financial instruments with characteristics of equity ...€¦ · • goal is to develop a better...

© Australian Accounting Standards Board 2017

AOSSG

Wednesday, 29 November 2017

Kala Kandiah, Technical Director, AASB

Janri Pretorius, Senior Project Manager, AASB

Financial Instruments with

Characteristics of Equity

(“FICE”)

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• Project Background and Objective

• Summary of IASB Discussions

• Group Exercise – Illustrative Examples

• Comparing Results

• Key Take-Aways

Agenda

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Why does the IASB think change is needed?

• IAS 32 is rule-based and challenging to apply

• Different classification conclusions for the same type of instrument

• Significant practice issues reported

• IFRS IC received several queries and escalated issue to IASB

• Goal is to develop a better distinction between equity and non-equity instruments

• Intent is to create an outcome that is more intuitive and reasonable

Current status of project

Discussion Paper expected H1 2018

The FICE Research Project

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Financial liabilities

• Contractual obligation:

o deliver cash / financial asset;

o exchange financial assets / liabilities under unfavourable conditions

• Contract settled in own equity instruments

o non-derivative: obliged to deliver variable number of equity

o derivative: settled other than by exchange of fixed amount of cash or financial asset for fixed number of equity

Equity instrument

Contract that evidences a residual interest in assets of entity after deducting all liabilities

Classifying Claims under IAS 32

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Classifying Claims – Liability or Equity?

Alpha α Timing of

settlement

Beta β Independence of

settlement amount

Gamma γ Timing and

independence

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Classifying Claims - Gamma Approach

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Ordinary share – Obligation to deliver a fixed number of ordinary shares

• An entity issues a financial instrument that will be settled by delivering 1,000 ordinary shares, which the entity is able to deliver;

• Obligation to transfer economic resources only at liquidation at an amount equal to a pro-rata share of the entity’s net assets on liquidation;

• Settlement not prior to liquidation and amount not independent of the entity’s economic resources;

• Equity under γ

• Equity under IAS 32 [No contractual obligation to pay dividend or redeem shares]


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Ordinary bond – Obligation to transfer a specific amount of cash at a specified time prior to liquidation

• An entity issues a financial instrument that is to be settled by delivering CU1,000, payable in 12 months’ time (the date of settlement);

• Settlement prior to liquidation and amount independent of the entity’s economic resources;

• Liability under γ o Related income or expenses are presented in PL as the liability is

not solely dependent on the residual amount;

• Liability under IAS 32 [Meets the definition of liability. Contractual obligation to pay cash in future.] o Related income and expenses presented in profit or loss;


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Shares redeemable for their fair value

• An open-ended mutual fund provided their members

with a right to redeem their interest in the fund at any

time for a cash amount equal to the fair value of their

interest at time of redemption.

• How would the members’ interest be classified

under IAS 32 and Gamma?

Puttable instruments subordinate to other classes

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Under IAS 32, the instrument would be classified as equity if it satisfies the criteria in paragraphs 16A and 16B [or 16C and 16D] of IAS 32

Under the general Gamma approach, these instruments would be classified as liability because the entity could be required (at the discretion of the holder) to settle it at any time prior to liquidation, or when liquidation itself is certain

However, the IASB has decided to retain the exception in IAS 32 for the Gamma approach in relation to these types of instruments

‘Puttables Exception’ under Gamma Approach

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Most subordinate Shares redeemable for their fair

value

• Equity under γ and IAS 32

Meets the exception criteria in paragraphs 16A and

16B of IAS 32

‘Puttables Exception’ under Gamma Approach

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Warrants

• An entity issues bonds with warrants attached.

• Each bondholder holding a CU1,000 face-value bond gets the right to purchase 100 shares of the company at CU20 per share over the next five years.

• The warrants will be physically settled by delivering a fixed number of own shares; and receiving a fixed amount of cash equal to strike price.

• How would the warrant be classified under IAS 32 and Gamma?

Group Exercise - Illustrative Example 1

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Callable preferred shares with resets

• An entity issued 1,000 preference shares;

• The entity is allowed to redeem the preference shares on 3 specific dates over the next 3 years.

• No contractual obligation to pay dividends or to call the instruments;

• If the entity does not redeem the preference shares, the redemption amount increases over time at a pre-determined rate in the form of a step-up dividend clause;

• How would the callable preferred shares be classified under IAS 32 and Gamma?


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Forward to sell own shares (‘net share settlement’)

• An entity entered into an agreement to sell 1,000 of

its own shares;

• As consideration, the entity will receive a variable

amount of its own shares worth CU5,000 (ie the

forward price under the agreement);

• The contract specifies net settlement of shares;

• How would the forward contract be classified

under IAS 32 and Gamma?


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Presenting Claims - Gamma Approach

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Priority of claims on liquidation

Potential dilution of ordinary shares

Additional supporting information about the presentation and classification requirements of the Gamma Approach

Disclosing Claims

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• Do you believe that the guidance being developed will solve the issues found in practice?

• Should the ‘puttables exemption’ be retained under the Gamma approach?

• For purposes of classification of liabilities: It is possible to continuously avoid settlement, until liquidation where settlement is no longer unavoidable. Do you think the consideration of ‘liquidation’ under the gamma approach is useful and makes sense?

Key Take-Aways

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Your presenters

Kala Kandiah,

Technical Director

[email protected]

+61 3 9617 7626

Disclaimer

This presentation provides personal views of the presenter and does not necessarily

represent the views of the AASB or other AASB staff. Its contents are for general

information only and do not constitute advice.

The AASB expressly disclaims all liability for any loss or damages arising from reliance

upon any information in this presentation.

This presentation is not to be reproduced, distributed or referred to in a public document

without the express prior approval of AASB staff.

Janri Pretorius,

Senior Project Manager

[email protected]

+61 3 9617 7620

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Engage with the AASB

Discussion group

AASB Alumni

@AASBAustralia

@krispeachAASB

Your input is important

You don’t have to be technical

Let us know how we can better engage with you

[email protected]

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