This site uses cookies to provide you with a more responsive and personalised service. By using this site you agree to our use of cookies. Please read our cookie notice for more information on the cookies we use and how to delete or block them.
The full functionality of our site is not supported on your browser version, or you may have 'compatibility mode' selected. Please turn off compatibility mode, upgrade your browser to at least Internet Explorer 9, or try using another browser such as Google Chrome or Mozilla Firefox.

Financial instruments with characteristics of equity (FICE)

Date recorded:

Cover note (Agenda Paper 5)

The staff presented agenda papers 5A-5F to begin Board discussions on two practice issues:

  • Accounting for financial instruments that contain contingent settlement provisions
  • The effects of laws on contractual terms

At this meeting, the staff sought the Board’s view on the direction of the staff’s future work. Based on the Board’s feedback provided at this meeting, the staff will develop proposals for the clarified principles and bring back further analysis at a future Board meeting.

Contingent settlement provisions and related issues—introduction (Agenda Paper 5A)

The objective of this paper was to begin the Board’s discussion on accounting for financial instruments that contain contingent settlement provisions. In particular, the staff explored what clarifications could be made to the underlying principles in IAS 32.

The questions that have arisen in practice regarding the application of IAS 32:25 are:

  • The order of applying the requirements for contingent settlement provisions in paragraph 25 of IAS 32 and the requirements for compound instruments in paragraph 28 of IAS 32. This question affects whether a financial instrument with a contingent settlement provision is classified as a financial liability in its entirety or as a compound instrument comprised of a liability component and an equity component
  • Whether probability of the contingent event occurring should be factored into the classification of a financial instrument with contingent settlement provision
  • Whether and how probability of the contingent event occurring should affect the measurement of the financial instrument
  • How to account for discretionary interest or dividend payments if the entire proceeds are allocated to the liability component of a compound instrument, and whether there is an inconsistency between paragraphs 36 and AG37 of IAS 32
  • How to determine whether an event is within the entity’s control, for example, an event contingent on shareholders’ approval
  • How to interpret the meaning of ‘non-genuine’ in paragraph 25(a) of IAS 32
  • How to interpret the meaning of ‘liquidation’ in paragraph 25(b) of IAS 32 in the context of processes that are similar to liquidation

Other questions arising from practice issues involving contingent events are:

  • How an ‘all or nothing settlement contingency’ affects the classification of financial instruments
  • Whether there is an inconsistency between the contingent settlement provision requirements in paragraph 25 of IAS 32 and the indirect obligation requirements in paragraph 20(b) of IAS 32 where alternative settlement outcomes exist and the issuer has the choice of settlement

The staff analysed these practice questions in Agenda Papers 5B-5D to establish whether there are:

  • Inconsistencies in IAS 32 requirements that need to be addressed
  • Underlying principles and rationale that need to be clarified
  • Issues that merit further discussion by the Board

Contingent settlement provisions and related issues—practice issues and potential solutions (part 1) (Agenda paper 5B)

In this paper the staff analysed the following practice issues arising from accounting for contingent settlement provisions:

  • Order of applying requirements in IAS 32
  • Does the probability of a contingent event occurring affect classification?
  • Impact of probablility in measurement
  • Discretionary payments

The staff asked the Board for any initial views or questions of the staff’s analysis.

Board discussion

Board members made positive comments about the work performed by the staff.

One concern raised related to potentially amending the classification and measurement of the financial liability by considering the probablility of an uncertain event. Currently, IAS 32 is clear on the measurement and the accounting is fairly straightforward. This change could result in more complex accounting. If this route were to be taken, the measurement would need to be reassessed each period, depending on the probability of the uncertain event. The Board did not feel this was consistent with the objective to provide clarifications to IAS 32 as it was a more fundamental change.

The Board highlighted that there were two types of contingencies, those that affect the timing of payment, and the other that affects the determination of whether a payment is made. The Board asked the staff to think about these two contingencies seperately.

The clarification regarding the order to apply the current IAS 32 requirements may cause a change in the way preparers have been accounting for financial instruments. It may be necessary to consider introducing transition rules to order to help preparers.

The Board asked the staff to focus more on the concepts and principles. Once these prinicples are agreed, the staff can apply these to the examples.  

Contingent settlement provisions and related issues—practice issues and potential solutions (part 2) (Agenda paper 5C)

In this paper the staff analysed the following practice issues arising from accounting for contingent settlement provisions:

  • Assessing control
  • Meaning of ‘non-geniune’
  • Meaning of ‘liquidation’

The staff asked the Board for any initial views or questions of the staff’s analysis.

