instruments should be classified as assets or liabilities.

Part 2: Issues that likely would require further analysis and deliberations at future meetings

Which hybrid instruments should be separated into equity and non-equity components?

Staff noted that a hybrid instrument was an instrument that had both equity and non-equity features. It highlighted that such instruments would be split up if such an instrument required payment and after that payment an equity instrument remained outstanding. Further it noted that some Board members wanted puttable instruments and bonds with a conversion option for a fixed number of own equity instruments. The staff was asked to consider what was meant by a 'fixed' number as this would create difficulties in applying the current guidance in IAS 32 in practice.

How should redeemable ownership instruments be reported?

The Board discussed what was meant by a 'redeemable' instrument, that is, was redemption an option or a requirement. No decisions were made.

Should instruments that are classified as equity in the financial statements of a subsidiary retain that classification in the consolidated financial statements?

The Board discussed two alternatives:

• Carry over the classification from the subsidiary's financial statements (unless nature of instrument is altered by arrangements between holder and other group members)
• Always reconsider classification from the perspective of the consolidated financial statements

Some Board members believed that only perpetual instruments should be accounted for on the carry over alternative. For all other instruments consolidation would trigger reassessment.

Discussion at the January 2009 IASB Meeting

The Board continued its discussions on developing the proposals for an Exposure Draft on financial instruments with the characteristics of equity. At this meeting the staff sought for the Board's input on classification of puttable and mandatorily redeemable instruments (thereafter 'redeemable instruments') with the characteristics of equity. The staff identified four possible alternatives for the accounting treatment of such instruments:

• All perpetual and some redeemable instruments are classified as equity
• Separate redeemable instruments into equity and non-equity components
• Develop rules on which instruments are to be classified as equity
• Classify all redeemable instruments as liabilities.

Before the actual staff proposals were discussed, one staff member presented an alternative approach to addressing redeemable instruments. It was noted that this approach involves two steps: firstly, identifying what is to be recognised and, as a second step, deciding how the 'things' that qualify for recognition are to be classified.

The staff member noted that the following 'things' would potentially be eligible for recognition in financial statements:

• Rights of other parties to compel an entity to take actions it would otherwise not take for no (additional) compensation
• Ownership or property rights in the entity held by other parties
• Any amounts of assets in excess of what would be required to satisfy the items in the previous two points (this could occur in co-operative, mutual entities, etc.)

On the issue of classification criteria it was noted that the staff member's approach was based only on one factor: subordination. The staff member highlighted that two issues were already identified where this criterion would have to be further developed: consolidation and anti-abuse provisions).

The Board had a lively debate on the approach. One Board member asked whether the staff member would see a puttable instrument as more or less subordinated as a perpetual instrument. It emerged that much of this discussion was depending on the definition of subordination. The Board continued to debate whether a further distinction between what triggers redemption was helpful (that is, does redemption occur during specified period/at a specified date or on occurrence of a specific event). It was noted that puttable instruments (at fair value, a formula or book value) must also be considered in the analysis. One Board member remarked that splitting out the put option might be the only way to come to a satisfying answer.

The Board did not conclude on the approach, but staff was directed to continue developing the approach addressing the issues discussed at this meeting.

The staff then continued to address its main proposals. After short debate the Board decided to defer discussion on the staff proposals until the alternative approach was deliberated as it concluded that further discussions would not make sense at this point.

Discussion at the March 2009 IASB Meeting

Staff introduced the session by reminding Board members that it had been asked to analyse an approach where redeemable instruments were divided into two categories:

• Instruments that are redeemable upon the occurrence of an event that is certain to occur (such as death or retirement)
• All other redeemable instruments

The staff asked the Board the following questions:

Q1. Does the Board agree that instruments that are redeemable at the option of the issuer (callable instruments) are perpetual?

The Board agreed provided the instrument has no other feature of a financial liability.

Q2. Does the Board agree that instruments that are redeemable at the option of the holder or that are required to be redeemed only upon the holder's retirement or death should be classified as equity?

Staff clarified on request that the redemption price was not relevant for this criterion. Board members noted that such an instrument could possibly not provide any kind of equity return, but would still be classified as equity. This was also extended to limited life entities, but this discussion was deferred to a later question.

In the end the Board agreed.

Q3. Does the Board agree that instruments that are required to be redeemed on a specific date, in a range of dates, or upon an event that is certain to occur (except for retirement or death) should be classified as liabilities?

The Board agreed.

Q4. Does the Board agree that instruments that are required to be redeemed upon an event that is not certain to occur should be classified as liabilities?

