Classifying Financial Instruments of an SME

(As Either Liabilities or Equity)

Ex1
SME A issues ordinary shares. Shareholders are entitled to a pro rata share of any dividends or other
distributions of the entity. Dividends are discretionary.

SME A does not have a contractual obligation to make dividend distributions or to redeem
the shares (i.e., it cannot be required to deliver cash or another financial asset to the
shareholders). The ordinary shares are classified as equity.

Ex2
The facts are the same as in Example 1 except that, because of legal requirements in its jurisdiction,
SME A is required to pay an annual dividend of at least 10 per cent of the par value of its issued
shares.

SME A has a contractual obligation to make dividend distributions (i.e., it is required to

deliver cash or another financial asset to the shareholders and it does not, therefore, have the
unconditional right to avoid such payment). The ordinary shares are financial liabilities
accounted for in accordance with Section 11/12.

Ex3
The facts are the same as in Example 1. However, in this example, SME A must redeem the shares for
par in the event of an initial public offering (IPO). SME A has discretion on whether or not to initiate
an IPO.

Because SME A has discretion on whether or not to initiate an IPO, it can avoid redeeming
the shares by avoiding the IPO. The ordinary shares are classified as equity.

Ex4
SME A has 100,000 preference shares in issue, which are all held by institutional investors. The
preference shares must be redeemed for cash on the earlier of five years from the issue date of the
shares or the date upon which SME A initiates an IPO. SME A has discretion on whether or not to
initiate an IPO.

SME A has a contractual obligation to deliver cash to its preference shareholders on the
earlier of a specified date (i.e., five years after the issue date of the preference shares) or on
the date of initiation of an IPO. Because SME A cannot avoid the redemption of the
preference shares, the preference shares are classified as financial liabilities and are
accounted for under Section 11/12.

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Ex5
SME A issues preference shares that are mandatorily redeemable at par 30 years later. Dividends are
discretionary.

A contractual obligation to deliver cash exists to repay the principal in 30 years’ time. That
present obligation is a liability. Because the dividend payments are at the discretion of SME
A, it could avoid paying those dividends and consequently they are not liabilities. SME A
has issued a compound financial instrument. At initial recognition, in accordance with
paragraph 22.13, the present value of the amount to be redeemed in cash is the financial
liability component with the residual amount of the proceeds being the equity component of
the compound financial instrument. The liability component is accounted for in accordance
with Section 11/12.

Ex6
SME A issues preference shares that are redeemable at par at the option of the holder. Dividends are
discretionary.

A contractual obligation to deliver cash exists to repay the principal at the holder’s request.
That present obligation is a liability. SME A cannot avoid redeeming the shares. Because the
dividend payments are at the discretion of SME A, it could avoid paying those dividends
and consequently they are not liabilities. SME A has issued a compound financial
instrument. At initial recognition, in accordance with paragraph
22.13, the present value of the amount to be redeemed in cash is the financial liability
component, with the residual amount of the proceeds being the equity component of the
compound financial instrument. The liability component is accounted for in accordance with
Section 11/12.

Ex7
SME A issues preference shares that are redeemable at par at the option of SME A. Dividends are
discretionary.

SME A does not have a contractual obligation to make dividend distributions or redeem the
shares (i.e., it cannot be required to deliver cash or another financial asset to another party).
The preference shares are classified as equity. An obligation will arise if SME A exercises its
option and informs the shareholders of its intention to redeem.

Ex8
A shareholder provides an interest-free loan to SME A. There is no specified maturity date. However,
the shareholder may ask for the loan to be repaid at any time. The shareholder does not intend to
require the loan to be repaid.

A contractual obligation to deliver cash exists because of the need to repay the principal. A
contractual obligation that is conditional on a counterparty exercising its right is a financial
liability, because the entity does not have the unconditional right to avoid delivering cash or
another financial asset. The loan is a financial liability and is accounted for in accordance
with Section 11/12.