IAS 32 - Financial Instruments: Disclosure and Presentation

IAS 32 – Financial Instruments: Disclosure and Presentation

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IAS 32 – Financial Instruments: Disclosure and Presentation

Overview:

This standard specifies the presentation requirements for the financial instruments. Financial instruments recognition, measurement and disclosure are subject to the requirements of IFRS 9, IFRS 39 and IFRS 7 respectively.

The following categories are available for presentation:

  • Financial Assets,
  • Financial Liabilities and
  • Equity Instruments

The standard also establishes the principles for off-setting financial liabilities and assets. It addresses in the following ways:

  1. Prescribing the accounting treatment for repurchased shares/treasury shares
  2. Prescribing conditions under which liabilities and assets in a balance sheet may be offset
  3. Clarifying financial instrument classification into equity or liability

Effective date and Adaptation:

IAS 32: Financial Instrument Disclosure and Presentation was adopted by the International Accounting Standard Board in April 2001.

Every entity shall apply IAS 32 for every period beginning on and after 1 January 2005.

Objective of the Standard:

It establishes presentation principles for financial instruments along with the following:

  • Provides financial instrument definitions,
  • Provides guidance on Compound financial instruments,
  • Provides rules for treasury shares presentation,
  • Prescribes rules for distinguishing equity from liabilities,
  • Provides the conditions for offsetting of financial assets and financial liabilities in statement of financial position.

Scope:

IAS 32 applies to every contract to sell or buy non-financial items that can be settled through another financial instrument or net in cash, with the exception of contracts that were/are entered into and are continued to be held for the purpose of the delivery or receipt of a non-financial item in accordance with the requirements of an organization’s expected sale, purchase or usage.

It is applicable to the presentation and disclosure of every type of financial instrument except the following:

  • Employee Rights and Obligations under Employee Benefit Plans – under IAS 19
  • Interest in subsidiaries, associates and joint ventures – under IAS 27, IAS 28, IAS 31, IFRS 10
  • Insurance Contracts – under IFRS 4. In insurance contracts, IAS 32 requirements are applied to embedded derivatives that are required under IAS 39 to be separately accounted for.
  • Obligation and Contracts under Share based payment transactions – IFRS 2

Important Definitions:

  • Fair Value: the price received to sell an asset or paid for the transfer of a liability at the measurement date between market participants in an orderly transaction.
  • Financial Instruments: these are contracts between entities that on one side give rise to an equity instrument or a financial liability for one entity and at the same time gives rise to a financial asset of the other entity.
  • Financial Assets: Financial asset is:
    • An equity instrument of some other entity,
    • Cash,
    • Any contractual right to receive another financial asset or cash,
    • A contact that may be or will be settled in the own equity instruments of an entity.
  • Financial Liability: Financial liability is:
    • A contractual obligation with another entity to deliver another financial asset or cash or to exchange financial liability or financial asset under unfavourable conditions to the entity,
    • A contract that may be or will be settled in own equity instruments of the entity.
  • Equity Instrument: A residual or remaining interest evidenced through a contract in an entity’s assets, net of all the entity’s liabilities.
  • Compound Financial Instrument: These are instruments that have the characteristics of both, an equity and a liability from the perspective of the issuer.
  • Puttable Instrument: it is a kind of financial instrument that gives a right to the person holding the instrument to be able to put the instrument back, for any other financial asset of any amount of cash. The instrument is put back automatically in the following circumstances:
    • Uncertain future event occurrence,
    • Death of instrument holder,
    • Retirement of instrument holder

Financial Instruments Presentation rules:

On initial recognition, classification of financial instruments as financial asset, financial liability or equity instrument is made in accordance with:

  • The respective definitions,
  • The contract substance

ACCOUNTING REQUIREMENTS UNDER IAS 32:

  • Treasury Shares:
    Cost of own instruments of an entity (reacquired instruments) is subtracted from equity:

    • Consideration received or paid is directly recognised in equity,
    • On sale, purchase, cancellation or issue of treasury shares, gain or loss is not recognised,
    • These may be acquired and held by the entity itself or other consolidated group members.
  • Owner Transaction:
    • Equity transaction costs are deducted from equity,
    • Distribution to equity instrument holders is directly debited into equity.
  • Offsetting:
    A financial liability and a financial asset can be offset ONLY when a legally enforceable right to offset exists and an intention exists to settle in net or to settle simultaneously both amounts.
    The set-off right:

    • MUST not be a future event contingency,
    • MUST be enforceable legally in all of the below circumstances:
      • The default event,
      • The bankruptcy or insolvency event of the entity itself and the counterparties,
      • The normal business course.
  • Compound Financial Instrument:
    The requirements of IAS 32 are that the liability and equity components are to be presented and accounted for separately in accordance with their substance based upon their respective definitions. The split is made on initial recognition and not revised subsequently for any changes in the share prices, market interest rates etc.Accounting Treatment:

    • Separate amount for liability component is determined,
    • The liability amount is deducted from the compound financial instrument’s fair value as a whole,
    • The residual amount is assigned as the equity component,
    • Gains, losses, interest and dividends relating to the liability component are reported in profit and loss,
    • Dividend payments relating to:
Classification Treatment
Preferred shares classified as liabilities treated as expense
To holders of equity classified financial instruments charged against equity, not earnings
    • Transaction costs relating to:
Classification Treatment
Of an equity transaction Deducted from equity
An issue of compound financial instrument Allocated to both, equity and liability in proportion to the proceeds allocation
  • Classification as Equity or Liability:
    The classification should be based according to the contract substance and the definitions of the respective component and not the legal form. The classification is:

    • Made on initial recognition,
    • Not subsequently changed.
Classified as Liability Classified as Equity
If there exists an obligation to settle in another financial instrument or cash.

If it may be settled in a variable number of the own instruments of the entity.

Only if it includes no contractual obligation to settle in another financial instrument or cash and if the instrument may be or will be settled in the own equity instruments of the issuer.
  • Preference Shares:
Classified as Liability Classified as Equity
  • Pay a fixed rate of dividend
  • On a future date, have a mandatory redemption feature,
  • By substance they are contractual obligation for cash delivery.
  • Do not have a fixed maturity,
  • Issuer has no contractual obligation to make any kind of payment.
  • Contingent Settlement Provision:
Classified as Liability Classified as Equity
  • The issuer lacks the unconditional right to avoid the settlement by delivery of any other financial instrument or cash.
  • Non genuine contingent settlement provision,
  • The instruments meets all the conditions of IAS 32.16A and 16B for the puttable instruments,
  • The obligation would only be required to settle in the event of the liquidation of the issuer.
  • Rights Issue Classification:
    Rights that are issued pro-rata to an organization’s same class all existing shareholders in the same class for fixed specific amount of currency, they should be equity classified regardless of the exercise prise denominated currency.
  • Cost of reacquiring or issuing Equity Instrument:
    The amount net of income tax benefit is deducted from equity.

Disclosure Requirement:
The disclosure requirements of financial instruments are now under IFRS 7 Financial Instruments: Disclosures and not under IAS 32.

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