Defining equity

IAS 32 Financial Instruments: Presentation is a standard that has had a somewhat contested history, but apparently remains difficult to replace. To paraphrase Winston Churchill, one might say it is the worst way of distinguishing debt from equity, apart from all the other ways. The standard was first issued in 1995 as the first part of the IASC’s financial instruments project (discussed above). As originally issued it dealt with the debt/equity divide, and minimum disclosures about financial instruments. The disclosures have been moved into IFRS 7 and IAS 32 has otherwise been revisited a number of times, most recently in 2008.

The fundamental dividing line that the standard establishes is that something can only be classified as equity if there is no contractual requirement to deliver cash or another asset to the holder – everything else is a liability, and the balance sheet must distinguish clearly between the two categories. It may be worth pointing out that the IASB also specifies that minority interests (or ‘non-controlling interests’ in IFRS terms) should be shown as a separate category of shareholders’ equity, and not be shown, as many companies used to do, as a third financing category.

When the standard started to be applied much more widely, in 2005, the IASB was made aware of a thorny problem that started out as the New Zealand farm cooperative problem and later extended to be also the German limited partnership problem. The New Zealand standard-setter ...

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