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 (FICE).At this meeting, the staff presented three papers and will ask the IASB for tentative decisions related to the classification and presentation of issued financial instruments applying IAS 32 and IAS 1.

The first two papers related to sweep issues and the final paper related to presentation of equity instruments and is a follow up to the discussion in December 2022.

Classification and Presentation: Sweep issues (Part A) (Agenda Paper 5A)

This paper covered three sweep issues: fixed for fixed condition, shareholder discretion and reclassification.

Fixed-for-fixed condition

The staff recommended clarifying that the foundation principle is met if the entity knows how many functional currency units it is entitled to receive per type of own share if the option is exercised.

The foundation principle states that a derivative on own equity that meets the fixed-for-fixed condition should have a fair value on the settlement date (settlement value) that is: (i) only affected by fluctuations in the price of the underlying equity instruments (exposed to equity price risk); and (ii) not affected by fluctuations in other variables that the holder of the underlying equity instruments would not be exposed to (not exposed to other risks).

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

IASB discussion

One IASB member did not agree with the staff recommendation as the IASB member believed the convertible bond has exposure to equity risk and therefore has variable consideration.

Another IASB member analogised it to having two different instruments – firstly a convertible bond which would convert into 100 shares of the parent and the second being 100 shares of the parent in exchange for 200 shares of the subsidiary. Both would meet equity as they meet the fixed-for-fixed criteria. Therefore, putting them together should result in the same conclusion.

IASB decision

11 out of 12 IASB members voted in favour of the staff recommendations.

Shareholder discretion

In February 2022, the IASB discussed the classification of a financial instrument with a contractual obligation to deliver cash (or to settle it in such a way that it would be a financial liability) at the discretion of the issuer’s shareholders. The IASB explored a factors-based approach to help an entity in applying its judgement. The wording below reflects the staff’s thinking on how to articulate the factors.

Factors that an entity could consider when making that assessment include:

  • Whether a shareholder decision would be routine in nature, that is, in the normal course of the entity’s business activities in accordance with the entity’s established operating and corporate governance procedures
  • Whether a shareholder decision relates to an action that would be proposed by the entity’s management
  • Whether different classes of shareholders would benefit differently from a shareholder decision
  • Whether the exercise of a shareholder decision-making right would enable those shareholders to require redemption of (or payment of a return on) their shares in cash or another financial asset (or other settlement in such a way that it would be a financial liability)

The factors set out are examples of factors that an entity could consider when assessing whether a shareholder decision is treated as a decision of the entity. Other factors may be pertinent to that assessment. The weightings applied to each factor when making that assessment depends on the specific facts and circumstances.

The staff believe that the risk of manipulation of the assessment by entities would be mitigated by IAS 1:122 which requires entities to disclose judgements that management has made. In addition, in a future meeting, the staff will consider whether any additional disclosures should be included in IFRS 7 regarding judgements made.

The staff think it will be important to clarify the objective of the proposed amendment in the Basis for Conclusions in the forthcoming exposure draft (ED), and why the factors are optional:

  • The objective is to help entities apply their own judgement in making that assessment based on the contractual terms and conditions, facts and circumstances
  • The factors are optional so that they do not limit or constrain in any way an entity’s judgements in making its assessment. The assessment requires significant judgement to be applied on a case-by-case basis. There is not one factor that works in all situations, some are relevant in some cases but not in others or there may be additional relevant factors. For that reason, the factors are not intended to be an exhaustive list but rather represent common factors that would often be relevant

The staff asked the IASB if they have any comments or questions on the proposed factors to consider.

IASB discussion

One IASB member did not agree with the staff recommendation. He noted that as part of the FICE project, understanding how legal obligations impact classification has not been discussed and without detailed discussions, he believes that the IASB is raising issues without resolving them. He noted that his preference would be to do nothing in this area, as he believes these changes might cause more problems than they resolve. The Chair was also sceptical as to whether these factors would change current practice. However, he did not object to including them in the ED. He noted that IFRS Accounting Standards are applied by partnerships and cooperations which have blurred legal structures and may therefore struggle to apply this.

Other IASB members noted that this is a frequently asked question and providing guidance would assist preparers. However, they were of the view that these items ‘should’ be considered rather than ‘could’ be considered.  

Another IASB member thought it might be helpful to add the consequence of each factor and add examples to make the factors and the consequence of the factors clearer.

The IASB was not asked to make any decisions.

