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IAS 32 Financial Instruments: Classification of Instruments Denominated in a Foreign Currency

Go To List of IFRIC Issues The issue before the IFRIC concerns the classification of a convertible bond denominated in a foreign currency (ie a currency other than the functional currency of the entity issuing the bond). Such a bond allows the holder to convert the bond into a fixed number of the entity's equity instruments in exchange for a fixed amount of foreign currency. For example an entity whose functional currency is the Euro issues a US dollar-denominated convertible bond that can be converted into a fixed number of the entity's equity instruments (ie it contains an option to exchange a fixed number of the entity's shares for a fixed amount of US dollars). Discussion at IFRIC's April 2005 Meeting The IFRIC addressed the classification of the written option in a convertible bond denominated in a foreign currency. Such bonds allow the holders to convert the bond into a fixed number of the entity's equity instruments in exchange for a fixed amount of foreign currency. The IFRIC agreed that the result of applying IAS 32 to this fact pattern would be to classify the entire instrument as a liability. Discussion at IFRIC's June 2005 Meeting At the June meeting of IFRIC, the IFRIC considered draft amendments to IAS 32 that it could recommend to the Board to enable the appropriate classification of the equity element of the instrument. Some IFRIC members believed this classification is possible under existing IAS 32. However, a clear majority believed this was not possible and that the standard should be amended to require such classification. The IFRIC members debated the draft wording and requested some amendments. The proposed amendment will be put to the IASB at its June meeting. The IFRIC were advised that IASB members are cognisant of the need for timely resolution of this issue. The IFRIC members also agreed that it was not appropriate for wording to be published in the IFRIC Update explaining the IFRIC's reasons for not taking this onto the agenda – this topic is clearly on the agenda, albeit that the expected outcome is an amendment to a standard rather than an IFRIC interpretation. The IFRIC noted that as a result of its publication in the April 2005 IFRIC Update of their view that IAS 32 currently requires classification as a liability, companies in certain jurisdictions applying IFRS had, for their March quarterly reporting, reclassified these instruments as liabilities in compliance with that view. The chairman reminded the public that non-authoritative publications such as the IFRIC Update and the IASB Update should not be read in the same way as final standards and interpretations. The Update publications reflect the progress of an issue through the due process and should not be read or interpreted as being the final views of either the IASB or the IFRIC. Discussion at the June 2005 IASB Meeting IAS 32 Financial Instruments: Disclosure and Presentation establishes principles for classifying financial instruments. IAS 32.22 states that a contract that will be settled by the entity by delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash or another financial asset is an equity instrument. On the other hand, IAS 32.24 states that a contract that will be settled by the entity delivering or receiving a fixed number of its own equity instruments in exchange for a variable amount of cash or another financial asset is a financial asset or financial liability. The issue discussed by the Board concerns the classification of the written option in a convertible bond denominated in a foreign currency (that is, a currency other than the functional currency of the entity issuing the bond). Such a bond allows the holder to convert the bond into a fixed number of the entity's equity instruments in exchange for a fixed amount of foreign currency. Although the issue has been raised in the context of a convertible bond it applies equally to freestanding instruments i.e. to all contracts entered into by an entity to exchange a fixed number of own shares for a fixed amount of cash that is denominated in a foreign currency. Such contracts can be simple forward agreements or options on own equity. Consequently, the implications of the issue go beyond just convertible bonds. The majority of Board members were sympathetic to the fact that convertible bonds that are 'genuinely' issued in a foreign currency because investors operate in that foreign currency should be allowed the equity treatment. The Board was however, concerned about providing an exception as this would have to be restricted sufficiently in order to avoid structuring opportunities. Board members also indicated that the question of whether equity has a currency (that is, as equity is a residual item, is it subject to normal functional currency considerations) should be answered but that this would be addressed in the Liability / Equity project. The Board agreed to explore an amendment to IAS 32 but wanted to understand better the potential structuring opportunities that could arise before proceeding. The Board indicated that should it decide to allow equity classification that it should be made clear that the foreign currency exposure could not be hedged under IAS 39 as there is no profit or loss impact on the equity item. Discussion at IFRIC's November 2006 Meeting Project removed from IFRIC's agenda.