International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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Financial instruments: Financial liabilities and equity 3565
The treatment of the costs and gains associated with instruments is determined by their
classification in the financial statements under IAS 32, and not by their legal form. Thus
dividends paid on shares classified as financial liabilities (see 4.5 above) will be
recognised as an expense in profit or loss, not as an appropriation of equity.
The basic principle summarised above also applies to compound instruments and
requires any payments in relation to the equity component to be recorded in equity
and any payments in relation to the liability component to be recorded in profit or
loss. (As discussed at 6.6.3.B above, it is not clear whether this basic principle also
applies when the full amount of the issuance proceeds of a compound instrument is
allocated to the liability.) A mandatorily redeemable preference share with
dividends paid at the discretion of the entity results in the classification of a liability
equal to the net present value of the redemption amount and an equity classification
equal to the excess of the proceeds over the liability component (the net present
value of the redemption amount) (see 4.5.1 above). Because the redemption
obligation is classified as a liability, the unwinding of the discount on this component
is recorded and classified as an interest expense. Any dividends paid, on the other
hand, relate to the equity component and are therefore recorded as a distribution of
profit. [IAS 32.AG37].
Gains and losses associated with redemptions or refinancings of financial liabilities are
recognised in profit or loss, whereas redemptions or refinancings of equity instruments
are recognised as changes in equity. [IAS 32.36].
Similarly, gains and losses related to changes in the carrying amount of a financial
liability are recognised as income or expense in profit or loss, even when they relate to
an instrument that includes a right to the residual interest in the assets of the entity in
exchange for cash or another financial asset (see 4.6 above). However, IAS 32 notes that
IAS 1 requires any gain or loss arising from the remeasurement of such an instrument to
be shown separately in the statement of comprehensive income, where it is relevant in
explaining the entity’s performance. [IAS 32.41].
Changes in the fair value of an instrument that meets the definition of an equity
instrument are not recognised in the financial statements. [IAS 32.36].
IAS 32 permits dividends classified as an expense (i.e. because they relate to an
instrument, or component of an instrument, that is legally a share but classified as a
financial liability under IAS 32) to be presented in the statement of comprehensive
income or separate income statement (if presented), either with interest on other
liabilities or as a separate item. The standard notes that, in some circumstances, separate
disclosure is desirable, because of the differences between interest and dividends with
respect to matters such as tax deductibility. Disclosure of interest and dividends is
required by IAS 1 (see Chapter 3) and IFRS 7 (see Chapter 50). [IAS 32.40].
8.1
Transaction costs of equity transactions
An entity typically incurs various costs in issuing or acquiring its own equity instruments,
such as registration and other regulatory fees, amounts paid to legal, accounting and
other professional advisers, printing costs and stamp duties. The transaction costs of an
equity transaction are accounted for as a deduction from equity, but only to the extent
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they are incremental costs directly attributable to the equity transaction that otherwise
would have been avoided. The costs of an equity transaction that is abandoned are
recognised as an expense. [IAS 32.37].
Although IAS 32 does not provide a definition of directly attributable incremental
costs, IFRS 9 does define an incremental cost as ‘one that would not have been
incurred if the entity had not acquired, issued or disposed of the financial instrument.’
[IFRS 9 Appendix A]. IFRS 9 also gives as examples of costs which do meet this criteria:
fees and commission paid to agents, advisors, brokers and dealers, levies by regulatory
agencies and security exchanges, and transfer taxes and duties. [IFRS 9.B5.4.8]. Such costs
together with other directly related costs such as underwriting and printing costs are
usually considered to be incremental and directly attributable to the issue of equity.
Internal administrative or holding costs e.g. costs which would have been incurred in
any case if the equity instrument had not been issued, are not considered to be
incremental or directly attributable.
IAS 32 requires that only the costs of ‘issuing or acquiring’ equity are recognised in
equity. Accordingly, it seems clear that the costs of listing shares already in issue should
not be set off against equity, but recognised as an expense.
The standard also requires that transaction costs that relate jointly to more than one
transaction (for example, costs of a concurrent offering of some shares and a stock
exchange listing of other shares) are allocated to those transactions using a basis of
allocation that is rational and consistent with similar transactions. [IAS 32.38]. In its agenda
decision of September 2008, the Interpretations Committee declined to provide further
guidance on the extent of the transaction costs to be accounted for as a deduction from
equity and how to allocate costs that relate jointly to more than one transaction,
believing existing guidance to be adequate.
