Is common stock an asset or liability
IAS 32 Financial instruments: identification
In IAS 32 Financial instruments: identification will describe the accounting rules for reporting financial instruments. In particular, it concerns the classification of such instruments as financial assets, financial liabilities or equity instruments. The standard also provides guidance on how to classify related party interests, dividends and profits / losses, and when financial assets and financial liabilities may be offset.
IAS 32 was reissued in December 2003 and is to be applied to reporting periods beginning on or after January 1, 2005.
History of the creation of IAS 32
Design E40 Financial instruments
E40 is changed and becomes the standard draft E48 Financial instruments republished
|June 1995||The "Disclosures and Presentation" area of E48 is known as IAS 32 Financial instruments: information and presentation accepted; work on approach and evaluation will continue|
|January 1, 1996||Date of entry into force of IAS 32 (1995)|
|December 1998||IAS 32 was revised by IAS 39; The date of entry into force is January 1, 2001|
|December 17, 2003||The revised version of IAS 32 is published by the IASB|
|January 1, 2005||Date of entry into force of IAS 32 (revised 2003)|
|August 18, 2005||The disclosure requirements in IAS 32 are replaced by IFRS 7 Financial instruments: disclosures, which is mandatory for fiscal years beginning on or after January 1, 2007; the title of IAS 32 was changed to "Financial Instruments: Presentation"|
|June 22, 2006||Draft proposed changes to puttable instruments and obligations arising on liquidation|
|February 14, 2008||IAS 32 amended with regard to puttable instruments and obligations arising in the event of liquidation.|
Special edition of the IAS Plus-Newsletters on the changes to IAS 32 and IAS 1 with regard to puttable financial instruments and obligations arising in the event of liquidation (in English, 100 KB).
|January 1, 2009||The effective date of changes to puttable instruments and obligations arising on liquidation|
|August 6, 2009||Draft standard ED / 2009/9 Classification of subscription rights released|
|December 16, 2011||Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32) released|
Focused on IFRS-Newsletter Changes to the offsetting rules for financial instruments (205 KB)
|May 17, 2012||Changes issued as part of the annual improvements 2009-2011 (income tax effect of distributions to the owner) - further information|
|January 1, 2013||Effective date of May 2012 changes (annual improvements 2009-2011)|
|1st of January 2014||Date of entry into force of the changes from December 2011|
Changes planned by the IASB
Summary of IAS 32
Objective of IAS 32
The objective set out in IAS 32 is to improve the understanding of the users of the financial statements for the influence of financial instruments on the asset, financial and earnings position of a company.
The IASB pursues this objective in IAS 32 in several ways:
- Clarification of the classification of financial instruments as equity or debt that have been issued by a company;
- Regulation of accounting for treasury shares (the shares repurchased by the company);
- Establishing strict conditions under which assets and liabilities may be netted on the balance sheet;
- Requirement of a large number of disclosures about financial instruments including information about their fair values;
IAS 32 is always together with IAS 39Financial instruments: approach and valuation or IFRS 9Financial instruments consider. IAS 39 and IFRS 9 deal with the initial valuation of financial assets and liabilities, as well as their subsequent valuation, impairment, derecognition and the mapping of hedging relationships ("hedge accounting"). IAS 39 was gradually replaced by IFRS 9 as the IASB worked through the various phases of its financial instruments project.
scope of application
IAS 32 regulates the presentation and disclosure of information about all types of financial instruments, with the following exceptions [IAS 32.4]:
- Investments in subsidiaries, associated companies and joint ventures that are listed in accordance with IAS 27 Consolidated financial statements, IAS 28 Shares in associated companies and joint ventures or IFRS 11 Joint agreements are accounted for. However, IAS 32 must be applied to all derivatives on investments in subsidiaries, associated companies or joint ventures.
- Employer's rights and obligations under defined benefit plans [see IAS 19Employee benefits]
- Rights and obligations from insurance contracts (these are defined in accordance with IFRS 4Insurance contracts accounted for). However, IAS 32 must be applied to financial instruments that take the form of (re) insurance contracts, but generally involve the transfer of financial risks. IAS 32 also applies to derivatives that are embedded in insurance contracts.
- Contracts for future consideration in a business combination [see IFRS 3Business combinations].
- Financial instruments, contracts and obligations from share-based payments (these are defined in accordance with IFRS 2Share-based payments accounted for). However, if these are transactions that were concluded using a non-financial position but can be settled in cash, by means of another financial instrument or by exchanging financial instruments, these must be accounted for in accordance with IAS 32. According to IAS 32, treasury shares for such remuneration must also be shown.
