IAS 32 — Financial Instruments: Presentation

IAS 32 — Financial Instruments: Presentation

Classification

In order to decide on whether a transaction is a financial instrument (and how to classify it if it is a financial instrument) it is important to have a good understanding of the instruments as defined by IAS 32:

Definition

Financial instrument. Any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity.

Financial asset.

Any asset that is:

1. cash;
2. an equity instrument of another entity;
3. a contractual right:

• to 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

Financial asset.

Examples:

• trade receivables;
• options;
• shares (as an investment).

Financial liability.

Examples:

• trade payables;
• debenture loans (payable);
• mandatorily redeemable preference shares; * forward contracts standing at a loss.

Equity instrument.

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

Examples:

• own ordinary shares;
• warrants;
• non-cumulative irredeemable preference shares.

Derivative.

A derivative has three characteristics:

– its value changes in response to an underlying variable (e.g.

share price or interest rate)

– it requires little or no initial net investment – it is settled at a future date.

IAS 32 clarifies that an instrument is only an equity instrument if in the definition of a financial liability are not met.

Compound instruments

Where a financial instrument contains some characteristics of equity and some of financial liability then its separate components need to be classified separately.

Method:

1. Determine the carrying amount of the liability component (by measuring the fair value of a similar liability that does not have an associated equity component);
2. Assign the residual amount to the equity component.