The equity instrument: no obligation

Learning objectives

• Explain that an issued instrument is an equity instrument only if there is no unavoidable contractual obligation to deliver cash.L1
• Distinguish an equity instrument from a financial liability on the basis of the terms of an issue contract.L2

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.

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

3 questions

• An issued share is an equity instrument as soon as it is called a share, whatever its redemption terms.L1
• Which condition must be met for an issued instrument to be an equity instrument?L1
• Ambre SA issues 10,000 perpetual securities for 1,000,000. Contract terms (case facts): no redemption date, no right of redemption for the holder; the dividend is paid only if the general meeting of Ambre so decides, and Ambre has no obligation to decide so. How does Ambre classify these securities at issue?L2