Module 22 Liabilities and Equity

2009
IFRS Foundation: Training Material for the IFRS® for SMEs
Module 22 – Liabilities
and Equity
IFRS Foundation: Training Material
for the IFRS® for SMEs
including the full text of
Section 22 Liabilities and Equity
of the International Financial Reporting Standard (IFRS)
for Small and Medium-sized Entities (SMEs)
issued by the International Accounting Standards Board on 9 July 2009
with extensive explanations, self-assessment questions and case studies
IFRS Foundation®
30 Cannon Street
London EC4M 6XH
United Kingdom
Telephone: +44 (0)20 7246 6410

Fax: +44 (0)20 7246 6411
Email:info@ifrs.org
Publications Telephone: +44 (0)20 7332 2730

Publications Fax: +44 (0)20 7332 2749
Publications Email: publications@ifrs.org
Web: www.ifrs.org
This training material has been prepared by IFRS Foundation education staff. It has not been approved by the
International Accounting Standards Board (IASB). The training material is designed to assist those training others to
implement and consistently apply the IFRS for SMEs. For more information about the IFRS education initiative visit
http://www.ifrs.org/Use+around+the+world/Education/Education.htm.
IFRS Foundation®
30 Cannon Street | London EC4M 6XH | United Kingdom
Telephone: +44 (0)20 7246 6410 | Fax: +44 (0)20 7246 6411
Email: info@ifrs.org Web: ww.ifrs.org
Copyright © 2012 IFRS Foundation®
Right of use
Although the IFRS Foundation encourages you to use this training material, as a whole or in part, for educational
purposes, you must do so in accordance with the copyright terms below.
Please note that the use of this module of training material is not subject to the payment of a fee.
Copyright notice
All rights, including copyright, in the content of this module of training material are owned or controlled by the IFRS
Foundation.
Unless you are reproducing the training module in whole or in part to be used in a stand-alone document, you must
not use or reproduce, or allow anyone else to use or reproduce, any trade marks that appear on or in the training
material. For the avoidance of any doubt, you must not use or reproduce any trade mark that appears on or in the
training material if you are using all or part of the training materials to incorporate into your own documentation.
These trade marks include, but are not limited to, the IFRS Foundation and IASB names and logos.
When you copy any extract, in whole or in part, from a module of the IFRS Foundation training material, you must
ensure that your documentation includes a copyright acknowledgement that the IFRS Foundation is the source of
your training material. You must ensure that any extract you are copying from the IFRS Foundation training
material is reproduced accurately and is not used in a misleading context. Any other proposed use of the IFRS
Foundation training materials will require a licence in writing.
Please address publication and copyright matters to:

IFRS Foundation Publications Department
30 Cannon Street London EC4M 6XH United Kingdom
Telephone: +44 (0)20 7332 2730 Fax: +44 (0)20 7332 2749
Email: publications@ifrs.org Web: www.ifrs.org
The IFRS Foundation, the authors and the publishers do not accept responsibility for loss caused to any person who
acts or refrains from acting in reliance on the material in this publication, whether such loss is caused by negligence
or otherwise.
The IFRS Foundation logo, the IASB logo, the IFRS for SMEs logo, the ‘Hexagon Device’, ‘IFRS Foundation’, ‘eIFRS’,
‘IAS’, ‘IASB’, ‘IASC Foundation’, ‘IASCF’, ‘IFRS for SMEs’, ‘IASs’, ‘IFRS’, ‘IFRSs’, ‘International Accounting Standards’
and ‘International Financial Reporting Standards’ are Trade Marks of the IFRS Foundation.
Contents
INTRODUCTION __________________________________________________________ 1
Learning objectives ________________________________________________________ 1
IFRS for SMEs ____________________________________________________________ 2
Introduction to the requirements_______________________________________________ 2
REQUIREMENTS AND EXAMPLES ___________________________________________ 3
Scope of this Section _______________________________________________________ 3
Classification of an instrument as liability or equity ________________________________ 7
Original issue of shares or other equity instruments ______________________________ 15
Sale of options, rights and warrants ___________________________________________ 20
Capitalisation or bonus issues of shares and share splits __________________________ 23
Convertible debt or similar compound financial instruments ________________________ 25
Treasury shares __________________________________________________________ 29
Distributions to owners _____________________________________________________ 31
Non-controlling interest and transactions in shares of a consolidated subsidiary ________ 33
Appendix to Section 22 – Example of the issuer’s accounting for convertible debt _______ 42
SIGNIFICANT ESTIMATES AND OTHER JUDGEMENTS _________________________ 45
COMPARISON WITH FULL IFRSs ___________________________________________ 46
TEST YOUR KNOWLEDGE ________________________________________________ 47
APPLY YOUR KNOWLEDGE _______________________________________________ 51
Case study 1 ____________________________________________________________ 51
Answer to case study 1 ____________________________________________________ 53
Case study 2 ____________________________________________________________ 55
Answer to case study 2 ____________________________________________________ 56
IFRS Foundation: Training Material for the IFRS® for SMEs (version 2012-3) iv
Module 22 – Liabilities and Equity
This training material has been prepared by IFRS Foundation education staff and has
not been approved by the International Accounting Standards Board (IASB).
The accounting requirements applicable to small and medium-sized entities (SMEs) are
set out in the International Financial Reporting Standard (IFRS) for SMEs, which was
issued by the IASB in July 2009.
INTRODUCTION
This module focuses on the principles for classifying financial instruments as either liabilities
or equity, and on accounting for equity instruments issued to individuals and other parties
acting in their capacity as investors in equity instruments (ie in their capacity as owners).
This module introduces the learner to the subject, guides the learner through the official text,
develops the learner’s understanding of the requirements through the use of examples and
indicates significant judgements that are required in Section 22. Furthermore, the module
includes questions that are designed to test the learner’s knowledge of the requirements and
case studies to develop the learner’s ability to classify financial instruments as either liabilities
or equity and to account for equity instruments issued to investors.
| Learning objectives
Upon successful completion of this module you should know the requirements for
classification of financial instruments as either liabilities or equity and for accounting for
equity instruments issued to parties acting in their capacity as investors in accordance with
the IFRS for SMEs. Furthermore, through the completion of case studies that simulate aspects
of the real-world application of that knowledge, you should have enhanced your competence
to apply those requirements. In particular you should, within the context of Section 22 of the
IFRS for SMEs, be able to:
 identify whether a financial instrument is within the scope of Section 22;
 classify financial instruments issued by an entity as either liabilities or equity;
 account for equity instruments issued to parties acting in their capacity as investors in
equity instruments;
 account for equity issued by means of sales of options, rights, warrants, bonus issues and
similar transactions;
 identify puttable instruments and instruments that impose upon the entity an obligation
to deliver a pro-rata share of net assets only on liquidation, which should be classified as
equity (some exceptions are specified);
 identify compound financial instruments (eg convertible instruments) and allocate the
proceeds between the liability component and the equity component of such instruments;
 account for treasury shares;
 measure and account for non-cash dividends; and
 account for changes in a parent’s controlling interest in a subsidiary that do not result in a
loss of control.
IFRS Foundation: Training Material for the IFRS® for SMEs (version 2012-3) 1
IFRS for SMEs

1
A distinction needs to be drawn between the IFRS for SMEs (mandatory requirements) and the
other material that is published with it.
The mandatory requirements are accompanied by other (non-mandatory) material, as follows:

 the Basis for Conclusions, which summarises the IASB’s main considerations in reaching
the conclusions in the IFRS for SMEs;
 the dissenting opinion of an IASB member who did not agree with the issue of the
IFRS for SMEs;
 a preface, which provides a general introduction to the IFRS for SMEs and explains its
purpose, structure and authority; and
 implementation guidance including illustrative financial statements and a disclosure
checklist.
In the IFRS for SMEs the Glossary is part of the mandatory requirements.
In the IFRS for SMEs there are appendices in Section 21 Provisions and Contingencies,
Section 22 Liabilities and Equity and Section 23 Revenue. Those appendices are non-mandatory
guidance.
Introduction to the requirements
The objective of general purpose financial statements of a small or medium-sized entity is to

provide information about the entity’s financial position, financial performance and cash
flows that is useful for economic decision-making by a broad range of users (eg existing and
potential investors, lenders and other creditors) who are not in a position to demand reports
tailored to meet their particular information needs. The objective of Section 22 Liabilities and
Equity is to establish principles for classifying financial instruments issued by an entity as
either liabilities or equity and for accounting for equity instruments issued to parties acting in
their capacity as owners.
Equity is the residual interest in the assets of an entity after deducting all its liabilities.
A liability is a present obligation of the entity arising from past events, the settlement of
which is expected to result in an outflow from the entity of resources embodying economic
benefits. There is an exception in Section 22 for puttable instruments and instruments that
impose on the entity an obligation to deliver a pro-rata share of net assets only on liquidation.
Such instruments are classified as equity instruments only if they are subordinate to all other
classes of instruments and satisfy specific criteria. Without this exception, these instruments
would be liabilities.
An issue of shares or other equity instruments, for example options or warrants, is recognised
as equity when another party is obliged to provide cash or other resources in exchange for the
instruments.
Equity instruments are measured at the fair value of the cash or other resources received or
receivable, net of any direct costs of issuing the instruments. If payment is deferred, the time
value of money is taken into account if its effect is material.
Capitalisation or bonus issues (stock dividends) and share splits do not result in changes to
total equity. They are recognised by reclassifying amounts within equity in accordance with
laws in the relevant jurisdictions.

Proceeds on the issue of a compound financial instrument are allocated between the liability
and equity components. First, the liability component is measured at the fair value of a
similar liability that does not have a conversion feature or similar associated equity
component, and then the residual amount is allocated to the equity component.
Treasury shares (eg when an entity purchases its own equity instruments) are measured at the
fair value of the consideration paid. Treasury shares are classified as equity (not assets) and are
deducted from equity. No gain or loss is recognised on the purchase, sale, issue or cancellation
of treasury shares.
Changes in a parent’s controlling interest in a subsidiary that do not result in a loss of control
are transactions between the owners. Consequently, no gain or loss is recognised on such
transactions.
REQUIREMENTS AND EXAMPLES
The contents of Section 22 Liabilities and Equity of the IFRS for SMEs are set out below and shaded
grey. Terms defined in the Glossary of the IFRS for SMEs are also part of the requirements.
Those terms are in bold type the first time they appear in the text of Section 22. The notes
and examples inserted by the IFRS Foundation education staff are not shaded. The insertions
made by the staff do not form part of the IFRS for SMEs and have not been approved by the IASB.
Scope of this section
22.1 This section establishes principles for classifying financial instruments as either liabilities
or equity and addresses accounting for equity instruments issued to individuals or other
parties acting in their capacity as investors in equity instruments (ie in their capacity as
owners). Section 26 Share-based Payment addresses accounting for a transaction in
which the entity receives goods or services (including employee services) as
consideration for its equity instruments (including shares or share options) from
employees and other vendors acting in their capacity as vendors of goods and services.
Notes
A financial instrument is any contract that gives rise to a financial asset of one entity
and a financial liability or equity instrument of another entity. This section does not
apply to the holder of the financial asset. It is important to note the difference
between Section 22 and Section 26 Share-based Payment. Section 26 specifies the
accounting and reporting for equity instruments that are issued to suppliers of goods
or services, including employees, in return for goods or services. The notes below
explain in more detail what is covered by Section 22.
Classifying financial instruments as either liabilities or equity