Some Board members asked what the difference to the scenario in question 2 (see above) was. Another Board member believed that in this situation only bifurcation of the instrument produces a sensible outcome. The Board did not provide a definite position on this question as it interacted with the next question

Q5. Does the Board agree that instruments that are redeemable at the option of the holder (except upon death or retirement) should be classified as liabilities?

The chairman asked whether this would resolve the issue with puttable instruments in Germany. It was clear from the staff analysis that it did not. One Board member noted that the staff could try to expose this, but would get significant pushback from constituents on this point. This Board member gained support for his idea that the issue could be resolved by splitting out the embedded written put option. After some debate, the Board agreed that on questions 4+5 the staff would bring back an analysis on a bifurcation approach.

Q6. Are there other types of instruments that are redeemable (mandatorily or at the option of the holder) that the Board thinks should be classified as equity?

Board members mentioned shares of limited life entities that should be treated as equity. The staff was also asked to analyse the situation where the shareholders could trigger liquidation of an entity.

Discussion at the May 2009 IASB Meeting

The staff presented their papers which set out the general principles and decision rules for distinguishing between equity instruments and financial liabilities. The staff began discussions by focussing on one of the general principles, namely:

"An instrument shall be separated into a liability and equity components if the instrument has two separate or alternative outcomes, one of which would require equity classification if it were the only outcome and one of which would require liability classification if it were the only outcome."

Staff explained that as a consequence of this principle an equity instrument puttable at the option of the holder to the issuer would be bifurcated into an equity component and a liability component as the two outcomes were:

1. equity (no exercise of put option) or
2. liability (exercise of put option or the put option itself).

The staff then explained that under the proposed general principles that a convertible bond would not contain an equity component because both outcomes were liabilities (that is (1) if the conversion option was not exercised the outcome would be liability and (2) the conversion option is by default a liability under the principle. It was explained that the second outcome results in liability by virtue of the option meeting the definition of a derivative and the Board's previous decision (reflected in the decision rules) to treat all derivatives as liability instruments regardless of whether equity is delivered under them.

Board members began to question whether their previous decision to treat all derivatives as liabilities was appropriate. One Board member made the point that under this rule, forward contracts over equity would be treated as liabilities as would warrants. Some Board members felt that instruments that reduced leverage, such as equity forwards, should not be classified as liabilities. One Board member commented that treating derivatives as liabilities would at least result in the same accounting for both cash share appreciation rights and equity share appreciation rights. However, the Staff had earlier commented that the scope of the proposals had yet to be determined.

One Board member recommended that the Staff avoid a form-based model as this would be open to structuring opportunities. At least two Board members felt that the following decision rule included in the Staff paper would be open to structuring opportunities:

"An issuer would classify the following other instruments as equity: Instruments that the holder is required to own in order to do business with or otherwise actively engage in activities of the issuer and that are redeemable only if the holder dies, retires, resigns, or otherwise ceases to actively engage in the activities of the issuer. (This would include holdings the amount of which vary based on volume of business transacted by the holder)"

The Board went on to discuss some of the other outcomes of applying the proposed principles which were set out in the Staff paper. Following this the Chairman asked the Board whether they agreed with the general principles and decision rules described in the Staff paper. A majority agreed for the staff to proceed to build on the current platform but felt that additional changes were needed to deal with undesirable outcomes of applying the proposed principles.

Discussion at the June 2009 IASB Meeting

Measurement of equity instruments and separated hybrid instruments

The Board discussed several aspects of the measurement requirements for freestanding equity instruments and equity hybrids (that is, instruments that are separated into an equity component and a liability or asset component). The following decisions were, unless otherwise noted, agreed without significant detailed discussion.

Transaction costs

The Board agreed that transaction costs or fees incurred to issue freestanding equity instruments and equity hybrids should be expensed immediately.

One Board member was concerned that this principle is contrary to the notion of 'cost' in IAS 16. For example: an item of property, plant and equipment was acquired in exchange for shares (value 100) and additional costs of 10. If the 10 was related to the issue of the shares, it would be expensed; if it was directly attributable to bringing the asset to the location or condition necessary to use it, it would be included in the cost of the asset. No other Board members were concerned about this difference. In the example, the 10 was not a transaction with shareholders in their capacity as shareholders and should therefore be excluded from equity.

Initial measurement of freestanding equity instruments

The Board agreed that freestanding equity instruments should be measured initially at their transaction prices.

Separation of equity hybrids (that is, IAS 32 'compound instruments')

The Board agreed that the separated components of an equity hybrid should be measured as follows: first, the liability (or asset) component should be measured at the fair value as if it were a freestanding liability (or asset); second, the remainder of the transaction price for the hybrid instrument should be allocated to the equity component.