IAS 32 applies to contracts for the purchase or sale of non-financial items if this can be settled in cash, by another financial instrument or through the exchange of financial instruments, with the exception of contracts for the purpose of receiving or delivering a non-financial item for the company's anticipated procurement, sales, or consumption requirements have been received and will continue to be met [IAS 32.8].
Financial instrument: a contract that simultaneously results in a financial asset in one company and a financial liability or equity instrument in another company.
Financial asset: financial assets include:
- Means of payment;
- Another company's equity instruments;
- contractual rights
- receive liquid or other financial assets from another company; or
- to exchange financial assets or financial liabilities with another company on terms that are potentially beneficial to the company;
- Contracts that are or can be settled in the entity's own equity instruments that are any of the following
- a non-derivative financial instrument that contains or may contain a contractual obligation by the company to receive a variable number of the company's own equity instruments;
- a derivative financial instrument that is not or cannot be fulfilled by exchanging a fixed amount of cash or other financial assets for a fixed number of the company's own equity instruments (restrictions apply as to which instruments are to be regarded as a company's own equity instruments in this context [IAS 32.11]).
Financial liability: financial liabilities include:
- contractual obligations
- transfer liquid funds or other financial assets to another company; or
- swap financial assets or financial liabilities with another entity on terms that are potentially unfavorable; or
- Contracts that can or will be settled in the company's own equity instruments that are the following (mirroring the definition under financial assets):
- a non-derivative financial instrument by which the company is or may be required to deliver a variable number of the company's own equity instruments; or
- a derivative financial instrument that cannot be exchanged for a
A fixed amount of cash or other financial assets is or can be met against a fixed number of the company's own equity instruments (restrictions apply as to which instruments are to be regarded as a company's own equity instruments in this context [IAS 32.11]).
Equity instrument: a contract that creates a residual interest in a company's assets after deducting all debts.
Fair value: The amount at which an asset could be exchanged or a debt settled between knowledgeable, willing and independent business partners.
The definition of a financial instrument used in IAS 32 is the same as in IAS 39.
Classification as debt or equity
According to the principle of IAS 32, financial instruments are to be classified as either a financial liability or an equity instrument. The decisive factor here is the economic content of the contract, not its legal form ("substance over form"). The company must make a classification at the time of initial approach. The assignment may not be changed later due to changed conditions [IAS 32.15].
A financial instrument is only an equity instrument if (a) the instrument does not contain a contractual obligation to deliver cash or other financial assets to another company and (b) if the instrument can or will be settled in the issuer's own equity instruments, it either:
- is a cash instrument that does not contain any contractual obligation for the issuer to deliver a variable number of its own equity instruments; or
- a derivative that the issuer settles only by exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments [IAS 32.16].
Illustration - Preferred Stock
When a company issues preferred stock that provides a fixed dividend and that includes an obligation to buy back at a later date, the substance is the contractual obligation to deliver and should therefore be recognized as a liability. In contrast, ordinary preferred stocks have no fixed maturity and the issuer has no contractual obligation to make any payments. Therefore these represent equity [IAS 32.18].
Illustration - instruments with put option
A financial instrument grants the holder the right to return it to the issuer for cash or another financial asset (a “puttable instrument”). It is a financial liability even if the amount of the cash to be transferred or the other financial assets is determined on the basis of an index or another variable that is subject to fluctuations. It is also irrelevant whether the legal structure of the instrument with the right of cancellation gives the holder a residual claim on the assets of the issuer.
Illustration - Issuing a fixed amount of money in the form of equity instruments
A contractual right or obligation to receive or deliver a number of its own shares or other equity instruments that vary in number such that the fair value of the entity's own equity instruments it receives or delivers is the fixed amount of money comply with contractual law or the contractual obligation is a financial liability [IAS 32.20].