Section 22 requires an issuer of a financial instrument to classify at initial recognition
the financial instrument as either a financial liability or as equity according to the
substance of the contractual arrangement and the definitions of a financial liability
and equity in the IFRS for SMEs. For example, some instruments, such as mandatorily
redeemable preference shares, may have the legal form of equity, but are, in
accordance with the IFRS for SMEs, classified as liabilities.
The distinction between equity and liability can often be of great importance to
entities because it affects whether interest, dividends, losses and gains on those
instruments are recognised in equity (ie as an appropriation of or addition to equity) or
included in profit for the year (see the notes under paragraph 22.3). The distinction
will also affect gearing (leverage) and solvency ratios, which may result in a breach of
debt covenants and may be important if the company is required by law to maintain a
certain level of equity.
Accounting for equity instruments issued to parties acting in their capacity as owners
Section 22 covers the accounting treatment for equity instruments that are issued to
individuals or other parties acting in their capacity as investors in equity instruments
(ie in their capacity as owners); for example, capital contributions, reacquisitions of the
entity’s own equity instruments and dividends.
Owners are defined in the IFRS for SMEs as holders of instruments classified as equity.
Consequently, ‘an owner’ in an entity is any party holding an instrument in that entity
which the entity classifies as equity. ‘An owner’ does not refer to the legal owner or
controlling party of an entity.
Equity includes capital contributed by, and other amounts attributable to, the owners
of the entity (eg retained earnings). The different categories of equity differ depending
upon the nature of the organisation, for example, depending upon whether the entity
is a sole proprietorship, partnership or company. The categories might also differ
depending on legal and other requirements in different jurisdictions.
Generally, for sole proprietorships and partnerships, there is little need to distinguish
between capital contributed and profits retained in the business for investment
purposes. Any distinction made within equity will usually depend upon the sole
proprietor’s preference or the partnership agreement. There may be legal
requirements, but they are generally much less restrictive than those for companies
and more specific to the organisation. For this reason, this module focuses on the
more standardised requirements of companies. The formation of companies is usually
governed by legislation and there is usually a clear distinction between capital
contributed and profits retained in the business.
The IFRS for SMEs does not specify particular categories of equity. Consequently,
Section 22 specifies only general accounting requirements for the equity of an entity.
Note: throughout this module there are many examples of accounting for equity
transactions with parties acting in their capacity as owners. Those examples illustrate
common ways of accounting for these transactions within equity that also meet the
requirements of this section. However, an entity must comply with the legal
requirements of its jurisdiction as well as with Section 22. For example, this may
involve the recognition of different ‘reserves’ that are not classified in the same way as
those that are illustrated in the examples that follow. Jurisdictions may specify
particular requirements for categorising equity into a number of ‘reserves’ and may
restrict the use of particular ‘reserves’ in specific circumstances. For example, there
may be restrictions regarding out of which ‘reserves’ dividends can be paid.
Accounting for changes in a parent’s ownership interest that do not result in a loss of control
Changes in a parent’s controlling interest in a subsidiary that do not result in a loss of
control are treated as equity transactions with the owners and no gain or loss is
recognised (see paragraph 22.19).
Definition: equity
In the IFRS for SMEs, equity is the residual interest in the assets of the entity after
deducting all its liabilities.
Definition: financial liability

In the IFRS for SMEs, a financial liability is 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;
or
(b) a contract that will be, or may be, settled in the entity’s own equity instruments
and:
(i) under which the entity is, or may be, obliged to deliver a variable number of the
entity’s own equity instruments; or
(ii) will or may be settled other than by the exchange of a fixed amount of cash or
another financial asset for a fixed number of the entity’s own equity
instruments. For this purpose, the entity’s own equity instruments do not
include instruments that are themselves contracts for the future receipt or
delivery of the entity’s own equity instruments.
Note: part (b) of the definition of a financial liability was made in relation to
classification of certain complex financial instruments and is unlikely to be relevant to
most entities with simple transactions. Module 11 Basic Financial Instruments and
Module 12 Other Financial Instruments Issues contain more detail on applying the
definition of a financial liability.
Examples—acting in the capacity of an owner
Ex1 On 1 January 20X1 the controlling shareholder of SME A contributes cash of

CU50,000 (1) and a property with a fair value of CU50,000 to SME A.
The controlling shareholder is acting in the capacity of an owner of SME A. Both the
contribution of cash and the contribution of property are within the scope of
Section 22.
22.2 This section shall be applied when classifying all types of financial instruments except:
(a) those interests in subsidiaries, associates and joint ventures that are accounted
for in accordance with Section 9 Consolidated and Separate Financial
Statements, Section 14 Investments in Associates or Section 15 Interests in
Joint Ventures.
(b) employers’ rights and obligations under employee benefit plans, to which
Section 28 Employee Benefits applies.
(c) contracts for contingent consideration in a business combination (see Section 19
Business Combinations and Goodwill). This exemption applies only to the
acquirer.
(d) financial instruments, contracts and obligations under share-based payment
transactions to which Section 26 applies, except that paragraphs 22.3–22.6 shall
be applied to treasury shares purchased, sold, issued or cancelled in connection
with employee share option plans, employee share purchase plans, and all other
share-based payment arrangements.
Notes
The general classification principles established in Section 22 do not apply to those
financial instruments specified in paragraph 22.2. Those financial instruments are
specified in other sections of the IFRS for SMEs.
Classification of an instrument as liability or equity
22.3 Equity is the residual interest in the assets of an entity after deducting all its liabilities.
A liability is a present obligation of the entity arising from past events, the settlement of
which is expected to result in an outflow from the entity of resources embodying
economic benefits. Equity includes investments by the owners of the entity, plus
additions to those investments earned through profitable operations and retained for
use in the entity’s operations, minus reductions to owners’ investments as a result of
unprofitable operations and distributions to owners.
(1)
In this example, and in all other examples in this module, monetary amounts are denominated in ‘currency units (CU)’.
Notes
Section 22 requires the issuer of a financial instrument to classify the instrument, or
its component parts, on initial recognition, as a financial liability, or as an equity
instrument, in accordance with the substance of the contractual arrangement and
with the definitions of a financial liability and equity.
After classification under Section 22, the following requirements apply:
 Section 11 and 12 cover the accounting treatment for financial liabilities.
Interest, dividends, losses and gains relating to a financial instrument, or to a
component of a financial instrument that is a financial liability, are recognised
in profit or loss. Dividend payments on shares that are wholly recognised as
financial liabilities are therefore recognised as expenses in the same way that
interest on a bond is recognised. Similarly, gains and losses associated with
redemptions or refinancing of financial liabilities are recognised in profit or
loss. Changes in the fair value of particular financial liabilities are recognised
in profit or loss in the period of the change.
 Section 22 covers the accounting treatment for equity instruments.
Distributions to the holders of an equity instrument reduce equity directly.
Dividends on, and redemptions or refinancing of, equity instruments are
therefore recognised as changes in equity. Changes in the fair value of an
equity instrument are not recognised in the financial statements.
When an issuer determines whether a financial instrument is a financial liability or an
equity instrument, the instrument is an equity instrument if, and only if, the
instrument does not meet the definition of a financial liability.
Some considerations when making the assessment
A critical feature in differentiating a financial liability from an equity instrument is
the existence of a contractual obligation of the issuer either to deliver cash or another
financial asset to the holder, or to exchange financial assets or financial liabilities with
the holder under conditions that are potentially unfavourable to the issuer.
If an entity does not have an unconditional right to avoid delivering cash or another
financial asset to settle a contractual obligation, that obligation meets the definition of
a financial liability, except for those instruments that are classified as equity
instruments in accordance with the exemption in paragraph 22.4.
The appropriate classification is determined by the entity at the point of initial
recognition. An entity must consider all terms and conditions agreed between itself
(and its consolidated subsidiaries, if any) and the holders of the instruments. Entities
should distinguish between those cases in which the entity contractually has no
discretion over paying out cash or other financial assets and those in which, if a
payment is not made, there are other consequences. Even if an entity expects to
deliver cash or other financial assets to the holder of the instrument, provided that
there is no contractual obligation to do so, the instrument is not a financial liability.
In addition, the potential inability of an issuer to settle an obligation when
contractually required to do so, for example because of the need to obtain approval for
payment from a regulatory authority or because of a lack of funds or profits, does not
negate the contractual obligation.
Share capital can come in many forms. If distributions to shareholders are at the
discretion of the issuer (even if they are cumulative) and there is no requirement to
redeem the shares, the shares are equity instruments. The classification of issued
shares as equity instruments or as financial liabilities is not affected by, for example:
 a history of making distributions;
 an intention to make distributions in the future; or
 the amount of the issuer’s ‘reserves’ or profit or loss for the period.
Examples—classification of financial instruments as equity or financial

liabilities
Ex2 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 (ie it cannot be required to deliver cash or another financial asset to
the shareholders). The ordinary shares are classified as equity.
Ex3 The facts are the same as in Example 2 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 (ie 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.
Ex4 The facts are the same as in Example 2. However, in this example, in SME A’s
jurisdiction, tax is not payable on distributed profits under CU100,000. A 50 per
cent tax rate applies to all undistributed profits and to any distributed profits in
excess of CU100,000. Consequently, SME A always plans to make dividend
payments of at least CU100,000 in the light of the significant tax benefits.
Regardless of the intention of SME A and the probability of the entity making dividend
payments, there is no contractual obligation to deliver cash (or other financial assets)
to the shareholders. The ordinary shares are classified as equity.
Ex5 The facts are the same as in Example 2. 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.
Ex6 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 (ie 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.
Ex7 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.
Ex8 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.
Note: for Examples 8 and 9, refer to Section 22.13 in order to obtain more detail about
the method for determining the different components of the compound financial
instrument.
Ex9 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 (ie 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.
Ex10 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.
22.4 Some financial instruments that meet the definition of a liability are classified as equity
because they represent the residual interest in the net assets of the entity:
(a) A puttable instrument is a financial instrument that gives the holder the right to sell
that instrument back to the issuer for cash or another financial asset or is
automatically redeemed or repurchased by the issuer on the occurrence of an
uncertain future event or the death or retirement of the instrument holder. A puttable
instrument that has all of the following features is classified as an equity instrument:
(i) It entitles the holder to a pro rata share of the entity’s net assets in the event of
the entity’s liquidation. The entity’s net assets are those assets that remain
after deducting all other claims on its assets.
(ii) The instrument is in the class of instruments that is subordinate to all other
classes of instruments.
(iii) All financial instruments in the class of instruments that is subordinate to all
other classes of instruments have identical features.
(iv) Apart from the contractual obligation for the issuer to repurchase or redeem the
instrument for cash or another financial asset, the instrument does not include
any contractual obligation to deliver cash or another financial asset to another
entity, or to exchange financial assets or financial liabilities with another entity
under conditions that are potentially unfavourable to the entity, and it is not a
contract that will or may be settled in the entity’s own equity instruments.
(v) The total expected cash flows attributable to the instrument over the life of the
instrument are based substantially on the profit or loss, the change in the
recognised net assets or the change in the fair value of the recognised and
unrecognised net assets of the entity over the life of the instrument (excluding
any effects of the instrument).
(b) Instruments, or components of instruments, that are subordinate to all other classes
of instruments are classified as equity if they impose on the entity an obligation to
deliver to another party a pro rata share of the net assets of the entity only on
liquidation.
Notes
Because a puttable instrument contains a contractual obligation for the issuer to
deliver cash or another financial asset to the holder, such instruments are classified as
financial liabilities in accordance with the requirements of Section 22. However,
because they represent the residual interest in the net assets of the entity, puttable
instruments that meet all the criteria in paragraph 22.4(a) are classified as equity,
which is an exception to the principle.
Pro-rata share of the net assets on liquidation