Subsequent measurement

The Board agreed that equity instruments and separated components that the entity cannot be required to redeem should not be remeasured.

The Board agreed that at each reporting date, equity instruments and separated equity components with redemption requirements should be remeasured at current redemption value. (Current redemption value is a defined term: it is the amount that would result from applying the redemption formula as if redemption was required at the measurement date.) Changes in current redemption value should be recorded as a transfer between retained earnings and the redeemable equity instruments or components.

The Board also agreed that the liability or asset component of a separated instrument should be subsequently remeasured as if it were a freestanding instrument.

Measurement of liability and asset instruments

The Board discussed how instruments classified as a liability (or asset) under the IASB's classification approach would be measured using the current measurement requirements in IFRS and US GAAP.

Board members were uncomfortable with the staff recommendations, which they thought would be open to abuse, in particular the ease with which a liability could be structured to achieve equity classification. Some Board members would prefer to account for the instruments 'net', while others preferred the current IAS 39 requirements. Staff noted that the FASB's current view is to report the position 'net'.

A bare majority of the Board (8 in favour) agreed that physically settled forward contracts and written put options on an entity's own equity instruments should be (a) reported on a net basis and (b) measured consistently with the financial instruments recognition and measurement project's conclusions.

Discussion at the July 2009 Joint IASB-FASB Meeting

Staff presented a preliminary analysis disaggregating the total changes in the fair value of financial liabilities with the characteristics of equity between recurring and non-recurring changes using the cost of capital method. By this method, the total change in the fair value, which is perceived to have little informative value, is disaggregated into a more informative 'flow' amount representing interest change and the remaining part of the change in the fair value, which represents a value effect with little predictive value.

Several members of both Boards seemed to be concerned that when liabilities with characteristics of equity are measured at fair value as proposed, net income and earnings per share will be distorted by the wealth effect (effect of future expected cash flows) that has little correlation with performance.

Other members challenged the staff, noting that, in their opinion, the disaggregation had little value and seems to contain relatively complex calculations. The staff responded that users demanded classical interest charge on more complex and hybrid instruments (such as zero coupon convertible bonds). Another Board member stated that he had the impression that, given complexity of the calculation and presentation, perhaps the Boards could revisit the measurement basis as such. He proposed that the invitation to comment in the exposure draft ask whether respondents agreed with fair value measurement if the consequence is this type of disaggregation of fair value measurement.

A Board member was concerned about the lack of comparability and consistency with the general financial instruments project. He proposed that the same disaggregation criteria for all financial instruments. One FASB member noted that the FASB considered disaggregation of the changes in the fair value of financial assets into a credit risk part and remaining part and supported application also for financial liabilities in general. Several Boards members challenged applicability of such approach to derivatives.

One IASB member noted that in his opinion disaggregation in the statement of comprehensive income is not appropriate, and disclosing in the notes is most appropriate. In his view, the staff has tried to bring precision in a component of financial statements that is imprecise in nature. Another Board member responded that users are aware of the imprecise nature of the calculation but want the magnitude and direction of the change reported in the financial statements.

Overall the Board sensed that the proposed model is too complex and directed the staff to develop a simplified model of disaggregation of fair value changes on financial instruments with characteristics of equity.

Discussion at the September 2009 IASB Meeting

The Board considered the impact of the decisions made on Classification of Rights Issues on this project. The staff pointed out that the approved amendments to IAS 32 are inconsistent with the proposed classification approach. The Board decided to develop a new principle in the classification approach that would allow including some share-settled instruments to be classified as equity. Some Board members clearly did not feel comfortable with such outcome as they felt it was inconsistent with the principles in the approach. Some Board members noted that the staff would have to ensure that only transactions with shareholders acting in their capacity as shareholders were included in the principle to be developed. The staff pledged to provide additional analysis for October Board meeting.

The Board then discussed the details of the classification approach as presented by the staff (without reflecting the new principle). The staff presented a summary of the approach with examples reflecting the principles. The Board agreed with the basic idea behind those principles, which reflected and further articulated tentative decisions already taken by the Board.

The staff noted that accounting for share-based payments (and accounting for them until they vest) and subsidiaries' instruments in consolidation would have to be addressed on a next meeting. The staff also noted that the highlighted issue of classification of preferred shares that are mandatorily convertible to equity instruments may be solved by the new principle and would be addressed in that context. Detailed examples reflecting the changes would also be provided for the next meeting.

