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Financial instruments with characteristics of equity

Date recorded:

Financial Instruments with Characteristics of Equity research project — Agenda paper 5

The purpose of this session was to continue discussions on the Financial Instruments with Characteristics of Equity (FICE) project. The staff presented the following agenda papers:

  • Summary of discussions to date — Agenda paper 5A
  • Contractual terms — Agenda paper 5B
  • Accounting within equity — Agenda paper 5C

The Board was asked to comment on the staff analysis and their recommendations.

Financial Instruments with Characteristics of Equity research project- Summary of discussions to date — Agenda paper 5A


The research phase of this project involved evaluating potential ways to improve the classification of liabilities and equity, and the related presentation and disclosure requirements. 

The Board had explored the features to distinguish liabilities and equity: (i) the type of economic resources required to settle the claim; (ii) the timing of the transfer; (iii) the amount required to be transferred; and (iv) the priority of the claim relative to other claims. 

The Board had been developing an approach (labelled Gamma, see discussion in February 2016), which distinguished claims based on a combination of these features and would lead to outcomes broadly aligned with IAS 32. In December 2016, the Board discussed how the Gamma approach would apply to classifying derivatives whose classification under IAS 32 had been challenging in practice, focusing on whether derivatives with certain features would meet the ‘dependent solely on the residual amount’ criterion.

Appendix A summarised three approaches and Appendix B summarised classification outcomes for some simple instruments under the proposed approaches.

Financial Instruments with Characteristics of Equity research project Contractual terms — Agenda paper 5B


This paper explored whether rights and obligations arising from non-contractual terms (e.g. those arising from law) should be taken into account when classifying a financial instrument as equity or liability under the Gamma approach. The Staff analysed two instruments, the rights and obligations of which were created or affected by law: 1) mandatory tender offers (MTO) imposed by law and 2) bonds that were contingently convertible to ordinary shares as a result of regulatory requirements. The Staff looked at whether limiting the liability/equity classification assessment to contractual terms only would result in consistent accounting for items with similar economic consequences.

Staff analysis


MTOs were similar to written put options on NCIs (NCI puts), as both instruments gave the NCIs the right to decide whether or not to sell their shares to the entity. For the NCI puts, IAS 32 required an entity to recognise a gross liability at the present value of the amount payable upon exercise of the option. In contrast, for the MTO, if the entity’s obligation under the law to offer repurchase of the NCIs was not considered in classifying the claim, no gross liability would be recognised (as it would be outside the scope of IAS 32 due to its being a legal obligation, and outside the scope of IAS 37 because the MTO was executory in nature. Furthermore, IAS 37 was not designed to address the classification of equity and liabilities). Accordingly, this would lead to instruments with similar economic consequences being accounted for differently.

Contingently convertible bonds

If the legal conversion option was not taken into account, the convertible bond would be classified as a liability in its entirety (assuming no other contractual equity features). The Staff believed that not considering the legal requirements would be consistent with IFRS 9’s requirements on the asset-side classification. This was because IFRS 9 contained an example illustrating that the effect of regulation should not be considered when assessing whether the instrument’s cash flows met the SPPI condition.

The Staff emphasised throughout the paper that the financial instrument accounting requirements contained in IFRS literature were premised on contractual rights and obligations (except for IFRIC 2 which related to a narrow-scope fact pattern). In view of the inconsistency noted above in relation to MTOs, the Staff considered, but decided against, the alternative of considering rights and obligations that arose from law as equivalent to contractual terms. This was because this would require a fundamental change to financial instruments accounting (including recognition, reclassification and derecognition), which was beyond the original intention of the FICE project of addressing the distinction between liabilities and equity in IAS 32. .

Staff recommendation

The Staff recommended that:

  • the Gamma approach be applied only to the contractual terms of a financial instrument;
  • the Board not reconsider IFRIC 2 given that the Staff was not aware of any challenges with its application; and
  • the Board consider how to address the accounting for MTOs based on feedback to be received on the forthcoming discussion paper, including potential disclosure requirements.


The Board supported the Staff’s recommendations.

Most of the Board members agreed that it was more a practical solution than there being a conceptual justification for limiting the equity/liability assessment to the contractual terms of a financial instrument. This was because there were many different laws and regulations and conflicts might even exist between them given that they were written in different contexts and served different purposes. Furthermore, laws and regulations change overtime, and requiring entities to track these changes and reassess the classification of an instrument would be unduly burdensome (Brexit being a case in point as many UK contracts were drafted under the ambit of EU laws). Nevertheless, some Board members cautioned that not fully integrating all laws and regulations in the equity/liability assessment did not mean that they should be ignored entirely. Entities should consider whether the contractual terms are genuine in view of current laws and regulations (e.g. are there any current laws or regulations that would invalidate the settlement alternatives provided in a contract?). The Board also suggested distinguishing between the contractual considerations required under the Gamma approach and that under the Insurance Standard, lest entities analogise inappropriately to the latter which requires a consideration of the laws and regulations as part of the contractual assessment.

Despite the above, a few Board members believed that laws and regulations should be considered in the equity/liability classification assessment; however, they did not elaborate on how to overcome the practical problems noted above. One Board member observed that there were instances when entities did not include a term into a contract because those rights and obligations were well governed by the legal and/or regulatory framework within which the entity operated. Focusing only on the contractual terms could exclude an assessment of these implied rights and obligations, which, the Board member argued, would have been include in the contract had the laws and regulations not been in place.

Financial Instruments with Characteristics of Equity research project — Accounting within equity — Agenda paper 5C


This paper contained examples illustrating the accounting under the Gamma approach for equity components that arise from (1) convertible bonds and (2) written put options, using journal entries and the statement of changes in equity. The examples also illustrated the proposed approach of attributing profit or loss (P/L) and other comprehensive income (OCI) to derivative equity instruments.


The Board suggested that the Staff include further analysis on the following topics in the upcoming discussion paper (DP):

  • A fuller analysis of how NCI puts would be accounted for under the Gamma approach, including examples illustrating how P/L and OCI would be allocated between 1) equity attributable to the parent and 2) NCI.
  • An analysis of how EPS would be affected by the proposed attribution of P/L and OCI to derivative equity instruments, as well as by the proposed separate presentation in OCI of gains and losses on derivatives on own equity instruments that were classified as liabilities under the Gamma approach.

The Staff expects to ask the Board for permission to ballot the DP in the March Board meeting.

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