A pro-rata share in 22.4(a)(i) and 22.4(b) would be determined by:
(i) dividing the entity’s net assets on liquidation into units of equal amount; and
(ii) multiplying that amount by the number of the units held by the financial
instrument holder.
An instrument that has a preferential right on liquidation of the entity does not have
an entitlement to a pro-rata share of the net assets of the entity on liquidation.
For example, an instrument has a preferential right on liquidation if it entitles the
holder to a fixed dividend on liquidation, in addition to a share of the entity’s net
assets, when other instruments in the subordinate class with a right to a pro-rata share
of the net assets of the entity do not have the same right on liquidation.
Subordinate class
When determining whether an instrument is in the subordinate class, an entity
evaluates the instrument’s claim on liquidation as if it were to liquidate on the date
when it classifies the instrument. An entity reassesses the classification if there is a
change in relevant circumstances; for example, if the entity issues a new type of
financial instrument or redeems an existing financial instrument.
If an entity has only one class of financial instruments, that class is treated as if it were
the subordinate class.
22.5 The following are examples of instruments that are classified as liabilities rather than
equity:
(a) An instrument is classified as a liability if the distribution of net assets on
liquidation is subject to a maximum amount (a ceiling). For example, if in
liquidation the holders of the instrument receive a pro rata share of the net
assets, but this amount is limited to a ceiling and the excess net assets are
distributed to a charity organisation or the government, the instrument is not
classified as equity.
(b) A puttable instrument is classified as equity if, when the put option is exercised,
the holder receives a pro rata share of the net assets of the entity measured in
accordance with this IFRS. However, if the holder is entitled to an amount
measured on some other basis (such as local GAAP), the instrument is
classified as a liability.
(c) An instrument is classified as a liability if it obliges the entity to make payments
to the holder before liquidation, such as a mandatory dividend.
(d) A puttable instrument that is classified as equity in a subsidiary’s financial
statements is classified as a liability in the consolidated group financial
statements.
(e) A preference share that provides for mandatory redemption by the issuer for a
fixed or determinable amount at a fixed or determinable future date, or gives
the holder the right to require the issuer to redeem the instrument at or after a
particular date for a fixed or determinable amount, is a financial liability.
22.6 Members’ shares in co-operative entities and similar instruments are equity if:
(a) the entity has an unconditional right to refuse redemption of the members’
shares, or
(b) redemption is unconditionally prohibited by local law, regulation or the entity’s
governing charter.
Notes
Partnerships and some co-operative entities may provide their members with a right to
redeem their interests in the issuer at any time for cash, which results in the members’
interests being classified as financial liabilities, except for those instruments that are
classified as equity instruments in accordance with paragraph 22.4. This right to
redeem may be a legal requirement.
Classification as a financial liability does not preclude the use of descriptors such as
‘net asset value attributable to members’ and ‘change in net asset value attributable to
members’ in the financial statements of an entity that has no contributed equity. It
also does not preclude the use of additional disclosures to show that total members'
interests comprise items such as ‘reserves’ that meet the definition of equity and
puttable instruments that do not.
Examples—members’ shares in co-operative entities
Ex11 Co-operative A has instruments in issue that allow the holders to exercise their
right to request redemption of their instrument at specified dates and amounts.
All other characteristics of the instrument are equity. Co-operative A’s governing
charter states that the entity has a choice on whether to accept the holder’s
request. There are no other conditions or limitations on the level of redemptions
or on the entity’s discretion to make payments to holders. Co-operative A has never
refused to redeem holders’ shares, although the governing board has the right to do
so.
The instrument is equity. Co-operative A does not have an obligation to transfer cash or
another financial asset. A history of, or an intention to make, discretionary payments
does not trigger classification as a liability.
Ex12 The following example illustrates a format for a statement of comprehensive

income and a statement of financial position that may be used by entities whose
share capital is not equity because the entity has an obligation to repay the share
capital on demand, but does not have all the features, or meet the conditions in
paragraph 22.4. In this example, the entity has no obligation to deliver a share of
‘reserves’ to its members.
SME A’s statement of comprehensive income for the year ended 31 December 20X1
20X1 20X0
CU CU
Revenue 472 498

Expenses (classified by nature or function) (367) (396)
Profit from operating activities 105 102
Finance costs
-Other finance costs (4) (4)
-Distributions to members (50) (50)
Change in net assets attributable to members 51 48
SME A’s statement of financial position at 31 December 20X1

31 December 20X1 31 December 20X0
CU CU
Assets
…
Total assets 1,291 1180
Liabilities
Current liabilities
(classified in accordance with IAS 1) X X
Share capital repayable on demand 202 161

Total current liabilities 574 499
Total assets less current liabilities 717 681
Non-current liabilities
(classified in accordance with IAS 1) X X
Total non-current liabilities 187 196
Other components of equity(2)

Retained earnings 530 485
717 681
Memorandum note—total members’ interests
Share capital repayable on demand 202 161
Reserves (retained earnings) 530 485
732 646
(2)
In this example, the entity has no obligation to deliver a share of its ‘reserves’ to its members, so
the ‘reserves’ are shown as equity. If there is such an obligation, this section of the statement of
financial position may need to be fully or partially transferred to liabilities, depending upon the
amount of the obligation.
Original issue of shares or other equity instruments
22.7 An entity shall recognise the issue of shares or other equity instruments as equity when
it issues those instruments and another party is obliged to provide cash or other
resources to the entity in exchange for the instruments.
(a) If the equity instruments are issued before the entity receives the cash or other
resources, the entity shall present the amount receivable as an offset to equity
in its statement of financial position, not as an asset.
(b) If the entity receives the cash or other resources before the equity instruments
are issued, and the entity cannot be required to repay the cash or other
resources received, the entity shall recognise the corresponding increase in
equity to the extent of consideration received.
(c) To the extent that the equity instruments have been subscribed for but not
issued, and the entity has not yet received the cash or other resources, the
entity shall not recognise an increase in equity.
Notes
If a company issues shares at a premium to their par value, the excess over the par value
is sometimes credited to an account in equity called the ‘share premium’ (or ‘capital
surplus’). The share premium is a component of contributed equity. Use of a ‘share
premium’ account is sometimes specified by legislation. For example, a jurisdiction’s
legislation may permit or require the share premium to be used when ‘writing-off’ share
issue costs and/or for transferring an option reserve within equity when options lapse.
Some of the examples below illustrate ways a share premium account is required to be
used in particular jurisdictions. It is important to note that requirements for the use of
share premium often depend on a particular jurisdiction’s legislation.
Examples—issue of shares
Ex13 SME A has issued share capital of CU100,000, which was contributed at par on
incorporation of SME A. The par value of the ordinary shares of the entity is CU1
per share.
At a later date SME A issued a further 50,000 ordinary shares at CU5 per share at a
premium. The shares are issued for cash.
Journal entries:
Dr Cash (financial asset) CU250,000
Cr Share capital (equity) CU50,000
Cr Share premium (equity) CU200,000
To recognise the issue of 50,000 shares at a premium for cash.
Disclosure of equity in the statement of financial position:
Extract from SME A’s statement of financial position

After issue Before issue
CU CU
…
Equity
Share capital 150,000 100,000
Share premium 200,000 -
…
Total equity attributable to owners of the parent XXX,XXX XXX,XXX
Ex14 The facts are the same as in Example 13. However, in this example, although the
50,000 shares have been issued, the cash for those shares has not yet been received
by the entity.
Journal entries:
Dr Receivable for shares (financial asset) CU250,000
To recognise the issue of 50,000 shares at a premium prior to receipt of cash.

After issue Before issue
CU CU
…
Equity
Share premium 200,000 -
Receivable for equity shares (250,000) -
…
Ex15 The facts are the same as in Example 13. However, in this example, the additional
50,000 ordinary shares have been subscribed for and paid for, but are yet to be
issued. SME A does not have any obligation to refund the cash received (ie it must
correspondingly issue the shares).
Journal entries:
Cr Advance received for shares to be issued (equity) CU250,000
To recognise the cash received for future share issue.

After subscription Before subscription
CU CU
…
Equity
Advance received for share to be issued 250,000 -
…
22.8 An entity shall measure the equity instruments at the fair value of the cash or other
resources received or receivable, net of direct costs of issuing the equity instruments.
If payment is deferred and the time value of money is material, the initial measurement
shall be on a present value basis.
Example—fair value of other resources
Ex16 On 1 January 20X1 SME B issues 150,000 ordinary shares in exchange for
1,000 ounces of gold. The par value of the shares is CU2 per share when gold was
trading at CU800 per ounce.
Journal entries on 1 January 20X1:

Dr Gold (asset) CU800,000
To recognise the 150,000 shares issued in exchange for 1,000 ounces of gold with a fair value of
CU800,000.
Example—deferred payment
Ex17 On 1 January 20X1 SME B issues 150,000 ordinary shares at CU6 per share. The par
value of the shares is CU2 per share. The cash consideration is payable to SME B on
31 December 20X2. The shares are to be held in an escrow account until payment is
received. However, the shareholders are eligible to vote and earn dividends on the
shares during 20X1 and 20X2. Assume that the appropriate discount rate is 5 per
cent. SME B has a 31 December year-end.
Dr Receivable for shares (financial asset netted off
(a)
equity) CU816,327
To recognise the issue of 150,000 shares at the present value of the deferred consideration (ie fair value).
Journal entries on 31 December 20X1:

equity) CU40,816
Cr Interest receivable (profit or loss) CU40,816
To recognise the unwinding of the discount on the receivable in 20X1 (ie CU816,327 x 5%).
Notes
The amount recognised for share capital and share premium is not adjusted for the unwinding of the
discount.
The ‘receivable for shares’ is adjusted for the unwinding of the discount. However, that adjustment is
recognised in profit or loss.
Journal entries on 31 December 20X2:

equity) CU42,857
Cr Interest receivable (profit or loss) CU42,857
To recognise the unwinding of the discount on the receivable in 20X2.

