Financial instruments with characteristics of equity (FICE)
Reclassification — Introduction (Agenda Paper 5)
In June 2018, the IASB published Discussion Paper DP/2018/1 Financial Instruments with Characteristics of Equity. At this meeting, the IASB explored potential amendments to IAS 32 in relation to the reclassification between financial liability and equity instruments. The IASB was not asked to make any decisions.
IAS 32 has no general requirements on reclassification between financial liabilities and equity instruments. It is common for entities to modify the contractual terms of an instrument after initial recognition or change the substance of the contractual terms without a modification to the contract. It is unclear whether IAS 32 requires an entity to reassess the classification of a financial instrument after initial recognition.
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.
Some common examples of when the substance of the contractual terms changes without a modification to the contract are:
- Changes as a result of the passage of time
- Changes in an entity’s functional currency
- Changes to the entity’s ownership structure
- Settlement of linked instruments affecting the payments to be made on another instrument.
To address the issue, there are two views the IASB could consider; either require reclassification or prohibit reclassification unless IAS 32 specifically requires it. The staff do not recommend allowing an accounting policy choice. The staff expect prohibiting reclassification will result in a bigger change in practice than requiring reclassification.
The staff analysed both approaches in the paper and suggest:
- If the IASB decides to prohibit reclassification for changes in the substance of the contractual terms without a modification to the contract, it could consider requiring entities to still disclose information about the effects of such changes on the nature of the obligation
- If the IASB decides to require reclassification for changes in the substance of the contractual terms with a modification to the contract, further consideration would be needed in relation to the timing, measurement and disclosure of the reclassification
The staff asked the IASB members if they have any comments or questions.
IASB discussion
IASB members agreed that this was an area where there was a gap in the Standard and that it should be addressed with a principle-based solution. They also agreed with the staff that it should not be an accounting policy choice as this would lead to diversity in practice.
The majority of the IASB members agreed that there is sufficient guidance in the current standards regarding modification of the contractual terms. However, one IASB member disagreed that the current Standard was sufficient as it does not cover when there is a modification to equity. The staff commented that on the post-implementation review (PIR) of the IFRS 9 classification and measurement requirements, this was not raised as an issue.
IASB members were in agreement that the second approach would provide more useful information and reflect the economic substance. It would also cause less disruption as it appears to be closer to where practice is today.
The IASB discussed how frequently reclassification should be assessed and IASB members agreed with the staff that further analysis would be required. Some were cautious to have this classification reassessed at each reporting period and suggested that it should be assessed when the change occurred.
IASB members agreed that any amendments to the Standard should be explicit on whether remeasurement is required on reclassification and where any P&L gain or loss would be presented.
No decisions were made.