Cover note (Agenda Paper 5)

In June 2018, the IASB published Discussion Paper DP/2018/1 Financial Instruments with Characteristics of Equity (FICE). At this meeting, the staff presented three papers and asked the IASB for tentative decisions related to proposed amendments to IFRS 7 in relation to an entity’s issued equity instruments and additional disclosures related to the classification and presentation topics in the FICE project plan. The staff also asked the IASB for a tentative decision on the proposed transition requirements.

IASB discussion

A new IASB member, who had not been involved in the previous IASB discussions on FICE, wanted to state that the most important elements of the project are the disclosure of ordinary shares versus other types of shares, the definition of the waterfall and the definition of maximum dilution.

Project update (Agenda Paper 5A)

This paper provided an update on the FICE project based on the project plan the IASB discussed in October 2019. The project objective was to address known practice issues that arise when applying IAS 32 to classify financial instruments as financial liabilities or equity and improve the information provided in the financial statements about the financial instruments issued by the entity. A summary of the project and decisions made to date have been provided in the Appendix to the agenda paper. In this meeting, the staff presented their analysis and asked the IASB to make tentative decisions on the remaining topics. The next step will be to ask the IASB for its permission to begin the balloting process of an Exposure Draft (ED) with the aim to publish the ED towards the end of 2023.

No discussion was held on this paper.

Scope of IFRS 7 and additional disclosures (Agenda Paper 5B)

Scope of IFRS 7

The staff noted that IFRS 7 does not have specific disclosure requirements relating to an entity’s issued equity instruments or equity components of compound instruments. Therefore, the staff recommended adding an overall disclosure objective for issued equity instruments to the objective section of IFRS 7 to provide users of financial statements with useful information about an entity’s issued equity instruments so that they can understand how the entity is financed and its current and potential ownership structure. In addition, the staff recommended deleting the last part of the sentence in IFRS 7:3(a) from “unless the derivative meets the definition of an equity instrument in IAS 32”.

Terms and conditions

In April 2021, the IASB noted that, for financial instruments with characteristics of both debt and equity, users of financial statements want to better understand:

• The nature, amount, timing and uncertainty of cash flows arising from these types of issued financial instruments
• Cash flow characteristics not captured through classification as equity or financial liabilities but that are relevant to understand the nature of the financial instruments
• The reason for classification as financial liabilities or equity instruments, or compound instruments

To meet these objectives, the IASB decided in April 2021 that an entity would be required to disclose ‘debt-like features’ of financial instruments that are classified as equity, ‘equity-like features’ of financial instruments that are classified as financial liabilities and debt-like and equity-like features that determine the classification of such financial instruments as financial liabilities, equity instruments or compound financial instruments. However subsequently the staff have received feedback that it would be key for the IASB to define ‘debt-like’ features or ‘equity-like’ features or provide additional guidance. The staff therefore recommended including explanations and examples of debt-like and equity-like features in the Application Guidance and Illustrative Examples sections of the forthcoming ED. The staff also recommended clarifying that the disclosures of debt-like and equity-like features would include both quantitative and qualitative information, so that users can understand the impact of these features on the nature, amount, timing and uncertainty of the entity’s cash flows. For compound financial instruments, the staff recommended disclosing the amounts allocated initially to the financial liability and equity components.

The staff considered there may be a need for other terms and conditions disclosures as follows.

Significant judgements made on classification

IAS 32:15 requires the issuer of a financial instrument to classify the instrument as a financial liability or as equity in accordance with the substance of the contractual arrangement and the definitions of a financial liability and an equity instrument. As this may require significant judgement, the staff recommended including an explicit requirement in IFRS 7 for entities to disclose any significant judgments made in determining the classification of the financial instrument as a financial liability or as equity.

Passage-of-time changes

In June 2022, the IASB tentatively agreed that reclassifications between financial liabilities or equity instruments are generally prohibited other than for changes in the substance of the contractual terms arising from changes in circumstances outside the contract. Accordingly, reclassification is prohibited for passage-of-time changes. The staff recommended disclosing terms and conditions that become effective or cease to be effective with the passage of time before the end of the contractual term of the instrument to provide users with a better understanding of the nature, amount, timing and uncertainty of cash flows and other features.

Reclassifications

In June 2022, the IASB tentatively agreed to add general requirements in IAS 32 to prohibit reclassifications other than for changes in the substance of the contractual terms arising from changes in circumstances outside the contract. This does not affect reclassifications already required in IAS 32, for example specific reclassification requirements on puttable instruments and obligations arising on liquidation. In order to help users understand the change in classification and its effect on measurement, the staff recommended relocating the disclosure requirement in IAS 1:80A to IFRS 7 and expand it to cover reclassifications when changes in the substance of the contractual terms arise from changes in circumstances outside the contract. Entities would be required to disclose the amounts reclassified into and out of financial liabilities or equity, and the timing and reason for that reclassification.