Cr Receivable for shares (financial asset netted off
equity) CU900,000
To recognise the settlement of the receivable.
(a)
900, 000
PV  2
 816, 327
(1.05)
22.9 An entity shall account for the transaction costs of an equity transaction as a deduction
from equity, net of any related income tax benefit.
Notes
An entity may incur costs in issuing or acquiring its own equity instruments. Such costs
might include registration and other regulatory fees, amounts paid to legal, accounting
and other professional advisers, printing costs and stamp duties. The transaction costs
of an equity transaction are accounted for as a deduction from equity (net of any related
income tax benefit) to the extent that they are incremental costs that are directly
attributable to the equity transaction and that otherwise would have been avoided.
Example—issue costs
Ex18 SME A issues 200,000 ordinary shares at CU1.25 per share. The par value of the
ordinary shares of the entity is CU1 per share. The shares are issued for cash and
CU1,000 share issue costs are incurred.
Journal entries:
(3)
To recognise the issue of the 200,000 shares.
22.10 How the increase in equity arising on the issue of shares or other equity instruments is
presented in the statement of financial position is determined by applicable laws.
For example, the par value (or other nominal value) of shares and the amount paid in
excess of par value may be presented separately.
Notes
The examples supporting paragraphs 22.7–22.9 illustrate the use of a share premium
account (sometimes called capital surplus). This is one common way in which the par
value (or other nominal value) of shares and the amount paid in excess of par value may
be presented separately.
(3)
‘Writing off’ the share issue costs of CU1,000 against share premium in accordance with the
legislation of the jurisdiction in which the entity operates.
Sales of options, rights and warrants
22.11 An entity shall apply the principles in paragraphs 22.7–22.10 to equity issued by means
of sales of options, rights, warrants and similar equity instruments.
Notes
A share option is an instrument that gives the holder the right, but not the obligation, to
buy a certain number of shares in the company. If the holder exercises the option, the
company increases its share capital when it issues the shares to the option holder.
Section 22 only covers accounting for share options that are issued to parties acting in
their capacity as owners. Share options issued to employees or suppliers for services or
goods are accounted for under Section 26 Share-based Payment.
Another form of an option is a warrant. The main difference between a warrant and an
option is that the warrant is generally linked to another form of financing. For example,
warrants may be given to a lender as part of a loan agreement in order to obtain funding
at a lower interest rate. They may also be given to a holder of preference shares as an
incentive to encourage the holder’s investment.
A rights issue is an issue of new shares where existing shareholders are given the right to
purchase an additional number of shares in proportion to their current shareholding.
If all shareholders exercise their rights and take up the shares, there will be no change in
each individual shareholder’s percentage ownership in the company. Shareholders have
the choice of either accepting or rejecting the rights. They may also have the option of
selling their rights to another party (for example, to another shareholder).
Examples—share options and rights
Ex19 SME A has a 31 December year-end. On 1 January 20X1 SME A has ordinary share
capital of CU100,000, which was contributed at par on incorporation of SME A.
The par value of the shares of the entity is CU1 per share.
On 1 January 20X1 the entity issues a further 150,000 ordinary shares at CU5 per
share. The shares are issued for cash.
Also on 1 January 20X1, as an incentive to encourage investment, each shareholder
is permitted to buy one share option for every share purchased on 1 January 20X1 at
CU0.5 per option. Each option allows the holder to buy one share on 31 January
20X2 at CU4 per share. 100,000 share options are purchased.
On 31 January 20X2 95,000 share options are converted into ordinary shares and
5,000 options lapse.

To recognise the issue of 150,000 shares for cash.

Cr Option reserve (equity) CU50,000
To recognise the issue of 100,000 share options for cash. The share options meet the requirement for
equity classification because the only obligation of the entity is to issue a fixed number of shares for a fixed
amount of cash.
On 31 December 20X1 no further journal entries are made in respect of the options,
because they are equity instruments and consequently the options are not remeasured
to fair value at each reporting date.

Dr Option reserve (equity) CU47,500
To recognise the issue of shares for the 95,000 options exercised.
Dr Option reserve (equity) CU2,500

Cr Share Premium (equity)(4) CU2,500
To recognise the lapse of 5,000 options.
On 31 January 20X2 SME A has the following items in its statement of financial
position:
CU
…
Equity
Share capital 345,000
Share premium 932,500
Option reserve 0
Retained earnings xxx
Total equity attributable to owners of the parent XXX
(4)
The transfer of the option reserve to share premium relating to the 5,000 options that lapsed to
share premium in accordance with the legislation of the jurisdiction in which the entity operates.
Ex20 On 1 January 20X1 SME C has the following items in its statement of financial
position:
CU
…
Equity
Share capital (50,000 shares at CU10 par value each) 500,000
Share premium 2,000,000
Retained earnings 3,600,000
Total equity attributable to owners of the parent 6,100,000
On 2 January 20X1 SME C declares a rights issue of one new ordinary share for each
five outstanding ordinary shares.
 exercise price: CU55
 last date to exercise the rights: 1 March 20X1.
The following journal entries record the above transaction, assuming that all rights are
taken up:
Note: in this example there are no entries until the rights are exercised.
To recognise the issue of 10,000 shares at CU55 each in a rights issue.
Capitalisation or bonus issue of shares and shares splits
22.12 A capitalisation or bonus issue (sometimes referred to as a stock dividend) is the issue
of new shares to shareholders in proportion to their existing holdings. For example, an
entity may give its shareholders one dividend or bonus share for every five shares held.
A share split (sometimes referred to as a stock split) is the dividing of an entity’s
existing shares into multiple shares. For example, in a share split, each shareholder
may receive one additional share for each share held. In some cases, the previously
outstanding shares are cancelled and replaced by new shares. Capitalisation and
bonus issues and share splits do not change total equity. An entity shall reclassify
amounts within equity as required by applicable laws.
Example—bonus issues and share splits
Ex21 On 31 December 20X0 SME A’s statement of financial position included the
following items.
CU
…
Equity
On 1 January 20X1 SME A gave its existing shareholders one bonus share for every
two shares held. The commercial law to which the entity is subject requires bonus
issues to first be accounted for as a depletion of share premium, if any.
The bonus issue could be recognised by the entity on 1 January 20X1 as follows:
Dr Share premium (equity)(5) CU20,000
Dr Retained earnings (equity) CU30,000
To recognise 5,000 bonus shares issued.
(5)
Note: a jurisdiction might require, permit or prohibit use of the share premium in this way.

After bonus issue Before bonus issue
(1 January 20X1) (31 December 20X0)
CU CU
…
Equity
Share premium – 20,000
Retained earnings 1,050,000 1,080,000
Total equity attributable to owners of the parent 1,200,000 1,200,000
Note: there is no change in total equity as a result of the bonus issue. However,
components within equity are reclassified.
Ex22 The facts are the same as in Example 21. However, in this example, on 1 January
20X1, instead of a bonus issue, the entity declared a share split of its existing shares
at 2-for-1. Every share of par value CU10 is converted to 2 shares of CU5 each.
It is not necessary to recognise any adjustment to the classifications within equity. This
will only have an impact on disclosures in the notes to the financial statements.

After share split Before share split
CU CU
…
Equity
Share premium 20,000 20,000
Retained earnings 1,080,000 1,080,000
Total equity attributable to owners of the parent 1,200,000 1,200,000
Note: on 1 January 20X1, there are 20,000 shares in issue with a par value of CU5 each.
Prior to the share split, on 31 December 20X0, there were 10,000 shares in issue with a
par value of CU10 each.
Convertible debt or similar compound financial instruments
22.13 On issuing convertible debt or similar compound financial instruments that contain
both a liability and an equity component, an entity shall allocate the proceeds between
the liability component and the equity component. To make the allocation, the entity
shall first determine the amount of the liability component as the fair value of a similar
liability that does not have a conversion feature or similar associated equity component.
The entity shall allocate the residual amount as the equity component. Transaction
costs shall be allocated between the debt component and the equity component on the
basis of their relative fair values.
Notes
The terms of a financial instrument may be structured in such a way that it contains
both equity and liability components (ie the instrument is neither entirely a liability,
nor entirely an equity instrument). Such instruments are known as compound financial
instruments. The liability and equity components of a compound financial instrument
are accounted for separately (this bifurcation is sometimes called ‘split accounting’).
Split accounting is consistent with the economic substance of the compound financial
instrument (ie it can be regarded as if it were two instruments—one liability instrument
and one equity instrument). From the perspective of the issuer, such an instrument
comprises two components:
 a contractual obligation to deliver cash (financial liability) by making payments of
interest and principal, which exist as long as the loan is not converted; and
 a call option granting the holder the right, for a specified period of time, to convert
the loan into a fixed number of ordinary shares of the entity (equity instrument).
The economic effect of issuing such an instrument is substantially the same as issuing
simultaneously:
 a debt instrument with an early settlement provision; and
 warrants to purchase ordinary shares.
Accordingly, the issuing entity presents the liability and equity components separately
in its statement of financial position.
The sum of the carrying amounts assigned to the liability and equity components on
initial recognition is equal to the total proceeds from issuing the convertible
instrument. No gain or loss is recognised on initially recognising the components of the
instrument separately. First the carrying amount of the liability component is
determined by measuring the fair value of a similar liability that does not have an
associated equity component. The carrying amount of the equity instrument is then
determined by deducting the fair value of the financial liability from the total proceeds
from issuing the compound financial instrument.
Compound financial instruments can also be issued with other embedded features such
as rights that investors might possess to sell a specified amount of their equity
instruments at a set price within a specified time. The fair value of any such derivative
feature embedded in the compound financial instrument other than the equity
component is included in the liability component (which is accounted for under
Section 12).
On conversion of a convertible instrument (for example, at maturity), the entity

derecognises the liability component and recognises it as equity. The original equity
component remains as equity (although it may be transferred from one line item within
equity to another). There is no gain or loss in accounting for the conversion of the
instrument.
Transaction costs that relate to the issue of a compound financial instrument are
allocated to the liability and equity components of the instrument in proportion to the
allocation of proceeds. Transaction costs that relate jointly to more than one
transaction are allocated to those transactions by using a rational basis that is consistent
with similar transactions.
22.14 The entity shall not revise the allocation in a subsequent period.
Notes
Classification of the liability and equity components of a convertible instrument is not
revised as a result of a change in the likelihood that a conversion option will be
exercised, even when exercising the option may appear to have become economically
disadvantageous to some holders. The entity’s contractual obligation to make future
payments remains outstanding until it is extinguished (for example, through conversion
or maturity of the instrument).
22.15 In periods after the instruments were issued, the entity shall systematically recognise
any difference between the liability component and the principal amount payable at
maturity as additional interest expense using the effective interest method (see
paragraphs 11.15–11.20). The appendix to this section illustrates the issuer’s
accounting for convertible debt.
Notes
For application of the requirements of paragraphs 22.13–22.15 see Appendix to
Section 22 Example of the issuer’s accounting for convertible debt.
Example—calculations for convertible bonds
Ex23 An entity issues 5,000 convertible bonds on 1 January 20X1. The bonds have a
five-year term and are issued at par with a nominal value of CU1,000 per bond (ie
total proceeds from the issue on 1 January 20X1=CU5,000,000). Interest is payable
annually in arrears at 5 per cent. Each bond is convertible at the option of the
holder at any time up to maturity into 100 equity shares with a par value of CU1.
When the bonds were issued, the prevailing market interest rate for similar debt
instruments without a conversion feature is 8 per cent.
On 1 January 20X1 (at initial recognition) the liability component is first measured at the
fair value of a similar liability that does not have a conversion feature (see paragraph
22.13). Then the equity component is measured at the difference between the proceeds
of the bond issue and the liability component. The fair value of the liability component
at the time of issuing the instrument is calculated at the present value of the cash flows
of a similar liability that does not have a conversion feature, discounted using the
market interest rate for similar bonds that have no conversion rights (in this example
8 per cent), as follows:
CU
Present value of principal = 5,000,000 ÷ (1.08)5

