IASB Seeks Clarity By Distinguishing Equity From Liability

In June 2018, the International Financial Standards Board (IASB) published its discussion paper on financial instruments with characteristics of equity (FICE). As part of its conceptual framework project, the discussion paper deals with improvements of IAS 32 Financial Instruments: Presentation with special regard to complex financial instruments.

Background

The IASB found that the implementation of IAS 32 has gone well for most of the standard financial instruments ( read our article on IAS 32's classification requirements for preference shares). However, rapid innovation in recent years has caused the structure of financial instruments to grow more complex, creating challenges in applying the requirements of the standard and consequently leading to varying accounting treatments. Due to this variance, it became harder for investors to assess how these financial instruments may affect companies' financial positions and performances.

Therefore, the IASB took action by:

formulating a clear rationale for the principles of 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 equity) enhancing the presentation and disclosures concerning financial liabilities and equity More action

With a new pair of proposed amendments, the IASB aims to—without changing the requirements for the more standard financial instruments—provide preparers with a clearer rationale for classification, and investors with richer and more comparable information for the more complex instruments.

The changes take the form of a new classification principle as well as "timing" and "amount" features:

Source: ISG

The main goal of these amendments is two sided: on the one hand they allow financial statement preparers determine if the company has an obligation to transfer either cash or another financial asset at a fixed date or only at liquidation ("timing feature"), and on the other hand to determine if the obligation is dependent on the company's available economic resources or not ("amount" feature).

Classifying preference shares may serve as an area in which to illustrate the new...

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