A PRACTICAL GUIDE TO THE CLASSIFICATION OF …

1 Liability or equity ?A PRACTICAL GUIDE TO THE CLASSIFICATION OF FINANCIAL INSTRUMENTS UNDER IAS 32 MARCH 2013 Important Disclaimer:This document has been developed as an information resource. It is intended as a GUIDE only and the application of its contents to specific situations will depend on the particularcircumstances involved. While every care has been taken in its presentation, personnel whouse this document to assist in evaluating compliance with International Financial ReportingStandards should have sufficient training and experience to do so. No person should actspecifically on the basis of the material contained herein without considering and takingprofessional advice. Neither Grant Thornton International Ltd, nor any of its personnel nor anyof its member firms or their partners or employees, accept any responsibility for any errors itmight contain, whether caused by negligence or otherwise, or any loss, howsoever caused,incurred by any person as a result of utilising or otherwise placing any reliance upon this or equity ?

2 ILiability or equity ?When an entity issues a financial instrument, itmust determine its CLASSIFICATION either as a liability(debt) or as equity . That determination has animmediate and significant effect on the entity sreported results and financial position. Liabilityclassification affects an entity s gearing ratios andtypically results in any payments being treated asinterest and charged to earnings. Equityclassification avoids these impacts but may beperceived negatively by investors if it is seen asdiluting their existing equity the CLASSIFICATION process and itseffects is therefore a critical issue for managementand must be kept in mind when evaluatingalternative financing 32 Financial Instruments: Presentation (IAS 32) addresses this CLASSIFICATION IAS 32 s approach is founded uponprinciples, its outcomes can sometime seemsurprising.

3 This is partly because, unlike previouspractice in many jurisdictions around the world,IAS 32 does not look to the legal form of aninstrument. Instead, it focuses on the instrument scontractual obligations. Identifying the substance ofthe relevant obligations can itself be challenging,reflecting the huge variety of instruments issued bydifferent types of entities around the , these principles sometime result ininstruments that intuitively seem like equity beingaccounted for as liabilities. As a result, the IASB hasmade some amendments to the Standard whichdepart from its core principles, further complicatingthe CLASSIFICATION the member firms within GrantThornton International one of the world s leadingorganisations of independently owned andmanaged accounting and consulting firms havegained extensive insights into the more problematicaspects of debt and equity CLASSIFICATION under IAS 32.

4 Grant Thornton International, through itsIFRS team, develops general guidance that supportsits member firms commitment to high quality,consistent application of IFRS. We are pleased toshare these insights by publishing the secondedition of Liability or equity ? A PRACTICAL GUIDE tothe CLASSIFICATION of financial instruments under IAS 32 (the GUIDE ). The GUIDE reflects thecollective experience of Grant ThorntonInternational s IFRS team and member firm IFRS experts. It addresses IAS 32 s key application issuesand includes interpretational guidance in certainproblematic areas. The second edition of the Guidereflects amendments that have been made to IAS 32since the GUIDE was first published and our latestthinking on some of the more problematic areas or equity ?

5 Sections of the GuideThe GUIDE is organised as follows: Section Agives an overview of the GUIDE Section Bconsiders the basic principle offinancial liability CLASSIFICATION . It discussescontractual obligations, how they arise and theireffects Section Clooks at those financial instrumentswhich can be settled in an entity s own equityinstruments and considers whether they shouldbe classified as liabilities or as equity Section Daddresses the 2008 amendments toIAS 32 relating to puttable instruments andobligations arising on liquidation Section Ediscusses compound financialinstruments instruments which possess bothliability and equity components Section Fconsiders briefly the IASB s potentialplans for the development of a new model forliability and equity A and B set out the full definitions of financial liability and equity C and D discuss certain specific issuesraised in the main body of the GUIDE in

6 Furtherdetail. Grant Thornton International LtdMarch 2013 IntroductioniA: Overview of the Guide11 Purpose of the Guide12 The importance of CLASSIFICATION as liability or equity13 Overview of IAS 32 and its CLASSIFICATION Financial instruments within the scope of IAS The basics of IAS 32 s CLASSIFICATION Implications of CLASSIFICATION as either liability or as equity4B: What is a contractual obligation to pay cash or another financial asset?51 Section overview52 Contractual Examples of contractual obligations to pay cash or another financial Members shares in co-operative entities and similar Contractual obligation that is not explicit103 Economic compulsion114 Contingent settlement Settlement terms not genuine135 Linked Dividend pushers and dividend blockers146 Guarantees within a group15C.

7 Instruments settled in an entity s own equity instruments161 Section overview162 The fixed test173 The fixed for fixed Own equity Obligations to purchase own equity instruments for Put and call options over non-controlling Settlement options234 Problems affecting application of the fixed and fixed for fixed Contracts to be settled by a fixed number of own equity instruments in exchange for a fixed amount of foreign Changes to the conversion Contingent conversion or exercise25 ContentsD: Puttable instruments and obligations arising on liquidation271 Section overview272 The puttable instruments What is a puttable instrument? The conditions to be met to achieve equity CLASSIFICATION under the Amendments293 The obligations arising on liquidation Other contractual No requirement to consider the expected total cash flows throughout the life of the The identical features condition374 Changes in CLASSIFICATION as a result of the Non-controlling Derivatives over puttable instruments and obligations arising on liquidation38E.

8 Compound financial instruments391 Section overview392 Examples of compound financial Financial instruments with payments based on profits of the Convertible bonds403 Split accounting for a compound financial instrument414 Compound instruments containing embedded non- equity derivatives425 Hybrid instruments426 Conversion of a convertible Early settlement of a convertible Amendment of the terms of a compound instrument to induce early conversion44F: Future Developments45 Appendix A: Definition of a financial liability46 Appendix B: Definition of equity47 Appendix C: Steps to follow in applying split accounting to a compound instrument48 Appendix D: Application of the fixed for fixed test49 Glossary51 Liability or equity ?

9 : Section A 1A. Overview of the GUIDE Summary of requirements IAS 32 addresses the equity or liability CLASSIFICATION of financial instruments. Certain financial instruments are scoped out of IAS 32 CLASSIFICATION as a financial liability or as equity depends on the substance of a financial instrument rather than its legal form. The substance depends on the instrument s contractual rights and obligations a basic principle of liability CLASSIFICATION is that a financial instrument which contains a contractual obligation whereby the issuing entity is or may be required to deliver cash or another financial asset to the instrument holder is a financial liability exceptions to the basic principle of CLASSIFICATION were introduced in 2008 by the Amendments to IAS 32 and IAS 1.

10 Puttable Financial Instruments and Obligations Arising on Liquidation instruments which may or will be settled in an entity s own equity instruments are classified according to specific criteria the fixed test for non-derivatives and the fixed for fixed test for derivatives instruments possessing the characteristics of both equity and liability CLASSIFICATION are compound instruments. The equity and liability components are accounted for Purpose of the GUIDE Liability or equity ? A PRACTICAL GUIDE to the CLASSIFICATION of financial instruments under IAS 32 (theGuide) explains the principles for determining whether the issuer of a financial instrument should classifythe instrument as a liability, equity or a compound instrument.