3,402,916
Present value of the interest = 250,000 x (1 minus (1.08)5) ÷ 0.08 998,178
Total liability component 4,401,094
Equity component (residual component, convertible loan reserve) 598,906
Proceeds from the issue 5,000,000
Present value of the interest:

250,000/1.08 + (250.000/1.08^2) + (250.000/1.08^3) + (250.000/1.08^4) + (250.000/1.08^5)=998,178
Alternatively, the following formula can be used to calculate the present value of the interest payments.
In the formula, future payments (C) are discounted by the periodic rate of interest (i) over the number of
periods (n):
C  1  1  (1  i )  n 
PV   1     
i  (1  i ) n 
C
 i 
During 20X1 to 20X5, the entity systematically recognises the difference between the
liability component (CU4,401,094) and the principal amount payable at maturity
(CU5,000,000) as additional interest expense, by using the effective interest method as
shown below unless the bond is converted prior to maturity:
Year Liability at the Effective Interest paid Liability at the
beginning of the interest annually end of the year
year (8%) (5%)
CU CU CU CU
20X1 4,401,094 352,087 (250,000) 4,503,181
20X2 4,503,181 360,254 (250,000) 4,613,435
20X3 4,613,435 369,075 (250,000) 4,732,510
20X4 4,732,510 378,601 (250,000) 4,861,111
20X5 4,861,111 388,889 (250,000) 5,000,000
Ex24 The facts are the same as in Example 23. On 31 December 20X1 2,000 bonds are
converted into shares. The remaining 3,000 bonds are converted into shares on
31 December 20X5 (maturity).
Journal entries for the year ended 31 December 20X1:
Dr Finance costs (profit or loss) CU352,087
Cr Convertible loan (liability element) CU352,087
To recognise the unwinding of the discount in the convertible loan in 20X1.
31 December 20X1:
Dr Convertible loan (liability element) CU250,000
Cr Cash (financial asset) CU250,000
To recognise the cash outflow for ‘interest’ paid to holders of convertible instruments.
Dr Convertible loan (liability element) CU1,801,272

Dr Convertible loan reserve (equity element) CU239,562
Cr Share capital (equity) [200,000 shares at CU1
par value] CU200,000
Cr Share premium (equity) CU1,840,834
To recognise the conversion of 2,000 of the 5,000 bonds into 200,000 shares. The carrying amount of the
liability element attributable to the 2,000 bonds of CU1,801,272 (=4,503,181 x 2/5) is converted to equity
with no gain or loss on conversion. It is added to CU239,562 (=2/5 x 598,906), which is the amount
attributable to the 2,000 bonds already sitting in equity.
During 20X2 to 20X5, the interest is charged to expense using the effective interest
method, in accordance with paragraph 22.15, as shown below for the remaining bonds
(note that the numbers presented in the table below are derived by applying a factor of
3,000/5,000 to the numbers presented in table in example 23).
Year Liability at the Effective ‘Interest’ paid Liability at the
beginning of the interest (5% per year) end of the year
year (8%)
CU CU CU CU
20X2 2,701,909 216,152 (150,000) 2,768,061
20X3 2,768,061 221,445 (150,000) 2,839,506
20X4 2,839,506 227,161 (150,000) 2,916,667
20X5 2,916,667 233,333 (150,000) 3,000,000
The journal entries to recognise interest paid and the unwinding of the discount during
years’ 20X2 to 20X4 are not shown here to avoid repetition because they are easily
determined from the table above.
Journal entries for the year ended 31 December 20X5:
Cr Convertible loan (liability element) CU233,333
To recognise the unwinding of the discount in the convertible loan in 20X5.
31 December 20X5:
Dr Convertible loan (liability element) CU150,000
To recognise the cash outflow for ‘interest’ paid to holders of convertible instruments.
Dr Convertible loan (liability element) CU3,000,000

Dr Convertible loan reserve (equity element) CU359,344
Cr Share capital (equity)
[300,000 shares at CU1 par value] CU 300,000
Cr Share premium (equity) CU3,059,344
To recognise the conversion of the remaining 3,000 bonds into 300,000 shares. The carrying amount of
the liability element attributable to the 3,000 bonds of CU3,000,000 is converted to equity with no gain or
loss on conversion. It is added to the remaining CU359,344 (= 3/5 x 598,906) that is sitting in equity.
Treasury shares
22.16 Treasury shares are the equity instruments of an entity that have been issued and
subsequently reacquired by the entity. An entity shall deduct from equity the fair value
of the consideration given for the treasury shares. The entity shall not recognise a gain
or loss in profit or loss on the purchase, sale, issue or cancellation of treasury shares.
Notes
Treasury shares are an entity’s own equity instruments, held by the entity or other
members of its consolidated group (ie any consolidated subsidiaries). Treasury shares
are not recognised as a financial asset of the entity regardless of the reason for which
they are reacquired.
Example—treasury shares
Ex25 On 31 December 20X0 SME A’s statement of financial position included the
following:
CU
…
Equity
Retained earnings 600,000
On 1 January 20X1 SME A reacquires 4,000 shares in itself from its shareholders for
cash consideration of CU75 per share.
The treasury shares could be presented in SME A’s statement of financial position as
follows:

After reacquisition Before reacquisition
CU CU
…
Equity
Treasury shares (300,000) –
Retained earnings 600,000 600,000
Total equity attributable to owners of the parent 900,000 1,200,000
Note: the fair value of the consideration given for the shares reacquired (CU300,000 cash)
is deducted from equity and there is no impact on profit or loss for the year.
Ex26 The facts are the same as in Example 25. On 1 June 20X1 SME A sold 2,000 of the
treasury shares in exchange for CU100 per share.
Journal entries to record the sale on 1 June 20X1:
Cr Treasury shares (equity) CU150,000
Cr Retained earnings (equity) CU50,000
To recognise the sale of 2,000 treasury shares.
The treasury shares could be presented in the statement of financial position as follows:
Extract from SME A’s statement of financial position on 1 June 20X1

After sale Before sale
CU CU
…
Equity
Treasury shares (150,000) (300,000)
Retained earnings 650,000 600,000
Total equity attributable to owners of the parent 1,100,000 900,000
Distributions to owners
22.17 An entity shall reduce equity for the amount of distributions to its owners (holders of its
equity instruments), net of any related income tax benefits. Paragraph 29.26 provides
guidance on accounting for a withholding tax on dividends.
Notes
Distributions to holders of an equity instrument are debited by the entity directly to
equity, net of any related income tax benefit. Legal requirements in an entity’s
jurisdiction may have specific requirements regarding where in equity the
distributions can or must be debited from. Distributions are often taken out of
retained earnings (sometimes called accumulated profits).
A liability to pay a dividend is recognised when the dividend is appropriately
authorised and is no longer at the discretion of the entity. This is the date:
 when the declaration of the dividend is approved by the relevant authority,
(eg the shareholders), if such approval is required (eg by the jurisdiction or by
the entity’s governing documents); or
 when the dividend is declared (eg by management or the board of directors) if
further approval is not required.
Example—distributions to shareholders
Ex27 In 20X1 SME A declares and pays a dividend of CU0.5 per share to the owners of
SME A in respect of the year ended 31 December 20X1. SME A has 100,000 ordinary
shares in issue.
Journal entries to record the dividend on the date it is declared (once the dividend is
declared SME A has a financial liability):
Cr Dividend payable (financial liability) CU50,000
To recognise the present obligation arising from declaring the dividend.
The payment of the dividend is recorded as follows:

Dr Dividend payable (financial liability) CU50,000
To derecognise the liability for dividends declared when settled in cash.
22.18 Sometimes an entity distributes assets other than cash as dividends to its owners.
When an entity declares such a distribution and has an obligation to distribute non-cash
assets to its owners, it shall recognise a liability. It shall measure the liability at the fair
value of the assets to be distributed. At the end of each reporting period and at the
date of settlement, the entity shall review and adjust the carrying amount of the
dividend payable to reflect changes in the fair value of the assets to be distributed, with
any changes recognised in equity as adjustments to the amount of the distribution.
Notes
Sometimes an entity distributes assets other than cash to its owners acting in their
capacity as owners. For example, non-cash assets such as investments (eg shares in
another entity), inventory, or property, plant or equipment may be distributed.
In those situations, an entity may also give its owners a choice of receiving either
non-cash assets or a cash alternative. Measuring the obligation to distribute non-cash
assets to its owners at the fair value of the assets to be distributed faithfully presents
the economic substance of the distribution. The financial information reflects the
reality that, on distribution, the assets available to meet existing lenders’ claims
against the entity will be reduced by the fair value of the assets to be distributed.
Example—non-cash dividend
Ex28 On 31 December 20X1 SME A declares and distributes to its owner (who owns 100
per cent of SME A) a tract of land (classified as property, plant and equipment) with
a carrying amount of CU1,000 and a fair value of CU100,000.
Initial recognition of the dividend on 31 December 20X1:
To recognise the settlement of the obligation to ‘pay’ the dividend on 31 December 20X1:
Cr Gain on realisation of land (profit or loss) CU99,000
Cr Property, plant and equipment—land (asset) CU1,000
Ex29 On 1 September 20X1 SME A declares that it will distribute to its owner (who owns
100 per cent of SME A) two cars that are no longer used in the business.
On 1 September 20X1 the carrying amount of the two cars is CU55,000 and their
combined fair value, measured with reference to the published prices of used cars,
is CU56,000
On 31 December 20X1 (SME A’s reporting date), the fair value of the cars is
estimated to be CU56,800 and the carrying amount is CU54,500.
On 10 April 20X2 the cars are distributed to the owner when their fair value is
estimated to be CU55,000 and their carrying amount is CU54,000.
Initial recognition of the dividend on 1 September 20X1:
Because the distribution has not been made at the end of the reporting period, SME A
remeasures the liability at 31 December 20X1:
Dr Retained earnings (equity) CU800
Cr Dividend payable (financial liability) CU800
SME A is required to remeasure the liability at the date of its settlement (10 April 20X2).
The first journal entry below shows the remeasurement and the second journal entry
shows the distribution:
Cr Retained earnings (equity) CU1,800

