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Amendment to IAS 32: Classification of financial instruments puttable at fair value

Date recorded:

At its June meeting, the Board had a preliminary discussion on the classification as liabilities or equity of financial instruments puttable at a pro rata share of the fair value of the residual interest in the issuer ('financial instruments puttable at fair value'). The Board noted that the application of IAS 32 to financial instruments puttable at fair value gives rise to anomalous accounting because, assuming that the fair value of the entity is higher than the entity's net asset value, the balance sheet will always show net liabilities, and those net liabilities will increase the better the entity performs.

The Board agreed to explore whether it should propose an amendment to IAS 32 in the short term through one of the following possible approaches:

(a) An exception so that instruments puttable at fair value are classified as equity;

(b) Continuing to classify such instruments as liabilities but amending their measurement so that changes in their fair value would not be recognised;

(c) Considering whether all puttable instruments (and not only those puttable at fair value) should be separated into a put option and a host instrument.

(d) Do nothing (staff recommendation).

Concerns were raised regarding amendments to IAS 32 at this stage, but if an amendment were to be made, the Board leaned toward approach (a).

Approach (a)

If the Board decides to use approach (a), the staff proposed the following drafting:

A financial instrument that will or may require the entity to redeem it and that otherwise evidences a residual interest in the assets of an entity after deducting all of its liabilities shall be classified as a liability unless all of the following criteria are met:

  • there is no other instrument classified as equity.
  • the instrument is the most subordinated class of all instruments issued by the issuer and has no preferential rights relative to other instruments of the issuer.
  • the redemption price is a pro-rata share of the fair value (or, in the absence of an otherwise determinable fair value, a formula that all the shareholders agree represents a reasonably close approximation of fair value) of the residual interest in the assets of the issuer at the redemption date.
  • the redemption event is the same for all of the instruments.
  • holders of the instrument participate in the issuer's net assets and distributions of profit on a prorate basis."

More detailed guidance would be provided in the Application Guidance. It was also suggested that an additional restriction be added making it clear that this exception would only be available to non-public entities.

Approach (b)

If the Board decides to use approach (b), the staff recommends that the Board:

  • introduce a fifth category of financial instruments in the definitions (eg 'financial liabilities that evidence a residual interest in the entity'. Such a category would be defined along the lines of the exception proposed in approach (a);
  • amend paragraph 47 of IAS 39 to specify that financial liabilities in this fifth category are measured at the amount initially recognised and not re-measured, as follows: "After initial recognition, an entity shall measure all financial liabilities at amortised cost using the effective interest method, except for: … (c) financial liabilities that evidence a residual interest in the entity, which shall be not be re-measured subsequent to initial recognition."

Staff were asked to continue work on approach (a) by considering as many examples as possible that would then be discussed at the September meeting, so the Board can aqssess the extent of the impact of such an amendment.

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