Foreign currency price and rights offered pro rata

Learning objectives

• Analyse the classification of rights offered pro rata to existing owners when the exercise price is denominated in a foreign currency.L3
• Justify the classification adopted in the light of the fixed-for-fixed condition and its exception.L4

Normative references

• IAS 32 §11A financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. A financial asset includes cash, an equity instrument of another entity, a contractual right to receive cash or another financial asset or to exchange financial assets or liabilities under potentially favourable conditions, and certain contracts settled in own equity instruments. A financial liability includes a contractual obligation to deliver cash or another financial asset or to exchange financial assets or liabilities under potentially unfavourable conditions, and certain contracts settled in own equity instruments (a variable number of instruments, or a derivative other than a fixed-for-fixed exchange); rights, options or warrants to acquire a fixed number of own equity instruments for a fixed amount of any currency are equity if they are offered pro rata to all existing owners of the same class of non-derivative equity instruments. An equity instrument is a contract that evidences a residual interest in the assets after deducting all liabilities. The paragraph also defines a puttable instrument.
• 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.
• IAS 32 §22Except as stated in para. 22A, a contract that will be settled by receiving or delivering a fixed number of own equity instruments in exchange for a fixed amount of cash or another financial asset is an equity instrument (the 'fixed-for-fixed' condition); changes in fair value arising from variations in market interest rates that do not affect the amount or the number of instruments do not prevent this; any consideration received or paid is added directly to or deducted directly from equity, and changes in the fair value of the equity instrument are not recognised. Para. 22A overrides this conclusion when the instruments to be delivered are themselves instruments classified as equity under the exceptions in paras 16A to 16D.

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

1 question

• Quartz SA, whose functional currency is the euro, issues a warrant to an investor: on exercise, the investor will receive 20,000 Quartz shares against 100,000 dollars (5 dollars per share), an amount fixed in the contract. The warrant is not offered pro rata to all existing shareholders (case facts). How does Quartz classify this warrant?L3