International Financial Reporting Standards

Case study: issuing financial instruments Vienna, June 2014

The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation.

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The requirements are set out in International Financial Reporting Standards (IFRS), as issued by the IASB at 1 January 2014, including those with an effective date after 1 January 2014, but not the IFRSs they will replace. Disclaimer: The IFRS Foundation, the authors, the presenters and the workshop organisers do not accept responsibility for any loss caused by acting or refraining from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise and this presentation is not a form of advice or opinion. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Framework-based approach for applying IFRS

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• What are the economics of the phenomenon (eg transaction or event)? • What information about the phenomenon is relevant for informing resource allocation decisions by existing and potential investors and lenders who cannot require information directly and that can be faithfully represented? • Then consider IFRS requirements • Make judgements to develop accounting policy • Make judgements and estimates to apply the requirements with rigour and consistency ©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Background

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• Buildityourself (BIY) • plans to expand its operations • management are considering how to raise L$20 million to finance acquisition of warehouses • your advice is sought on the accounting for each of the ten alternatives being considered by management

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Discussion

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• Why contractual cash flows differ for each of the instruments (risks, rights, obligations)? • What elements as set out in the Conceptual Framework arise? • How would the contracts be accounted for in accordance with IFRS when first recognised? • When classification in accordance with IFRS differs from what would flow from the Conceptual Framework, discuss possible reasons why the Standard deviates from the element definitions. ©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Identifying elements Asset (see Conceptual Framework ¶4.4(a))

• resource controlled by the entity… • expected inflow of economic benefits Liability (¶4.4(b)) • present obligation… • expected outflow of economic benefits Equity (¶4.4(c))

• assets – liabilities

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Income (¶4.25(a)) • recognised increase in asset/decrease in liability in current reporting period • that result in increased equity except… Expense (¶4.25(b)) • recognised decrease in asset/increase in liability in current period • that result in decreased equity except…

IFRSs relevant to the classification of the issue of financial instruments • IAS 32 Financial Instruments: Presentation • IAS 39 Financial Instruments: Recognition and Measurement • IFRS 7: Financial Instruments: Disclosures • IFRS 9: Financial Instruments (if adopted early) • IFRIC 2 Members’ Shares in Co-operative Entities and Similar Instruments

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Alt 1: fresh issue of ordinary shares—identifying elements

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the share issue? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 1—elements Asset

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Liability

Equity

No. There is no present obligation the settlement of which is expected to result in an outflow of cash or other assets.

Yes. The claim against BIY that arises from receiving 20m in exchange for new ordinary shares is equity (ie on 1/1/20X0 assets (cash) increased by 20m without a corresponding increase in liabilities— because there is no obligation for BIY to deliver cash or other assets).

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 1: fresh issue of ordinary shares—IFRS accounting

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On initial recognition how would BIY classify the shares issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 1—IAS 32 Asset

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Liability

Equity

No. There is no present obligation for BIY to deliver cash or other resources (IAS 32.17).

Yes. An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all its liabilities (IAS 32.11). The instrument contains no contractual obligation to deliver cash or another financial asset or exchange under potentially unfavourable conditions (IAS 32.16).

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 2: mandatorily redeemable fixed-term variable-rate debentures

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 2—elements Asset

Liability

Yes. At 1 January 20X0 BIY has a present obligation to pay the contractual cash flows to the debenture holders. Consequently, the L$20 million claim against BIY is all a liability.

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

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Equity

Alt 2: mandatorily redeemable fixed-term variable-rate debentures

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On initial recognition how would BIY classify the instument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 2—IAS 32 Asset

Liability

Yes. At 1 January 20X0 BIY has a present obligation to pay the contractual cash flows to the debenture holders. Consequently, the L$20 million claim against BIY is all a financial liability.

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

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Equity

Alt 3: mandatorily redeemable fixed-term fixed-rate debentures

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 3—elements Asset

Liability

Yes. At 1 January 20X0 BIY has a present obligation to pay the contractual cash flows to the debenture holders. Consequently, the L$20 million claim against BIY is all a liability.

