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European paper on liability-equity distinction

  • EFRAG (European Financial Reporting Advisory Group) (dk green) Image

28 Jan 2008

EFRAG and several European accounting standard setters have jointly published a discussion paper 'Distinguishing between Liabilities and Equity' as part of EFRAG's Pro-active Accounting Activities in Europe (PAAinE) programme.

Comments on the paper are requested by 28 July 2008. The IASB has an Agenda Project on this topic, as does the US Financial Accounting Standards Board (FASB).
  • EFRAG's paper. The paper analyses the distinction between equity and liabilities under the existing IASB Framework and current IFRSs. The paper concludes that "the distinction principle used therein has apparent shortcomings. The shortcomings cannot be accommodated by merely 'fixing' bits and pieces or by amending definitions. Rather, a fundamental review of the principle itself is warranted." The paper concludes that participating or sharing in losses is "the decisive factor for distinguishing equity from debt". Therefore, any capital that is available to absorb the reporting entity's losses should be classified as equity. Click to download the Discussion Paper (PDF 1,023k).
  • FASB's paper. On 30 November 2007, the FASB published its Preliminary Views (PV) on Financial Instruments with Characteristics of Equity (see IASPlus News Story 5 Dec 2007). FASB favours the 'basic ownership' approach, which limits the instruments that can be classified as equity to the lowest residual interests in an entity. The holders of those instruments are viewed as the owners of the entity. All other instruments represent either liabilities or assets. An instrument that reduces the net assets available to the owners of the entity is a liability; and an instrument that enhances net assets available to the owners is an asset. Under this approach, forward contracts, options, and convertible debt would be classified as liabilities or assets. You can download the paper from FASB's Website (PDF 510k) without charge.
  • IASB's paper. At its December 2007 meeting, the IASB decided to issue a Discussion Paper on Financial Instruments with Characteristics of Equity. The IASB's DP is planned for March 2008. It would incorporate FASB's preliminary views document, possibly with additional material or questions, and invite public comments.

 

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