Cr Property, plant and equipment (asset) CU54,000
Cr Gain on disposal of cars (profit and loss) CU1,000
Non-controlling interest and transactions in shares of a

consolidated subsidiary
22.19 In consolidated financial statements, a non-controlling interest in the net assets of a

subsidiary is included in equity. An entity shall treat changes in a parent’s controlling
interest in a subsidiary that do not result in a loss of control as transactions with equity
holders in their capacity as equity holders. Accordingly, the carrying amount of the non-
controlling interest shall be adjusted to reflect the change in the parent’s interest in the
subsidiary’s net assets. Any difference between the amount by which the non-
controlling interest is so adjusted and the fair value of the consideration paid or
received, if any, shall be recognised directly in equity and attributed to equity holders of
the parent. An entity shall not recognise gain or loss on these changes. Also, an entity
shall not recognise any change in the carrying amounts of assets (including goodwill)
or liabilities as a result of such transactions.
Notes
When a parent increases or decreases its stake in an existing subsidiary without losing
control, no adjustment is made to goodwill or to any other assets or liabilities, and no
gain or loss is recognised in profit or loss. Examples 30 and 31 show the journal entries
required. To assist understanding, the detailed journal entries are illustrated in
Examples 32 and 33.
Example—changes in a parent’s interest without loss of control
Ex30 Since SME Z was formed it has been owned 75 per cent by SME A and 25 per cent by
SME B.
On 31 December 20X5, when the carrying amount of SME Z’s net assets was
CU100,000, SME A reduced its holding in SME Z to 60 per cent by selling 15 per cent
of SME Z’s shares to SME B for CU20,000.
The journal entry on 31 December 20X5 to recognise in SME A’s consolidated financial
statements the sale of shares in SME Z is as follows:
Cr Non-controlling interests (equity) CU15,000
Cr Equity (eg retained earnings) CU5,000
Note: because SME A had owned the shares in SME Z from the date on which SME Z was
incorporated, it is assumed that the group carrying amounts of SME Z’s assets and its
liabilities would be measured at the same amounts in SME Z’s financial statements and
in SME A’s consolidated financial statements.
Ex31 The facts are the same as in Example 30. However, in this example, SME A
increased its holding in SME Z to 90 per cent by buying 15 per cent of SME Z’s
shares from SME B for CU20,000.
The journal entry on 31 December 20X5 to recognise in SME A’s consolidated financial
statements the purchase of additional SME Z shares is as follows:
Dr Non-controlling interests (equity) CU15,000
Dr Equity (for example, retained earnings) CU5,000
Note: because SME A had owned the shares in SME Z from the date on which SME Z was
incorporated, it is assumed that the group carrying amounts of SME Z’s assets and its
liabilities would be measured at the same amounts in SME Z’s financial statements and
in SME A’s consolidated financial statements.
Ex32 On 1 January 20X8 SME A acquires 85 per cent of SME B for CU70 and obtains
control.
SME A estimates the useful life of the goodwill arising on acquisition to be
ten years.
The statements of financial position of SME A and SME B and the consolidated
statement of financial position of the group as at 1 January 20X8 are as follows
(note that the assets and liabilities of SME B have already been adjusted to their fair
values under Section 19 Business Combinations and Goodwill):
SME A SME B SME A

(parent) (subsidiary) Group(consolidated)
CU CU CU
Current assets 700 50 750
(a)
Investment in SME B 70 –
Other non-current assets 500 30 530

(b)
Goodwill 27.5
Total assets 1,270 80 1,307.5
Current liabilities 70 30 100
Total liabilities 70 30 100
Shareholders’ equity
Issued equity
100 ordinary shares 100 100

(c)
10 ordinary shares 10 -
Share premium 500 500

(d)
Retained earnings 600 40 600
(e)
Non-controlling interest 7.5
Total shareholders’ equity 1,200 50 1,207.5
Total liabilities and shareholders’ equity 1,270 80 1,307.5
(a) The investment of CU70 is eliminated on consolidation.

(b) Goodwill of CU27.5=(CU70 less 85%×CU50) arises on acquisition of SME B, ie the excess of the
consideration paid for SME B over the proportion of net assets acquired.
(c) Share capital of SME B is eliminated upon consolidation.
(d) The retained earnings balance of SME B of CU40 as at 1 January 20X8 arose pre-acquisition and is
eliminated upon consolidation.
(e) The non-controlling interest (NCI) in SME B is CU7.5=15% × (CU50); ie the proportion of net assets
held by the NCI in SME B.
For the year ended 31 December 20X8 SME A earns a profit of CU100 and SME B
earns a profit of CU50.
On 31 December 20X8 SME A acquires an additional 10 per cent interest in SME B
for CU10.
The statements of financial position of SME A and SME B and the consolidated
statement of financial position of the Group as at 31 December 20X8 are as follows:
SME A SME B SME A Group

(parent) (subsidiary) (consolidated)
CU CU CU
Investment in SME B (a) (b)
80 - -

(c)
Goodwill 24.75
Total assets 1,370 130 1,444.75
Issued equity

(d)
Retained earnings—SME A 700 700

(e,
Retained earnings—SME B 90 39.75
f)
(g)
Group retained earnings 739.75
(h)
Non-controlling interest 5
Total liabilities and shareholders’ equity 1,370 1,444.75

130
(a) On 31 December 20X8, SME A made an additional investment of CU10 in SME B. The investment
balance as at 31 December 20X8 in SME A’s statement of financial position is CU80 (=CU70 + CU10).
(b) The investment of CU80 is eliminated on consolidation.
(c) After one year of amortisation goodwill is equal to CU24.75 (=27.5 minus 10% × 27.5).
(d) Share capital of SME B is eliminated upon consolidation.
(e) Of the CU90 retained earnings balance of SME B, the CU40 relating to pre-acquisition profits is
(f) CU39.75 represents SME A’s share in the profits earned by SME B after control is established, ie
CU42.5 (=85% x CU50) less the amortisation of goodwill of CU2.75 (=10% × CU27.5). Although 95%
is held at the year-end, 85% was held for the whole year until 31 December 20X8, so the share of
profits is 85%.
(g) The difference between the amount by which the NCI is adjusted because of SME A’s additional
investment and the fair value of the consideration is CU0 ((15% × CU100 minus 5% × CU100) minus
CU10). No adjustment to retained earnings is required (see double entry below).
(h) The NCI in SME B is CU5 (=5% × CU100); ie the proportion of net assets held by the NCI in SME B at
December 31 20X8.
Journal entry for (g)

In summary an appropriate journal entry on 31 December 20X8 to recognise the
additional investment is as follows:
Dr Non-controlling interests (equity) CU10
Dr Equity (eg retained earnings) CU0
Cr Cash (financial asset) CU10
Ex33 The facts are the same as in Example 32 except that, in this example, on
31 December 20X8 SME A acquired the additional 10 per cent interest in SME B for
CU25.
The statements of financial position of SME A and SME B and the consolidated statement
of financial position of the Group as at 31 December 20X8 are as follows:
CU CU CU

(a) (b)
Investment in SME B 95 -
(c)
Goodwill 24.75
Total assets 1,370 130 1,429.75
Issued equity
(d)
(e,
f)
(g)
Retained earnings— (15)
adjustment
(h)
(a) On 31 December 20X8 SME A made an additional investment of CU25 in SME B. The investment
balance as at 31 December 20X8 in SME A’s statement of financial position is CU95 (CU70 + CU25).
(c) After one year of amortisation goodwill is equal to CU24.75 (=27.5 minus 10% × 27.5).
CU42.5 (=85% × CU50) less the amortisation of goodwill of CU2.75 (=10% × CU27.5).
(g) The difference between the amount by which the NCI is adjusted and the fair value of the consideration
is CU15 ((15% × CU100 minus 5% × CU100) minus CU25).
(h) The NCI in B is CU5=5% × (CU100), which is the proportion of net assets held by the NCI in SME B at
December 31 20X8.
Double entry for (f)

In summary an appropriate journal entry on 31 December 20X8 to recognise the
Dr Non-controlling interests (equity) CU10
Dr Equity (eg retained earnings) CU15
Cr Cash (financial asset) CU25
Ex34 The facts are the same as in Example 33 except, in this example, on 31 December
20X8 SME A sold 10 per cent of SME B for CU12.
The statements of financial position of SME A and SME B and the consolidated financial
statement of the Group as at 31 December 20X8 are as follows:

CU CU CU

(a) (b)
Investment in SME B 58 -
(c)
Goodwill 24.75
Total assets 1,370 130 1,466.75
Issued equity
(d)
(e,
f)
(g)
Retained earnings— 2
adjustment
(h)
(a) On 31 December 20X8 SME A disposed of 10 per cent of its interest in SME B for CU12.
The investment balance as at 31 December 20X8 in SME A is CU58 (=CU70 minus CU12).
(c) Goodwill of CU24.75=27.5 minus 10% × 27.5 less amortisation.
CU42.5 (=85% × CU50) less the amortisation of goodwill of CU2.75 (=10% × CU27.5).
(g) The difference between the amount by which the non-controlling interest is adjusted and the fair value
of the consideration is CU2 (= (25% × CU100 minus 15% × CU100) minus CU12).
(h) The NCI in SME B is CU25 (=25% × (CU100); ie the proportion of net assets held by the NCI in SME B
at 31 December 20X8.
Double entry for (g)

In summary, an appropriate journal entry on 31 December 20X8 to recognise the
Dr Cash (financial asset) CU12
Cr Non-controlling interests (equity) CU10
Cr Equity (eg retained earnings) CU2
Appendix to Section 22
Example of the issuer’s accounting for convertible debt
The Appendix accompanies, but is not part of, Section 22. It provides guidance for applying the requirements of
paragraphs 22.13–22.15.
On 1 January 20X5 an entity issues 500 convertible bonds. The bonds are issued at par with a face value of CU100
per bond and are for a five-year term, with no transaction costs. The total proceeds from the issue are CU50,000.
Interest is payable annually in arrears at an annual interest rate of 4 per cent. Each bond is convertible, at the holder’s
discretion, into 25 ordinary shares at any time up to maturity. At the time the bonds are issued, the market interest rate
for similar debt that does not have the conversion option is 6 per cent.
When the instrument is issued, the liability component must be valued first, and the difference between the total
proceeds on issue (which is the fair value of the instrument in its entirety) and the fair value of the liability component
is assigned to the equity component. The fair value of the liability component is calculated by determining its present
value using the discount rate of 6 per cent. The calculations and journal entries are illustrated below:
CU
Proceeds from the bond issue (A) 50,000
Present value of principal at the end of five years (see calculations below) 37,363
Present value of interest payable annually in arrears for five years 8,425
Present value of liability, which is the fair value of liability component (B) 45,788
Residual, which is the fair value of the equity component (A)–(B) 4,212
The issuer of the bonds makes the following journal entry at issue on 1 January 20X5:
Dr Cash CU50,000
Cr Financial Liability—Convertible bond CU45,788
Cr Equity CU4,212
The CU4,212 represents a discount on issue of the bonds, so the entry could also be shown ‘gross’:
Dr Cash CU50,000
Dr Bond discount CU4,212
Cr Financial Liability—Convertible bond CU50,000
Cr Equity CU4,212
After issue, the issuer will amortise the bond discount according to the following table:
(a) Interest (b) Total interest (c) Amortisation of (d) Bond (e) Net liability
payment expense bond discount discount (CU)=50,000–(d)
(CU) (CU)=6%x(e) (CU)=(b)–(a) (CU)=(d)–(c)
1/1/20X5 4,212 45,788
31/12/20X5 2,000 2,747 747 3,465 46,535
31/12/20X6 2,000 2,792 792 2,673 47,327
31/12/20X7 2,000 2,840 840 1,833 48,167
31/12/20X8 2,000 2,890 890 943 49,057
31/12/20X9 2,000 2,943 943 0 50,000
Totals 10,000 14,212 4,212
At the end of 20X5, the issuer would make the following journal entry:
Dr Interest expense CU2,747
Cr Bond discount CU747
Cr Cash CU2,000
Calculations
Present value of principal of CU50,000 at 6 per cent
CU50,000/(1.06)^5 = 37,363
Present value of the interest annuity of CU2,000 (= CU50,000 × 4 per cent) payable at the end of each of five years
The CU2,000 annual interest payments are an annuity—a cash flow stream with a limited number (n) of periodic
payments (C), receivable at dates 1 to n. To calculate the present value of this annuity, future payments are discounted
by the periodic rate of interest (i) using the following formula:
Consequently, the present value of the CU2,000 interest payments is (2,000/.06)×[1–[(1/1.06)^5]=8,425