The Interpretations Committee noted that only incremental costs directly attributable
to issuing new equity instruments or acquiring previously issued equity instruments
are considered to be related to an equity transaction under IAS 32, but that the terms
‘incremental’ and ‘directly attributable’ are used with similar but not identical
meanings in many Standards and Interpretations, leading to diversity in practice. It
therefore recommended that the IASB develop common definitions for both terms to
be added to the Glossary as part of the annual improvements process.33 However, the
IASB did not propose any such amendments in the next exposure draft published in
August 2009.
It may well be that, in an initial public offering (‘IPO’), for example, an entity
simultaneously lists its existing equity and additional newly-issued equity. In that
situation the total costs of the IPO should, in our view, be allocated between the newly
issued shares and the existing shares on a rational basis (e.g. by reference to the ratio of
the number of new shares to the number of total shares), with only the proportion
relating to the issue of new shares being deducted from equity.
Financial instruments: Financial liabilities and equity 3567
Transaction costs that relate to the issue of a compound financial instrument are
allocated to the liability and equity components of the instrument in proportion to the
allocation of proceeds (see Example 43.4 at 6.2 above). [IAS 32.38].
IAS 32 does not specifically address the treatment of transaction costs incurred to
acquire a non-controlling interest in a subsidiary, or dispose of such an interest without
loss of control in the consolidated financial statements of the parent entity. IFRS 10
indicates that ‘changes in a parent’s ownership interest in a subsidiary that do not result
in the parent losing control of the subsidiary are equity transactions’. [IFRS 10.23].
Accordingly, we believe that the costs of such transactions should be deducted from
equity in accordance with the principles described above.
IAS 32 and IFRS 10 do not specify whether such costs should be allocated to the
parent’s equity or to the non-controlling interest, to the extent it is still reflected in
the statement of financial position. In our view, this is a matter of choice based on
the facts and circumstances surrounding the transaction, and any local legal
requirements. On any subsequent disposal of the subsidiary involving loss of control,
the transaction costs previously recognised in equity should not be reclassified from
equity to profit or loss, since they represent transactions with owners in their
capacity as owners rather than components of other comprehensive income.
[IAS 1.106, 109].
The amount of transaction costs accounted for as a deduction from equity in the period
is required to be disclosed separately under IAS 1 (see Chapter 3 at 3.3) and IFRS 7 (see
Chapter 50 at 7.3).
8.2
Tax effects of equity transactions
As originally issued, IAS 32 required distributions to shareholders and transaction costs
of equity instruments to be shown net of any tax benefit. Annual Improvements to
IFRSs 2009-2011 Cycle issued in May 2012 amended IAS 32 so as to remove the
reference to income tax benefit from IAS 32. This means that all tax effects of equity
transactions are allocated in accordance with the general principles of IAS 12. [IAS 32.35A].
Unfortunately, it is not entirely clear how IAS 12 requires the tax effects of certain equity
transactions to be dealt with and different views can be taken whether tax benefits in
respect of distributions are to be recognised in equity or profit or loss (see Chapter 29
at 10.3.5).
9 TREASURY
SHARES
Treasury shares are shares issued by an entity that are held by the entity. [IAS 32.33]. In
consolidated financial statements, this will include shares issued by any group entity
that are held by that entity or by any other members of the consolidated group. They
will also include shares held by an employee benefit trust that is consolidated or
treated as an extension of the reporting entity. Treasury shares will generally not
include shares in a group entity held by any associates or the entity’s pension fund.
However, IAS 1 requires disclosure of own shares held by subsidiaries or associates,
[IAS 1.79(a)(vi)], and IAS 19 – Employee Benefits – requires disclosure of own shares
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held by defined benefit plans. [IAS 19.143]. Holdings of treasury shares may arise in a
number of ways. For example:
• The entity holds the shares as the result of a direct transaction, such as a market
purchase, or a buy-back of shares from shareholders as a whole, or a particular
group of shareholders.
• The entity is in the financial services sector with a market-making operation that
buys and sells its own shares along with those of other listed entities in the normal
course of business, or holds them in order to ‘hedge’ issued derivatives.
• In consolidated financial statements:
• the shares were purchased by another entity which subsequently became a
subsidiary of the reporting entity, either through acquisition or changes in
financial reporting requirements; or
• the shares have been purchased by an entity that is a consolidated SPE of the
reporting entity.
The circumstances in which an entity is permitted to hold treasury shares are a matter
for legislation in the jurisdiction concerned.
