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IAS 32 — Classification of financial instruments that gives the issuer contractual right to choose the form of settlement

Date recorded:

The Committee received a request to clarify the accounting for three financial instruments that give the issuer the contractual right to choose the form of settlement, but do not have a specified maturity date. Specifically, the issuer can choose to deliver either cash or a fixed number of its own equity instruments.

The submitter asked whether all three of the described instruments would have the same accounting treatment:

  • Instrument 1 is puttable for cash by the holder but the issuer has a contractual right to choose instead to deliver a fixed number of its own ordinary shares instead of cash.
  • Instrument 2 is convertible by the holder into a fixed number of the issuer’s ordinary shares but the issuer has a contractual right to choose to pay cash instead of delivering its own shares.
  • Instrument 3 is puttable by the holder and, upon the holder’s exercise of that put, the issuer has the contractual right to choose to deliver either cash or a fixed number of its own ordinary shares.

Staff proposed to the Committee not to add the issue to the agenda on the basis that: ‘if the issuer has the contractual right to choose to settle a non-derivative financial instrument in cash or a fixed number of its own shares, that financial instrument would meet the definition of an equity instrument in IAS 32 Financial Instruments: Presentation as long as the value of the fixed number of the issuer’s shares did not exceed substantially the value of the cash’. In respect of the three described instruments, the Committee believed that ‘if the substance of particular financial instruments is the same, the issuer cannot achieve different classification results simply by describing those contractual arrangements differently’.

In the May 2013 meeting, a Committee member pointed out that when referring to the substance of the three instruments in the agenda decision, it should say ‘contractual substance’.

The Committee approved the agenda decision (as modified by the drafting comment) and decided an interpretation was not necessary and consequently tentatively decided not to add this issue to its agenda. Subsequently, staff received three comment letters on the Committee’s tentative agenda decision, which they analysed and presented to the Committee. Staff highlighted that a non-derivative financial instruments meets the definition on an equity instrument in its entirety if the issuer has a contractual right to choose the settle the instrument in cash or a fixed number of its own equity share irrespective of whether the amount of the cash to be delivered under the cash settlement alternative is fixed or variable. This is consistent with the Committee’s discussion in May 2013. At the May 2013 meeting, Committee members agreed that the three financial instruments described in the submission meet the definition of an equity instrument, irrespective of whether the amount of cash to be delivered under the cash settlement alternative was fixed or variable.

Staff noted that financial instruments, in particular those that are more structured or complex and that include liability components, require careful analysis to determine whether they contain equity or non-equity components that must be accounted for separately in accordance with IAS 32. Consequently, staff added an observation to the proposed agenda decision as presented in Appendix of the staff paper. Staff recommended the Committee should finalise its decision not to add this issue to its agenda formally and requested any comments on the proposed wording for the final agenda decision.

In the September 2013 meeting, a member said that Staff should deal with this particular issue by re-iterating the facts and demonstrate how the standard applies to this issue. This should be done in the first paragraph and leave in the rest of the proposed words.

Another member highlighted there is inconsistency in the guidance within IFRS 2 Share-based Payment and IAS 32. The conceptual framework seems to be inconsistent too as there is clearly a difference between debt and equity. The Committee agreed this would be dealt with in a separate project.

Another member requested clarification on some of the wording in particular in paragraph 2 of the agenda decision where staff referred to “same as” but it did not specify same as what.

The Committee agreed with Staff’s recommendation and had minor comments on the proposed wording for the final agenda decision as above.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.