Consequences of treating equity vs liability
What are the consequences of treating a contract as equity and how its treatment is different if treated as liability?
The consequences of treating particular contract as equity are as follows:
Treatment when the financial instrument is equity:
- Any consideration received (such as the premium received for a written option or warrant on the entity’s own shares) is added directly to equity.
- Any consideration paid (such as the premium paid for a purchased option) is deducted directly from equity.
- Changes in the fair value of an equity instrument are not recognised in the financial statements.
- Income and expenses on instruments classified as equity instrument are taken directly to equity.
- Gains and losses on redemptions, refinancing, etc, of financial instruments classified as equity are shown as movements in equity.
Treatment when the financial instrument is a liability:
- Income and expenses on instruments classified as liabilities are reported in the statement of comprehensive income.
- Gains and losses on redemptions, refinancing, etc, of such instruments are also reported in comprehensive income.
- Example: Dividends on preference shares classified as liability are shown as expense like interest on bonds.