Obligations to redeem own equity instruments

For obligations to redeem own equity instruments, the staff recommended that IFRS 7 is amended to require entities to disclose:

• The component of equity in which the debit entry was initially recognised
• The amount of remeasurement gain or loss recognised in profit or loss during the reporting period
• If the obligation is settled during the reporting period, the amount of profit or loss, if any, that was recognised on settlement
• If the written put option has expired unexercised, the amount removed from financial liabilities and included in equity
• If any cumulative amount in retained earnings was transferred within equity, the cumulative amount and the component of equity it was transferred to

Financial liabilities containing contractual obligations to pay amounts based on an entity’s performance or changes in the entity’s net assets

IFRS 7 requires separate disclosure of the net gain/loss arising on financial liabilities designated at fair value through profit or loss from the net gain/loss financial liabilities mandatorily measured at fair value through profit or loss. The staff recommended a further disaggregation for both financial liabilities designated and mandatorily measured at fair value through profit or loss. In other words, an entity should disclose separately the amount of the total gains or losses included in the paragraph 20(a)(i) disclosures that arise from remeasuring financial liabilities containing contractual obligations to pay amounts based on the entity’s performance or changes in the entity’s net assets in each reporting period.

The staff asked the IASB whether they agree with their recommendations.

IASB discussion

Scope of IFRS 7

Overall, IASB members were supportive of the staff recommendation to add equity instruments to the overall disclosure objective. One IASB member suggested widening the scope to replace ‘entity’s issued equity instrument’ with ‘instruments classified as equity’ in order to capture puttable instruments. However, the staff noted that the new requirements include only very specific disclosure requirements for puttable instruments, and they are not in scope of the full IFRS 7 disclosures. The staff agreed that they will think about the best way to incorporate puttable instruments.

Terms and conditions

In relation to significant judgements, the IASB noted that there is an overall disclosure requirement for significant judgements in IAS 1 and therefore, if it is duplicated in IFRS 7, the requirement should refer back to IAS 1, to make it clear that this is an extension of that requirement. IASB members noted that it should be made clear why this requirement is being repeated within IFRS 7. The staff agreed and stated there are a few places in IFRS 7 where there is a disclosure requirement to explain the judgement made. Another IASB member suggested that instead of including this requirement multiple times in IFRS 7, an overall requirement around disclosure of judgements made could be added in IFRS 7 with examples of areas where the judgement is most likely required.

The paper noted that disclosures explaining economic compulsion and existence of indirect obligations would be useful and is covered in the proposed requirements to disclose debt-like and equity-like features. An IASB member challenged whether these disclosures really cover these important items. The staff noted that economic compulsion is not considered in the classification of the instrument under IAS 32, and they can only ask preparers to provide factual information such as the terms and conditions. IASB members agreed with the staff rationale and noted that they would like to see the draft wording. There will need to a be a balance between providing the relevant terms and conditions and overloading the financial statements.

Overall, IASB members agreed with the passage of time disclosure, noting that they preferred the wording used in the table i.e. ‘Require entities to disclose, if applicable, information about terms and conditions that become effective or cease to be effective with the passage-of-time before the end of the contractual term of the instrument’ to the alternative words used in the recommendation. The staff confirmed in the meeting that the intention was to use this wording and that this disclosure requirement was an ongoing requirement.

In relation to the obligation to redeem equity instruments disclosures, an IASB member asked if in addition to including the component of equity, the amount in each component could be included. The staff noted that this was their intention and will ensure the wording is updated to be clearer.

IASB decision

14 out of 14 voted in favour of the staff recommendation.

Transition (Agenda Paper 5C)

The purpose of this paper was to ask the IASB for tentative decisions related to transition when an entity applies the proposed amendments to IAS 32, IFRS 7 and IAS 1 as part of the FICE project.

The staff recommended the proposed amendments are required to be applied fully retrospectively with comparatives restated.

For entities already applying IFRS, the staff recommended that the IASB:

• Provide transition relief related to the proposed classification requirements. When it is impracticable (as defined in IAS 8) to apply the effective interest method retrospectively, the fair value at the beginning of the earliest comparative period presented would be treated as the amortised cost of the financial liability at that date. When the liability component of a compound financial instrument with a contingent settlement provision is no longer outstanding at the date of initial application, an entity is not required to separate the liability and equity components
• Require disclosure of the nature and amount of any changes in classification resulting from initial application
• Provide transition relief from the quantitative disclosures in IAS 8:28(f)
• Provide no transition relief from the requirements in IAS 34 for interim financial statements issued within the annual period in which an entity first applies the amendments

For first-time adopters, the staff recommended that the IASB provide transition relief related to the proposed classification requirements. Where it is impracticable (as defined in IAS 8) to determine the fair value of a financial liability prior to the date of transition, an entity would use the fair value at the date of transition.

The staff asked the IASB if they agree with their recommendations.

IASB discussion

IASB members agreed that no effective date should be given as yet, but a question should be asked in the ED to understand how long preparers will need for implementation.

One IASB member disagreed with providing specific relief for first time adopters, as reliefs are already provided in IFRS 1. There was some discussion amongst IASB members on this, but it was concluded that the staff will amend the wording to ensure any reliefs provided would be in addition to the reliefs in IFRS 1.

IASB members asked the staff to make it clearer what is meant by impracticable and potentially to add the wording from IAS 8 to be more specific. In addition, the IASB asked the staff to ensure it is clear that the examples given in the paper for where hindsight is used is not a closed list, but just examples.

IASB decision

14 out of 14 voted in favour of the staff recommendation.