Illustration - A party has a choice as to how the instrument will be settled
If a derivative financial instrument gives a contracting party a right to choose the type of settlement (for example, if the issuer or holder can choose between net settlement in cash or by swapping shares for cash), it is a financial asset or a financial liability, unless all settlement alternatives would amount to an equity instrument. [IAS 32.26]
Puttable financial instruments and obligations arising in the event of liquidation
On February 14, 2008, the International Accounting Standards Board approved IAS 32 and IAS 1Presentation of the conclusion changed in the balance sheet with regard to the classification of puttable financial instruments and obligations that only arise in the event of liquidation. As a result of the changes, some financial instruments that currently meet the definition of a financial liability will be classified as equity because they represent the most subordinate claim on the company's net assets. The changes include detailed requirements, but are broadly due to the following:
- Puttable instruments that are in rank below all other classes of instruments and entitle the holder to a proportionate share of the net assets of the company in the event of its liquidation. A puttable financial instrument gives the holder the right to return the instrument for cash or other financial assets or will automatically revert to the issuer upon the occurrence of an uncertain future event, death or retirement of the holder of the instrument.
- Instruments, or parts of instruments, which are in rank behind all other instrument classes and which only impose the obligation on a company in the event of liquidation to transfer a proportionate share of the company's net assets to another company.
The changes are based on proposals that were published in a draft by the Board in June 2006. The changes come into effect for fiscal years beginning on or after January 1, 2009, with earlier application permitted. You can view the press release of the IASB here (in English, 49 KB).
You can get one here Special edition of the IAS Plus- Newsletters on the changes to IAS 32 and IAS 1 Download regarding puttable financial instruments and obligations arising in the event of liquidation (in English, 100 KB).
This newsletter contains the following examples, which are used to explain the types of instruments that will be affected by the new regulations:
Issued financial instrument
Classification according to the current version of IAS 32
Classification according to the amended version of IAS 32
Share that can be terminated at any time during the term at fair value, which at the same time represents the most subordinate form of capital, but provides for a fixed dividend payment at the company's discretion and otherwise does not contain any further obligations
Callable share at fair value that is not the most subordinate instrument
Shares that can only be terminated at fair value in the event of liquidation, which at the same time represent the most subordinate form of capital, but provide for a fixed, unconditional dividend payment
Hybrid capital (partly equity, partly debt)
Shares that can only be terminated at fair value in the event of liquidation, which at the same time represent the most subordinate form of capital, but provide for a fixed dividend payment at the company's discretion and otherwise contain no further obligations
Any of the instruments described above that are issued by a subsidiary and held by a non-controlling party in the consolidated financial statements
Hybrid financial instruments
Some financial instruments - sometimes called hybrid instruments - have both a debt and an equity component from the perspective of the issuer. In this case, IAS 32 requires that the components are accounted for and presented separately depending on their economic content on the basis of the definition of debt and equity.The allocation is to be made upon issue and not to be changed due to later changes in market interest rates, share prices or other events that change the probability of exercising the conversion option [IAS 32.29 et seq.].
To illustrate, a convertible has two components. One is a financial liability, namely the contractual obligation of the issuer to pay money, and the other is an equity instrument, namely the option of the holder to convert into common stock. Another example is a debt instrument with a separable warrant.
If the initial book value of a hybrid financial instrument has to be divided between its equity and debt components, the equity component must be assigned the residual value that results after deducting the separately determined fair value of the liability component from the fair value of the entire instrument [IAS 32.32].
Interest, dividends, profits and losses related to an instrument that has been classified as a liability should be recognized in profit or loss. This means that dividend payments on preferred shares that have been classified as a liability should be treated as an expense. On the other hand, distributions (e.g. dividends) to the holder of a financial instrument that is classified as equity are to be recognized directly in equity and are not recognized in profit or loss [IAS 32.35].
The costs for the repurchase of own equity instruments (own shares) are deducted from equity. A profit or loss on the purchase, sale, issue or withdrawal of own shares is not recorded. Own shares can be bought and held by the company or other group members. The consideration paid or received is offset directly against equity [IAS 32.33].
IAS 32 also contains rules for offsetting financial assets and financial liabilities. It stipulates that a financial asset and a financial liability must be offset against each other and presented as a net amount if and only if an entity [IAS 32.42]:
- has a legally enforceable right to set off those amounts; and
- it intends to settle on a net basis or realize the asset and settle the liability at the same time.
Cost of issuing or buying back equity instruments
The transaction costs of an equity transaction are to be accounted for as a deduction from equity, reduced by all associated income tax benefits [IAS 32.35].
Information on financial instruments is no longer in IAS 32, but in IFRS 7Financial instruments: disclosures regulated.
The information with regard to treasury shares can be found in IAS 1Presentation of the conclusion and IAS 24Information on relationships with related companies and persons for share buybacks from related companies and persons [IAS 32.34 and 39].
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