IAS 32 — Financial Instruments: Presentation
IAS 32 Financial Instruments: Presentation outlines the accounting requirements for the presentation of financial instruments, particularly as to the classification of such instruments into financial assets, financial liabilities and equity instruments. The standard also provide guidance on the classification of related interest, dividends and gains/losses, and when financial assets and financial liabilities can be offset.
IAS 32 was reissued in December 2003 and applies to annual periods beginning on or after 1 January 2005.
History of IAS 32
|September 1991||Exposure Draft E40 Financial Instruments|
|January 1994||E40 was modified and re-exposed as Exposure Draft E48 Financial Instruments|
|June 1995||The disclosure and presentation portion of E48 was adopted as IAS 32 Financial Instruments: Disclosure and Presentation|
|1 January 1996||Effective date of IAS 32 (1995)|
|December 1998||IAS 32 was revised by IAS 39, effective 1 January 2001|
|17 December 2003||Revised version of IAS 32 issued by the IASB|
|1 January 2005||Effective date of IAS 32 (2003)|
|18 August 2005||Disclosure provisions of IAS 32 are replaced by IFRS 7 Financial Instruments: Disclosures effective 1 January 2007. Title of IAS 32 changed to Financial Instruments: Presentation|
|22 June 2006||Exposure Draft of proposed amendments relating to Puttable Instruments and Obligations Arising on Liquidation|
|14 February 2008||IAS 32 amended for Puttable Instruments and Obligations Arising on Liquidation|
|1 January 2009||Effective date of amendments for puttable instruments and obligations arising on liquidation|
|6 August 2009||Exposure Draft Classification of Rights Issues proposing to amend IAS 32|
|8 October 2009||Amendment to IAS 32 about Classification of Rights Issues|
|1 February 2010||Effective date of the October 2009 amendment|
|16 December 2011||Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32) issued|
|17 May 2012||Amendments resulting from Annual Improvements 2009-2011 Cycle (tax effect of equity distributions). Click for More Information|
|1 January 2013||Effective date of May 2012 amendments (Annual Improvements 2009-2011 Cycle)|
|1 January 2014||Effective date of December 2011 amendments|
- IAS 32 (2003) superseded SIC-5 Classification of Financial Instruments – Contingent Settlement Provisions
- IAS 32 (2003) superseded SIC-16 Share Capital – Reacquired Own Equity Instruments (Treasury Shares)
- IAS 32 (2003) superseded SIC-17 Equity – Costs of an Equity Transaction
- IFRIC 2 Members' Shares in Co-operative Entities and Similar Instruments
Amendments under consideration by the IASB
Summary of IAS 32
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.
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 [IAS 32.11]
Financial instrument: a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
Financial asset: any asset that is:
- an equity instrument of another entity
- a contractual right
- to receive cash or another financial asset from another entity; or
- to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
- a contract that will or may be settled in the entity's own equity instruments and is:
- a 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.
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]
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]
Financial instruments disclosures are in IFRS 7 Financial Instruments: Disclosures, and no longer in IAS 32.