Financial instruments with characteristics of equity

Date recorded:


The IASB is currently investigating potential improvements:

  • to the classification of liabilities and equity in IAS 32 Financial Instruments: Presentation, including investigating potential amendments to the definitions of liabilities and equity in the Conceptual Framework; and
  • to the presentation and disclosure requirements for financial instruments with characteristics of equity, irrespective of whether they are classified as liabilities or equity.

The IASB has identified a number of financial reporting problems related to the classification of financial instruments as liabilities or equity. To address these challenges, the IASB needs to:

  • identify, confirm (or correct) and reinforce the underlying rationale of the distinction between liabilities and equity in IAS 32;
  • identify relevant features of claims that need to be communicated by means other than the distinction between liabilities and equity; and
  • improve the consistency, completeness and clarity of the requirements.

Thus far, the IASB has:

  • explored the features of claims that are used in IAS 32 to distinguish between liabilities and equity that are relevant to users and assessed why those features are relevant;
  • identified three approaches (Alpha, Beta and Gamma) based on those features that are candidates for reinforcing the underlying rationale of IAS 32 and improving the requirements; and
  • discussed additional challenges that arise when accounting for derivatives on ‘own equity’.

In this meeting, the following issues will be discussed:

  • subclasses of liabilities, including presenting income and expense arising from particular types of liabilities;
  • attribution of profit or loss and other comprehensive income to subclasses of equity; and
  • claims with conditional alternative settlement outcomes.

Subclasses of liabilities including presenting income and expense arising from particular types of liabilities

In previous meetings, the IASB has acknowledged that a single distinction between equity and liabilities cannot convey all of the similarities and differences between claims. Hence, the IASB decided that improvements to presentation and disclosures should be explored, in addition to improvements to the distinction between liabilities and equity.

The agenda paper considers whether the IASB should use subclasses of financial liabilities. These would provide additional information that will be useful to:

  • assess financial performance (by presenting separately income and expense arising from particular subclasses of liabilities); and
  • assess financial position (through the presentation of different subclasses on the balance sheet, or within different subtotals within total liabilities).

In order to speed up the process, the staff intends to focus on developing approach Gamma. This approach focuses on the distinction between liabilities and equity on both

  • the timing of required settlement, which is relevant to assessing the extent to which the entity is expected to have the economic resources required when it is required to transfer them; and
  • the amount of economic resources required to settle the claim, which is relevant to assessing the extent to which the entity has:
    • sufficient economic resources to satisfy the total claims against it if they were all to be settled at a point in time; and
    • produced sufficient return on its economic resources to satisfy the promised return on claims against it.

The classification outcomes under Approach Gamma are closest to the existing outcomes from applying IAS 32.

The staff concludes that under Approach Gamma:

  1. it will be useful to present income and expense arising from liabilities for a specified amount that is not independent of the entity (i.e., those liabilities that do not promise a return independent of the entity) in other comprehensive income (OCI);
  2. it will be useful to present liabilities for a specified amount that is not independent of the entity on the statement of financial position (within total liabilities); and
  3. one class of instrument that the presentation requirements in (a) and (b) will be useful for is a share redeemable at fair value.

Attribution of profit or loss and other comprehensive income to sub-classes of equity

The objective of the agenda paper is to explore how subclasses within equity might help in providing additional information about features the IASB identified as being relevant. The staff intends to reduce the gap between the information provided for items classified as equity and those classified as liabilities.

The preliminary views of the staff are:

  • the attribution of profit or loss and other comprehensive income should be expanded to classes of equity other than ordinary shares of the parent;
  • the carrying amount of each subclass of equity should also be updated to reflect the attribution; and
  • subclasses of equity should include:
    • ordinary shares; and
    • senior classes of equity.

Claims with conditional alternative settlement outcomes

The purpose of the agenda paper is to discuss claims with alternative liability or equity settlement outcomes that are:

  • conditional on rights within the control of the entity; or
  • contingent on the occurrence or non-occurrence of uncertain future events beyond the control of both the entity and holder of the claim.