Discussion at the October 2009 Joint IASB-FASB Meeting

The staff described a new proposal (Approach 4.1) for distinguishing between liability and equity instruments and asked the Boards whether they were interested in pursuing this approach. Staff explained the difference between Approach 4.1 and Approach 4, which the Boards had discussed previously. Under Approach 4, shares that are issued pursuant to the contract (that is, all share-settled instruments) would be classified as liabilities regardless of their terms. Under the new Approach 4.1, share-settled instruments would be subject to a separate classification principle, under which the shares that an entity is not using as currency would be classified as equity. In particular, an instrument required to be settled by issuing equity instruments would be equity unless:

• (a) either party has a cash settlement option,
• (b) it requires net settlement in shares or either party has a net settlement option, or
• (c) the contract exposes either party to risks of changes in value other than those resulting from share price changes, time value of money, counterparty performance risk, and possibly foreign currency.

This classification principle would result in equity classification of certain share-settled instruments like preferred shares convertible into common shares, forwards to sell shares, physically settled written call options, and stock options. These instruments would have been classified as a liability under Approach 4.

Puttable or mandatorily redeemable instruments would be classified as equity if they are redeemable upon death or retirement, or upon the holder ceasing to participate in the activities of an entity. All other puttable or mandatorily redeemable instruments would be separated or classified as liabilities in their entirety.

Some Board members questioned whether convertible debt instruments should be classified as liabilities as proposed under Approach 4.1 or whether the convertible instrument should be bifurcated. Some suggested that this issue may be better addressed as part of the Financial Instruments Project.

Several members raised concern about the arbitrage and structuring opportunities with Approach 4.1, including unstated cash settlement features. For example, Approach 4.1 would allow an entity to avoid liability classification by writing a gross physically settled written call option (which would be classified as equity) and not having sufficient authorised and unissued shares available to satisfy the contract, in which case the entity would pay the holder cash instead of shares. The economics of the transaction would be the same as if the issuer had written the derivative to be cash settled; the derivative to be cash settled however would be classified as a liability.

Some members from both Boards raised concerns that under Approach 4.1 the information about the effects of dilution by particular instruments to shareholders would not be reflected in the financial statements. It was suggested that shareholders should be informed about the dilutive effect of certain instruments through appropriate presentation in the financial statements.

It was also explained that in relation to developing a definition of a liability in the conceptual framework that is consistent with Approach 4.1, the staff intended to keep the definition of a liability similar to what is in the current framework (that is, a liability requires a transfer of cash or assets) and to provide exceptions to the definition for share-settled instruments classified as a liability and for cash-settled instruments classified as equity.

Most members agreed to pursue Approach 4.1 and to consider ways to resolve arbitrage issues inherent in Approach 4.1.

Discussion at the December 2009 IASB Meeting

Scope exemption for share-based payments

The Boards considered granting a scope exemption for share based payments from the requirements of the Financial Instruments with Characteristics of Equity project.

The Boards considered this issue in the context of the Approach 4.1 and Approach 4 (as discussed on the October joint meeting). Both Boards preferred to scope out share-based payments from the scope of the project under the Approach 4.1. Nonetheless, some Board members were concerned that a full exemption from the project was not economically justified, especially in the post-vesting period. More specifically, some Board members expressed their preference for a more limited exemption under the Approach 4 (for instance, covering only stock options in the pre-vesting period). On the other hand, other Board members were concerned that scoping-in share-based payments in the project would re-open the debates that preceded deliberations of share based payments standards on which no consensus existed.

Finally, both Boards approved a scope exemption for share based payments from the project under both Approach 4 and Approach 4.1.

Presentation of physically-settled forward purchase contracts and physically-settled written put options

The Board revisited their tentative decision (made in June 2009) that these instruments should be presented net with changes in income (consistent with other derivatives).

Most of the Board members were uncomfortable with that decision as it would lead to reporting of many changes of own share price in profit or loss. Consequently, both Boards failed to confirm their original tentative decision.

Some proponents of the gross presentation of physically-settled forward purchase contracts noted that such approach would avoid most of the structuring opportunities and that it was an approach preferred by the regulators. Nonetheless, other Board members struggled to apply such logic for physically-settled written put options or physically-settled forward sale contracts and did not see any economic justification for a different accounting treatment.

One Board member proposed an alternative of net presentation with changes reported directly in equity. As several Board members found that alternative worth exploring, the Board asked the staff to analyse consequences of such a decision. The Board expects to deliberate the issue on a next meeting.

