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
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IFRS Accounting Standards (IAS 32)
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U.S. GAAP (ASC 480-10, ASC 470-20, ASC
815-40)
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Redeemable equity securities (e.g., puttable
shares) and noncontrolling interests
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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.
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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 mezzanine or
temporary equity.
|
Convertible debt — separation of an equity
component
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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.
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Conversions in accordance with original terms
|
No gain or loss is recognized upon the
conversion of convertible debt into the issuer’s equity shares
in accordance with the original terms.
|
No gain or loss is recognized upon the
conversion of convertible debt into cash, other assets, or the
debtor’s equity shares in accordance with the original terms
unless both (1) the conversion occurred upon the issuer’s
exercise of a call option and (2) the conversion option was not
substantive at issuance.
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Extinguishments of convertible debt
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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 (1) the debt’s net carrying amount and
(2) the consideration paid.
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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 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.
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Obligations to issue a variable number of equity shares
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Contracts that will be settled in a variable number of shares are
accounted for as assets or liabilities.
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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 delivering a variable number of equity shares is
classified as an asset or a liability if, at inception, the
obligation’s monetary value is based either solely or
predominantly on (1) a fixed monetary amount, (2) variations in
something other than the fair value of the issuer’s equity
shares, or (3) variations inversely related to changes in the
fair value of the issuer’s equity shares.
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