The Association of Corporate Treasurers is doubtful whether the changes proposed are really an improvement in creating relevant and understandable financial reporting. We recognise that anomalies can arise by classifying the sorts of puttable instrument described as liabilities, since by revaluing to fair value the entire capitalisation of a business can appear as a liability and so create an entity with apparently zero or negative net assets.
However our fundamental concern centres on the difficulty in viewing something as equity if the company is obliged, perhaps not in its own time and not at its option, to make a payment or other transfer of assets otherwise than on its winding up. Equity provides a buffer that protects creditors and the expectation is that this buffer will not be reduced (except in controlled circumstances). A puttable instrument does not fulfil this equity function. In other words classifying these instruments as equity is not consistent with the Framework. As stated in the alternative view AV2 – “Key to the Framework definition of a liability is that it is a present obligation or the entity, the settlement of which would result in an outflow of resources of the entity. Thus, a share puttable at fair value clearly meets the definition of a liability in the Framework.” We agree with this alternative view.
It is not apparent that there is a clear principle underlying the proposed changes. Rather the section titled “Principle” is in fact a set of detailed rules. We generally do not favour an excessively rules based form of standard and fear that heading in this direction will leave greater scope for abuses.
To the extent that the definition of an equity instrument in paragraph 16 of IAS 32 is amended to make it clear that the obligation to deliver a pro rata share of net assets on liquidation does not turn the instrument into a financial liability we have no objection to this change. However if the instrument is puttable by the holder it should not be reclassified into equity.
While we are not in favour of the substantive changes proposed, if they are to go ahead then the idea that disclosures of the fair values of these puttable instruments should be provided will be helpful, albeit that this treatment is more like the treatment of a liability than equity, a point made in AV3.
