Under current IFRSs claims on an entity are classified into liabilities and equity and generally only instruments classified as liabilities are directly measured with changes in such measurement are presented in comprehensive income. In order to determine if a claim is classified as a liability or as a claim on equity, IFRSs generally use the conceptual definition of a liability. Sophisticated financial instruments have been developed to exploit the differentiation between equity and liability and instruments that are economically similar may fall on different sides of the divide and therefore be reported very differently. In some cases, the current requirements of IAS 32 Financial Instruments: Presentation also lead to the classification of what are felt to be ownership instruments in various corporate structures as liabilities.
Therefore, the IASB picked up the topic again in its July 2013 Discussion Paper DP/2013/1 A Review of the Conceptual Framework for Financial Reporting, suggesting to continue to define equity as residual interest but to refine the definition. In its comment letter on DP/2013/1, EFRAG recommended that the IASB consider the equity/liability distinction in parallel to, and separate from, the wider project and has now published the DP Classification of Claims to further the discussion and to assist the IASB in developing a discussion paper of its own, which is currently expected to be published at the same time as an Exposure Draft of the revised Conceptual Framework.
The EFRAG DP does not say how the distinction between claims should be made, but discusses approaches to defining elements and aims to identify the choices that must be made in classifying the claims on an entity and the consequences of those choices requirements, including the choices taken in current IFRS. The paper also identifies the extent to which each of the choices is consistent with identified objectives and how these objectives may conflict with each other. Finally, the paper also suggests a possible order in which these choices could be taken and identifies which ones appear to have been taken in developing current IFRS requirements. Choices that need to be taken in developing classification requirements, including the choices taken in current IFRSs, are illustrated by means of a helpful flowchart.
To assist in reducing the identified conflicts between objectives in a two-element approach, the paper also identifies three additional elements that are believed could help in reducing conflicts. These additional elements, which were identified based on current problems with financial reporting, are participating obligations, obligations to transfer claims on equity, and instruments that are contractually bail-inable. The paper shows how they may interact with existing elements and some advantages and disadvantages of including them.
The DP also contains a glossary of terms as discussions around the classification of claims showed that there is not a common vocabulary for describing and understanding the issues. Therefore, a glossary has been developed with the aim of developing a common terminology to increase shared understanding.
Comments on the DP, which also contains several specific questions, are requested by 31 October 2014. Please click to access the Discussion Paper and a corresponding press release on the EFRAG website.