Contingent settlement clauses

Learning objectives

• Explain the effect on classification of a contingent settlement provision that is beyond the control of both the issuer and the holder.L2
• Analyse a contingent settlement provision to decide whether it is genuine and whether it requires classification as a liability.L3

Normative references

• IAS 32 §25When an instrument requires the delivery of cash or another financial asset (or a settlement that would make it a liability) depending on the occurrence or non-occurrence of uncertain future events beyond the control of both the issuer and the holder (a share price index, consumer price index, interest rate, taxation requirements, or the issuer's revenue, net income or debt-to-equity ratio), the issuer does not have the unconditional right to avoid delivery and the instrument is a financial liability, except in three cases: the part of the provision that could require such settlement is not genuine; settlement can be required only on liquidation of the issuer; or the instrument meets the conditions in paras 16A and 16B.
• IAS 32 §AG28A part of a contingent settlement provision that is not genuine does not affect classification: a contract that requires settlement in cash or in a variable number of own shares only on the occurrence of an event that is extremely rare, highly abnormal and very unlikely to occur is an equity instrument; the same applies when settlement in a fixed number of shares is contractually precluded in circumstances that have no genuine possibility of occurring.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

2 questions

• Which statements about contingent settlement provisions are correct? Several answers are possible.L2
• A working paper analyses the contingent settlement provisions of several issued instruments. Which of the working paper's conclusions is wrong?L3