IASB releases exposure draft - Financial Instruments with Characteristics of Equity

The IASB has published Exposure Draft (ED) 2023/5 Financial Instruments with Characteristics of Equity which proposes to amend IAS 32 Financial Instruments: Presentation, IFRS 7 Financial Instruments: Disclosures, and IAS 1 Presentation of Financial Statements. These amendments may affect whether entities classify financial instruments as equity instruments or financial liabilities, along with disclosure and presentation changes.

The ED proposes a large suite of amendments to IAS 32, IFRS 7 and IAS 1, which, in the words of the IASB, are intended to only change classification outcomes if there is enough evidence that such a change would provide more useful information to users of financial statements.

The proposed amendments include the following key clarifications and new requirements to be considered:

• The effects of laws and regulations on the classification of financial instruments:
  • Only contractual rights and obligations that are enforceable by laws or regulations and are in addition to those created by relevant laws or regulations are considered in classifying a financial instrument or its component parts.
  • A contractual right or obligation that is not solely created by laws or regulations, but is in addition to a right or obligation created by relevant laws or regulations shall be considered in its entirety in classifying the financial instrument or its component parts. That is the entity shall not disaggregate such a contractual right or obligation into contractual and non-contractual parts.
     
• The ‘fixed-for-fixed’ condition in IAS 32.16(b)(ii) for classifying a derivative that will or may be settled in an issuer’s own equity instruments:
  • For the fixed-for-fixed condition to be met, the amount of consideration exchanged for each of an entity’s own equity instruments is required to be denominated in the entity’s functional currency and either:
    • fixed (will not vary under any circumstances); or
    • variable solely because of a preservation or passage-of-time adjustment.
  • If the contract gives one party a choice of settlement between two or more classes of a company’s own equity instruments, an instrument is an equity instrument only if all settlement alternatives meet the fixed-for-fixed condition.
  • If a contract will or may be settled only by the exchange of a fixed number of one class of a company’s own non-derivative equity instruments for a fixed number of another class of the company’s own non-derivative equity instruments, the fixed-for-fixed condition is met.
     
• The requirements of IAS 32.23 for classifying financial instruments containing an obligation for an entity to purchase its own equity instruments:
  • The requirements in IAS 32 for contracts containing an obligation for an entity to purchase its own equity instruments also apply to contracts that will be settled by delivering a variable number of another class of the entity’s own equity instruments.
  • On initial recognition of the obligation to redeem an entity’s own equity instruments, if the entity does not yet have access to the rights and returns associated with ownership of the equity instruments to which the obligation relates, those equity instruments would continue to be recognised.
  • An entity is required to use the same approach for initial and subsequent measurement of the financial liability.
  • Accounting for a contract containing an obligation for an entity to purchase its own equity instruments that expire without delivery.
  • Written put options and forward purchase contracts on an entity’s own equity instruments that are gross physically settled are required to be presented on a gross basis.
     
• The requirements in IAS 32.25 and IAS 32.28 for classifying financial instruments with contingent settlement provisions:
  • Some financial instruments with contingent settlement provisions are compound financial instruments with liability and equity components.
  • When measuring the financial liability (initial and subsequent measurement), a company disregards the probability and estimated timing of the contingent event occurring and discounts the settlement amount to its present value assuming that the settlement will occur at the earliest possible date.
  • A company recognises payments that are at its own discretion in equity, even if the equity component has an initial carrying amount of zero.
  • Clarification of the terms ‘liquidation’ and ‘not genuine’.
     
• The effect of shareholder discretion on the classification of financial instruments:
  • Whether an entity has an unconditional right to avoid delivering cash or another financial asset (or otherwise to settle a financial instrument in such a way that it would be a financial liability) depends on the facts and circumstances in which shareholder discretion arises. Judgement is required to assess whether shareholder decisions are treated as entity decisions.
  • Description of the factors an entity is required to consider in making the above assessment and guidance on applying those factors.
     
• The circumstances in which a financial instrument (or a component of it) is reclassified as a financial liability or an equity instrument after initial recognition:
  • A general requirement that prohibits the reclassification of a financial instrument after initial recognition, unless IAS 32.16E applies or the substance of the contractual arrangement changes because of a change in circumstances external to the contractual arrangement.
  • Requirements on how to account for such reclassifications.

The IASB has also proposed amendments to IFRS 7 to expand the objective of IFRS 7 to enable users of financial statements to understand how an entity is financed and what its ownership structure is, including potential dilution to the ownership structure from financial instruments issued at the reporting date. The IASB has also proposed amendments to the scope of IFRS 7 in respect of equity instruments and other amendments to improve the information disclosed about:

• the nature and priority of claims against an entity on liquidation arising from financial liabilities and equity instruments;
• the terms and conditions of financial instruments with both financial liability and equity characteristics;
• terms and conditions that become, or stop being, effective with the passage of time;
• the potential dilution of ordinary shares; and
• instruments that include obligations to purchase the entity’s own equity instruments.

The IASB has also proposed amendments to IAS 1 Presentation of Financial Statements to require an entity to present additional information about amounts attributable to ordinary shareholders. The proposed amendments comprise the following:

• separate presentation in the statement of financial position of issued share capital and reserves attributable to ordinary shareholders of the parent company from other owners of the parent company;
• allocation of profit or loss and other comprehensive income between the ordinary shareholders of the parent company and other owners of the parent company in the statement of comprehensive income;
• reconciliation for each class of ordinary share capital and each class of other contributed equity in the statement of changes in equity; and
• separate presentation of dividends relating to ordinary shareholders and those relating to other owners of the company.
   

The IASB proposes to require an entity to apply the proposed amendments retrospectively with the restatement of comparative information (a fully retrospective approach). However, to minimise costs, the IASB proposes not to require the restatement of information for more than one comparative period, even if the entity chooses or is required to present more than one comparative period in its financial statements.

The ED is open for comments until 29 March 2024 and may be accessed here.

The IASB has also released a Snapshot of the proposed amendments, which may be accessed here.