Which two categories are used in IFRS 32 to subdivide all financial instruments?

Synopsis

IAS 32 classifies financial instruments into:

  • Financial assets
  • Financial liabilities
  • Equity

...in accordance with the substance of the arrangement and the definitions of these elements. In certain cases, such as convertible debt, the instrument is split into a liability and equity element. Financial assets and liabilities may only be offset where there is a legally enforceable right to offset and the entity intends to settle on a net basis. Any treasury shares are deducted from equity.

Interest, dividends, losses and gains related to a financial liability are recognised in profit or loss; dividends in relation to equity instruments are recognised directly in equity.

  • Read the unaccompanied version of IAS 32

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Which version of the standard?

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Recent amendments

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The following interpretations refer to IAS 32

  • IFRIC 2 Members’ Shares in Co-operative Entities and Similar Instruments
    Provides guidance on classifying members’ shares in co-operative entities as financial liabilities or equity.
  • IFRIC 12 Service Concession Arrangements 
  • Accounting guidance for arrangements where a contract is granted for the supply of public services such as roads.
  • IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments
    Addresses the accounting by an entity which issues equity instruments in order to settle, in full or part, a financial liability.

Current proposals

  1. The IASB is engaged in a research project to investigate potential improvements to the classification of liabilities and equity and the presentation and disclosure requirements for financial instruments with the characteristics of equity regardless of whether they are classified as equity or liabilities. A discussion paper was issued in June 2018 and the next stage is expected to be an exposure draft.
    • Read DP/2018/1 Financial Instruments with Characteristics of Equity 

This page was last updated 30 August 2022.

The DP outlines clearer classification principles while keeping IAS 32’s existing requirements essentially unchanged.

IAS 32 Financial Instruments: Presentation sets out how an issuer distinguishes between a financial liability and equity and works well for many, simpler financial instruments. However, classifying more complex financial instruments under IAS 32 – e.g. those with characteristics of equity – can be more challenging, leading to diversity in practice.

Proposals aim to improve information about financial instruments issued

In response, the IASB has published a discussion paper (DP) Financial Instruments with Characteristics of Equity (FICE) that seeks to improve IAS 32 by:

  • establishing clearer principles for classifying financial instruments as either financial liabilities or equity;
  • improving the clarity and consistency of the classification requirements for the more complex financial instruments that create a challenge in practice – e.g. derivatives on own equity; and
  • enhancing the presentation and disclosures about financial liabilities and equity.

 “These proposals could mean more liabilities and less equity – plus enhanced presentation and disclosure – for hybrid capital instruments.”

Chris Spall,
KPMG’s global IFRS financial instruments leader

Clearer classification principles

To help issuers of financial instruments distinguish between a liability and equity, the Board proposes that issuers assess the presence or otherwise of two particular features of an instrument – i.e. the timing and the amount.

A non-derivative financial instrument would be classified as a financial liability if it contains:

  • an unavoidable contractual obligation to transfer cash or another financial asset at a specified time other than at liquidation (timing); and/or 
  • an unavoidable contractual obligation for an amount independent of the entity’s available economic resources   (amount). 

Since equity is ‘the residual interest in the assets of the entity after deducting all of its liabilities’, a contract that contains neither of the two features would be classified as equity.   

In a change to current IAS 32 requirements, the timing and the amount features would be applied consistently, regardless of whether a contract is settled by delivering an entity’s own equity. For example, irredeemable fixed-rate cumulative preference shares would be classified as a financial liability. This is because the amount is independent of an entity’s available economic resources – i.e. an issuer is not required to pay the principal and dividend before liquidation but the fixed-rate dividends accumulate over time. These preference shares might be classified as equity under current IAS 32.    

Derivatives on own equity are currently classified as equity using the fixed-for-fixed condition. However, since IAS 32 does not explain the rationale for this condition, it is difficult to apply in practice when a derivative is more complex. 

Consistent with the principles for classifying non-derivative financial instruments, the DP clarifies that the classification of a derivative on own equity would be determined using the timing and amount features. This means that a derivative on own equity would be classified as a financial asset or a financial liability if: 

  • it is net-cash settled – i.e. the derivative requires the entity to deliver cash or another financial asset, and/or contains a right to receive cash for the net amount, at a specified time other than at liquidation (timing); and/or
  • the net amount of the derivative is affected by a variable that is independent of an entity’s available economic resources (amount). 

A derivative on own equity is classified as equity if neither of the conditions above are met.

The DP also discusses the relationship between compound instruments and redemption obligation arrangements and proposes that transactions that have the same settlement outcome should be accounted for consistently, regardless of how the transaction is structured – e.g. a convertible bond and a written put option on own equity.  

Enhanced presentation and disclosure proposed

To help distinguish the broad spectrum of financial instruments, the Board proposes that more information is disclosed in the financial statements to help users assess an entity’s financial position and performance and ease comparison between entities.   

For example, financial liabilities that provide equity-like returns would be distinguished from other financial liabilities by separate presentation in the statement of financial position, and presentation of their income and expenses in other comprehensive income (OCI) without subsequent reclassification. This would also apply to non-equity derivatives. 

In response to investors’ requests for more information, the Board is proposing additional disclosures on equity instruments as well as considering how returns on equity are distributed or attributed among the different equity instruments an entity issues. 

Find out more

The IASB’s comment deadline on the proposals closed on 7 January 2019. Read our comment letter(PDF 818 KB) to learn more about KPMG’s position.

The Board will consider the comments received on this DP before deciding whether to develop an exposure draft with proposals to amend or replace parts of IAS 32 and/or to develop non-mandatory guidance. 

For more information on the proposals, speak to your KPMG contact.

What are the two criteria used to classify financial assets?

IFRS 9 divides all financial assets that are currently in the scope of IAS 39 into two classifications - those measured at amortised cost and those measured at fair value.

What are the two categories required by IAS 39 for classification of financial liabilities?

Classification of financial liabilities Under IFRS 9, there will be the same two financial liability classification categories as existed under IAS 39, i.e.: Financial liabilities at fair value through profit or loss. Financial liabilities at amortised cost.

What are the categories and classifications of financial instruments?

Financial instruments may be divided into two types: cash instruments and derivative instruments. Financial instruments may also be divided according to an asset class, which depends on whether they are debt-based or equity-based. Foreign exchange instruments comprise a third, unique type of financial instrument.

What is a financial instrument according to IAS 32?

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.