This is equivalent to the sum of the present values of the five individual CU2,000 payments, as follows:
CU
Present value of interest payment at 31 December 20X5=2,000/1.06 1,887
Present value of interest payment at 31 December 20X6=2,000/1.06^2 1,780
Total 8,425
Yet another way to calculate this is to use a table of present value of an ordinary annuity in arrears, five periods,
interest rate of 6 per cent per period. (Such tables are easily found on the Internet.) The present value factor is 4.2124.
Multiplying this by the annuity payment of CU2,000 determines the present value of CU8,425.
SIGNIFICANT ESTIMATES AND OTHER JUDGEMENTS
Classification
Equity is the residual interest in the assets of an entity after deducting all its liabilities.
In most cases little difficulty is encountered in determining whether a financial instrument
issued by an entity is an equity instrument or a financial liability. However, judgement may
be required to classify some instruments appropriately when it is difficult to identify whether
or not an obligation exists either to deliver cash or another financial asset or to exchange
financial assets or financial liabilities under conditions that are potentially unfavourable to
the issuer. For example:
 Partnerships—classification depends on how the partnership agreements are structured.
 Member’s shares and other financial instruments in co-operative entities—do they
represent the residual interest in the net assets of the entity?
 Preference shares—classification depends upon the specific contractual or other
obligations.
Judgement may need to be applied to determine whether a financial instrument with the legal
form of a single instrument has the substance of two instruments—one liability and one equity
instrument (ie it is a compound financial instrument—see notes relating to paragraph 22.13).
For compound financial instruments further judgements and estimates may be necessary in
separating the instrument into its equity and liability components.
Measurement
1
An entity measures equity instruments at the fair value of the cash or other resources received
or receivable, net of direct costs of issuing the equity instruments. For compound financial
instruments the equity component is measured as the residual amount. When non-cash
resources are received, estimation might be required to determine the fair value of the
resource (eg items of equipment or unlisted shares), particularly where the entity is required
to use valuation techniques that use inputs that are not based on observable data.
Sometimes an entity distributes assets other than cash as dividends to its owners. As in the
paragraph above, significant estimation might be required to measure the fair value of
non-cash assets (eg an item of plant and equipment or the entity’s own shares).
COMPARISON WITH FULL IFRSs
The requirements for classifying financial instruments as either liabilities or equity and
accounting for equity instruments issued to investors as set out in full IFRSs (see IAS 32
Financial Instruments: Presentation) differ from those requirements in the IFRS for SMEs (see
Section 22 Equity), as issued at 9 July 2009, in the following ways:
 The IFRS for SMEs is drafted in simple English.
 The IFRS for SMEs includes additional requirements to IAS 32 for the recognition of the
issue of shares or other equity instruments. However, such guidance is consistent with
practice under full IFRSs.
 The IFRS for SMEs contains less detailed requirements than IAS 32 on classifying puttable
financial instruments and obligations arising on liquidation that meet the definition of a
liability but that may represent the residual interest in the net assets of the entity.
Differences may arise in practice because of the simplified classification requirements
under Section 22.
TEST YOUR KNOWLEDGE
Test your knowledge of the requirements for classifying financial instruments as either
liabilities or equity and accounting for equity instruments issued to investors in accordance
with the IFRS for SMEs by answering the questions below.
Once you have completed the test check your answers against those set out below this test.
Assume that all amounts are material.
Mark the box next to the most correct statement.
Question 1
Equity is the:
(a) total amount due by an entity to its creditors.
(b) residual interest in the assets of the entity after deducting its liabilities.
(c) total amount of cash contributed by the owners of the entity.
Question 2
Equity instruments issued to investors are measured by the issuer on initial recognition at the:
(a) fair value of the cash or other resources received or receivable. Any direct costs of
issuing the equity are recognised as an expense in profit or loss.
(b) fair value of the cash or other resources received or receivable plus direct costs of
issuing the equity.
(c) fair value of the cash or other resources received or receivable net of direct costs of
issuing the equity.
Question 3
In the consolidated financial statements of a group, the non-controlling interest in a

subsidiary is presented in the statement of financial position:
(a) within equity.
(b) as a separate line item between liabilities and equity.
(c) within liabilities.
Question 4
On 31 December 20X0 SME A declares that it will distribute particular items of inventory with
a carrying amount (cost) of CU500 to its shareholders. The fair value of the inventory on
31 December 20X0 is CU600. The inventory will be transferred to shareholders on 25 January
20X1.
How should the dividend payable be recorded on 31 December 20X0?
(a) Dr Retained earnings CU600
Dr Inventory CU100
Cr Dividend payable (non-cash) CU600
Cr Profit on disposal (profit or loss) CU100
(b) Dr Inventory CU500
Dr Loss on disposal (profit or loss) CU100
(c) Dr Retained earnings CU600
Question 5
The facts are the same as in question 4. What journal entries should be recorded on transfer
of the inventory on 25 January 20X1? Assume that the fair value of the inventory on
25 January 20X1 is CU590.
(a) Dr Dividend payable CU600
Cr Retained earnings CU600
(b) Dr Dividend payable CU600
(c) Dr Dividend payable CU600
Cr Inventory CU500
(d) Dr Dividend payable CU600
Cr Inventory CU500
Question 6
Treasury shares are:

(a) an entity’s own equity instruments held by the entity or other members of the
consolidated group.
(b) an entity’s own equity instruments that are held in escrow for another entity.
(c) an entity’s own equity instruments held by an entity outside the consolidated group.
Question 7
SME A issues shares for CU10,000 payable in cash by the holders in two years’ time. At the
time of the transaction SME A incurs direct costs of CU100 when the shares are issued. What
amount should be recorded in equity? (5 per cent is considered the market rate for similar
two-year fixed-interest rate loans.)
(a) CU10,000
(b) CU9,900
(c) CU9,070
(d) CU8,970
Question 8
On 31 December 20X2 a parent disposes of 10 per cent of its wholly owned subsidiary for
CU400 when the group carrying amount of the subsidiary’s net assets is CU2,500.
What, in the group’s consolidated financial statements, is the correct accounting treatment
for recognising the difference between the consideration received (CU400) and the increase in
non-controlling interest (CU250) in respect of the disposal?
(a) recognise the gain of CU150 in profit or loss.
(b) recognise the loss of CU150 in profit or loss.
(c) recognise the CU150 as an increase in the equity attributed to equity holders of the
parent.
(d) recognise the CU150 increase in equity attributed to non-controlling interests.
Question 9
SME A declares a share split (sometimes referred to as a stock split). The total equity of SME A
will:
(a) increase.
(b) decrease.
(c) neither increase or decrease.
Question 10
Entity A buys back 1,000 of its own equity shares for CU50 per share. Entity A measures the
fair value of the shares on purchase at CU50. The shares will be held as treasury shares to
enable Entity A to satisfy its obligations under its employee share option scheme. Entity A
should recognise the following journal entries:
(a) Dr financial asset 50,000

Cr cash 50,000
(b) Dr treasury shares (equity) 50,000
Cr cash 50,000
(c) Dr liability 50,000
Cr cash 50,000
Answers
Q1 (b) paragraph 22.3

Q2 (c) paragraph 22.8
Q3 (a) paragraph 22.19
Q6 (a) definition of treasury shares in glossary
Q7 (d) paragraph 22.8
Q10 (b) paragraph 22.16
APPLY YOUR KNOWLEDGE
Apply your knowledge of the requirements for classifying financial instruments as either
liabilities or equity and accounting for equity instruments issued to investors in accordance
with the IFRS for SMEs by solving the case studies below.
Once you have completed the case studies check your answers against those set out at the end
of the test.
Case study 1
The following are several different types of financial instruments that may be issued by
entities to obtain financing. In the table below identify whether the instruments are equity or
financial liability, and why.
Description of instrument Equity or financial Reason

liability?
Ordinary shares. Discretionary
dividends.
A five-year bank loan with fixed
interest payable annually in
arrears.
Two different classes of ordinary
shares—class one and class two.
Dividends are discretionary in
both classes. Class two
shareholders have reduced
voting rights, but rank ahead of
class one ordinary shareholders
on the winding up of the entity.
Ordinary shares. Dividends are
discretionary. Shareholders pay
tax at a low rate to encourage
investment. The entity must
redeem the shares for par if
there is a change in tax law,
meaning that shareholders will
be required to pay tax on
dividends at the normal rate in
the future. It is possible that tax
rates may be increased in the
future.
Preference shares that entitle the
holder to redeem the shares if
the entity’s average profit over
the past three years falls below a
particular level determined in
accordance with the IFRS for SMEs.
A bank loan at a fixed annual
interest rate with the option for
the holder to convert the loan
into a fixed number of shares of
the entity.
Members’ shares in co-operative
entities that are redeemable at
the holder's request. Assume
that the exemption in
paragraph 22.4 is not applicable.
Cash dividend once declared.
Shares puttable at fair value.
The shares are not the most
subordinate.
Shares puttable at a pro-rata
share of net assets on
liquidation. The shares are the
most subordinate. There is a
fixed discretionary dividend.
No other obligations exist.
Answer to case study 1
Description of instrument Equity or financial Reason

liability?
Ordinary shares. Discretionary Equity. No contractual obligation to pay
dividends. dividends or redeem the shares.
A five-year bank loan with fixed Financial liability to The entity (the issuer) has an
interest payable annually in be accounted for in obligation to pay annual interest and
arrears. accordance with repay the principal in five years.
Section 11/12.
Two different classes of ordinary Both classes are The entity has no contractual
shares—class one and class two. equity. obligation to pay dividends or redeem
Dividends are discretionary on the shares.
both classes. Class two
shareholders have reduced
voting rights, but rank ahead of
class one ordinary shareholders
on the winding up of the entity.
Ordinary shares. Dividends are Financial liability to Neither the holder nor the entity has
discretionary. Shareholders pay be accounted for in control over tax payable on dividends.
tax at a low rate to encourage accordance with The settlement provision is
investment. The entity must Section 11/12. contingent. Because the entity
redeem the shares for par if cannot avoid redeeming the shares if
there is a change in tax law, tax rates increase to the normal rate,
meaning that shareholders will the entity does not have the
be required to pay tax on unconditional right to avoid
dividends at the normal rate in repayment.
the future. It is possible that tax
rates may be increased in the
future.
Preference shares that entitle the Financial liability to Neither the holder nor the entity can
holder to redeem the shares if be accounted for in prevent the entity’s profits from
the entity’s average profit over accordance with falling below the predetermined
the past three years falls below a Section 11/12. level. The settlement provision is
particular level determined in contingent. As the entity cannot
accordance with the IFRS for SMEs. avoid redeeming the shares if its
profits fall below the predetermined
level, the entity does not have the
unconditional right to avoid
repayment.
A bank loan at a fixed annual Convertible loan. The substance is that both a financial
interest rate with the option for Split into liability liability and an equity instrument
the holder to convert the loan and equity exist: a financial liability to deliver
into a fixed number of shares of components in cash (by making scheduled interest
the entity. accordance with payments and repaying the
Section 22. The loan principal), which exists as long as the
component is bond is not converted; and
subsequently a written call option granting the
accounted for in holder the right to convert the loan
accordance with into a fixed number of ordinary
Section 11/12. The shares of the entity.
equity component is
accounted for in
accordance with
Section 22.
Members’ shares in co-operative Financial liability to The issuer has an obligation to

