As we addressed here, the IASB has issued the Exposure Draft Financial Instruments with Characteristics of Equity—Proposed amendments to IAS 32, IFRS 7 and IAS 1, with a comment deadline of March 29, 2024.

We previously looked at the aspects of the exposure draft relating to the “fixed-for-fixed” criterion. Here’s another one. IAS 32 currently contains the following stipulation:

• An entity’s contractual obligation to purchase its own equity instruments gives rise to a financial liability for the present value of the redemption amount even if the obligation to purchase is conditional on the counterparty exercising a right to redeem (eg a written put option that gives the counterparty the right to sell an entity’s own equity instruments to the entity for a fixed price).

Note that the requirement is to measure the liability at the present value of the full redemption amount, rather than at a net amount based on the difference between the gross amount of consideration payable and the fair value of the shares to be received on settlement or exercise, as would be the case if the position could be net settled in cash. The exposure draft proposes leaving that basic approach unchanged, while adding the following:

• The redemption amount is discounted, assuming redemption will occur at the earliest possible redemption date specified in the contract. Therefore, the probability and estimated timing of the counterparty exercising their right to redeem have no effect on the initial or subsequent measurement of the financial liability.

The basis for conclusions notes that the current requirement is consistent with the treatment of shares that are mandatorily redeemable, thereby resulting in an entity reporting the same information in its financial statements irrespective of whether a redemption clause is embedded in the instrument or in a stand-alone derivative contract. It also notes:

• The Board remains of the view that recognizing a financial liability for the gross amount of consideration payable on settlement helps users of an entity’s financial statements assess its exposure to liquidity risk. For example, if a forward contract or written put option over the entity’s own shares is settled in cash, the entity’s assets would be reduced by the gross amount of that cash outflow because, unlike other derivatives, the entity would receive its own shares on settlement, not assets. There would therefore be a reduction instead of an increase in the net assets of the entity. For these reasons the Board proposes no changes to the requirement to recognize the financial liability at the present value of the redemption amount.

Even so, the document notes various measurement issues raised in practice, including how to measure the financial liability if the amount payable on redemption is variable and subject to a cap; the discount rate to be used to calculate the present value of the redemption amount if settlement occurs only after a specified period; and how to measure the financial liability if there are multiple contingencies that affect the redemption amount, among others. While measurement issues in general are outside the scope of the current project, the Board concluded it could at least make a few clarifying additions and changes, as illustrated above.

The exposure draft also makes clearer than before that any gains or losses on remeasuring the financial liability are recognized in profit or loss. Some took the view that this conflicts with the requirements in IFRS 10 to account in equity for transactions with owners in their capacity as owners. But the Board reiterated that remeasuring a financial liability isn’t (in the sense that IAS 1 looks at such things) a contribution by or distribution to owners, or any kind of change in an ownership interest. The exposure draft also takes on the question of the initial recognition of the redemption amount, and the component of equity against which that amount should be debited: some recognize the amount in non-controlling interest, raising a potential question over whether a portion of non-controlling interests has thereby been derecognized and whether the payment of dividends to non-controlling shareholders still represents a transaction with owners in their capacity as owners; others recognize the amount in another component of equity. The Board again didn’t specify the component of equity to be debited, observing as it has before that there could be jurisdiction-specific restrictions or regulations governing the use of some components of equity. It did specify though that the liability should be removed “from a component of equity other than non-controlling interests or issued share capital.”

To sum up the above: just about every aspect of this accounting (recognizing the liability based on the full value of the redemption amount; the initial treatment of the amount recognized; subsequent treatment of changes in the carrying amount) has been questioned in the past, but even so the IASB sticks to its guns. Presumably then the feedback on the current draft won’t provide too much more that it hasn’t heard before…

The opinions expressed are solely those of the author.