IAS 32/Ind AS 32 Financial Instruments
In this article, we will discuss on IAS 32 — Financial Instruments, financial asset, financial liability, and equity instrument.
Financial instruments are one of the easiest topics to understand as there are only two aspects, viz.,
1. Amortized Cost
2. Fair value (Profit & loss or OCI)
Let’s start with understanding the meaning of Financial Instruments:
What is a financial instrument?
A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
Example;
Trade receivable one entity is payable of another entity.
A 500 rupee note is a legal tender issued by RBI, the person holding it own a financial asset and RBI is liable to pay, so records financial liability
Now, the next question arises is:
What is a financial asset?
A financial asset is any asset that is:
(a) cash;
(b) an equity instrument of another entity; Example –
Shares owned of a listed entity
© a contractual right:
(i) to receive cash or another financial asset from another entity; or
Example; Trade receivable, Loan receivable
(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
Example; Purchased options
(d) a contract that will or may be settled in the entity’s own equity instruments:
(i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments;
Example; Equity instruments receivable against Rs. 500,000 loan receivable, the no of shares received are variable, depending on the price of each share.
(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments.
Example; 1 share received for every Rs. 500 of loan receivable, so for a total receivable of Rs. 500,000, a total of 1000 shares will be received.
Read Top 11 Elements of Financial Statements
What is a financial liability?
A financial liability is any liability that is:
(a) a contractual obligation:
(i) to deliver cash or another financial asset to another entity;
Example; Trade payable, Loan payable
(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity
Example; Written options
(b) a contract that will or may be settled in the entity’s own equity instruments:
(i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments;
Example; Equity instruments to be issued against payable of Rs. 500,000, the no of shares to be issued are variable, depending on the price of each share.
(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments.
Example; 1 share issued for every Rs. 500 of loan payable for a total payable of Rs. 500,000, a total of 1000 shares will be issued.
The equity conversion option embedded in a convertible bond denominated in foreign currency to acquire a fixed number of the entity’s own equity instruments is an equity instrument if the exercise price is fixed in any currency.
What is an equity instrument?
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Example; Treasury shares- Buyback of shares reduces equity
If an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be deducted from equity.
No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments.
Such treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received shall be recognised directly in equity
Equity a/c — Dr
Asset/Cash a/c — Cr
How are puttable financial instruments dealt?
A puttable instrument is a financial instrument that gives the holder of the instrument the right to put the instrument back to the issuer for cash or another financial asset or is automatically put back to the issuer on the occurrence of an uncertain future event or the death or retirement of the instrument holder.
As an exception, puttable instruments are classified as an equity instrument even if they meet the definition of financial liability.
What is the objective of this standard?
The objective of this Standard is to establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities.
It applies to:
i. The classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments;
ii. The classification of related interest, dividends, losses and gains; and
iii. The circumstances in which financial assets and financial liabilities should be offset.
How to differentiate between a Liability & equity?
Liability
If there is an obligation to pay, and does not have the unconditional right to avoid delivering cash or another financial asset-It is a financial liability.
Example
Contingent settlement provisions unless possibility of settlement is remote
Settlement options requiring to pay
Equity
If there is no contractual obligation to pay, and the other party cannot require paying cash or another financial asset-it is recognized as equity.
Example
No. of equity instruments and the price per unit of equity instruments is fixed (Fixed to fixed contract)
Which financial instruments have both financial liability & equity components?
Compound Financial Instruments contains both components of liability & equity.
Such components shall be classified separately as financial liabilities or equity instruments.
Illustration;
A convertible bond
Helphumans.org issues 5,000 convertible bonds at the beginning of 1 April 2014.
The bonds have a four-year term, and are issued at par with a face value of Rs. 2000 per bond, giving total proceeds of Rs. 10, 00,000.
The bonds are convertible into ordinary at any time up to maturity into 600 ordinary shares.
The interest payable at the end of each year is at a nominal interest rate of 7%.
The prevailing market rate of interest for a similar borrowing is 10%. And discounting factor for a four year period is 0.683 & annuity factor for 4 years is 3.169
To know more about What is the value of the equity component in the bond? Visit Takshila learning…..
Visit our IFRS Course BLOG SECTION to explore more topics.
Learn IAS 19 / Ind AS 19 Employee Benefits
Takshila Learning also offers an DipIFRS Course which is also one of our Best Selling Courses. To know more register with us @www.takshilalearning.com.
With the increase in the use of technology in our day to day lives, we have designed Online Classes for various Courses such as School from K-12, Professional Courses, i.e., CA/CS/CMA/IFR, Skill Development courses, i.e, Digital Marketing and Competitive Exams, i.e., SSC/Banking/Railways. Our courses are comprised of HD video lectures, MCQ series, modules, assignments, sample papers, and notes.
Call at 8800999280 / 8800999283 / 8800999284

Author's Bio: 

k