Criteria for classifying as either financial liability or equity

What is the core criteria while classifying a financial instrument as either financial liability or equity?

The core criteria while classifying a financial instrument is to examine whether there exists a future obligation on the part of the entity to part with either cash or any other financial asset of the company while settling a particular contract.

The substance of a financial instrument, rather than its legal form, governs its classification in the entity’s balance sheet. Substance and legal form are commonly consistent, but not always. Some financial instruments take the legal form of equity but are liabilities in substance and others may combine features associated with equity instruments and features associated with financial liabilities. Compulsorily convertible preference shares, eg, provides for mandatory redemption by the issuer only by converting such preference shares into equity shares and as such, the entity does not have any obligation to part with either cash or any other financial asset of the company while redeeming such preference shares.

Consequences of treating equity vs liability

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…

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Classification of Foreign Currency Convertible Bond (FCCB)

Classification of Foreign Currency Convertible Bond (FCCB) An entity has issued a foreign currency convertible bond (FCCB). The Bond is denominated in foreign currency and would be converted into a fixed number of equity shares. Will this be treated as equity instrument or as a financial liability? Contracts that will…

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Bifurcation of compound financial instruments

Bifurcation of compound financial instruments Should the entity monitor a compound financial instrument in bifurcating such instrument into liability and equity component constantly and account for the same on every reporting period? A compound financial instrument should be evaluated for the terms of the financial instrument to determine whether it…

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What are treasury shares and how are these presented

What are treasury shares and how are these presented What are treasury shares and how are these presented in the financial statements? If an entity acquires its own equity instruments, these instruments are known as ‘treasury shares’ and are deducted from equity. No gain or loss shall be recognised in…

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Own use exemption as per the Accounting Standard

Own use exemption as per the Accounting Standard What is meant by own use exemption as per the Accounting Standard? Contracts that are entered into for the purpose of the receipt or delivery of a non-financial item for the entity’s own use is excluded from the scope of Accounting Standards…

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Contract is settled through the entity’s own equity instrument

Contract is settled through the entity’s own equity instrument When a contract is settled through the entity’s own equity instrument, can it be regarded as equity? A contract that will be settled by the entity receiving or delivering a fixed number of its own shares for no future consideration or…

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