Board discussion

Board members asked the staff to ensure that changes are sufficiently narrow and to proceed with caution.

Assessing control: Board members were in agreement that nothing should be added in this area. It is difficult to assess how shareholders will act. They act as individuals for their own economic interest, which may coincide with acting as an owner of the entity. Therefore, Board members stated that limited clarifications should be made in this area. 

Meaning of ‘non geniune’: This is a judgement and refers to a limited set of circumstances. The only clarification Board members thought would be useful to add, is that ‘non-geniune’ does not refer only to the probability of the event occuring.

‘Meaning of liquidation’: Board members agreed that liquidation means to cease trading and if it is not clear that this should be clarified.

Contingent settlement provisions and related issues—practice issues and potential solutions (part 3) (Agenda paper 5D)

In this paper the staff analysed the following practice issues arising from accounting for contingent settlement provisions:

  • ‘All or nothing’ settlement contingencies
  • Issuer’s choice of settlement

The staff asked the Board for any initial views or questions of the staff’s analysis.

Board discussion

Board members suggested that no changes should be made in this area.

The effects of laws on contractual terms—practice issues and potential solutions (Agenda Paper 5E and 5F)

The purpose of these papers was to facilitate the Board’s initial discussion with respect to the effects of laws on contractual terms of a financial instrument.  The papers discussed whether and if so, to what extent an enity should be required to treat a legal requirement as part of the contractual terms of a financial instrument.

The question was analysed in two parts:

  • Whether a legal requirement is part of the contractual terms
  • Whether a legal requirement that is not in the contract, but is implied by law is part of the contractual terms

The staff believe that it is clear that the classification of financial instrument as financial liability or equity instruments is based solely on contractual terms. However based on feedback, the staff recognise it will be key to understand:

  • Whether there is scope to read the references in IAS 32 to ‘contractual rights and obligations’ as wider than just explicit contractual terms
  • What is meant by the underlying prinicple in IAS 32 to classifiy a financial instrument in accordance with the ‘substance of the contractual arrangement’

The staff conclude that the substance of the contractual arrangement requires the following:

  • There must be existing contractual rights and obligations
  • Terms that have economic or commercial substance

Based on this, the staff have prepared the following principles in order to help detemine whether legal requirements or terms that are required by law should be regarded as part of the contractual terms regardless of whether a term is explicitly stated in the contract, and should be considered in classifying a financial instrument as a financial liability or an equity instrument:

  • Guiding Prinicple A—Are the terms negotiable and agreed through a choice of contracting parties?
  • Guiding Principle B—Do laws limit, modify or prohibit an existing right and obligation in a contract?
  • Guiding Principle C—Are the terms sufficiently specific to allow reasonable determination of contractual rights and obligations?

The staff have also provided two alternative approaches:

  • Alternative Approach X—All inclusive approach, i.e. all terms explicit in the contract are part of the contractual terms and implied terms are also part of the contractual terms
  • Aternative Approach Y—Will a term apply to the contract even if the law changes in the future?

The staff would like to develop the Guiding Principles A, B & C further and present the staff recommendation at a future meeting. The staff did not recommend that the Board explore Alternative Approaches X and Y any further.  The staff recognise there will be a question about whether a future change in the relevant law subsequent to initial recognition could require a reclassification of the financial instrument between financial liabilities and equity and this will be discussed at a later stage.

The staff asked the Board if they have any comments or questions on the staff analysis, preliminary views and next steps discussed in Agenda Paper 5E and this paper. In particular, they asked if the Board agrees that the staff should further develop Guiding Principles A, B and C but not explore Approaches X and Y described in this paper.

Board discussion

Board members noted that any clarifications added in relation to this could have a knock-on impact across IAS 32 and in IFRS 9. Hence, the Board asked the staff to keep the scope narrow and proceed with caution. There was limited appetite to explore Approaches X and Y further.

The Board noted that the financial instruments standards focus on contractual terms which is different to other standards, but feedback from stakeholders showed that this should not change.

One Board member asked the staff to try not to introduce new terms such as ‘sufficiently specific’ and ‘reasonable detemination’ in Guiding Principle C. Another Board member suggested that these guiding principles are not added to the literature, as feedback is when such guiding prinicples are added, preparers have to assess all instruments against those principles.

The Board suggested that the staff reach out to those in the legal profession to understand their views.

The staff said that they will return with updated papers at a future Board meeting.

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.