Reclassification

It was noted that in practice the term reclassification is used synonymously with derecognition. In June 2022, it was concluded that reclassification:

  • Refers to a change in the classification of an existing financial instrument when there has been no derecognition
  • Would not involve the recognition of a new financial instrument
  • May be a way to reflect that the nature of the obligation has substantially changed when the requirements for derecognition and recognition are not met. Reclassification may therefore be appropriate when a financial instrument continues to exist but there has been a change in the substance of its contractual terms without a modification to the contract

The staff noted that ‘reclassification’ is also mentioned in IAS 32:23 which discusses the accounting on initial recognition and expiry (derecognition) of a contract containing an obligation for an entity to purchase its own equity instruments for cash or another financial asset. It requires:

  • A financial liability to be recognised initially at the present value of the redemption amount, reclassified from equity
  • Reclassification of the financial liability to equity if the contract expires without delivery

Staff recommendation

To avoid the term ‘reclassification’ being used inconsistently in IAS 32 with the existing requirements for reclassification of puttable instruments and obligations arising on liquidation and the proposed amendments on reclassification, the staff recommended replacing ‘reclassified’ with ‘transferred’ and ‘reclassification’ with ‘transfer’ in IAS 32:23.

The staff recommended reclassification at the date of the change in circumstances. However, the staff recommend asking a question in the forthcoming ED to see if there are any practical considerations which would affect an entity’s ability to determine the date of a change in circumstances or to reclassify at that date.

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

IASB discussion

One IASB member noted that ‘transfer’ has been used elsewhere in the standards and is associated with a different meaning. An alternative would be to use words in IFRS 9 ‘remove and include’ rather than ‘transfer’. IASB members noted that the staff should ensure this is the only place it needs to be amended.

In relation to the date of reclassification, an IASB member suggested including a backstop, i.e if an entity was not able to work out the date of change in circumstance, then the year end could be used. The staff noted that in a previous meeting, the IASB was not in alignment with that suggestion however will ask in the ED whether there are any practical considerations and will revisit based on feedback received.

IASB decision

12 out of 12 voted in favour of replacing ‘reclassified’ with ‘remove and include’ and for the staff recommendation that the reclassification is at the date of change in circumstance.

Classification and Presentation: Sweep issues (Part B) (Agenda Paper 5B)

This paper covered sweep issues on ‘the effects of laws on the contractual terms’ and ‘obligations to redeem own equity instruments’. It also covered a sweep issue on presentation.

The effects of laws on the contractual terms

In December 2021, the IASB tentatively decided to propose amendments to IAS 32 to require an entity to classify financial instruments as financial liabilities or equity by considering:

  • Terms explicitly stated in the contract that give rise to rights and obligations that are in addition to, or more specific than, those established by applicable law; and
  • Applicable laws that prevent the enforceability of a contractual right or a contractual obligation

In July 2022, members of the Accounting Standards Advisory Forum (ASAF) disagreed with the tentative decision. The main concerns highlighted by ASAF members were that they thought there was inconsistency with current accounting principles, the framework is complex and may create unintended outcomes. They also questioned whether there is a difference between a contractual term and a legal term. Based on the feedback the staff think it is important to simplify the amendments.

The staff recommended simplifying the proposed principles, by only requiring that financial instruments are classified as financial liabilities or equity by considering enforceable contractual terms that give rise to rights and obligations that are in addition to, or more specific than, those established by applicable law.

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

IASB discussion

IASB members noted that this could result in two instruments that are economically the same, having the same terms, with the only difference being that one has cash flows determined by law whereas the other is determined by contractual terms having different classifications. However, they noted that a workable solution is required and feedback from the ED would be useful as part of the decision-making process.

IASB decision

All IASB members voted in favour of the staff recommendation.

Obligations to redeem own equity instruments

The staff received feedback that IAS 32:23 is not explicitly clear on where the remeasurement gains or losses on these financial liabilities are recognised, i.e. in equity or in profit or loss.

The staff recommended that IAS 32:23 explicitly requires remeasurement gains or losses on the financial liability to be recognised in profit or loss to avoid any lack of clarity and to reduce diversity in practice.

The staff also noted measurement of the financial liability recognised when applying IAS 32:23 was not addressed in previous meetings. IAS 32:23 requires the financial liability to be recognised at the ‘present value of the redemption amount’ and refers to IFRS 9 for the subsequent measurement of the financial liability and therefore questions have been raised on both initial measurement and subsequent measurement. The staff believe that these questions are beyond the scope of the current project. However, they recommended clarifying that the same measurement approach would apply initially and subsequently (i.e. the probability and estimated timing of the holder exercising the written put option is not considered in its initial and subsequent measurement.) In addition, they recommended removing the reference to IFRS 9 for subsequent measurement, as all financial instruments are in scope of IFRS 9.

