MANUEL L.

QUEZON UNIVERSITY
School of Accountancy and Business Arts

APPLIED AUDITING 2nd Sem. 2017 - 2018

IAS 32 — Financial Instruments: Presentation

Overview
IAS 32 Financial Instruments: Presentation outlines the accounting requirements for the presentation of
financial instruments, particularly as to the classification of such instruments into financial assets, financial
liabilities and equity instruments. The standard also provide guidance on the classification of related interest,
dividends and gains/losses, and when financial assets and financial liabilities can be offset.

IAS 32 was reissued in December 2003 and applies to annual periods beginning on or after 1 January 2005.

Summary of IAS 32

Objective of IAS 32
The stated objective of IAS 32 is to establish principles for presenting financial instruments as liabilities or
equity and for offsetting financial assets and liabilities. [IAS 32.1]

IAS 32 addresses this in a number of ways:

 clarifying the classification of a financial instrument issued by an entity as a liability or as equity
 prescribing the accounting for treasury shares (an entity's own repurchased shares)
 prescribing strict conditions under which assets and liabilities may be offset in the balance sheet

IAS 32 is a companion to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9Financial
Instruments. IAS 39 deals with, among other things, initial recognition of financial assets and liabilities, mea-
surement subsequent to initial recognition, impairment, derecognition, and hedge accounting. IAS 39 is progres-
sively being replaced by IFRS 9 as the IASB completes the various phases of its financial instruments project.

Scope
IAS 32 applies in presenting and disclosing information about all types of financial instruments with the
following exceptions: [IAS 32.4]
 interests in subsidiaries, associates and joint ventures that are accounted for under IAS 27 Consolidated
and Separate Financial Statements, IAS 28 Investments in Associates or IAS 31Interests in Joint
Ventures (or, for annual periods beginning on or after 1 January 2013, IFRS 10Consolidated Financial
Statements, IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint
Ventures). However, IAS 32 applies to all derivatives on interests in subsidiaries, associates, or joint
ventures.
 employers' rights and obligations under employee benefit plans (see IAS 19 Employee Benefits)
 insurance contracts(see IFRS 4 Insurance Contracts). However, IAS 32 applies to derivatives that are
embedded in insurance contracts if they are required to be accounted separately by IAS 39
 financial instruments that are within the scope of IFRS 4 because they contain a discretionary participa-
tion feature are only exempt from applying paragraphs 15-32 and AG25-35 (analyzing debt and equity
components) but are subject to all other IAS 32 requirements
 contracts and obligations under share-based payment transactions (see IFRS 2 Share-based Payment)
with the following exceptions:
o this standard applies to contracts within the scope of IAS 32.8-10 (see below)
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o paragraphs 33-34 apply when accounting for treasury shares purchased, sold, issued or cancelled
by employee share option plans or similar arrangements

IAS 32 applies to those contracts to buy or sell a non-financial item that can be settled net in cash or another
financial instrument, except for contracts that were entered into and continue to be held for the purpose of the
receipt or delivery of a non-financial item in accordance with the entity's expected purchase, sale or usage re-
quirements. [IAS 32.8]

Key definitions [IAS 32.11]

Financial instrument: a contract that gives rise to a financial asset of one entity and a financial liability or
equity instrument of another entity.

Financial asset: any asset that is:

 cash
 an equity instrument of another entity
 a contractual right
o to receive cash or another financial asset from another entity; or
o to exchange financial assets or financial liabilities with another entity under conditions that are
potentially favourable to the entity; or
 a contract that will or may be settled in the entity's own equity instruments and is:
o a non-derivative for which the entity is or may be obliged to receive a variable number of the
entity's own equity instruments
o a derivative that will or may be settled other than by the exchange of a fixed amount of cash or
another financial asset for a fixed number of the entity's own equity instruments. For this purpose
the entity's own equity instruments do not include instruments that are themselves contracts for
the future receipt or delivery of the entity's own equity instruments
o puttable instruments classified as equity or certain liabilities arising on liquidation classified by
IAS 32 as equity instruments

Financial liability: any liability that is:

 a contractual obligation:
o to deliver cash or another financial asset to another entity; or
o to exchange financial assets or financial liabilities with another entity under conditions that are
potentially unfavourable to the entity; or
 a contract that will or may be settled in the entity's own equity instruments and is
o a non-derivative for which the entity is or may be obliged to deliver a variable number of the
entity's own equity instruments or
o a derivative that will or may be settled other than by the exchange of a fixed amount of cash or
another financial asset for a fixed number of the entity's own equity instruments. For this purpose
the entity's own equity instruments do not include: instruments that are themselves contracts for
the future receipt or delivery of the entity's own equity instruments; puttable instruments classi-
fied as equity or certain liabilities arising on liquidation classified by IAS 32 as equity instruments

Equity instrument: Any contract that evidences a residual interest in the assets of an entity after deducting all
of its liabilities.

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Fair value: the amount for which an asset could be exchanged, or a liability settled, between knowledgeable,
willing parties in an arm's length transaction.

The definition of financial instrument used in IAS 32 is the same as that in IAS 39.

Puttable instrument: a financial instrument that gives the holder the right to put the instrument back to the
issuer for cash or another financial asset or is automatically put back to the issuer on occurrence of an uncertain
future event or the death or retirement of the instrument holder.

