Financial instruments with characteristics of equity

Date recorded:

Financial Instruments with Characteristics of Equity research project - Agenda paper 5

The purpose of this session is to continue discussions on the Financial Instruments with Characteristics of Equity (FICE) project. The staff will present the following agenda papers:

  • (a) Summary of discussions to date - Agenda paper 5A
  • (b) Contractual terms – Agenda paper 5B
  • (c) Accounting within equity – Agenda paper 5C

The Board will be asked to comment on the staff analysis and their recommendations.

Financial Instruments with Characteristics of Equity research project- Summary of discussions to date- Agenda paper 5A


The research phase of this project involves evaluating potential ways to improve the classification of liabilities and equity, and the related presentation and disclosure requirements.

The Board has explored the features to distinguish liabilities and equity: (i) the type of economic resources required to settle the claim; (ii) the timing of the transfer; (iii) the amount required to be transferred; and (iv) the priority of the claim relative to other claims.

The Board has been developing an approach (labelled Gamma, see discussion in February 2016), which distinguishes claims based on a combination of these features and would lead to outcomes broadly aligned with IAS 32. In December 2016, the Board discussed how the Gamma approach would apply to classifying derivatives whose classification under IAS 32 has been challenging in practice, focusing on whether derivatives with certain features would meet the ‘dependent solely on the residual amount’ criterion.

Appendix A summarises three approaches and Appendix B summarises classification outcomes for some simple instruments under the proposed approaches.

Financial Instruments with Characteristics of Equity research project – Contractual terms - Agenda paper 5B


This paper explores whether rights and obligations arising from non-contractual terms (e.g. those arising from law) should be taken into account when classifying a financial instrument as equity or liability under the Gamma approach. The Staff analysed two instruments, the rights and obligations of which are created or affected by law: 1) mandatory tender offers (MTO) imposed by law and 2) bonds that are contingently convertible to ordinary shares as a result of regulatory requirements. The Staff looked at whether limiting the liability/equity classification assessment to contractual terms only would result in consistent accounting for items with similar economic consequences.

Staff analysis


MTOs are similar to written put options on NCIs (NCI puts), as both instruments give the NCIs the right to decide whether or not to sell their shares to the entity. For the NCI puts, IAS 32 requires an entity to recognise a gross liability at the present value of the amount payable upon exercise of the option. In contrast, for the MTO, if the entity’s obligation under the law to offer repurchase of the NCIs is not considered in classifying the claim, no gross liability would be recognised (as it would be outside the scope of IAS 32 due to its being a legal obligation, and outside the scope of IAS 37 because the MTO is executory in nature. Furthermore, IAS 37 is not designed to address the classification of equity and liabilities). Accordingly, this would lead to instruments with similar economic consequences being accounted for differently.

Contingently convertible bonds

If the legal conversion option is not taken into account, the convertible bond would be classified as a liability in its entirety (assuming no other contractual equity features). The Staff believes that not considering the legal requirements would be consistent with IFRS 9’s requirements on the asset-side classification. This is because IFRS 9 contains an example illustrating that the effect of regulation should not be considered when assessing whether the instrument’s cash flows meet the SPPI condition.

The Staff emphasises throughout the paper that the financial instrument accounting requirements contained in IFRS literature are premised on contractual rights and obligations (except for IFRIC 2 which relates to a narrow-scope fact pattern). In view of the inconsistency noted above in relation to MTOs, the Staff considered, but decided against, the alternative of considering rights and obligations that arise from law as equivalent to contractual terms. This is because this would require a fundamental change to financial instruments accounting (including recognition, reclassification and derecognition), which is beyond the original intention of the FICE project of addressing the distinction between liabilities and equity in IAS 32. 

Staff recommendation

The Staff recommends that:

  • (a) the Gamma approach be applied only to the contractual terms of a financial instrument;
  • (b) the Board not reconsider IFRIC 2 given that the Staff is not aware of any challenges with its application; and
  • (c) the Board consider how to address the accounting for MTOs based on feedback to be received on the forthcoming discussion paper, including potential disclosure requirements.

Financial Instruments with Characteristics of Equity research project – Accounting within equity - Agenda paper 5C


This paper contains examples illustrating the accounting under the Gamma approach for equity components that arise from (1) convertible bonds and (2) written put options, using journal entries and the statement of changes in equity. The examples also illustrate the proposed approach of attributing profit or loss and other comprehensive income to derivative equity instruments.

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