This Exposure Draft contains proposals by the International Accounting Standards Board to amend IAS 32 Financial Instruments: Presentation to classify as equity financial instruments puttable at the fair value of a pro rata share of the net assets of the entity (financial instruments puttable at fair value) and instruments with obligations for a pro rata share of the net assets of the entity on its liquidation (obligations arising on liquidation), provided specified criteria are met.
Under IAS 32, equity classification of a financial instrument depends upon specified conditions being met; one of those conditions is that the instrument does not include a contractual obligation to deliver cash or another financial asset to another entity. An instrument with such an obligation is a financial liability.
Some entities have issued financial instruments puttable at the fair value of a pro rata share of the net assets of the entity. After the revised IAS 32 was issued in 2003, constituents raised concerns about the consequences of applying IAS 32 and IAS 39 Financial Instruments: Recognition and Measurement to financial instruments puttable at fair value. For example, those standards require an entity to recognise such instruments as a liability and to measure them at an amount not less than the amount payable on demand, ie the fair value of the puttable instruments. This can result in the entire market capitalisation of an entity being recognised as a liability. Such an entity is likely to report negative net assets, because of unrecognised intangible assets and goodwill, and because the measurement of recognised assets and liabilities may not be at fair value.
Issues similar to those raised by constituents relating to the classification of financial instruments puttable at fair value also apply to the classification of ordinary shares in a limited life entity. The entity is obliged to liquidate because it has a limited life. Therefore, IAS 32 requires these shares to be classified as financial liabilities because the entity has an obligation to transfer cash or another financial asset to the shareholders. Hence, a limited life entity would have no equity. Similar
issues also apply to some partnerships that are required to liquidate upon the exit of a partner (eg on retirement or death).
The objective of this Exposure Draft is to develop a limited scope, short-term solution to improve the financial reporting of financial instruments puttable at fair value and instruments with obligations arising on liquidation that have characteristics similar to ordinary shares, pending the outcome of the Board’s longer-term project on liabilities and equity.
