IAS 32 FINANCIAL

INSTUMENTS
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Introduction of IAS 32:

IAS 32 Financial instrument presentation outlines the accounting requirements of financial

instruments particularly as to the classification of such instruments into financial assets, financial
liabilities & equity instruments. The standards also provide guidance on the classification of
related interest, dividends & gains/losses , & when financial assets & financial liabilities can be
offset.[ CITATION Del15 \l 1033 ]

Some of key definitions are:

Financial instrument:

A contract that gives rise to financial asset of one entity & financial liability or equity instrument
of another entity

Financial assets:

Any asset that is cash, an equity instrument of another entity or to exchange financial assets or
financial liabilities with another entity under conditions that potentially favorable to the entity or
a contract that will or may be settled in the entity own equity instruments. Puttable instruments
classified as equity or certain liabilities arising on liquidation classified by IAS 32 as equity
instruments.[ CITATION Del15 \l 1033 ]

Financial liability:

Any liability that is a contractual obligation to deliver cash or another financial asset to another
entity or to exchange financial liabilities with another entity under conditions that potentially
unfavorable to the entity or a contract that will or may be settled in the entity own equity
instruments or a non-derivative for which the entity is or may be obliged to deliver a variable
number of the entity own equity instruments.[ CITATION Del15 \l 1033 ]

Equity instruments:

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

Fair value:
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The amount for which an asset could be exchanged or a liability settled b/w willing parties.

Objective & scope 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 & for offsetting financial assets & liabilities.

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 own repurchased shares)
 Prescribing strict conditions under which assets & liabilities may be offset in the balance
sheet.

IAS 32 is a companion to IAS 39 Financial Instrument recognition & measurement & IFRS 9
Financial instruments. IAS 39 & IFRS 9 deal with initial recognition of financial assets &
liabilities, measurement subsequent to initial recognition, impairment, derecognition & hedge
accounting. IAS 39 was progressively replaced by IFRS 9 as the IASB completed the various
phases of its financial instrument project.[ CITATION cou12 \l 1033 ]

Scope of IAS 32:

IAS 32 applies in presenting & disclosing information about all types of financial instruments
with the following exceptions:

 Interests in subsidiaries, associates & joint ventures that are accounted of under IAS 27
Consolidated & separate Financial statements, IAS 28 investment in Associates or IAS
31 interests in joint ventures. However IAS 32 applies to all derivatives on interests in
subsidiaries, associates or joint ventures.
 Employers’ rights & obligations under employee benefit plans.
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 Insurance contracts (IFRS 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
participation feature but are subject to all other IAS 32 requirements

Contracts & obligations under share-based payment transaction with the following exemptions:

This standard applies to contracts within scope of IAS 32.

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 & 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 requirements. Other than the contracts which were established
& held with the intention of the receipt or delivery of the underlying non-financial item as per
the expected usage purchase or sale requirements of the entity include:

a) When the contractual terms allow each party to settle the contract net in cash or another
financial instrument.
b) When the entity has past practices to settle such contracts net in cash or another financial
instrument even though it is not explicit in the terms of the contract (whether with the
counter party by selling the contract before its exercise or expiry).
c) When for such contracts the entity has past practices to take the delivery of underlying
non-financial item & selling it within a short time period after delivery to earn profit from
short term fluctuations in price that non-financial item
d) When the non-financial item involving the contract is readily convertible into cash.
[ CITATION cou12 \l 1033 ]

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, & the definitions of financial liability & equity instrument. Two exceptions from this from
this principle are certain puttable instrument meeting specific criteria & certain obligations
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arising on liquidation. The entity must make the decision at the time the instrument is initially
recognized. The classification is not subsequently changed based on changed circumstances.

A financial instrument is an equity instrument only if the instrument includes no contractual

obligations to deliver cash or another entity & if the instrument 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 derivatives 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.

Illustration preference shares:

If an entity issues preference shares that pay a fixed dividend & that have a redemption feature at
a future date, the substance is that they are a contractual at a future date the substance is that they
are a contractual obligation to deliver cash & therefore should be recognized as liability. In
contrast preference shares that do not have fixed maturity & where the issuer does not have a
contractual obligation to make any payment are equity. In this example even though both
instrument are legally termed preference shares they have different contractual terms & one is
financial liability while the other is equity.

