HKAS 32 - Financial Instruments - Presentation
1. Objective of HKAS 32
The objective of HKAS 32 is to establish principles for:
The principles in HKAS 32 complement the principles for:
2. Scope (Paragraphs 4-10)
2.1 General Scope
HKAS 32 shall be applied by all entities to all types of financial instruments except:
| Excluded Item | Relevant Standard |
|---|---|
| Interests in subsidiaries, associates or joint ventures accounted for under HKFRS 10, HKAS 27 or HKAS 28 | However, derivatives linked to these interests ARE within scope |
| Employers' rights and obligations under employee benefit plans | HKAS 19 |
| Insurance contracts as defined in HKFRS 17 | With specific exceptions (see below) |
| Financial instruments, contracts and obligations under share-based payment transactions | HKFRS 2 (with exceptions for paragraphs 8-10 and treasury shares) |
2.2 Insurance Contract Exceptions
HKAS 32 does apply to:
2.3 Contracts to Buy or Sell Non-Financial Items (Paragraphs 8-10)
HKAS 32 applies to contracts to buy or sell non-financial items that can be settled net in cash or another financial instrument, or by exchanging financial instruments, as if the contracts were financial instruments.
Exception: Contracts entered into and continued to be held for the purpose of receipt or delivery of a non-financial item in accordance with the entity's expected purchase, sale or usage requirements.
Settlement net in cash occurs when:
| Method | Description |
|---|---|
| (a) Terms permit either party to settle net in cash or another financial instrument | |
| (b) Entity has a practice of settling similar contracts net in cash (by offsetting contracts or selling before exercise/lapse) | |
| (c) Entity has a practice of taking delivery and selling within a short period for profit | |
| (d) The non-financial item is readily convertible to cash |
Key Rule: A written option to buy or sell a non-financial item that can be settled net in cash under (a) or (d) is always within scope - it cannot be held for receipt/delivery purposes.
3. Definitions (Paragraphs 11-14)
3.1 Core Definitions
Financial Instrument: Any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
Financial Asset: Any asset that is:
- (a) Cash
- (b) An equity instrument of another entity
- (c) A contractual right:
- (i) To receive cash or another financial asset from another entity; OR
- (ii) To exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity
- (d) A contract that will or may be settled in the entity's own equity instruments and is:
- (i) A non-derivative for which the entity is or may be obliged to receive a variable number of its own equity instruments; OR
- (ii) A derivative that will or may be settled other than by exchange of a fixed amount of cash for a fixed number of the entity's own equity instruments
Financial Liability: Any liability that is:
- (a) A contractual obligation:
- (i) To deliver cash or another financial asset to another entity; OR
- (ii) To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity
- (b) A contract that will or may be settled in the entity's own equity instruments and is:
- (i) A non-derivative for which the entity is or may be obliged to deliver a variable number of its own equity instruments; OR
- (ii) A derivative that will or may be settled other than by exchange of a fixed amount of cash for a fixed number of the entity's own equity instruments
Equity Instrument: Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Puttable Instrument: A financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset or is automatically put back to the issuer on the occurrence of an uncertain future event or the death or retirement of the instrument holder.
3.2 Key Clarifications on Definitions
"Contract" and "Contractual" (Paragraph 13):
"Entity" (Paragraph 14):
3.3 Rights Issues Amendment (Paragraph 11)
Rights, options or warrants to acquire a fixed number of the entity's own equity instruments for a fixed amount of any currency are equity instruments IF the entity offers them pro rata to all of its existing owners of the same class of its own non-derivative equity instruments.
3.4 Exception to Financial Liability Definition
An instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in:
4. Presentation - Liabilities and Equity (Paragraphs 15-27)
4.1 Core Classification Principle (Paragraph 15)
The issuer of a financial instrument shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions.
