Financial Instruments with Characteristics of Equity

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marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

@ Marek: This was my first thought about the accounting treatment, and that´s why I wrote that it was all clear yesterday. BUT after reading the aditional posts I am not sure about whether the fact that the payment can be postponed let´s say until liquidation makes the dividends non-discretional because the issuer can basically avoid the payment (obligation to deliver cash) and this would not be a liability, right?
JRSB
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Re: Financial Instruments with Characteristics of Equity

Post by JRSB »

@Marek ok yes if that's the case (and it may differ by country) then that would settle it as liability (part of whole) for me! I can envisage a scenario where the unpaid amounts are only paid after creditors in full, and receive pro rata attribution of net assets just like ordinary holders.
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

@marea
it's still a liability, see IAS 32.16C

@JRSB
not only it can differ by country, it can differ by each issued instrument :)
If the terms of preference shares were such that the unpaid dividends are forfeited on liquidation and preference shareholders are treated as ordinary shareholders then yes - I would agree to classify them as equity :)
marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

@ Marek. I think IAS 32 16C is only applicable to puttable instruments as I understand and would not apply in this case IMO.
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

only paras 16A and 16B are about puttable instruments
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exIFRS
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Re: Financial Instruments with Characteristics of Equity

Post by exIFRS »

I apologize I mislead @marea on this one. I agree only A and B relate to puttable instruments I knew that the whole liquidation thing was still niggling the back of my mind. It may also be worth looking at this document too: https://www.grantthornton.global/global ... report.pdf.
marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

Thanks for clarifying :-)
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exIFRS
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Re: Financial Instruments with Characteristics of Equity

Post by exIFRS »

As one final, unhelpful aside, in trying to get to the bottom of this I found this comment in a KPMG review of the current FICE project (emphasis added):
"In a change to current IAS 32 requirements, the timing and the amount features would be applied consistently, regardless of whether a contract is settled by delivering an entity’s own equity. For example, irredeemable fixed-rate cumulative preference shares would be classified as a financial liability. This is because the amount is independent of an entity’s available economic resources – i.e. an issuer is not required to pay the principal and dividend before liquidation but the fixed-rate dividends accumulate over time. These preference shares might be classified as equity under current IAS 32."
https://assets.kpmg/content/dam/kpmg/xx ... iendly.pdf
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

hm, so apparently a counterpoint, too bad it's left without any explanation...
marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

I found an interesting explanation from IASB DP/2018/1 about FICE

"One classification outcome that would change as a result of the articulation of
the second feature is that of irredeemable fixed-rate cumulative preference
shares (see paragraph 3.23(c)). IAS 32 classifies such cumulative preference
shares as equity instruments because there is no contractual obligation to
transfer cash or another financial asset or to deliver a variable number of shares
at a specified time other than at liquidation
"

At the bottom of this page is the link to the DP
https://www.iasplus.com/en/news/2018/06/fice-dp
marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

one additional question,
How is the term liquidation interpreted in this case? Would this explanation be equally applied in the case of selling the company?
JRSB
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Re: Financial Instruments with Characteristics of Equity

Post by JRSB »

Selling the company would only impact this in a specific case if there was some stipulation as to the settlement of otherwise of the preference shares as part of the sale agreement but otherwise it wouldn't have any impact.
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

Thanks marea for digging this out. I must admit that I have no clue how to reconcile the quoted paragraph from DP with IAS 32.16C.

PS direct link to the DP (par. 3.15 page 43)
https://www.ifrs.org/-/media/project/fi ... e-2018.pdf
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

I'm also thinking about financial statements. You don't remeasure equity after initial recognition, so with cumulative preference shares you'll end up with huge 'hidden' liability payable at liquidation.
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Re: Financial Instruments with Characteristics of Equity

Post by JRSB »

The unpaid coupon recorded cumulatively as unpaid dividends, ie that aspect itself being a 'liability' but in substance equity ?
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

yes, I'm talking about that cumulative dividend that will build up unrecognised in financial statements even though there's contractual obligation to pay it at liquidation

but after re-reading para 16C I see that it covers only instances when:
1/ liquidation either is certain to occur and outside the control of the entity (for example, a limited life entity) or
2/ is uncertain to occur but is at the option of the instrument holder

So this is not applicable to typical preference shares.

I guess we've established, based on explicit wording in IASB's DP, that cumulative preference shares, where the contractual obligation to pay dividends arises on liquidation only, and that liquidation does not meet the conditions in para 16C, are classified as equity
marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

I thought that dividends will accrue over time...

@ Marek I would maybe also add "where preference shares that are ireedimable and payment of dividends is at the discretion of the issuer" would be classified as equity. To have the whole picture.

Thank you all so much for your help on this topic. I´ve learned a lot :-)
DJP
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Re: Financial Instruments with Characteristics of Equity

Post by DJP »

Hello everyone,

If I understand this case correctly, the issuer can avoid settlement of the amount invested and dividends (even if they accumulate). If so, this meets the definition of equity as per IAS 32 para 16. At liquidation the whole arrangement may be seen as a liability and take precedence over equity claims, but I am not sure if that matters for IFRS accounting purposes.

Question is: is the liquidation of this company something that is planned (like a close-ended mutual fund with a maturity)? Or are we talking about liquidation in case of a bankruptcy?

Cheers
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

I suppose the liquidation is not planned, otherwise we would fall under IAS 32.16C
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

PS. and congrats to you marea for starting the most discussed topic so far ;)
marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

Thank you Marek :-). I was surprised how complex this topic could be.

Last clarification: Would the fixed cumulative dividends not be recognised in SOFP, provided that the preference shares are entiteled to a yearly fixed dividend?
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

well, the general rule is that equity instruments are not remeasured subsequently, so you won't recognise undistributed dividends in SoFP
once a dividend is paid it will be recognised as a typical dividend, i.e. debited directly to equity (e.g. retained earnings)

sounds too good to be true, hm? :)
marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

Right :-), otherwise it would undermine the reasoning of recognising the preference shares as equity I guess.
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Re: Financial Instruments with Characteristics of Equity

Post by JRSB »

That part I'm not clear on. for example if you have declared but unpaid dividends on ordinary shares at year end, that's a liability. Deloitte IAS 32 guidance talks about 'accrued unpaid preference dividends' presumably which would be liabilities.
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

I won't say I'm 100% sure, but in marea's case you have no obligation to pay dividends unless you declare one for ordinary shareholders. Which may never happen and that's why these preference shares are not a liability. It would seem to be against this logic to recognise these preference dividends in SoFP every year, unless of course dividend is declared for ordinary shareholders

Ps. Mabe Deloitte's guidance is in the context of preference shares where dividend is mandatory each year?
pub_acco
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Re: Financial Instruments with Characteristics of Equity

Post by pub_acco »

I think the unpaid cumulative dividends are not recognized as a liability until the issuer declares to pay some or all of them. But the cumulative amount has to be disclosed in accordance with IAS 1.137, and the accrued amounts continue to limit the EPS of common shares every year. So, they are never "hidden" or "good" for common share holders.
marea
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Re: Financial Instruments with Characteristics of Equity

Post by marea »

It makes sense to me. Thank you.
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Marek Muc
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Re: Financial Instruments with Characteristics of Equity

Post by Marek Muc »

Great points, pub_acco
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