Classifying share-settled instruments as equity

The Boards discussed the decision from the October Joint meeting to pursue Approach 4.1, which would classify some instruments settled by delivering shares as equity. This approach was supported by most of the IASB members. On the other hand, most of the FASB members preferred Approach 4 as a starting point for any potential exemptions to a general principle.

After a prolonged and inconclusive debate covering implications of each of the approaches on classification of convertible debt and fixed-for-fixed condition as well as potential for reduction of scope of the project to amend IAS 32, the Boards finally agreed refocus their discussion on the original issue. Back in October 2009 the Approach 4.1 was perceived as a minor modification of the Approach 4 that subsequently proved to be more substantive. The Boards asked the staff to come back to Approach 4 and consider a less substantive modification than Approach 4.1 and present its analysis to the Board at a future meeting.

Discussion at the January 2010 Joint IASB-FASB Meeting

Classification of instruments an entity will settle by issuing its own shares

The Boards continued their discussion from the December IASB/FASB meeting on the classification approach for instruments that an entity is required to settle (and has the ability to settle) by issuing its own shares.

The Boards discussed the Approach 4.2 that would require classification as equity for more instruments than Approach 4.0 and fewer instruments than Approach 4.1 (as defined during previous joint meetings). This Approach was developed as a compromise that should alleviate IASB and FASB differences. The particular instruments that would be classified as equity under Approach 4.2 (and not Approach 4.0) would include rights issues and 'regular-way' forward contracts to issue shares that are outstanding for a relatively short time, stock-purchase warrants issued solely for the purpose of raising additional capital as well as mandatorily convertible preferred shares (convertible to ordinary shares). The requirements of Approach 4.2 would result in classifying convertible instruments as liabilities in their entirety.

Some IASB members were troubled that these exceptions to the classification criteria have no conceptual basis. The staff replied that they were exceptions to accommodate the concerns by both of the Boards. The IASB members were particularly concerned that some of these exceptions might lead to otherwise identical stand-alone instruments to be treated differently based on to which other instruments they were attached.

One IASB member was particularly troubled by the basic principles underlying the classification approach and expressed his view that first the answer to a more fundamental question whether writing an option on own shares should be classified as equity or as a derivative liability should be addressed. Based on his view, answer to this question should be the basis for the development of a classification approach.

In an indicative vote, the IASB supported classification of forwards/options to issue fixed amounts of shares for cash as equity (15 votes), whereas the FASB was opposed (two votes against three).

Another IASB member suggested that the basis for the classification should be whether there is a 'determinable obligation' of the entity and should be not dependent on the short-term/ long-term horizon.

The FASB Chairman pointed out that the issue took the Boards back to the 'dilution' versus 'solvency' perspective the Boards already discussed many times. He underlined that this was the tension point between the FASB and the IASB as the IASB was in the 'solvency view' whereas the FASB was in the 'dilution view'. As the IASB was unanimous in this view and the FASB was split, the FASB Chairman expressed his support for the classification approach 4.2 on the conditions that overall classification principles were tightened and additional disclosures that show dilution effects were provided. The FASB chairman acknowledged that the IASB was 'not particularly unhappy with IAS 32' but the US GAAP needed a change. Therefore, he expressed his willingness to work for a converged compromise.

In a protracted debate, various IASB members argued for the 'solvency' view. In particular these members were concerned by the impact of the classification of these instruments as liabilities on the performance statement and negative impact that could have on usefulness of the information provided. The IASB chairman and FASB Chairman tried to find a common ground that the majority of both Boards would be able to support. They agreed that the dilution issue could be addressed by a set of comprehensive and consistent disclosures that would capture wealth transfers and address the issue of using operating cash flows to re-purchase the shares (based on issued call options).

One FASB member was particularly worried that the IASB members come to each meeting with a new larger set of items that should be classified as equity. The IASB members responded that they become concerned with the implication of the classification principles when they see particular application on a set of examples.

Another FASB member was troubled by the effect of the proposed classification approach on convertible debt and possible arbitrage. She proposed a classification approach based on the improvement of IAS 32 (that is, bifurcation) and not based on a completely new classification approach. Several IASB members agreed. Nonetheless, other IASB members disagreed as they believed that IAS 32 had its own problems that needed to be addressed. They agreed that the result of the classification might be very similar but urged the Boards to develop a new approach.

Finally, both Boards asked the staff to develop a modified classification approach ('Approach 5') based on improved and modified IAS 32 requirements, particularly for cash-settled instruments and better articulation of the fixed-for-fixed rule (the Boards briefly discussed the 'specified-for-specified' rule, a modification of the fixed-for-fixed rule designed to make it more granular). The Boards agreed that the staff should include in its analysis the classification of these instruments in the consolidated financial statements as well as treatment of convertible instruments. In addition, at the same time the staff should prepare an analysis of disclosure requirements that would address the dilution aspects of the issue (including wealth transfer and its disclosure in the Statement of Changes in Equity) and granularity of these disclosures.

