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Financial instruments with characteristics of equity

Date recorded:

In this session, the IASB discussed the challenges with accounting for derivatives on ‘own equity’ and how IAS 32 addresses those challenges. The agenda paper introduces the topic by examining why the topic is relevant. It then continues with a definition and types of derivatives on own equity. As a next step, the paper considers the relevant requirements of IAS 32, especially the fixed-for-fixed condition and the redemption obligation requirements. It concludes with a proposal of potential ways forward.

In prior sessions, the staff had identified relevant features that influence whether a non-derivative claim meets the definition of a financial liability or of equity. Those features include:

  1. timing of required transfer of economic resources;
  2. amount of economic resources required to settle a claim;
  3. type of resource required to be transferred; and
  4. priority of the claim on liquidation.

In this session, the Board focused on the timing and the amount. The IASB was not asked to make any decisions at this point, however the staff wanted to highlight the consequences of the approaches they are developing, the conceptual challenges of the fixed-for-fixed condition and application challenges.

One example in the agenda paper is a forward contract for the receipt of a fixed amount of cash in exchange for the delivery of a fixed number of ordinary shares. The staff had analysed that the instrument consists of a receivable for cash that would meet the definition of a financial asset and an obligation to deliver a fixed number of equity instruments that would meet the definition of equity. For instruments where the asset ‘leg’ does not meet the fixed-for-fixed condition, the entire instrument is a financial liability. This means that changes in the equity ‘leg’ would be recognised as income and expense.

To overcome this challenge, the staff proposed to either componentise derivatives in finer detail or to require all derivatives on ‘own equity’ to be classified as financial assets or financial liabilities, including those that actually meet the fixed-for-fixed condition. However, the IASB should first consider the challenges for some other types of derivatives before deciding whether the staff should develop an alternative to the fixed-for-fixed condition.

IASB discussion

This was an education session for the Board and the papers did not ask for any Board decisions.

As suggested by the agenda paper, the Board spent most of the time discussing the fixed-for-fixed condition. In general, many Board members acknowledged the simplifying nature of the condition and warned that an alternative approach might add complexity. Some Board members suggested refining the fixed-for-fixed condition rather than developing a new approach. Several Board members expressed a desire to include instruments that are denominated in a foreign currency in the condition.

Componentising would be very difficult for instruments where the asset leg and the equity leg were interdependent (e.g., share options). A componentising approach would therefore have to be considered very thoroughly. One Board member proposed using componentisation only under very special circumstances whilst another Board member would only use componentising for presenting performance.

One Board member asked to reconsider the basic ownership approach. However, this approach was rejected by several Board members as remeasurement was the main criticism raised by constituents and under the basic ownership approach everything would be remeasured.

One Board member struggled to apply the approaches developed by staff to fixed-for-fixed instruments. The Board member said that whilst the approaches worked well with obligations they would not work with instruments with both, rights and obligations. This was especially true when the entity issued the instrument and therefore had a right to receive cash.

Two Board members stressed that the project should aim at expanding sections of equity in the balance sheet and in the statement of changes in equity (i.e., thinking about having categories of equity). A fellow Board member suggested focusing on the diluting effect of derivatives and to introduce disclosures to that effect.

The Board did not discuss the redemption obligation requirements in IAS 32.

Correction list for hyphenation

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