IAS32- classification

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Leo
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IAS32- classification

Post by Leo »

Hi everyone,

If a contract specifies that the shares issued will pay a fixed dividends in the next 5 years, but the shareholder has can choose freely whether to convert or not those shares into cash. Is it considered as an equity instrument or a financial liability?

Thanks
JRSB
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Re: IAS32- classification

Post by JRSB »

What's your view Leo? ;)
Leo
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Re: IAS32- classification

Post by Leo »

just a practical example.

Company A issues 100 shares with nominal value of 1euro (which is the nominal value of other existing shares), for 10 euros each. For a consideration of a 1 000 euros.
So Scenario 1:
Each share will give dividend of XX each year until year number 5, and shares will be redeemed against cash at the value at the maturity date.

For me, this is a financial liability in its entirety. Because the issuer has a contractual obligation to deliver cash (dividend + redeemed shares at maturity year number 5)

Scenario 2:
Each share will give dividend of xx for the first 5 years after issue and at year 5, the holders have the option to redeem the shares or not at the fair value.

For me, this is still a financial liability in its entirety. Because the issuer cannot avoid to deliver cash if the holders decide to redeem the shares.

Scenario 3:
Each share will give dividend of XX for the first 5 years, that's it.

For me, this is still a financial liability because the issuer cannot avoid to deliver cash, even thought the dividend maybe be something not material, like 0.01 EUROS per share. (I'm not sure about this one)

Scenario 4:
each share will give the same rights than other existing shares. Only the dividends for the new issued shares must be paid first to the holders, then if any left, to the other existing shareholders.

For me, this is not a financial liability but a equity instrument because even though the dividend are paid first to the holders of the new shares, it's still the issuer that has the discretion to pay the dividends or not.



are the above conclusion correct or not? and which one please ?
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Marek Muc
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Re: IAS32- classification

Post by Marek Muc »

have a read:
https://ifrscommunity.com/knowledge-bas ... vs-equity/

and let us know what's left unresolved and why
Leo
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Re: IAS32- classification

Post by Leo »

did it and also the post where ExIFRS, you, Marea and JRSB discussed whether a preference shares should be considered as a liability or equity.

still not clear for me for the scenario 3. Is it entirely equity, liability or partially?

Imagine that you issue one million worth of shares, with mandatory payment of dividend of only 1 euros next year.

Does this make the insturment to be classified as liability in it's entirety ? Because yes, there is no avoidable obligation for the issuer to pay cash, isn't ?
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Marek Muc
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Re: IAS32- classification

Post by Marek Muc »

Fully liability in this case.

Is this a real life scenario? What's behind this nominal dividend?
Leo
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Re: IAS32- classification

Post by Leo »

Thanks Marek, no, is not, but just a stress test to push the scenario to the extreme to see if the theory can still be applicable and make sense nonetheless.
JRSB
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Re: IAS32- classification

Post by JRSB »

I guess there's a point at which the substance of the arrangement is equity even if there's a guaranteed 'dividend', perhaps where the existence of the dividend makes no economic difference to shareholders, though one for arguing with the auditors rather than in applying the standards correct technically. Is there an imagined scenario where such an arrangement would be beneficial? If it was to incentivise investment in the first place, then that would imply a change in economic value so wouldn't be an immaterial factor.
Leo
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Re: IAS32- classification

Post by Leo »

Now I think scenario 3 is a hybrid instrument rather than full liability.
Leo
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Re: IAS32- classification

Post by Leo »

Hi,

Please allow me to reconsider Marek's position in this post.

In a case where a company issue prefs and the prefs are redeemable at the issuer's discretion but provide for a mandatory payment of the dividend each year.

In that case, I would say that the principal is classified as equity and the dividend are classified as liability when they arises.

This is because there is no contractual obligation to deliver cash or another fi assets for the principal.

Do you agree?
hubertd
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Re: IAS32- classification

Post by hubertd »

You apply split accounting only for compound or hybrid instruments and prefs from your example are neither. It’s a liability in its entirety.
Leo
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Re: IAS32- classification

Post by Leo »

thanks, why this isn't a compound financial instrument? There is no contractual obligation to pay the principal.
Leo
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Re: IAS32- classification

Post by Leo »

Let me put it differently, if a prefs provides mandatory redemption for the principal amount but the dividends are at the issuer's discretion.

That's a compound financial instrument where the present value of the principal is a liability which is discounted by market rate, and the residual value in equity.

So why, the other way around would be different?
CPA Kevin Matt
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Re: IAS32- classification

Post by CPA Kevin Matt »

Leo wrote: 08 Jan 2024, 14:35 Hi,

Please allow me to reconsider Marek's position in this post.

In a case where a company issue prefs and the prefs are redeemable at the issuer's discretion but provide for a mandatory payment of the dividend each year.

In that case, I would say that the principal is classified as equity and the dividend are classified as liability when they arises.

This is because there is no contractual obligation to deliver cash or another fi assets for the principal.

Do you agree?
While your opinion does make sense as also stated here: https://ifrscommunity.com/knowledge-bas ... nce-shares but the principal amount should represent a residual interest in an entity’s net assets to qualify as equity otherwise it would be a liability.
Leo
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Re: IAS32- classification

Post by Leo »

Agree, it's a compound instrument, provided there is something left in equity. However, in practice, I would guess that most of the companies would take the shortcut to say it's full liability.
CPA Kevin Matt
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Re: IAS32- classification

Post by CPA Kevin Matt »

Yeah in some way that becomes a short cut ;) . I would prefer to not get an observation from the auditor as against opting for a simplistic approach. I have seen a lot of companies follow a similar approach for inter-company loans too meaning even when the underlying nature of those loans is an investment into the other entity yet on the surface they are continued to be presented as loans. I am sure there would many more examples of similar kind.
Leo
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Re: IAS32- classification

Post by Leo »

auditors are focused on auditing the conso, so if the difference is under the threshold on individual entity level, they wouldn't bother.
CPA Kevin Matt
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Re: IAS32- classification

Post by CPA Kevin Matt »

Depends on the type of auditor. I have been an auditor myself (with one of the big 4's) and I very much wanted to look at the nature of eliminations performed to arrive at the consolidated results. Just because something did not surface to the face of the financial statement doesn't reduces it's classification importance in my view.
Leo
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Re: IAS32- classification

Post by Leo »

That's a fair point, but from someone who did prepare the conso accounts (and also audited a few), it's a nighmare to split account the intercompany loans, the software can't eliminate it properly so you have to plugg manual entries. At the year end, it's not something you want to spend your nights on.
Leo
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Re: IAS32- classification

Post by Leo »

But that being said, I fully agree that companies should present their statutory accounts as faithfully as possible.
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