2.4 Distinguishing Liabilities From Equity

The models for distinguishing liabilities from equity differ between IFRS Accounting Standards and U.S. GAAP. IFRS Accounting Standards focus on the substance of the contractual terms of a financial instrument rather than on its legal form. Under IFRS Accounting Standards, a financial instrument or its component parts should be classified upon initial recognition as a financial liability or an equity instrument according to (1) the substance of the contractual arrangement and (2) the definitions of a financial asset, a financial liability, and an equity instrument. If a financial instrument contains both a liability and an equity component, those components should be classified and accounted for separately (split accounting). However, aside from certain exceptions, an entity cannot apply split accounting under U.S. GAAP. The table below summarizes the key differences when an entity is distinguishing liabilities from equity under IFRS Accounting Standards and U.S. GAAP.

Topic	IFRS Accounting Standards (IAS 32)	U.S. GAAP (ASC 480-10, ASC 470-20, ASC 815-40)
Redeemable equity securities (e.g., puttable shares) and noncontrolling interests	Financial instruments in the form of shares that embody an obligation to transfer assets are classified as liabilities irrespective of whether the obligation is unconditional or conditional, with certain exceptions. The concept of mezzanine or temporary equity classification does not exist under IFRS Accounting Standards.	Financial instruments in the form of shares that embody an obligation to transfer assets are classified as liabilities only if the obligation is unconditional and the transfer of assets is therefore certain to occur. SEC registrants present equity-classified instruments that embody a conditional obligation to transfer assets as temporary equity.
Convertible debt — separation of an equity component	An issuer is required to separate convertible debt into liability and equity components unless the equity conversion feature must be bifurcated as a derivative liability. The liability and equity components are separated on the basis of the fair value of the liability component.	An issuer is required to present convertible debt as a liability in its entirety unless special accounting guidance applies. If the equity conversion feature does not have to be bifurcated as a derivative liability under ASC 815-15, recognition of an equity component may be required in accordance with special accounting models for convertible debt that (1) was issued at a substantial premium to par, (2) was modified or exchanged if extinguishment accounting did not apply and the fair value of the conversion feature increased, or (3) has a bifurcated conversion option derivative that was reclassified to equity. Different separation methods are used depending on the applicable accounting model.
Convertible debt issued at a substantial premium	There is no special accounting guidance on convertible debt issued at a substantial premium. An issuer is required to separate convertible debt into liability and equity components unless the equity conversion feature must be bifurcated as an embedded derivative.	There is a rebuttable presumption that the premium associated with convertible debt issued at a substantial premium to par should be presented as equity unless the equity conversion feature is bifurcated as an embedded derivative.
Conversions in accordance with original terms	No gain or loss is recognized upon the conversion of debt into the debtor’s equity shares in accordance with the original terms of a conversion feature. The conversion of debt into cash or other assets is accounted for as an extinguishment.	No gain or loss is recognized upon the conversion of debt into cash, other assets, or the debtor’s equity shares in accordance with the original terms of a conversion feature unless both (1) the conversion occurred upon the debtor’s exercise of a call option and (2) the conversion option was not substantive at inception.
Extinguishments of convertible debt	When convertible debt is extinguished, the debtor allocates the consideration paid between the liability and equity components on the basis of the fair value of the liability component.	When convertible debt is extinguished, a debt extinguishment gain or loss is generally recognized on the basis of the difference between the debt’s net carrying amount and the consideration paid.
Obligations to repurchase shares	Contracts that embody an obligation to repurchase the issuer’s equity shares by transferring assets are accounted for at the present value of the redemption amount if the issuer could be required to physically settle the contract by transferring assets in exchange for shares (e.g., a forward purchase or written put option contract that gives the counterparty the right to require either physical or net settlement).	Physically settled forward-purchase contracts that embody an obligation to repurchase a fixed number of the issuer’s equity shares for cash are accounted for at either the present value of the redemption amount or the settlement value. Other physically settled contracts that embody an obligation to repurchase the issuer’s equity shares by transferring assets (e.g., a physically settled written put option or a forward purchase contract that provides the counterparty with a right to require either physical or net settlement) are accounted for at fair value.
Treasury stock — repurchase of shares	As stated in paragraph 33A of IAS 32, if an entity issues “groups of insurance contracts with direct participation features” and the entity holds the underlying items, the “entity may elect not to deduct from equity a treasury share that is included in such a fund or is an underlying item when, and only when, an entity reacquires its own equity instrument for such purposes. Instead, the entity may elect to continue to account for that treasury share as equity and to account for the reacquired instrument as if the instrument were a financial asset and measure it at fair value through profit or loss.”	The repurchase of shares should be recorded as a reduction of equity. Treasury stock is recorded at the amount paid to repurchase the shares.
Obligations to issue a variable number of equity shares	Contracts that will be settled in a variable number of shares are accounted for as assets or liabilities.	ASC 480-10-25-14 states that a “financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares shall be classified as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on [a] fixed monetary amount,” “[v]ariations in something other than the fair value of the issuer’s equity shares,” or “[v]ariations inversely related to changes in the fair value of the issuer’s equity shares.”