Treasury shares do not include own shares held by an entity on behalf of others, such
as when a financial institution holds its own equity on behalf of a client. In such cases,
there is an agency relationship and as a result those holdings are not included in the
entity’s statement of financial position, either as assets or as a deduction from equity.
[IAS 32.AG36].
If an entity reacquires its own equity instruments, IAS 32 requires those instruments to
be deducted from equity. They are not recognised as financial assets, regardless of the
reason for which they are reacquired. No gain or loss is recognised in profit or loss on
the purchase, sale, issue or cancellation of an entity’s own equity instruments.
Accordingly, any consideration paid or received in connection with treasury shares
must be recognised directly in equity. [IAS 32.33, AG36].
IAS 1 requires the amount of treasury shares to be disclosed separately either on the
face of the statement of financial position or in the notes (see Chapter 3 at 3.1.6). In
addition, IAS 32 requires an entity to make disclosure in accordance with IAS 24 –
Related Party Disclosures – if the entity reacquires its own equity instruments from
related parties (see Chapter 35 at 2.5). [IAS 32.34].
As in the case of the requirements for the treatment of the equity component of a
compound financial instrument (see 6 above), IAS 32 does not prescribe precisely what
components of equity should be adjusted as the result of a treasury share transaction.
This may have been to ensure that there was no conflict between, on the one hand, the
basic requirement of IAS 32 that there should be an adjustment to equity and, on the
other hand, the legal requirements of various jurisdictions as to exactly how that
adjustment should be allocated within equity.
9.1
Transactions in own shares not at fair value
The requirement of IAS 32 that no profits or losses should ever be recognised on
transactions in own equity instruments differs from the approach taken in IFRS 2. If
Financial instruments: Financial liabilities and equity 3569
an employee share award is characterised as an equity instrument under IFRS 2 (a
‘share-settled’ award) and settled in cash (or other assets) at more than its fair value,
the excess of the consideration over the fair value is recognised as an expense (see
Chapter 30).
It is not clear whether or not the IASB specifically considered transactions in own equity
other than at fair value in the context of IAS 32, particularly since the relevant
provisions of IAS 32 essentially reproduce requirements previously contained in SIC-16
– Share Capital – Reacquired Own Equity Instruments (Treasury Shares) – which was
implicitly addressing market purchases and sales at fair value. In other words, the
provision can be seen merely as clarifying that, if an entity buys one of its own shares in
the market for £10 which it later reissues in the market at £12 or £7, it has not made,
respectively, a profit of £2 or a loss of £3.
This is slightly different to the situation where an entity purchases an equity instrument
for more than its fair value – i.e. if the original purchase had been for £11 when the
market price was £10. Such a transaction could occur, for example where the entity
wishes to rid itself of a troubl
esome shareholder or group of shareholders. In this case,
the entity might have to offer a premium specific to the holder over and above the ‘true’
fair value of the equity instruments concerned. However, in general, where an entity
purchases an equity instrument for more than its fair value, this can be indicative that
other consideration has been received by the entity. It should be noted that IFRS 2 is
explicit that any excess of the consideration over the fair value of an equity instrument
is recognised as an expense. [IFRS 2.28(b)].
A transaction in which the entity issues shares (or reissues treasury shares) for cash or
other assets with a fair value lower than the fair value of the shares would prima facie
fall within the scope of IFRS 2, requiring the shortfall to be accounted for under IFRS 2
(see Chapter 30 at 2.2.2.C).
9.2
IFRS 17 treasury share election
An entity applying IFRS 17 – Insurance Contracts – may elect not to deduct a treasury
share from equity, when it either:
• operates an investment fund that provides investors with benefits determined by
units in the fund and recognises the amounts to be paid to those investors as
financial liabilities; or
• issues groups of insurance contracts with direct participation features while
holding the underlying items.
Where an entity reacquires its own equity to hold in an investment fund or as an
underlying item in the above arrangements, it may elect to continue to account for the
treasury share as equity with the reacquired instrument being accounted as if it were
a financial asset measured through profit or loss in accordance with IFRS 9. The
election is irrevocable and made on an instrument by instrument basis. [IAS 32.33A].
IFRS 17 is applicable for periods beginning on or after 1 January 2021 but can be early
adopted by entities who have already adopted IFRS 9 and IFRS 15 – Revenue from
Contracts with Customers.
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10
‘HEDGING’ OF INSTRUMENTS CLASSIFIED AS EQUITY
A consequence of the requirement, discussed in 4.5.2 to 4.5.6 above, to treat discretionary
instruments with certain debt-like characteristics as equity is that the issuer will not be