The Boards will discuss the new classification approach at the regular February meeting. The remaining issues that were not discussed during the January meeting will be addressed at a separate special meeting in February).

This concluded the Monday session of the joint meeting.

Discussion at the February 2010 Joint IASB-FASB Meeting

Broad classification questions

The Board considered particular financial instruments and their desired classification in order to be able to determine a principle underpinning the model being developed.

Firstly, the Boards reaffirmed all their decisions already made during the project.

The Boards also agreed that nominally perpetual instruments issued by limited-life entities should be classified as equity in the separate financial statements of the issuer.

The Boards agreed that, consistent with the previous decisions, contracts that require issuance of specified number of puttable and mandatory redeemable equity instruments for a specified price (which are classified as equity in accordance with previous decisions) and contracts covering derivatives classified as equity would be classified as equity. On the other hand, contracts over puttable instruments that would be bifurcated when issued would be classified as a liability.

Contracts that require an entity to issue a specified number of equity instruments in exchange for no future compensation (prepaid instruments) would be classified consistently with contracts that require specified-for-specified issuance of equity instruments (see previous paragraph).

The Boards also agreed that mandatorily convertible preferred shares convertible into specified number of perpetual equity instruments or specified number of puttable or mandatory redeemable equity instruments would be classified as equity.

Finally, both Boards agreed that the classification of an instrument in a subsidiary's financial statements should be carried forward in the consolidated financial statements unless the nature of the instrument changes in consolidation because of arrangements between the instrument holder and another member of the consolidated group. If the nature of the instrument changes in consolidation, classification should be reconsidered in the consolidated financial statements.

Puttable shares and gross-up of freestanding written put options

The Boards decided that puttable shares should be separated into a share and a written put option, and that the written put option should be reported net as a liability even if the exchange is specified-for-specified. The Boards further decided that all freestanding written put options should be reported net as liabilities.

One Board member preferred grossing up of the separated put option as he believed that the agreed solution should facilitate structuring of the debt as equity. However, most Board members disagreed as they believed that any alternative that contains grossing up could be counterintuitive and extremely complex to implement.

The Boards agreed to add special provisions to prevent abuses (such as an example that issuing shares and an in-the-money put option at the same time to the same party should be linked as treated as a single debt instrument).

Convertible debt

The Boards considered bifurcation of convertible debt. The IASB preferred bifurcation of convertible debt as Board members believed that such treatment is more consistent with the overall IASB model. Moreover, the IASB members believed that the existing requirement for bifurcation of convertible debt is well understood, used in practice, and perceived as decision-useful. As one IASB member noted, even if convertible debt were classified as liability in its entirety under this project, it would be bifurcated under the proposed guidance for classification and measurement of financial liabilities, which would then require a new set of conditions for bifurcation and result in additional complexity.

On this basis the IASB decided to retain the conditions for bifurcation of convertible debt. Views of FASB members were divided, with some members preferring measurement of convertible debt at fair value through net income in its entirety, and others preferring bifurcation. Finally, the FASB narrowly decided to proceed with bifurcation.

The Boards also considered the methodology for bifurcation. Some Board members preferred a simplified bifurcation method by which the debt component would be allocated on the basis of a 'plain vanilla' instrument with the same maturity date, and the interest rate would be the rate of nonconvertible bond of comparable credit quality from the same issuer (with the remainder allocated to the equity component). Other Board members preferred to retain the IAS 32 bifurcation method, in which any interdependency is allocated to the liability component. Most Board members preferred the simplified method, subject to additional analysis by the staff that would consider potential consequences of such an approach.

Discussion at the 11 March 2010 Special Joint IASB-FASB Meeting

Broad issues: Derecognition requirements

The Boards discussed how to reflect derecognition of convertible debt measured at fair value when that debt is converted. Conversion may be in accordance with the original terms of the instrument or may be initiated by the issuer before the conversion period (or early in the conversion period).

The debate was difficult to follow because the Boards discussed a question that was not in the agenda papers and because the debate became heated at times. Some Board members were adamant that any settlement of the liability component should result in a gain or loss recognised in profit or loss. Others would record the transaction using a carry-over basis (carrying amount of the call option recognised in equity) plus any cash received.