Classification as liability or equity

The fundamental principle of IAS 32 is that a financial instrument should be classified as either a financial
liability or an equity instrument according to the substance of the contract, not its legal form, and the definitions
of financial liability and equity instrument. Two exceptions from this principle are certain puttable instruments
meeting specific criteria and certain obligations arising on liquidation (see below). The entity must make the
decision at the time the instrument is initially recognized. The classification is not subsequently changed based
on changed circumstances. [IAS 32.15]

A financial instrument is an equity instrument only if (a) the instrument includes no contractual obligation to
deliver cash or another financial asset to another entity and (b) if the instrument will or may be settled in the
issuer's own equity instruments, it is either:
 a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its
own equity instruments; or
 a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another
financial asset for a fixed number of its own equity instruments. [IAS 32.16]

Illustration – preference shares

If an entity issues preference (preferred) shares that pay a fixed rate of dividend and that have a mandatory re-
demption feature at a future date, the substance is that they are a contractual obligation to deliver cash and,
therefore, should be recognised as a liability. [IAS 32.18(a)] In contrast, preference shares that do not have a
fixed maturity, and where the issuer does not have a contractual obligation to make any payment are equity. In
this example even though both instruments are legally termed preference shares they have different contractual
terms and one is a financial liability while the other is equity.

Illustration – issuance of fixed monetary amount of equity instruments

A contractual right or obligation to receive or deliver a number of its own shares or other equity instruments
that varies so that the fair value of the entity's own equity instruments to be received or delivered equals the
fixed monetary amount of the contractual right or obligation is a financial liability. [IAS 32.20]

Illustration – one party has a choice over how an instrument is settled

When a derivative financial instrument gives one party a choice over how it is settled (for instance, the issuer or
the holder can choose settlement net in cash or by exchanging shares for cash), it is a financial asset or a
financial liability unless all of the settlement alternatives would result in it being an equity instrument. [IAS
32.26]

Contingent settlement provisions

If, as a result of contingent settlement provisions, the issuer does not have an unconditional right to avoid settle-
ment by delivery of cash or other financial instrument (or otherwise to settle in a way that it would be a
financial liability) the instrument is a financial liability of the issuer, unless:

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 the contingent settlement provision is not genuine or

 the issuer can only be required to settle the obligation in the event of the issuer's liquidation or
 the instrument has all the features and meets the conditions of IAS 32.16A and 16B for puttable instru-
ments [IAS 32.25]

Puttable instruments and obligations arising on liquidation

In February 2008, the IASB amended IAS 32 and IAS 1 Presentation of Financial Statements with respect to the
balance sheet classification of puttable financial instruments and obligations arising only on liquidation. As a
result of the amendments, some financial instruments that currently meet the definition of a financial liability
will be classified as equity because they represent the residual interest in the net assets of the entity. [IAS
32.16A-D]

Classifications of rights issues

In October 2009, the IASB issued an amendment to IAS 32 on the classification of rights issues. For rights
issues offered for a fixed amount of foreign currency current practice appears to require such issues to be
accounted for as derivative liabilities. The amendment states that if such rights are issued pro rata to an entity's
all existing shareholders in the same class for a fixed amount of currency, they should be classified as equity re-
gardless of the currency in which the exercise price is denominated.

Compound financial instruments

Some financial instruments – sometimes called compound instruments – have both a liability and an equity
component from the issuer's perspective. In that case, IAS 32 requires that the component parts be accounted for
and presented separately according to their substance based on the definitions of liability and equity. The split is
made at issuance and not revised for subsequent changes in market interest rates, share prices, or other event
that changes the likelihood that the conversion option will be exercised. [IAS 32.29-30]

To illustrate, a convertible bond contains two components. One is a financial liability, namely the issuer's con-
tractual obligation to pay cash, and the other is an equity instrument, namely the holder's option to convert into
common shares. Another example is debt issued with detachable share purchase warrants.

When the initial carrying amount of a compound financial instrument is required to be allocated to its equity
and liability components, the equity component is assigned the residual amount after deducting from the fair
value of the instrument as a whole the amount separately determined for the liability component. [IAS 32.32]
Interest, dividends, gains, and losses relating to an instrument classified as a liability should be reported in profit
or loss. This means that dividend payments on preferred shares classified as liabilities are treated as expenses.
On the other hand, distributions (such as dividends) to holders of a financial instrument classified as equity
should be charged directly against equity, not against earnings. [IAS 32.35]

Transaction costs of an equity transaction are deducted from equity. Transaction costs related to an issue of a
compound financial instrument are allocated to the liability and equity components in proportion to the alloca-
tion of proceeds.

Treasury shares
The cost of an entity's own equity instruments that it has reacquired ('treasury shares') is deducted from equity.
Gain or loss is not recognized on the purchase, sale, issue, or cancellation of treasury shares. Treasury shares
may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or
received is recognized directly in equity. [IAS 32.33]

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Offsetting
IAS 32 also prescribes rules for the offsetting of financial assets and financial liabilities. It specifies that a
financial asset and a financial liability should be offset and the net amount reported when, and only when, an
entity: [IAS 32.42]
 has a legally enforceable right to set off the amounts; and
 intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously. [IAS
32.48]

Costs of issuing or reacquiring equity instruments

Costs of issuing or reacquiring equity instruments (other than in a business combination) are accounted for as a
deduction from equity, net of any related income tax benefit. [IAS 32.35]

Disclosures
Financial instruments disclosures are in IFRS 7 Financial Instruments: Disclosures, and no longer in IAS 32.
The disclosures relating to treasury shares are in IAS 1 Presentation of Financial Statements and IAS
24 Related Parties for share repurchases from related parties. [IAS 32.34]

 DONE 

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