IAS 32
Financial Instruments: Presentation
1Objective and scope
IAS 32 establishes principles for presenting financial instruments as liabilities or equity, and for offsetting financial assets and financial liabilities. It works alongside IFRS 9 (recognition and measurement) and IFRS 7 (disclosure) to complete the financial instruments framework.
2Key definitions
3Classification: liability vs equity
Classification is determined by the substance of the contractual arrangement, not merely its legal form. An instrument is classified as equity only if it contains no contractual obligation to deliver cash or another financial asset (or to exchange instruments on potentially unfavourable terms), and, if it will or may be settled in the issuer's own equity instruments, it is a non-derivative with no such obligation, or a derivative that will be settled by a fixed amount of cash (or another financial asset) for a fixed number of the issuer's own equity instruments (the 'fixed-for-fixed' test).
| Instrument | Classification |
|---|---|
| Redeemable preference shares (issuer has a contractual obligation to redeem) | Financial liability |
| Irredeemable, non-cumulative preference shares (no obligation to pay a dividend or redeem) | Equity instrument |
| Ordinary shares | Equity instrument |
| Convertible bond (a compound instrument) | Split into a liability component and an equity component |
Splitting a convertible bond at issuance
Step 1: Value the liability component = present value of the future interest and principal cash flows, discounted at the market rate for an equivalent bond WITHOUT the conversion option.
Step 2: Equity component = proceeds received - liability component (a residual).
The liability component is subsequently measured at amortised cost using the effective interest method; the equity component is not remeasured.
A financial asset and a financial liability are offset, with the net amount presented, only when the entity currently has a legally enforceable right to set off the recognised amounts, and intends either to settle on a net basis or to realise the asset and settle the liability simultaneously.
4Presentation and disclosure
Interest, dividends, losses and gains relating to a financial instrument classified as a liability are recognised in profit or loss; distributions to holders of an equity instrument are debited directly to equity, not expensed. Most of the detailed disclosure requirements for financial instruments sit in IFRS 7, not IAS 32.
5Examinable focus
What KASNEB tests
The convertible bond split (present value of the liability component, residual to equity, then unwinding the discount through profit or loss using the effective interest method over the bond's life) is a heavily examined numerical question. Also expect a written classification test applied to redeemable vs irredeemable preference shares.