The Boards seemed to agree, by majorities in both Boards, that the settlement was a 'wealth transfer' and that the difference between the fair value of the shares on the settlement/conversion date and the carrying amount of the equity instrument should be displayed as a movement between components of equity.

Reassessment of classification

In a brief discussion, the Boards agreed that:

1. An instrument should be reclassified if events occur or circumstances change so that the instrument no longer meets the conditions for its existing classification. The reclassification should take place as of the date of the events that changed the classification.
2. An entity should remeasure a reclassified instrument according the requirements for the new classification as if it were a newly issued instrument on the date of the reclassification. An entity should report any difference in measurement on reclassification as an adjustment to a separate equity account and recognise no gain or loss in profit or loss.
3. There is no limit on the number of times an instrument may be reclassified.

Economic compulsion

The Boards discussed whether an instrument without an explicit settlement provision that would make it a liability should be classified as a liability if the issuer feels compelled to settle or redeem because not doing so imposes significant negative economic consequences.

The Boards agreed (by majorities in both Boards) to retain the principle in IAS 32 that 'economic compulsion' is not relevant to the classification of a financial instrument. If there is no [present] contractual obligation to deliver cash or other financial assets to the holder of the instrument at initial recognition, the instrument is not a liability.

Interaction with the Fair Value Option

The IASB agreed to adopt the FASB conclusion that an entity may not avoid separation (bifurcation) of an instrument with a liability and equity component by electing the fair value option for the instrument in its entirety. However, the entity would be permitted to apply the fair value option to a separated liability component if a comparable freestanding instrument would be eligible for the fair value option.

Scope exclusions and additions

The Boards agreed that the scope of the financial instruments with characteristics of equity document should match that of IAS 32.

Transition

The Boards approved a limited retrospective application transition requirement. In the first financial statements following the effective date, an entity would apply the new requirements to all instruments outstanding at the beginning of the first period presented. Under this alternative, net profit or loss would be restated for all periods presented, but beginning retained earnings would not be adjusted.

Disclosure

The Boards agreed to propose the following disclosure requirements:

Entities with financial instruments within the scope of this [draft] Standard shall disclose the nature and terms of the instruments, including information about settlement alternatives-assets or equity instruments. That disclosure shall include:

1. The identity of the entity that controls the settlement alternatives
2. The amount that would be paid, or the number of shares that would be issued and their fair value, determined under the conditions specified in the contract if the settlement were to occur at the reporting date
3. How changes in the fair value of the issuer's equity shares would affect those settlement amounts (for example, "the issuer is obligated to issue an additional X shares or pay an additional Y dollars in cash for each $1 decrease in the fair value of one share")
4. The maximum amount that the issuer could be required to pay to redeem the instrument by physical settlement, if applicable
5. The maximum number of shares that could be required to be issued, if applicable
6. That a contract does not limit the amount that the issuer could be required to pay or the number of shares that the issuer could be required to issue, if applicable
7. For a forward contract or an option indexed to the issuer's equity shares, all of the following:
   • i. The forward price or option strike price
   • ii. The number of issuer's shares to which the contract is indexed
   • iii. The settlement date or dates of the contract, as applicable.

Additional statement and schedule for publicly-traded entities

The Boards agreed to include in the exposure draft a requirement that a publicly-traded entity should be required to present a 'statement of capitalisation at fair value'. The additional statement would show the beginning balance plus issuances less repurchases or expirations plus (or minus) changes in fair value for financing liabilities. This statement of capitalisation should be supplemented by a separate schedule that discloses all of the entity's outstanding equity derivatives, exercise prices, and settlement terms.

Transition for first-time adopters and reclassification disclosures [IASB only]

The IASB agreed a limited retrospective application approach. In the first financial statements following the effective date, an entity would apply the new requirements to all instruments outstanding at the beginning of the first period presented (any adjustments will be through opening retrained earnings).

When reclassification is specifically required, IFRS requires disclosures of the amount, timing, and reason for the transfer between liabilities and equity (IAS 1 paragraph 80A and IFRIC 2 paragraph 13). Those instances when reclassification is required will be replaced by the proposals in the forthcoming ED. The Board agreed that those disclosures should be required for share-settled instruments that are transferred from equity to liabilities because there are no longer sufficient authorized shares to settle those instruments.

Comment period

The Board agreed that the proposals should be exposed for 120 days.

Drafting and Alternative Views

The Boards requested the staff to prepare a pre-ballot draft based on the package of conclusions reached by the Boards.

Two FASB Members (Messrs Linsmeier and Siegel) and one IASB Member (Mr Smith) indicated that they would present Alternative Views in the Exposure Draft. Those Board members variously do not support the approach in the exposure draft and/or do not see the package as a whole as an improvement in financial reporting.