4.2 Conditions for Equity Classification (Paragraph 16)
An instrument is an equity instrument if, and only if, BOTH conditions (a) AND (b) are met:
Condition (a): The instrument includes no contractual obligation:
Condition (b): If the instrument will or may be settled in the issuer's own equity instruments:
4.3 Puttable Instruments - Exception (Paragraphs 16A-16B)
Five Features Required for Equity Classification:
| Feature | Description |
|---|---|
| (a) | Entitles holder to pro rata share of entity's net assets on liquidation |
| (b) | Instrument is in the class subordinate to all other classes (no priority, no conversion needed) |
| (c) | All instruments in the subordinate class have identical features |
| (d) | No other contractual obligation to deliver cash or another financial asset (apart from the put) |
| (e) | Total expected cash flows over life are based substantially on profit or loss, change in recognised net assets, or change in fair value of net assets |
Additional Condition (Paragraph 16B): The issuer must have no other financial instrument or contract that:
4.4 Instruments with Obligation on Liquidation Only (Paragraphs 16C-16D)
Three Features Required for Equity Classification:
| Feature | Description |
|---|---|
| (a) | Entitles holder to pro rata share of net assets on liquidation |
| (b) | Instrument is in the class subordinate to all other classes |
| (c) | All instruments in the subordinate class have identical contractual obligation to deliver pro rata share on liquidation |
Additional Condition (Paragraph 16D): Same as paragraph 16B - no other instrument/contract that restricts or fixes the residual return.
4.5 Reclassification Rules (Paragraphs 16E-16F)
Reclassification from equity to liability:
Reclassification from liability to equity:
4.6 No Contractual Obligation to Deliver Cash (Paragraphs 17-20)
Critical Feature Differentiating Liability from Equity:
The existence of a contractual obligation of the issuer to:
Substance over Legal Form (Paragraph 18):
Examples of Indirect Obligations (Paragraph 20):
4.7 Settlement in Own Equity Instruments (Paragraphs 21-24)
Key Principles:
| Scenario | Classification |
|---|---|
| Variable number of shares to equal fixed amount | Financial liability |
| Fixed number of shares for fixed amount of cash | Equity instrument |
| Fixed number of shares for variable amount of cash | Financial asset/liability |
| Contract to purchase own shares for cash | Financial liability (present value of redemption amount) |
Example from Paragraph 21:
Example from Paragraph 22:
4.8 Contingent Settlement Provisions (Paragraph 25)
A financial instrument is a financial liability if it requires the entity to deliver cash or another financial asset upon the occurrence or non-occurrence of uncertain future events beyond the control of both parties.
Exceptions (instrument remains equity):
4.9 Settlement Options (Paragraphs 26-27)
When a derivative financial instrument gives one party a choice over how it is settled, it is a financial asset or a financial liability unless all of the settlement alternatives would result in it being an equity instrument.
Example: A share option that the issuer can decide to settle net in cash or by exchanging its own shares for cash → Financial liability
5. Compound Financial Instruments (Paragraphs 28-32)
5.1 Definition and Recognition
The issuer of a non-derivative financial instrument shall evaluate the terms to determine whether it contains both a liability and an equity component. Such components shall be classified separately.
Example: A bond convertible by the holder into a fixed number of ordinary shares of the entity.
Two Components:
5.2 Measurement on Initial Recognition (Paragraphs 31-32)
Step-by-Step Approach:
| Step | Action |
|---|---|
| 1 | Determine fair value of the compound financial instrument as a whole |
| 2 | Measure fair value of the liability component (including any embedded non-equity derivative features) |
| 3 | Assign equity component the residual amount (Step 1 - Step 2) |
Key Rules:
5.3 Conversion and Extinguishment
On Conversion at Maturity:
On Early Redemption/Repurchase:
Inducement Offers (Paragraph 35):
6. Treasury Shares (Paragraphs 33-34)
6.1 Core Principle
If an entity reacquires its own equity instruments, those instruments ('treasury shares') shall be deducted from equity. No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity's own equity instruments.
Key Rules:
6.2 Exception for Investment Funds (Paragraph 33A)
An entity may elect (irrevocably, on an instrument-by-instrument basis) not to deduct from equity a treasury share that is included in an investment fund or is an underlying item when the entity reacquires its own equity instrument for such purposes.
Instead, the entity may:
6.3 Agency Holdings (AG36)
When an entity holds its own equity on behalf of others (e.g., a financial institution holding its own equity on behalf of a client), there is an agency relationship and those holdings are not included in the entity's statement of financial position.
7. Interest, Dividends, Losses and Gains (Paragraphs 35-41)
7.1 Core Principle
Interest, dividends, losses and gains relating to a financial instrument or a component that is a financial liability shall be recognised as income or expense in profit or loss. Distributions to holders of an equity instrument shall be recognised by the entity directly in equity. Transaction costs of an equity transaction shall be accounted for as a deduction from equity.