Issuance of fixed monetary of equity instruments:

A contractual rights 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 own equity instruments to be received
or delivered equals the fixed monetary amount of the contractual right or obligation is financial
liability.

One party has 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 financial asset or a financial liability unless all of the settlement alternatives would
result in it being an equity instrument.

Contingent settlement provisions:

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If as a result of contingent settlement provisions the issuer does not have an unconditional right
to avoid settlement 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:

 The contingent settlement provision is not genuine or

 The issuer can only be required to settle cash the obligation in the event of the issuer
liquidation or
 The instrument has all the features & meets the conditions of IAS 32.[ CITATION IFR06 \l
1033 ]

Compound financial instruments:

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

To illustrate a convertible bond contains two components. One is a financial liability namely the
issuer’s contractual obligations to pay cash & the other is an equity instrument namely holder
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 & 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.

Interest, dividends, gains, & losses relating to an instrument classified as a liability should
reported in profit or loss. This means that dividend payments on preferred shares classified as
liabilities are treated as expense. On the other hand distributions such as dividends to holders of a
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financial instrument classified as equity should be charged directly against equity no against
earnings.

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 & equity components in
proportion to the allocation of proceeds.

 For example a convertible bond includes more than one elements or aspects relating to its
settlement one is the entity obligation to pay cash on redemption which is financial
liability & another is the holder option to convert the loan note into ordinary shares of the
issuer entity which equity instrument for the issuer. Another example includes the issue
of the loan Note with a detachable share warrant.
 This standard requires that the issuer of compound financial instrument should classify
the instrument equity components as equity & liability components as liability right on its
initial recognition. For this purpose the entity will measuring the fair value of the liability
component by measuring the fair value of compound financial instrument as whole & the
equity component will be allocated to the residual amount.
 After initial recognition of the equity component & the liability component with the
respective amounts as per the method mentioned above the subsequent change in the
value of liability will be recognized in the statement of profit & loss i.e. interest cost.
 At maturity of the compound financial instrument holders require the issuer of the
compound financial instrument to issue ordinary shares on redemption then the liability
component is de-recognized on maturity & will be transferred to equity for the issuance
of ordinary shares.
 The entity will recognize both equity components & liability component in respect of
compound financial instrument in the statement of financial position & this classification
will not be affected by the likelihood of settlement method. [ CITATION CPD16 \l 1033 ]

Treasury shares and offsetting:

Treasury shares:
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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 & held by the entity or by other members of the
consolidated group. Consideration paid or received is recognized directly in equity.

 The treasury shares are recorded at purchase price including transaction cost.
 These are presented as deduction from equity in the statement of financial position.
 Any gain or loss arising on cancellation or reissuance of treasury shares will be
recognized in equity.

Interest & dividend:

The interest or dividend relating to the financial instrument will be accounted for as follows:

 Any interest or dividend income relating to the financial asset will be reported to the
statement of profit & loss.
 Any interest expense relating to the instruments classified as financial liability will be
reported to statement of profit & loss.
 Dividend distribution to the equity instrument holders will be charged directly against
equity i.e. retained earnings.
 Any transaction cost for the equity instrument will be deducted from the equity.

Offsetting:

IAS 32 also prescribes rules for the offsetting of financial assets & financial liabilities. It
specifies that a financial asset & financial liability should be offset & the net amount reported
when & only when an entity:

 The entity has a present legal enforceable right to set off the recorded value of financial
asset and financial liability. and
 The entity has intention to settle the financial asset and financial liability either on a set
basis or to realize the financial asset & settle the financial liability at the same time.

Costs of issuing or reacquiring equity instruments:

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Costs of issuing or reacquiring equity instruments are accounted for as a deduction from equity,
net of any related income tax benefit.