Discussion at the July 2010 IASB Meeting

The project team presented the Board the results of the external review of the staff draft of the ED Financial Instruments with Characteristics of Equity. A small group of external commentators provided more than 600 individual comments on the draft. The reviewers concluded that the approach lacks principles and thus it would be very difficult to determine the classification of an instrument that was specifically not addressed by the draft. Consequently, these reviewers expressed doubts that the specific guidance in U.S. GAAP could be replaced by this draft. The reviewers also noted that the proposed approach provides in many instances inconsistent results and might lead to structuring opportunities. Finally, the reviewers questioned the proposed specified-for-specified criterion and questioned the relation between this criterion and the fixed-for-fixed criterion currently in IAS 32 Financial Instruments: Presentation.

The Board members noted that the most obvious criticism was the lack of principle, and as such the basic approach to this project needs to be reconsidered. Several Board members questioned whether it was still worth to continue trying to develop a new model and whether the current criteria in IAS 32 amended for the most pressing issues would not provide the appropriate classification. Moreover, several Board members noted that benefits of implementing new model of classification of these instruments would be limited as in majority of cases it would provide the same answers as the current guidance in IAS 32.

The staff noted that in some instances the criticism of IAS 32 was driven by the desire to classify more financial instruments as equity rather than unclear requirements of the Standard itself. On the other hand, the staff noted that such approach would not address one of the objectives of the project - convergence with U.S. GAAP.

The staff suggested that limited amendments of IAS 32 and relevant guidance in U.S. GAAP could lead to comparable outcomes by retaining the different approaches (more extensive guidance under the U.S. GAAP). One IASB member suggested that before the Boards jointly consider the next steps in this project the FASB staff should undertake an outreach in the U.S. regarding their reaction to the guidance in IAS 32 as a less prescriptive, more principle-based approach. Additionally, the IASB staff should identify the most pressing issues identified in relation to the current guidance in IAS 32 that could be addressed by a limited-scope project.

The Boards would discuss the project based on the additional outreach later in the year.

Discussion at the September 2010 IASB Meeting

At a previous Board meeting, the Board requested the staff to perform additional research and analysis on the way forward on the Financial Instruments with Characteristics of Equity (FICE) project, after considering the comments of external reviewers.

The staff provided possible ways to proceed in the project ranging from continuing with the pre-ballot draft to abandoning the project. The Board agreed to proceed with a targeted amendment of IAS 32 Financial Instruments: Presentation. The discussion focused on convergence with the FASB and the potential for a common project in this area. The Board will discuss that way forward with the FASB at a next joint meeting.

The Board suggested moving forward in phases. In the first phase, both Board would analyse the most significant differences between IFRS and US GAAP and amend the standards so as to provide the same accounting outcome (even though with a different set of Standards, with the US GAAP having extensive guidance on specific instruments). The main differences relate to convertible debt, puttable instruments and fixed-for-fixed derivatives as well as mandatorily convertible preference shares. Subsequently, the Boards would discuss the need for specific guidance on specific instruments and try to converge further on the scope of the guidance.

Some Board members expressed their concerns with the proposed approach as they feared that it might lead to implicit adoption of detailed guidance currently in US GAAP by analogy. One Board member felt that the Board should drop the project as it is unlikely that a converged standard will be achieved in the short to medium term. He noted that the US would try to retain the specific guidance whereas the IASB seems to be satisfied with IAS 32 and the high level guidance included there. The Board agreed to discuss these issues at a joint meeting with the FASB in October.

Discussion at the October 2010 IASB Meeting

The Boards considered the ways forwards in the FICE project and initial suggestions of some Board members to perform a targeted improvements approach in the areas of fixed-for-fixed guidance, convertible debt and redeemable and puttable instruments. Most Board members expressed their concerns over timing of the project, given the convergence priorities (mainly to finish the four big projects – Revenue, Leases, Financial Instruments and Insurance Contracts) by June 2011. They noted that given these priorities the FICE project should be deferred. Another Board member noted that the Boards should first agree on classification and measurement of basic financial liabilities before proceeding to hybrid instruments. Additionally, several Board members questioned the usefulness of the targeted improvements approach – they noted that convergence within these issues would require significant time and would not lead to full convergence in debt and equity classification, due to divergent nature of the other guidance in this area. Some Board members question the usefulness of the project before the Boards address the issue what is equity on a conceptual level.

Given all these concerns the Boards decided to remove the FICE projects from its active agenda for the time being.