IAS 32: is it debt or equity?

What is the IAS 32 debt or equity principle?

A financial liability is a contractual obligation to deliver cash or another financial asset, or to exchange financial instruments on potentially unfavourable terms, or a contract settled in the issuer's own shares that fails the tests below. An equity instrument is any contract that evidences a residual interest in the assets after deducting all liabilities. What matters is whether the issuer can avoid paying: an obligation that depends on events outside both parties' control, such as a change in tax law, still makes the instrument a liability, while an expectation of paying, or economic pressure to pay, does not. See IFRS 9 classification.

How do you decide whether an instrument is debt or equity?

The fixed-for-fixed test explains why a contract to deliver shares worth CU 100,000 is a liability: the number of shares varies with the share price, so the shares are being used like currency and the holder has no residual interest. A warrant to buy 1,000 shares for CU 5 each passes, because both the cash and the number of shares are fixed. Rights issues priced in a foreign currency pass too, if offered pro rata to all existing shareholders.

IAS 32 in practice: splitting a convertible bond

A company issues a 3-year convertible bond at its face value of CU 10,000 thousand, paying 5% interest annually. Holders can convert into a fixed number of shares at maturity. Similar bonds without the conversion option yield 8%. The liability is the present value of the coupons and repayment at 8%, CU 9,227 thousand; the remaining CU 773 thousand is the equity component, the value of the conversion option. All figures are in CU thousand.

Interest expense is 738 in the first year, not the 500 coupon, because the liability accretes to its face value of 10,000 by maturity. The equity component of 773 is never remeasured; on conversion it moves within equity, and the liability is transferred to equity too. Transaction costs are split in proportion to the two components. See the effective interest method.

How are preference shares classified?

Dividends on shares classified as liabilities are interest expense in profit or loss; dividends on equity shares go directly to equity. Some preference shares are compound, such as redeemable shares with discretionary dividends, where the redemption amount is a liability and the dividend feature is equity. See regulatory capital vs IFRS equity, which explains why bank capital instruments often sit in equity.

What is the puttable instruments exception?

Instruments the holder can sell back to the issuer for cash, such as units in some funds and shares in cooperatives, would normally be liabilities. IAS 32 classifies them as equity if they meet strict conditions: they entitle the holder to a pro rata share of net assets on liquidation, are the most subordinate class, have identical features, carry no other obligation to pay, and their expected cash flows are based substantially on the issuer's profit or loss or net assets. The exception applies only in the issuer's own financial statements, not to non-controlling interests in a group's consolidated statements.

How does IAS 32 treat treasury shares and offsetting?

• Treasury shares: a company's own shares bought back are deducted from equity, with no gain or loss recognised on buying, selling or cancelling them.
• Costs of an equity transaction, such as issuing new shares, are deducted from equity.
• Offsetting: a financial asset and liability are shown net only if the company has a currently legally enforceable right to set them off and intends to settle net or simultaneously. See IFRS 7 disclosures, which require details of offsetting.

Classification also flows into earnings per share, because profit attributable to ordinary shareholders is after dividends on preference shares classified as equity. See IAS 33 earnings per share.

What is changing in IAS 32?

The IASB's Financial Instruments with Characteristics of Equity (FICE) project published an exposure draft in November 2023, proposing to clarify the classification principles in IAS 32, add disclosures about instruments with both debt and equity features, and present amounts attributable to ordinary shareholders separately from other owners. The Board is still redeliberating: at its September 2026 meeting it made tentative decisions on obligations to buy back own equity instruments, and no date has been set for the final amendments.

How does IAS 32 compare with US GAAP?

US GAAP spreads the subject across ASC 480, which makes mandatorily redeemable shares and certain share-settled obligations liabilities, ASC 815-40 for contracts on a company's own equity, and ASC 470-20 for convertible debt. Since ASU 2020-06, most convertible debt is a single liability at amortised cost with no equity component, unlike the IAS 32 split. SEC registrants also show shares redeemable outside their control as temporary equity between liabilities and equity, a category IFRS does not have. See IFRS vs US GAAP key differences.

This guide is general information. It is not tax or legal advice for your situation.