Disclosures:

IAS 32 specifies presentation for financial instruments. The recognition & measurement & the
disclosure of financial instrument are the subjects of IFRS 9 or IAS 39 & IFRS 7 respectively.
For presentation financial instruments are classified into financial assets, financial liabilities &
equity instruments.

Financial instrument disclosures are in IFRS 7 Financial instruments: Disclosures & no longer in
IAS 32.

The disclosures relating to treasury shares are in IAS 1 Presentation of Financial Statements &
IAS 24 Related Parties for share repurchase from related parties.

Instruments & obligations arising on liquidations Amendments for puttable instruments:

In February 2008, the IASB amended IAS 32 & IAS 1 Presentation of Financial statements with
respect to the balance sheet classification of puttable financial instrument & obligations arising
only on liquidation. As a result of the amendments some financial instruments that currently
meet the definitions of financial liability will be classified as equity because they represent the
residual interest in the net assets of the entity. Under the revised IAS 32 subject to specific
criteria being met, these instruments will be classified as equity whereas prior to these
amendments they would classified as financial liabilities. The amendments are effective for
annual periods beginning on or after 1 January 2009, with early adoption permitted.

Purpose of Amendments:

Under the current requirement of IAS 32 if an issuer can be required to pay cash or another
financial asset in return of redeeming or repurchasing a financial instrument, the instrument is
classified as financial liability. This principle applies even if the amount payable is equal to the
holder’s interest in the net asset of the issuer, or if the amount is only ever payable at liquidation
& liquidation is certain because , for example there is a fixed liquidation date.
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The current requirements often lead to counter-intuitive results. For example the total amount
payable may equal the market value of the whole entity which may well be in excess of the
accounting net assets of the entity. In another scenario where liquidation is certain or is at the
option of the holder, instrument that represent the last residual interest in the entity may be
recognized as financial liabilities even when the instruments have characteristics similar to
equity. The objective of the February 2008 amendments is to provide “short-term, limited scope
amendment” designed to avoid these outcomes.

The IASB considers that some puttable financial instruments & financial instruments that impose
on the issuer an obligation to deliver a pro-rata share of net assets of the entity only on
liquidation are equity. The amendments deal with these two types of instruments separately & set
out extensive detailed criteria that need to be met in order to present the instrument as equity.
The impact of the amendments is restricted to the specific cases cited no analogies made to these
requirements.

Puttable financial instruments:

Puttable financial instruments will be presented as equity only if the all of the following criteria
are met:

(A) The holder is entitled to a pro-rata share of the entity’s net assets on liquidation.
(B) The instruments is in the class of instruments that is the most subordinate & all
instrument in that class have identical feature.
(C) The instrument has no other characteristics that would meet the definition of a financial
liability &
(D) The total expected cash flows attributable to the instruments over its life are based
substantially on the profit and loss, the change in the recognized net assets of the entity
(excluding any effects of the instrument itself). Profit & loss or change in recognized net
assets for this purpose is as measured in accordance with relevant IFRSs.

In addition to the criteria set out above, the entity must have no other instrument that has terms
equivalent to (d) above & that has the effect of substantially restricting or fixing the residual
return to the holders of the puttable financial instruments.[ CITATION Cor09 \l 1033 ]
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Instrument issued by subsidiaries:

For instruments of this nature issued by subsidiary that are held by non-controlling parties &
presented as equity in the subsidiary’s financial statements, equity presentation will not be
appropriate in the consolidated financial statements as the instrument will not be the most
subordinated instrument of the group.

References
Anon., 2006. IFRS. [Online]
Available at: https://www.ifrs.org/issued-standards/list-of-standards/ias-32-financial-instruments-
presentation/

Anon., 2009. Corner-I. [Online]

Available at: https://library.croneri.co.uk/cch_uk/fi/3-3

Anon., 2012. course hero. [Online]

Available at: https://www.coursehero.com/file/51693544/IAS-32-Notespdf/

Anon., 2015. Deloitee. [Online]

Available at: https://www.iasplus.com/en/standards/ias/ias32

Anon., 2016. CPD box. [Online]

Available at: https://www.cpdbox.com/how-to-account-compound-financial-instruments-ias-32/