Financial Instruments with Characteristics of Equity (FICE)

Date recorded:

Cover Note (Agenda Paper 5)

In June 2018, the IASB published Discussion Paper DP/2018/1 Financial Instruments with Characteristics of Equity. At this meeting, the IASB continued to discuss proposed amendments to IAS 32 in response to the feedback received on the DP.

The staff presented two agenda papers to the IASB, one providing a project update to the IASB and the other asking the IASB for a tentative decision on potential clarifications related to the classification of financial instruments applying IAS 32.

Project Update (Agenda Paper 5A)

The objectives of this project are to address known practice issues that arise when applying IAS 32 to classify financial instruments as financial liabilities or equity and to improve the information provided in the financial statements about the financial instruments issued by the entity.

In determining which classification issues to address, the IASB considered whether the issues have a widespread and material effect, financial reporting would be improved through a change and the issues can be resolved efficiently and effectively without fundamentally rewriting IAS 32 and other IFRS Accounting standards.

The staff provided the IASB with a table of progress against the project plan. Items that will be discussed in 2022 are: Reclassification between financial liabilities and equity instruments, obligations to redeem own equity instruments (e.g. put options on non-controlling interest), overall consistency check and other related matters (e.g. transition) and presentation (including presentation for obligations that arise only on liquidation).

The staff also included, as an appendix, a summary of the IASB’s tentative decisions to date.

Shareholders’ discretion (Agenda Paper 5B)

This paper asks the IASB to make tentative decisions on proposed clarifications related to the classification of financial instruments applying IAS 32 when payment is at the discretion of the issuer’s shareholders. More specifically, it discusses financial instruments that include a contractual obligation to deliver cash (or to settle an instrument in such a way that it would be a financial liability) when such settlement is at the discretion of the issuer’s shareholders. These shareholders may or may not be party to the financial instrument.

The staff recommend that the IASB include, as application guidance in IAS 32, factors that may be relevant for an entity to consider in assessing whether a decision of shareholders is within the control of the entity in classifying financial instruments as financial liabilities or equity. The staff recommend that these factors are provided as examples of potentially relevant factors to consider and not as an exhaustive list.

An entity would be required to consider factors that are relevant to the particular financial instrument and the specific facts and circumstances. The relevant factors may include but are not limited to:

  • Type of decision—whether the decision would be routine in nature and made as part of the entity’s operating and corporate governance process
  • Who would initiate the decision?—whether the decision would be initiated by management of the entity and subject to shareholders’ approval rather than a decision that would be initiated by shareholders
  • Would different shareholders benefit differently from the decision?—whether different classes of shareholders would benefit differently from the decision made or whether shareholders are also the holders of the instruments being assessed

Different weightings would be applied to the factors because some factors may be more or less relevant to the assessment depending on the particular facts and circumstances and the terms and conditions of the specific financial instrument. Different factors may provide more persuasive evidence in different circumstances. Where a financial instrument contains more than one obligation that gives the shareholders the rights to require payment of cash or settlement in a way that it would be a financial liability, an entity would perform the analysis for each obligation but consider whether any interdependencies affect the entity's overall right to avoid such settlement.

The staff asked if the IASB agree with their recommendations.

IASB discussion

The papers were discussed together.

Initially, there was discussion among the IASB whether it would be helpful to include an overall principle along with the factors provided by the staff. This would enable preparers to understand what they are being asked to assess and the factors then provide tools on how to make the assessment. It should be made clear that factors should be considered together and are interrelated.

IASB members commented that this was a judgemental area and would be different for each set of facts and circumstances, for each entity and will be dependent on the laws and regulations of that particular jurisdiction. This should be made clear in the ED.

One IASB member suggested that it was inappropriate to suggest there would be any circumstance that the shareholders will act in a certain way and took the view that if payment is at the discretion of the issuer’s shareholder then it would be a liability. However, if the company believed the shareholder would act in a certain way, this could be explained in a narrative disclosure.

The IASB discussed this, noting that shareholders are individuals and could act unpredictably. They also noted that a change as significant as this could change practice and the ramifications would be significant. Items such as dividends would be classified as liabilities rather than equity. This would go against the project objectives which were to resolve issues without fundamentally rewriting IAS 32. An IASB member noted that this is not an area where historically there has been abusive or misleading practice and therefore did not feel a need to fundamentally change IAS 32 in this area.

IASB members contemplated doing nothing. However, the staff noted that based on their discussions and outreach, this is a real issue in practice. The staff would prefer to offer a suggestion in the ED and if that is not supported through the comment letters, then take the approach of doing nothing. This will also enable the IASB to understand the impact of any clarifications/changes in this area.

The staff asked the IASB to vote on the staff recommendations in the paper, with a note, for some additional wording changes.

IASB decision

7 of the 12 IASB members voted in favour of the staff’s recommendation.

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