 For approach Gamma, the requirements for indirect obligations and contingent settlement alternatives should be:

  • updated to reflect the features used to identify a liability under approach Gamma. Under approach Gamma a liability settlement outcome would include either:
    • an obligation to transfer economic resources other than at liquidation; or
    • an obligation for a specified amount independent of the entity’s economic resources; and
  • aligned with the ‘no commercial substance’ requirements in the Conceptual Framework ED.

The Board is not being asked to make any technical decisions at this meeting, but to give the staff an indication of their preferred direction on these matters.

Board Discussion

Subclasses of liabilities including presenting income and expense arising from particular types of liabilities

One Board member disagreed with developing Approach Gamma. He said that while Approach Alpha was useful for liquidity and Approach Beta was useful for solvency and leverage, Approach Gamma lost the benefit of both by combining them. The Board member would prefer a binary distinction between debt and equity and not a subset of liabilities. Another Board member disagreed and said that there were many instruments between equity and liabilities and this should be reflected.

One Board member liked the current measurement for puttable instruments, even though the changes in measurement would be recognised in OCI. To her, OCI would have to enhance the development of the P&L. Own credit, for example, belonged in OCI as it was a temporary change in measurement until maturity, when the liability would be pulled to par again. This would not be the case with puttable instruments that were likely to be exercised. Another Board member considered bifurcating the instrument into an equity (i.e., the share) and a liability component (i.e., the put option). The Chairman said that the fair value measurement for puttable instruments would be counterintuitive as the liability from the instrument would rise with increasing success of the business (which resulted in higher share prices). The Research Director asked whether payments from the instrument could be contributions or distributions. The Technical Manager negated that by saying it was clearly a liability and therefore income and expense.

One Board member welcomed that the analysis was performed holistically which had not been the case in previous attempts in this project.  He said that the ability of instruments to absorb losses should be taken into account when classifying them. He expressed concerns that many investors only looked at net income instead of also including OCI in the analysis which were gains and losses as well. He said that the binary distinction between net income and OCI caused issues. Consequently, in his view, the debt/equity issue could not be resolved before resolving the performance presentation issue. The P&L (including EPS) should be restructured to provide better information. The Chairman replied that even if a good structure was found for the P&L, there would still be resistance from constituents.

The Technical Director summarised that the Board agreed with two classes of returns although there was no consensus as to whether both classes would be recognised in P&L or one class each in P&L and OCI. He asked the Board whether they wanted staff to explore both approaches. The Board confirmed this as the next step would be a discussion paper which usually explored more than one view.

As regards the subclasses in the statement of financial position, the Board agreed that subclasses would give relevant information and that disclosures about financing would largely increase the usefulness of financial statements. One Board member suggested that this part of the project be accelerated and that the Board could go straight to an exposure draft on disclosure. The Vice Chairman replied that the state of the discussions were not developed enough for an exposure draft.

Attribution of profit or loss and other comprehensive income to sub-classes of equity

There was broad support amongst Board members for the preliminary views developed by the staff. One Board member expressed support for the idea in the Conceptual Framework discussion paper to provide additional information about the allocation of returns for the subclasses of equity.

The Board members expressed different views as to whether the information should be given in the primary financial statements or in the notes. One Board member asked the Technical Manager how he would define attribution. The Technical Manager replied that attribution meant an amount being allocated to non-share equity ahead of ordinary shares. He conceded that derivatives would pose a challenge.

The Technical Manager asked if the Board wanted to reflect attribution also in EPS. The Board discussed EPS, in particular how the calculated diluted EPS could be different from the actual diluted EPS. However, it was concluded that addressing EPS issues would be challenging in this project.

Claims with conditional alternative settlement outcomes

The Board began the discussion by considering the substance of features. One Board member asked whether the analysis of features would strictly be confined to the contract itself or whether other facts and circumstances should be considered, for example, restrictions imposed by a regulator on how many shares can be redeemed. If a feature was substantive, it should be assessed what the probability of exercising the instrument was. Also, economic compulsion would have to be considered in that regard.

The Board continued discussing instruments where dividend payments were suspended until liquidation and the resulting relationship between measurement and going concern.


The staff summarised that they had been asked to develop concepts further, and that these went beyond IAS 32. The staff would also develop some examples on how certain instruments were affected by the concepts.

No technical decisions were made.

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