Financial instruments with characteristics of equity (FICE)

Date recorded:

Reclassification—proposed clarification (part 1) (Agenda paper 5A)

In June 2018, the IASB published Discussion Paper DP/2018/1 Financial Instruments with Characteristics of Equity. At this meeting, the staff asked the IASB for tentative decisions on proposed clarifications related to the reclassification of financial instruments between financial liabilities and equity instruments applying IAS 32.

IAS 32 has no general requirements on reclassification between financial liabilities and equity instruments. Diversity in practice exists when there are changes in the substance of the contractual terms without a modification to the contract such that reassessment would result in a different classification outcome from that initially assessed.

The staff believe there is sufficient guidance in the current standards regarding modification of the contractual terms and believe the IASB should focus on considering changes in the substance of the contractual terms without a modification to the contract, which is the area to which most practice questions relate.

Two types of such changes were identified:

  • Changes in circumstances, e.g. from a change in functional currency or the parent entity losing control over a subsidiary
  • Changes due to an existing contractual term becoming or ceasing to be effective with the passage of time, e.g. expiry of an option embedded in the contract or variable settlement terms becoming fixed after a specified date

The staff concluded that reclassification:

  • Refers to a change in the classification of an existing financial instrument when there has been no derecognition
  • Would not involve the recognition of a new financial instrument
  • May be a way to reflect that the nature of the obligation has substantially changed when the requirements for derecognition and recognition are not met. Reclassification may therefore be appropriate when a financial instrument continues to exist but there has been a change in the substance of its contractual terms without a modification to the contract

The arguments in favour of reclassification are:

  • Faithful representation of the financial instruments and the substance of the contractual arrangement at the reporting date
  • Reflects how the instrument would be classified if it was newly issued so entities that issued financial instruments with similar features as the reclassified financial instrument would provide comparable information to users of financial statements

The arguments against reclassification are:

  • Increased costs and complexity for preparers of financial statements
  • May not provide users of financial statements with useful information if reclassification requirements are not applied consistently, result in frequent reclassifications or create possible structuring opportunities to achieve a particular classification outcome

Reclassification—proposed clarification (part 2) (Agenda Paper 5B)

The staff recommended adding general requirements on reclassification to IAS 32 to prohibit reclassification other than for changes in the substance of contractual terms arising from changes in circumstances outside the contract. This does not affect reclassifications that are already required in IAS 32, for example specific reclassification requirements on puttable instruments and obligations arising on liquidation.

The staff recommended accounting for a reclassification at the beginning of the first reporting period after the change in the substance of the contractual terms without a modification to the contract.

The staff recommended that:

  • On reclassification from equity to financial liability—a financial liability is measured at fair value at the date of reclassification and any difference between the carrying amount of the equity instrument and the fair value of the financial liability would be recognised in equity
  • On reclassification of a financial liability to equity—an equity instrument is measured at the carrying value of the financial liability at the date of reclassification and no gain or loss is recognised

The staff recommended additional disclosure requirements for reclassifications when changes in the substance of the contractual terms arise from changes in circumstances outside the contract. This would help users of financial statements to better understand the change in classification and the impact on measurement, if any.

The IASB were asked if they agree with the staff’s recommendations.

IASB discussion

The papers were discussed together. In the papers, the staff discussed the three different approaches within the staff analysis. The IASB discussed the approaches in detail in the March 2022 meeting and agreed that Approach A, which is consistent with the current IAS 32 and prohibits any reclassification other than those specifically required, should not be considered further. The IASB reconfirmed its view at this meeting.

Approach B would require reclassification for all changes in the substance of contractual terms without a modification to the contract and Approach C would prohibit reclassification other than for changes in circumstances.

Some IASB members confirmed that conceptually they preferred Approach B. However, they understood that it would be more of a fundamental change to IAS 32. As the scope of the project is to clarify and strengthen IAS 32 and not to fundamentally change it, Approach B would not be consistent with the project objective. 

The staff confirmed that Approach B would be a substantial change to IAS 32 with potentially significant knock-on effects on IFRS 9. Approach C would likely also have knock-on effects on IFRS 9, but the staff believed these would be less significant. The staff also noted that many instruments that are currently classified as a liability would be structured in such a way that they would get equity classification on initial recognition. The staff also noted that Approach C focuses and addresses the urgent and pressing issues that have been raised.

All IASB members voted in support of continuing with Approach C.

The other major discussion point related to the accounting for a reclassification at the beginning of the first reporting period after the change. For example, if a change took place within a period, it would not be reflected until the next financial period. IASB members in general did not agree with this. The staff noted however that this was consistent with IFRS 9. IASB members replied that this project does not need to be consistent with IFRS 9 but should be consistent with the current requirements in IAS 32.

8 out of 10 IASB members voted in favour of recording the change in the period in which it occurred and not at the beginning of the first reporting period after the change.

There was a follow-on discussion relating to how the requirements would apply if the reclassification took place at a specific date (i.e. the date of a change of control). It was questioned whether the accounting treatment for the reclassification should then be from this date. The IASB decided to leave this point with the staff to consider further.

All IASB members voted in favour of the staff recommendation on accounting for the reclassification.

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