Summary
Highlights
IAS 32 is one of three standards dealing with financial instruments, focusing on presentation. It was revised in 2003 and applies from 2005 onwards. Its objective is to establish principles for presenting financial instruments, defining them, prescribing classification rules for equity versus financial liability, and describing compound financial instruments, treasury shares, and offsetting. It doesn't cover measurement or hedge accounting, which are addressed in IFRS 9 and IFRS 7.
A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or an equity instrument of another entity. It's a contract between two parties with clear economic consequences that generally cannot be avoided. An entity can be an individual, partnership, or incorporated body.
A financial asset is defined as cash, an equity instrument of another entity (not own shares), a contractual right to receive cash or another financial asset (e.g., trade receivables, loans, bonds), or a contractual right to exchange financial assets or liabilities under potentially favorable conditions (e.g., purchased call or put options). It also includes certain contracts settled in own equity instruments that involve receiving a variable number of own shares or derivatives settled other than by fixed-for-fixed exchanges.
A financial liability is a contractual obligation to deliver cash or another financial asset to another entity (e.g., trade payables, loans payable), or a contractual obligation to exchange financial instruments under potentially unfavorable conditions (e.g., written call or put options, excluding own equity instruments if they are not liabilities). Similar to financial assets, it includes certain contracts settled in own equity instruments where the entity is obliged to deliver a variable number of own shares or derivatives settled other than by fixed-for-fixed exchanges.
An equity instrument is defined as any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. This means equity is essentially the net assets. The classification between equity and liability focuses on whether there is a contractual obligation to transfer economic benefit to another party. If yes, it's a liability; if no, it's equity. Transactions in own equity involve contracts settled by the entity receiving or delivering a fixed number of its own shares for no future consideration or exchanging a fixed amount of cash/other financial assets for a fixed number of its own shares. The key here is 'own shares' and 'fixed amount'.
A compound financial instrument is a mix of both a liability and an equity element. A typical example is a convertible bond, where the issuer has a liability to repay but the holder has an option to convert it into the issuer's ordinary shares. IAS 32 requires these two elements to be classified and presented separately: the loan element as a liability and the conversion option as equity. Methods like the residual or 'with or without' method are used for this separation.
Treasury shares are own shares of an entity. When an entity acquires treasury shares, they cannot be presented as a financial asset; instead, their acquisition is directly deducted from equity. Offsetting a financial asset and liability means presenting them as a single net amount in the statement of financial position. This is permissible if the entity has a legally enforceable right to offset and intends to settle on a net basis or simultaneously realize the asset and settle the liability. If both conditions are met, offsetting is mandatory, not optional.
IAS 32 also covers other areas such as puttable instruments, contingent settlement provisions, and the presentation of interests and dividends.