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:
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 31 Interests in Joint
Ventures (or, for annual periods beginning on or after 1 January
2013, IFRS 10 Consolidated 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 participation feature are only exempt from applying
paragraphs 15-32 and AG25-35 (analysing 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:
- this standard applies to contracts within the scope of IAS 32.8-10 (see
below)
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
requirements. [IAS 32.8]
Key definitions
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
- receive cash or another financial asset from another entity; or
- 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:
- a non-derivative for which the entity is or may be obliged to receive a
variable number of the entity's own equity instruments
- 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 classified as equity or certain liabilities arising on
liquidation classified by IAS 32 as equity instruments
a contractual obligation:
- to deliver cash or another financial asset to another entity; or
- 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
- 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
- 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;
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 contractual 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 allocation 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 recognised 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 recognised directly in equity. [IAS 32.33]
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]