Objective
IAS 32 establishes principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities.
It focuses on the classification and presentation, not on recognition or measurement (which are covered by IFRS 9).
🧾 1. Scope
Applies to all types of financial instruments, except:
-
Investments in subsidiaries, associates, or joint ventures (IAS 27, 28, IFRS 11)
-
Share-based payments (IFRS 2)
-
Employer obligations under employee benefit plans (IAS 19)
💡 2. Key Definitions
| Term | Meaning |
|---|---|
| Financial Instrument | Any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. |
| Financial Asset | Cash, equity instrument of another entity, or contractual right to receive cash or another financial asset. |
| Financial Liability | Contractual obligation to deliver cash or another financial asset. |
| Equity Instrument | Any contract that evidences a residual interest in the assets of an entity after deducting liabilities. |
🧭 3. Classification: Liability vs. Equity
A. Financial Liability
A financial instrument is a liability if the issuer:
-
Has a contractual obligation to deliver cash or another financial asset, or
-
May be forced to deliver variable number of shares (not fixed).
B. Equity Instrument
An instrument is equity if:
-
There is no contractual obligation to deliver cash or another financial asset, and
-
It will be settled by issuing a fixed number of shares for a fixed amount of cash
(known as the “fixed-for-fixed” rule).
Example 1 – Equity vs Liability
| Instrument | Terms | Classification | Reason |
|---|---|---|---|
| Ordinary shares | Fixed number of shares issued for fixed cash | Equity | No obligation to repay cash |
| Redeemable preference shares (mandatory redemption in 5 years) | Must repay $1,000 per share | Liability | Obligation to repay cash |
| Convertible bond (convertible into fixed number of shares) | Convertible at holder’s option | Split instrument | Liability + Equity components |
🔀 4. Compound (Hybrid) Financial Instruments
Some instruments have both liability and equity components — e.g., convertible bonds.
Example 2 – Convertible Bond
-
$1,000 convertible bond
-
5% annual interest
-
Convertible into 100 ordinary shares after 3 years
👉 Split into:
-
Liability component: Present value of interest and principal (bond obligation)
-
Equity component: Option to convert to shares
Journal Entry on Issue:
🔄 5. Treasury Shares
When an entity buys back its own shares:
-
Deduct the cost of treasury shares from equity.
-
No gain or loss is recognized in profit or loss.
Example 3:
Buy back 1,000 own shares at $10 each
When reissued:
⚖️ 6. Offsetting Financial Assets and Liabilities
A financial asset and a financial liability are offset (netted) only if:
-
The entity has a legally enforceable right to offset the amounts; and
-
It intends to settle on a net basis or to realize the asset and settle the liability simultaneously.
Example 4:
-
Company A owes Bank $1,000.
-
Bank owes Company A $600.
-
If legal right to offset exists → only $400 shown as payable.
🧩 7. Puttable Instruments
Normally, an instrument that gives the holder the right to redeem (put) for cash is a liability.
However, IAS 32 allows some exceptions (classified as equity) if:
-
The holder is entitled to a pro-rata share of net assets,
-
It is the most subordinate class of instruments,
-
It has identical features among holders, and
-
There are no other equity instruments with similar rights.
📢 8. Presentation Rules Summary
| Classification | Criteria | Example |
|---|---|---|
| Financial Liability | Contractual obligation to deliver cash/asset | Bonds, redeemable shares |
| Equity Instrument | No obligation to deliver cash, fixed-for-fixed settlement | Ordinary shares |
| Compound Instrument | Contains both liability & equity | Convertible bonds |
| Treasury Shares | Entity’s own shares repurchased | Deducted from equity |
| Offsetting | Legal right + intention to settle net | Mutual receivable/payable |
🧮 9. Disclosure Requirements
Entities must disclose:
-
Terms and conditions of financial instruments
-
Classification policies (liability vs equity)
-
Reconciliation of number of shares outstanding
-
Nature and purpose of equity reserves
-
Information about offsetting and netting arrangements
🧭 10. Quick Recap Summary
| Topic | Key Point | Example |
|---|---|---|
| Classification | Focus on substance, not legal form | Redeemable preference share = liability |
| Compound Instruments | Split between liability and equity | Convertible bonds |
| Treasury Shares | Deduct from equity | Buyback of shares |
| Offsetting | Allowed only with legal right & intention | Mutual receivable/payable |
| Puttable Instruments | Exception – can be equity | Unit trust shares |