entities that are redeemable at be accounted for in redeem the shares for cash at the
the holder's request. Assume that accordance with request of the holder. The issuer
the exemption in paragraph 22.4 Section 11/12. cannot avoid this obligation.
is not applicable.
Cash dividend once declared. Financial liability to The entity has an obligation to settle
be accounted for in the amount payable in cash.
accordance with
Section 11/12.
Shares puttable at fair value. Financial liability to The entity has an obligation to settle
The shares are not the most be accounted for in the amount payable in cash.
subordinate. accordance with
Section 11/12.
Shares puttable at a pro rata Equity (see the Although the shares meet the
share of net assets on exception in definition of a financial liability the
liquidation. The shares are the paragraph 22.4). specific exemption in paragraph 22.4
most subordinate. There is a requires such an instrument to be
fixed discretionary dividend. classified as equity.
No other obligations exist.
Case study 2
The carrying amount of SME A’s equity at 1 January 20X6 was:

Equity CU
Ordinary share capital comprising 120,000 shares

of CU10 par value each 1,200,000
Share option reserve 300,000
Total equity 24,300,000
SME A enters into the following transactions in 20X6.

Date Additional information
1 February 20X6 Issues 2,000 additional ordinary shares for CU120,000.
31 March 20X6 Declares 1:1 bonus issue of 122,000 shares out of retained earnings.
30 June 20X6 Issues 50,000 non-redeemable preference shares at par of CU5 per share with a 6 per
cent fixed dividend on the par value payable annually (assume that 6 per cent is the
market rate of interest for this type of instrument).
31 December 20X6 Grants options to employees with a vesting period of three years starting from the
grant date (grant date is 31 December 20X6). The fair value of the options at the
grant date is CU60,000. In addition, a share-based payment expense of CU50,000 for
vested options granted to employees in an earlier period accountable for in 20X6
relates to employee service in 20X6.
31 December 20X6 Reacquires 200 SME A equity shares at CU70 per share.
31 December 20X6 Issues convertible debt with a face value of CU1,000,000. The debt has a three-year
term. Interest is payable yearly in arrears at 3 per cent per year (annual rate) and the
loan is convertible in full, at the holder’s discretion, at any time up to maturity into 250
ordinary shares. It is unlikely that the holder will convert. When the loan is issued, the
market interest rate for similar debt without any conversion option is 4 per cent.
31 December 20X6 Makes a profit of CU2,000,000 for 20X6.
15 January 20X7 Declares a dividend of CU0.5 per share for ordinary shareholders for the year ended
31 December 20X6
Prepare accounting entries to record the equity transactions in the accounting records of
SME A for the year ended 31 December 20X6.
Note: the measurement of some transactions above is outside the scope of Section 22 and only
the identification of such transactions is required here.
Answer to case study 2
The carrying amount of SME A’s equity at 31 December 20X6 is:
Equity CU
Ordinary share capital comprising 244,000 shares

of CU10 par value each 2,440,000
Treasury shares (14,000)
Convertible bond reserve 27,752
Share option reserve 350,000
Total equity 26,483,752
Journal entries to recognise the transactions are as follows:
1 February 20X6
To recognise the par value and premium received upon issue of 2,000 shares at CU60 per share.
31 March 20X6
Dr Retained earnings (equity) CU1,220,000
Cr Share capital (equity) CU1,220,000
To recognise the 1:1bonus issue of 122,000 shares at CU10 par value.
30 June 20X6
Cr Preference shares (financial liability) CU250,000
To recognise the 50,000 preference shares at CU5 par value.

Note: the issuer has assumed a contractual obligation to make a future stream of 6 per cent interest payments,
so the preference shares are a financial liability, not equity. The net present value of the interest payments is
CU250,000 and represents the fair value of the liability. The measurement of preference shares classified as
financial liabilities is specified in Section 12 but is included here for completeness.
31 December 20X6
Cr Preference shares (financial liability) CU7,500
To recognise the finance cost on the preference share liability.

Note: because the preference shares are recognised as a financial liability, the dividend that accumulates for
the six months is a finance cost that is recognised in profit or loss (=6% x 250,000 x 6/12).
Dr Share-based payment expenses (profit or loss) CU50,000
Cr Share option reserve (equity) CU50,000
To recognise vested options granted to employees in an earlier period.

Note: no entry would be recorded in 20X6 for the fair value of the share options granted as at 31 December
20X6. The fair value will be recognised in 20X7 to 20X9.
Share options issued to employees are within the scope of Section 26 Share-based Payment and not within the
scope of Section 22. They have been included here only for completeness. See Module 26 Share-based
Payment for the measurement of fair value and for the reasons for this journal entry.
Dr Treasury shares (equity) 14,000
Cr Cash (financial asset) 14,000
To recognise the reacquisition of 200 of the entity’s own shares at CU70 per share.
Dr Cash (financial asset) 1,000,000
Cr Convertible bond (financial liability) 972,249
Cr Convertible bond (equity) 27,751
To recognise the liability component and the equity component that arise from issuing convertible debt in
exchange for CU1,000,000.
Note: when the instrument is issued, the liability component must be valued first, and the difference between
the total proceeds on issue (which is the fair value of the instrument in its entirety) and the fair value of the
liability component is assigned to the equity component. The fair value of the liability component is calculated
by determining its present value using the discount rate of 4 per cent. The calculations and journal entries are
illustrated below.
15 January 20X7
The dividend to shareholders is declared after 31 December 20X6 (the end of the reporting period).
Consequently, the entity did not have a present obligation for the dividend at 31 December 20X6 and does not
recognise a liability at 31 December 20X6. However, the dividend would be disclosed in the notes to the financial
statements.
Calculations for convertible bond:
CU
Proceeds from the bond issue (A) 1,000,000
Present value of principal at the end of three years (see calculations below) 888,996
Present value of interest payable annually in arrears for three years 83,253
Present value of liability, which is the fair value of liability component (B) 972,249
Residual, which is the fair value of the equity component (A)–(B) 27,751
After issue, the issuer will amortise the bond discount according to the following table:
Opening Total interest Total Closing
liability (CU) expense at 4% (CU) payment (CU) liability (CU)
20X7 972,249 38,890 (30,000) 981,139
20X8 981,139 39,246 (30,000) 990,385
20X9 990,385 39,615 (1,030,000) -
Calculations
Present value of principal of CU1,000,000 at 4 per cent
CU1,000,000 ÷ (1.04)^3 = 888,996
Present value of the interest annuity of CU30,000 (=CU1,000,000 × 3 per cent) payable at the end of each of
three years
(CU30,000 ÷ .04)×[1 minus [(1 ÷ 1.04)^3] = 83,253
This is equivalent to the sum of the present values of the five individual CU30,000 payments, as follows:
CU
Present value of interest payment at 31 December 20X5=30,000 ÷ 1.04 28,846
Present value of interest payment at 31 December 20X6=30,000 ÷ 1.04^2 27,737
Present value of interest payment at 31 December 20X7=30,000 ÷ 1.04^3 26,670
Total 83,253

Module 22 Liabilities and Equity

Uploaded by

Module 22 Liabilities and Equity

Uploaded by

2009

IFRS Foundation: Training Material for the IFRS® for SMEs

with extensive explanations, self-assessment questions and case studies

Telephone: +44 (0)20 7246 6410

Publications Telephone: +44 (0)20 7332 2730

Copyright © 2012 IFRS Foundation®

Please address publication and copyright matters to:

IFRS for SMEs

The mandatory requirements are accompanied by other (non-mandatory) material, as follows:

Introduction to the requirements

The objective of general purpose financial statements of a small or medium-sized entity is to

laws in the relevant jurisdictions.

REQUIREMENTS AND EXAMPLES

Scope of this section

Classifying financial instruments as either liabilities or equity

Definition: financial liability

Examples—acting in the capacity of an owner

Ex1 On 1 January 20X1 the controlling shareholder of SME A contributes cash of

Classification of an instrument as liability or equity

Examples—classification of financial instruments as equity or financial

Ex10 A shareholder provides an interest-free loan to SME A. There is no specified

Pro-rata share of the net assets on liquidation

Examples—members’ shares in co-operative entities

Ex12 The following example illustrates a format for a statement of comprehensive

Revenue 472 498

SME A’s statement of financial position at 31 December 20X1

Share capital repayable on demand 202 161

Total assets less current liabilities 717 681

Total non-current liabilities 187 196

Other components of equity(2)

Original issue of shares or other equity instruments

Disclosure of equity in the statement of financial position:

Extract from SME A’s statement of financial position

Disclosure of equity in the statement of financial position:

Extract from SME A’s statement of financial position

Disclosure of equity in the statement of financial position:

Extract from SME A’s statement of financial position

Example—fair value of other resources

Journal entries on 1 January 20X1:

Journal entries on 31 December 20X1:

Journal entries on 31 December 20X2:

Dr Cash (financial asset) CU900,000

Sales of options, rights and warrants

Examples—share options and rights

Journal entries on 1 January 20X1:

Dr Cash (financial asset) CU50,000

Journal entries on 31 January 20X2:

Dr Option reserve (equity) CU2,500

Capitalisation or bonus issue of shares and shares splits

Example—bonus issues and share splits

Disclosure of equity in the statement of financial position:

Extract from SME A’s statement of financial position

Extract from SME A’s statement of financial position

Convertible debt or similar compound financial instruments

On conversion of a convertible instrument (for example, at maturity), the entity

Example—calculations for convertible bonds

Present value of principal = 5,000,000 ÷ (1.08)5

Present value of the interest:

Dr Convertible loan (liability element) CU1,801,272

Dr Convertible loan (liability element) CU3,000,000

Extract from SME A’s statement of financial position

Extract from SME A’s statement of financial position on 1 June 20X1

The payment of the dividend is recorded as follows:

Dr Dividend payable (financial liability) CU55,000

Non-controlling interest and transactions in shares of a

22.19 In consolidated financial statements, a non-controlling interest in the net assets of a

Example—changes in a parent’s interest without loss of control

SME A SME B SME A

Other non-current assets 500 30 530

Total assets 1,270 80 1,307.5

Current liabilities 70 30 100

Total liabilities 70 30 100

100 ordinary shares 100 100

Share premium 500 500

Total shareholders’ equity 1,200 50 1,207.5

Total liabilities and shareholders’ equity 1,270 80 1,307.5