IAS-32 - Financial Instruments: Disclosure and Presentation (Revised Dec 2003)
Objective of IAS 32
The stated objective of IAS 32 is to enhance users' understanding of the significance of on-balance sheet and off-balance sheet financial instruments to an enterprise's financial position, performance, and cash flows.
IAS 32 addresses this in essentially three ways:
- Clarifying the classification of a financial instrument issued by an enterprise as a liability or as equity.
- Prescribing strict conditions under which assets and liabilities may be offset in the balance sheet.
- Requiring a broad range of disclosures about financial instruments, including information as to their fair values.
IAS 32 applies in presenting and disclosing information about all types of financial instruments, whether recognised in the balance sheet or not, with the following exceptions: [IAS 32.1]
- investments in subsidiaries [see IAS 27], investments in equity method associates [see IAS 28], and investments in joint ventures [see IAS 31];
- obligations for post-employment benefits [see IAS 19 and IAS 26];
- employers' obligations under employee stock option and stock purchase plans [see IAS 19]; and
- obligations arising under insurance contracts [this is the subject of a current IASB agenda project].
The definition of financial instrument used in IAS 32 is the same as that in IAS 39. [IAS 32.5]
Classification as liability or equity
The fundamental principle of IAS 32 is that an instrument should be classified as either a liability or an equity instrument according to its substance, not its legal form. The enterprise must make the decision at the time the instrument is initially recognised. The classification is not subsequently changed based on changed circumstances. The key distinguishing feature is that a financial liability involves a contractual obligation either to deliver cash or another financial asset, or to issue another financial instrument, under terms that are potentially unfavourable to the issuer. An instrument that does not give rise to such a contractual obligation is an equity instrument. [IAS 32.18]
To illustrate, if an enterprise issues preference (preferred) shares that pay a fixed rate of dividend and that have a mandatory redemption feature at a future date, the substance is that they are a contractual obligation and, therefore, should be recognised as a liability. In contrast, normal preference shares do not have a fixed maturity, and the issuer does not have a contractual obligation to make any payment. Therefore, they are equity.
Some financial instruments - sometimes called compound instruments -have both a liability and an equity element. In that case, IAS 32 requires that the component parts be split, with each part accounted for and presented separately according to its substance. To illustrate, a convertible bond contains two components. One is a financial liability, namely the issuer's contractual obligation to pay cash, and the other is an equity instrument, namely the holder's option to convert into common shares. This split is made at the time the instrument is issued and is not subsequently revised as a result of a change in interest rates, share price, or other event that changes the likelihood that the conversion option will be exercised. [IAS 32.23]
Interest, dividends, gains, and losses relating to an instrument classified as a liability should be reported in the income statement. This means that dividend payments on preferred shares classified as liabilities are treated as expenses. On the other hand, distributions to holders of a financial instrument classified as equity should be charged directly against equity, not against earnings. [IAS 32.30]
SIC 5 provides further guidance on liability-equity classification. Where the rights and obligations regarding the manner of settlement of a financial instrument depend on the occurrence or non-occurrence of uncertain future events, or on the outcome of uncertain circumstances that are beyond the control of both the issuer and the holder, the financial instrument should be classified as a liability unless the possibility of the issuer being required to settle in cash or another financial asset is remote at the time of issuance, in which case the instrument should be classified as equity.
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 enterprise: [IAS 32.53]
- has a legally enforceable right to set off the amounts; and
- intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.
SIC 16 interprets IAS 32 with respect to treasury shares - equity shares repurchased and held by the issuing enterprise or its subsidiaries. Where an enterprise holds treasury shares, those shares should be presented in the balance sheet as a deduction from equity. No gain or loss should be recognised in the income statement on the sale, issuance, or cancellation of treasury shares. Consideration received should be presented in the financial statements as a change in equity.
Equity Issuance or Reacquisition Costs
SIC 17 provides that the transaction costs of issuing or acquiring an enterprise's own equity shares should be accounted for as a deduction from equity, net of any related income tax benefit.
An enterprise should describe its financial risk management objectives and policies, including hedging policies. [IAS 32.43A]
For each class of financial asset, financial liability, and equity, both recognised and unrecognised, IAS 32 requires disclosure of:
- the extent and nature of the financial instruments, including significant terms and conditions (including principal amount, maturity, early settlement or conversion options, amount and timing of cash flows, stated interest or dividend rates, collateral held or pledged, denomination in a foreign currency, and restrictive conditions and covenants); [IAS 32.47]
- accounting policies and methods adopted, including recognition criteria and measurement principles; [IAS 32.47]
- specified information about exposure to interest rate risk (including repricing dates and effective interest rates); [IAS 32.56]
- specified information about exposure to credit risk (including amounts and significant concentrations); [IAS 32.66]
- specified information about the fair value of the financial instrument, or a statement that it is not practicable to provide such information; [IAS 32.77] and
- special information if a financial asset is carried in excess of its fair value (the impairment provisions of IAS 39 would generally prohibit this). [IAS 32.88]
Note: Please note that these summaries are only for reference purposes and are not a substitute for the entire IFRS/IAS. Kindly read the whole text of IFRS/IAS before consulting these summaries.
Summaries are courtesy of Deloitte.
- IAS-01 - Presentation of Financial Statements (Revised Dec 2003)
- IAS-02 - Inventories (Revised Dec 2003)
- IAS-07 - Cash Flow Statements
- IAS-08 - Net Profit or Loss for The Period, Fundamental Errors and Changes in Accounting Policies (Revised)
- IAS-10 - Events after the Balance Sheet date (Revised Dec 2003)
- IAS-11 - Construction Contracts
- IAS-12 - Income Taxes
- IAS-14 - Segment Reporting
- IAS-15 - Information reflecting the effect of changing prices (Withdrawn Dec 2003)
- IAS-16 - Property, Plant and Equipment (Revised Dec 2003)
- IAS-17 - Leases (Revised Dec 2003)
- IAS-18 - Revenue
- IAS-19 - Employee Benefits
- IAS-20 - Accounting for Government grants
- IAS-21 - The effects of changes in foreign exchange rates (Revised Dec 2003)
- IAS-22 - Business Combinations
- IAS-23 - Borrowing Costs
- IAS-24 - Related Party Disclosures (Revised Dec 2003)
- IAS-26 - Accounting and reporting by defined benefit plans
- IAS-27 - Consolidated Financial Statements and Accounting for Investment in Subsidiaries (Revised Dec 2003)
- IAS-28 - Accounting for Investment in Associates (Revised Dec 2003)
- IAS-29 - Financial Reporting in Hyperinflationary Economies
- IAS-30 - Disclosures in Fin. Statements of Banks in Similar Fin. Institutions
- IAS-31 - Financial Reporting of Interests in Joint Ventures (Revised Dec 2003)
- IAS-32 - Financial Instruments: Disclosure and Presentation (Revised Dec 2003)
- IAS-33 - Earnings Per Share (Revised Dec 2003)
- IAS-34 - Interim Financial Reporting
- IAS-38 - Intangible Assets
- IAS-39 - Financial Instruments: Recognition and Measurement (Revised Dec 2003)
- IAS-40 - Investment Property (Revised Dec 2003)
- IAS-41 - Agriculture