The contractual obligation to deliver cash

Learning objectives

• Explain that an unavoidable contractual obligation to deliver cash or another financial asset makes the issued instrument a financial liability.L1
• Determine the classification of an issued instrument (liability or equity) from its contractual terms.L2

Normative references

• IAS 32 §16An issued instrument is an equity instrument, rather than a financial liability, if, and only if, two conditions are met: (a) it includes no contractual obligation to deliver cash or another financial asset, or to exchange financial assets or liabilities under conditions that are potentially unfavourable to the issuer; (b) if it will or may be settled in own equity instruments, it is a non-derivative that includes no obligation to deliver a variable number of own equity instruments, or a derivative that will be settled only by exchanging a fixed amount of cash or another financial asset for a fixed number of own equity instruments (with the same exception as in para. 11 for rights offered pro rata). By way of exception, an instrument that meets the definition of a financial liability is classified as equity if it has all the features and meets the conditions in paras 16A and 16B or paras 16C and 16D.

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

3 questions

• An instrument that imposes on the issuer a delivery of cash that it cannot avoid is a financial liability, even if the issuer presents it as an ownership security.L1
• Aube SA issues 50,000 preference shares at 20 each, or 1,000,000. The contract (case facts) requires Aube to redeem them in cash, at 20 each, five years after issue, with no possibility of refusing. How does Aube classify these shares at issue?L2
• Brume SA issues perpetual securities with a total nominal value of 2,000,000 and no redemption date. The contract obliges Brume to pay each year a fixed coupon of 5% of the nominal value, with no possibility of suspending or deferring it (case facts). Write a short justification of the classification at issue, distinguishing rule, case facts and conclusion.L2