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Financial instruments · IAS 32

IAS 32 Financial Instruments: Presentation

Summary, key points, exam traps and a worked example — written for ICAP, ACCA, ICAI, CIMA and ICAEW students.

On this page
  1. Objective
  2. Scope
  3. Key definitions
  4. Recognition & measurement
  5. Key disclosures
  6. Common exam traps
  7. Worked example
  8. Related standards
  9. Practise MCQs

Objective

Sets out how to classify financial instruments as financial liabilities or equity from the issuer's perspective, and when financial assets and liabilities can be offset.

Scope

  • All financial instruments, except interests in subsidiaries, associates and joint ventures, employee benefit plans, insurance contracts and most share-based payment transactions.

Key definitions

Financial instrument
A contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another.
Financial liability
Broadly, a contractual obligation to deliver cash or another financial asset, or to exchange financial instruments on potentially unfavourable terms (plus certain contracts settled in own equity).
Equity instrument
A contract evidencing a residual interest in the assets of an entity after deducting all of its liabilities.
Compound instrument
A non-derivative instrument containing both a liability and an equity component, such as a convertible bond.

Recognition & measurement

Liability or equity

  • Classify on substance: if the issuer has a contractual obligation it cannot avoid to deliver cash, it is a liability.
  • Preference shares redeemable mandatorily, or at the holder's option, are liabilities; their 'dividends' are finance costs.
  • Non-redeemable preference shares with discretionary dividends are equity.
  • Compound instruments are split: the liability component is the present value of contractual cash flows at the market rate for similar debt without conversion; equity is the residual.
  • The split is made at issue and is not revised later.
  • Treasury shares (own shares bought back) are deducted from equity; no gain or loss is recognised on them.
  • Transaction costs of an equity transaction are deducted from equity.

Offsetting

  • Offset a financial asset and liability only if there is a currently legally enforceable right to set off and an intention to settle net or simultaneously.

Key disclosures

  • Disclosure requirements are mainly in IFRS 7.

Common exam traps

  • Legal form ('shares') does not decide classification — substance does.
  • The equity component of a convertible is the residual after valuing the liability, not the other way round.
  • Interest on the liability component uses the market rate (effective rate), not the coupon rate.

Worked example: Convertible bond split

Scenario. An entity issues a 3-year convertible bond at its $10,000 par value with a 5% annual coupon paid in arrears. Similar debt without conversion rights carries 8%.

  1. PV of coupons = 500 × 2.5771 (3-year annuity at 8%) = $1,289.
  2. PV of principal = 10,000 × 0.7938 = $7,938.
  3. Liability component = 1,289 + 7,938 = $9,227.
  4. Equity component = 10,000 − 9,227 = $773.

Answer: Liability $9,227 (then amortised cost at 8%); equity $773.

Practise MCQs on this standard

Test your understanding of IAS 32 with free chapter-wise MCQs and explanations in these question banks.

CAF-6 Corporate ReportingICAP CAFACCA FR Financial ReportingACCACA Inter P1 Advanced AccountingICAI CA Intermediate

ICAI CA Intermediate examines Indian Accounting Standards, which are based on but can differ from IFRS. Check your syllabus.

Read the official IAS 32 text on ifrs.org