Financial instruments with characteristics of equity

Date recorded:

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.


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.


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 authorised 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.

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