11.2 Redeemable Equity Securities
Both U.S. GAAP and IFRS Accounting Standards require financial instruments
issued in the legal form of shares that embody an unconditional obligation that
requires the issuer to redeem the instrument by transferring its assets at a
specified or determinable date (or dates) or upon an event that is certain to occur
to be accounted for as liabilities (see Section 4.1 and paragraph 16 of IAS 32).
Under U.S. GAAP, financial instruments issued in the form of shares that embody
a conditional obligation that could require the issuer to redeem the instrument
generally are classified as equity because they are outside the scope of the
liability classification guidance in ASC 480. The definition of mandatorily
redeemable financial instruments (which must be classified as financial liabilities)
in ASC 480-10-20 is limited to unconditional obligations. Therefore, outstanding
shares that could be redeemed at the option of the holder,
or upon some contingent event, generally are not classified as financial liabilities
under ASC 480. Under U.S. GAAP, mandatorily redeemable equity securities that are
not certain to be redeemed (e.g., those containing an equity conversion option that
permits the securities to be converted into nonredeemable equity securities before
the mandatory redemption date) are also classified as equity. If redemption becomes
certain to occur, the securities would be reclassified, and accounted for, as a
liability. ASC 480-10-S99-3A indicates that when an equity instrument has a
redemption feature that is not solely within the control of the issuer, an SEC
registrant is required to present the instrument on the balance sheet between
permanent equity and liabilities in a section labeled “temporary equity” or
“mezzanine equity” (see Chapter
9).
Under IFRS Accounting Standards, an instrument should be accounted for as a
liability if it gives the holder the right to put the instrument back to the issuer
for cash or another financial asset (e.g., redeemable preferred shares) or is
automatically put back to the issuer upon the occurrence of an uncertain future
event (e.g., contingently mandatorily redeemable shares). Accordingly, there is no
concept of “temporary equity” under IFRS Accounting Standards. Paragraph 18(b) of
IAS 32 notes that the conditional redemption obligation creates a contractual
obligation for the issuer to deliver cash or another financial asset. Paragraph
19(b) of IAS 32 states that the fact that a contractual obligation is conditional
upon the holder’s exercising its right to require redemption does not negate the
existence of a financial liability since the issuer “does not have the unconditional
right to avoid delivering cash or another financial asset.” ASC 480 does not require
conditionally redeemable shares to be classified as liabilities.
Under IAS 32, the issuer is exempt, in limited circumstances, from the liability classification requirement for puttable financial instruments. Specifically, IAS 32 requires that puttable instruments be presented as equity if the following four criteria are met:
- The holder is entitled “to a pro rata share of the entity’s net assets [at] liquidation.”
- “The instrument is in the class of instruments that is [the most] subordinate” and all instruments in that class are identical.
- The instrument has no other characteristics that would meet the definition of a financial liability.
- “The total expected cash flows attributable to the instrument over the life of the instrument are based substantially on the profit or loss, the change in the recognised net assets or the change in the fair value of the recognised and unrecognised net assets of the entity.”
Under IFRS Accounting Standards, instruments, or components of instruments, that
obligate the entity to deliver a pro rata share of the net assets of the entity only
on liquidation should be presented as equity if they meet criteria (1) and (2)
above. See paragraphs 16A through 16D of IAS 32 for additional information.