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

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Equity

Alt 3: mandatorily redeemable fixed-term fixed-rate debentures

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On initial recognition how would BIY classify the instrument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 4: mandatorily redeemable debentures, holder can redeem early

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 4—elements Asset

Liability

Yes. At 1/1/X0 BIY has a present obligation to pay: (i) 900k on 31/12/X0, 900k on 31/12/X1 and 20,900k on 31/12/X2. FV at 1/1/X0 = +19,727,675 (ie PV at say 5%); and (ii) stand ready to issue another debenture paying interest at 4.5% for a period of up to 7 years starting 1/1/X3. FV = +272,325

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Equity

Alt 4: mandatorily redeemable debentures, holder can redeem early

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On initial recognition how would BIY classify the instrument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 5: mandatorily redeemable debentures, issuer can redeem early

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 5—elements Asset

Liability

Yes. The early redemption feature is an option (right = resource) that BIY expects future economic benefits from. Eg, if interest rates fall, BIY could early redeem the debentures and issue new debt at a lower rate. +544,650

Yes. At 1/1/X0 BIY has a present obligation to pay 1.2m on 31/12/X0, 1.2m on 31/12/X1 and 21,2m on 31/12/X2. FV at 1/1/X0 = +20,544,650 (ie PV at say 5%). Note: by exercising its early redemption option BIY can avoid the contractual cash outflows in X3–X9)

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Equity

Alt 5: mandatorily redeemable debentures, issuer can redeem early

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On initial recognition how would BIY classify the instrument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 6: mandatorily redeemable fixed-term preference shares

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 6—elements Asset

Liability

Yes. At 1/1/X0 BIY has a present obligation to pay the contractual cash flows to the preference shareholders. Consequently, the 20m claim against BIY is all a liability.

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

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Equity

Alt 6: mandatorily redeemable fixed-term preference shares

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On initial recognition how would BIY classify the instrument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 7: convertible debentures— exercisable only at maturity

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 7—elements Asset

Liability

Yes. At 1/1/X0 BIY has a present obligation to deliver the contractual cash flows including the 10 year annuity and the redemption amount—a liability of +L$17,683,480 (ie PV at 5%)

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Equity

Yes. At 1/1/X0 the principal amount must convert into a fixed amount of ordinary shares (a residual interest) on 31/12/X9. Fair value = +L$2,316,520 . There is no present obligation in respect of this amount because it will be settled in shares—equity.

Alt 7: convertible debentures— exercisable only at maturity

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On initial recognition how would BIY classify the instrument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 8: convertible debentures— exercisable before maturity

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 8—elements Asset

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Liability

Equity

Yes. At 1/1/X0 BIY has a present obligation to deliver the contractual cash flows—10 year annuity and redemption amount—a liability of +L$16,911,306. Any variation in the term of the annuity is controlled by the debenture holders, not BIY.

Yes. At 1/1/X0 the debenture holders hold an option to convert between 1/1/X4 and 31/12/X9 their debentures into a fixed number of ordinary shares (a residual interest, ie there is no present obligation because, if exercised, it will be settled in a fixed number of ordinary shares—equity).

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 8: convertible debentures— exercisable before maturity

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On initial recognition how would BIY classify the instrument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 9: debentures with conditional issuer-held early redemption

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 9—elements Asset

Liability

Yes. The early redemption feature is an option (right = resource) that BIY expects future economic benefits from. If interest rates fall, and BIY shares share price exceeds L$26, BIY could early redeem the debentures and issue new debt at a lower rate.

Yes. At 1/1/X0 BIY has a present obligation to pay contractual cash flows to the debenture holders—a liability. Market expectations of the probability of the uncertain future event regarding the early redemption feature occurring affects the FV of the liability.

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Equity

Alt 9: debentures with conditional issuer-held early redemption

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On initial recognition how would BIY classify the instrument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 10: convertible debentures with conditional early redemption

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Using only the Conceptual Framework, what elements other than L$20m cash asset would arise for BIY from the instrument issued? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alternative 10—elements Asset

Liability

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Equity

Yes. See alt. 9. Yes. At 1/1/X0 BIY has a Yes. See Alt 8. present obligation to pay contractual cash flows to the debenture holders—a liability.

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Alt 10: convertible debentures with conditional early redemption

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On initial recognition how would BIY classify the instrument issued in accordance with IFRS? Choose 1 of: (a) liability only; (b) equity only; (c) separate liability and equity components; (d) separate asset and liability components; or (e) separate asset, liability and equity components. © IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Compound financial instruments— judgements and estimates

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IFRS 9/IAS 39 assessing whether an embedded derivative is closely related to the host contract? Fixed for fixed—is BIY using its shares as currency?

Identifying relevant contractual cash flows. Determining the appropriate discount rate.

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Thank you

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