The staff also noted that similar questions arise for initial and subsequent measurement of some financial instruments in the scope of IAS 32:25 (i.e. instruments containing contingent settlement provisions where the contingency is associated with the liability component).

The staff recommended clarifying that the same measurement approach would apply initially and subsequently (i.e. the probability and estimated timing of the contingent event occurring is not considered in the initial and subsequent measurement of the financial liability or liability component).

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

IASB discussion

One IASB member disagreed in a previous meeting with the changes made to IAS 32:23 and therefore disagrees with the same changes being made to IAS 32:25.

IASB decision

11 out of 12 IASB members voted in favour of the staff recommendations.

Presentation sweep issue

IAS 32:41 states that gains and losses related to changes in the carrying amount of a financial liability are recognised as income or expense in profit or loss even when they relate to an instrument that includes a right to the residual interest in the assets of the entity in exchange for cash or another financial asset. Under IAS 1 the entity presents any gain or loss arising from remeasurement of such an instrument separately in the statement of comprehensive income when it is relevant in explaining the entity’s performance. This is referring to IAS 1:85 which states that an entity shall present additional line items (including by disaggregating the line items listed in paragraph 82), headings and subtotals in the statement(s) presenting profit or loss and other comprehensive income when such presentation is relevant to an understanding of the entity’s financial performance.

The staff recommended deleting the second sentence of IAS 32:41 to avoid any perceived duplication of requirements and instead add a cross-reference to IAS 1:85. However, the staff note that the requirement in IAS 1:85 would still apply, regardless of whether presentation or the reference IAS 1:85 is explicitly mentioned in this paragraph.

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

IASB discussion

One IASB member agreed with the proposal to delete the second sentence but did not agree with adding a cross-reference to IAS 1:85. IAS 1 is overarching and adding cross references to IAS 1 is inconsistent with other standards. The IASB voting was therefore amended in line with this suggestion.

IASB decision

All IASB members voted in favour of the staff recommendations to remove the second sentence.

9 out of 12 IASB members voted in favour of not including a cross reference to IAS 1.

Presentation of equity instruments (Agenda Paper 5C)

The purpose of this paper was to ask the IASB for tentative decisions on proposed clarifications related to the presentation of equity instruments in the scope of IAS 32. Users of financial statements require information to be accessible and less confusing, a clearer distinction of the distribution of profits amongst holders of different types of equity instruments so that they can understand the effect other classes of equity instruments have on the returns to ordinary shareholders and transparency as to whether an entity has issued other instruments classified as equity without having to go through multiple notes to the financial statements to try and piece together the information needed to calculate ratios and information to understand the key features that lead to the classification as equity or financial liability so that they can perform their own analyses and valuations.

The staff noted that the existing requirements in IAS 1 could be applied to meet the information needs of users of financial statements, however the staff believe that the existing requirements in IAS 1 should be amended so that amounts attributable to ordinary shareholders are more visible on the statement of financial position, the statement of comprehensive income and the statement of changes in equity.

The staff recommended that the IASB propose amendments that would require:

  • Line items in the statement of financial position that present issued capital and reserves attributable to ordinary shareholders of the parent separately from issued capital and reserves attributable to other owners of the parent (paragraph 54r of IAS 1)
  • The components of equity for the purposes of the statement of changes in equity to include each class of ordinary share capital separately from each class of other contributed equity (paragraph 108 of IAS 1)
  • Profit or loss and comprehensive income for the period attributable to ordinary shareholders of the parent to be presented separately from the respective amounts attributable to other owners of the parent (paragraph 81B of IAS 1)
  • Presentation in the statement of changes in equity or disclosure in the notes of the amount of dividends to ordinary shareholders separately from dividends to other owners during the period, and the related amount of dividends per share (paragraph 107 of IAS 1).

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

IASB discussion

The IASB asked the staff whether this is within the scope of the FICE project or the Primary Financial Statements project. The staff confirmed that it would be part of the FICE project. IASB members were keen to include this topic in the ED, to receive feedback and to understand from preparers whether these additional disclosures would cause practical and operational challenges.

IASB members believed that clear justification for these recommendations should be included within the Basis for Conclusions (BC), explaining the benefit of these disclosures to investors. One IASB member requested that additional clarity should be provided on how these items should be disclosed.

One IASB member was sceptical that entities would have the relevant information in order to disclose the information required by these recommendations.

IASB decision

11 out of 12 IASB members voted in favour of the staff recommendations.

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.