7.2 Classification Impact
| Item | Financial Liability | Equity Instrument |
|---|---|---|
| Interest/Dividends | Expense in profit or loss | Distribution in equity |
| Gains/Losses on redemption/refinancing | Profit or loss | Changes in equity |
| Changes in fair value | Recognised in financial statements | Not recognised |
7.3 Transaction Costs (Paragraphs 37-39)
Equity Transaction Costs:
Abandoned Equity Transactions:
Compound Financial Instruments:
Joint Transactions:
7.4 Tax Considerations (Paragraph 35A)
Income tax relating to:
Shall be accounted for in accordance with HKAS 12 Income Taxes.
7.5 Presentation of Dividends (Paragraph 40)
Dividends classified as an expense may be presented:
8. Offsetting a Financial Asset and a Financial Liability (Paragraphs 42-50)
8.1 Core Principle (Paragraph 42)
A financial asset and a financial liability shall be offset and the net amount presented in the statement of financial position when, and only when, an entity:
- (a) Currently has a legally enforceable right to set off the recognised amounts; AND
- (b) Intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.
8.2 Right of Set-Off (Paragraphs 45-46)
Definition: A debtor's legal right, by contract or otherwise, to settle or eliminate all or a portion of an amount due to a creditor by applying against that amount an amount due from the creditor.
Key Requirements:
8.3 Intention to Settle Net (Paragraphs 47-48)
Simultaneous Settlement:
When NOT Simultaneous:
8.4 When Offsetting is Usually Inappropriate (Paragraph 49)
| Situation | Reason |
|---|---|
| (a) Synthetic instruments | Different financial instruments used to emulate a single instrument |
| (b) Same risk, different counterparties | Forward contracts or derivatives with different counterparties |
| (c) Pledged collateral | Financial assets pledged as collateral for non-recourse liabilities |
| (d) Trust arrangements | Assets set aside in trust without creditor acceptance |
| (e) Insurance claims | Losses expected to be recovered from third party under insurance contract |
8.5 Master Netting Arrangements (Paragraph 50)
Definition: An agreement providing for a single net settlement of all financial instruments covered by the agreement in the event of default on, or termination of, any one contract.
Key Points:
8.6 Gross Settlement Systems (AG38F)
A gross settlement system may meet the net settlement criterion if it has all of the following characteristics:
| Characteristic | Description |
|---|---|
| (a) | Assets and liabilities submitted at same point in time for processing |
| (b) | Parties committed to fulfil settlement obligation once submitted |
| (c) | No potential for cash flows to change once submitted (unless processing fails) |
| (d) | Collateralised assets settled on securities transfer system (delivery vs payment) |
| (e) | Failed transactions re-entered until settled |
| (f) | Settlement through same settlement institution |
| (g) | Intraday credit facility in place, virtually certain to be honoured |
9. Application Guidance - Key Points
9.1 Financial Assets and Financial Liabilities (AG3-AG12)
Examples of Financial Assets:
Not Financial Assets:
9.2 Equity Instruments (AG13-AG14)
Examples of Equity Instruments:
9.3 Derivative Financial Instruments (AG15-AG19)
Characteristics:
Option Example:
9.4 Treatment in Consolidated Financial Statements (AG29-AG29A)
Key Principle:
10. Effective Date and Transition (Paragraphs 96-97)
10.1 General Effective Date
10.2 Puttable Instruments Amendments (June 2008)
10.3 Offsetting Amendments (December 2011)
10.4 Other Key Amendments
| Amendment | Effective Date |
|---|---|
| Classification of Rights Issues (October 2009) | Annual periods beginning on or after 1 February 2010 |
| Annual Improvements 2009-2011 Cycle (June 2012) | Annual periods beginning on or after 1 January 2013 |
| HKFRS 9 (September 2014) | When HKFRS 9 is applied |
| HKFRS 17 (January 2018) | When HKFRS 17 is applied |
11. Key Takeaways Summary Table
| Topic | Key Principle |
|---|---|
| Classification | Substance over legal form; based on contractual obligations |
| Equity Condition | No contractual obligation to deliver cash; fixed-for-fixed settlement in own equity |
| Puttable Instruments | Exception to liability classification if all 5 features + additional conditions met |
| Compound Instruments | Separate liability and equity components; equity is residual |
| Treasury Shares | Deducted from equity; no gain/loss recognised |
| Interest/Dividends | Liability → expense; Equity → distribution |
| Transaction Costs | Equity transactions → deduction from equity |
| Offsetting | Legal right + intention to settle net or simultaneously |
| Contingent Settlement | Liability unless not genuine, only on liquidation, or meets puttable exception |
| Settlement Options | Liability unless ALL alternatives result in equity |
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