IFRS PRACTICAL IMPLEMENTATION GUIDE AND WORKBOOK

Chapter

24 /

Financial In struments: Presentation (lAS 32 )

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3.1.2 This principle highl ights the need to consider not on ly the legal form of an instrument but

also the substance of the contractual arra ngement associated with the instrument when determining

whet her an instrument should be classified and presented as liabilities

equi ty. When substance

and legal form of an instrument are different, substance gove rns the cl assificat ion and present ation.

3.1.3 A cr itica l fea ture in differe ntiating a financial liabilit y from an equity instrument is the ex–

istence of a contrac tual obligation that meets the definition of a financial liability. If there is an ob–

ligation to deliver cash or another financial asset, the instrument usually meet s the defin ition of a

financi al liability, even though its form may be that of an equity instrument. It does not matter

whether the obligation is conditional on the counterparty exercising a right to requi re payment. An

obligation to deli ver cas h or another financial asse t usually is a financial liab ility even though the

obliga tion may be contingent upon the holder exercising a right to requ ire the deli very of cas h or

ano the r financial asset.

Example

Examp les offi nancial instruments that have the fo rm of equity instruments . but in substance meet

the defi nition of a finan cial liability and theref ore should be accounted fo r as finan cial liabilities.

are

• A pref erence share that provides for mandatory redemption by the issuer f or a fixed amount

at a fixed or determinable f uture date. This is a fi nancial liability of the issuer because the

issuer has

obligation to pay cash or anotherfinancial asset.

A pref erence share that gives the holder the right to require the issuer to redeem the instru–

ment at or af ter a particular date f or a fixed amount. This is a fi nancial liability of the issuer

because the issuer has an obligation to pay cash or anotherfinancial asset.

• A fi nancial instrument that gives the holder the right

put the instrum ent back

the issuer

fo r a fixed amount of cash or anotherfinancial asset. This is a fi nanc ial liability of the issuer

because the issuer has

W I

obligation to pay cash or another fi nancial asset.

Case Study 2

This case illustrates the application of the principle f or how to distinguish between liabilities and equity.

Facts

During 2004, Entity A has issued a number of financial instruments.

is evaluating how each of these

instruments should be presented under lAS 32:

(a) A perpetual bond (i.e., a bond that does not have a maturity date) that pays 5% interest each

year

(b) A mandator ily redeemable share with a fixed redemption amount (i.e., a share that will be

redeemed by the entity at a future date )

(d) A sold (written) call option that allow s the holder to purch ase a fixed number of ordinary shares

from Entity A for a fixed amount of cash

Required

For each of the above instruments, discuss whether it should be classified as a financial liability and, if

so, why.

Solution

(a) An issued perpetual bond (i.e., a bond that does not have a maturity date) that pays 5% interest

each year should be classified as a financial liability. Beca use the instrume nt contains an obli–

gation to pay interest, it meets the definition of a fina ncial liabilit y.

(b) An issued mandatorily redeemable share (i.e., a share that will be redeemed by the enti ty at a

future date) with a fixed redemption amount should be classified as a financia l liability.

Because the instrument contains an ob ligation to pay a fixed amount of cash or other financia l

asse ts on redempti on of the share, it meets the defini tion of a financi al liabi lity.

be classified as a financial liability. Because the entity cann ot avoid sett lemen t through delivery

of cash should the holder demand redemption, the share meets the defi nition of a financial

liability.