not be recognised at fair value). This would alter the carrying amount of the asset
even though there had been no change in the economics of the whole contract.
IFRS 9 states that subsequent reassessment is appropriate only when there has been a
change in the terms of the contract that ‘significantly’ modifies the cash flows,
accordingly the above issues are not expected to arise. [IFRS 9.BCZ4.105].
8
LINKED AND SEPARATE TRANSACTIONS AND
‘SYNTHETIC’ INSTRUMENTS
A derivative that is attached to a financial instrument, but is contractually transferable
independently of that instrument, or has a different counterparty from that instrument,
is not an embedded derivative, but a separate financial instrument. [IFRS 9.4.3.1].
This is also the case where a synthetic instrument is created by using derivatives to
‘alter’ the nature of a non-derivative instrument, as illustrated in the following example:
Example 42.20: Investment in synthetic fixed-rate debt
Company A issues a five year floating rate debt instrument. At the same time, it enters into a five year pay-
fixed, receive-variable interest rate swap with Entity B. Company A considers the combination of the two
instruments to be a synthetic fixed rate instrument.
Embedded derivatives are terms and conditions that are included in non-derivative host contracts and it is
generally inappropriate to treat two or more separate financial instruments as a single combined, or synthetic,
instrument. Each of the financial instruments has its own terms and conditions and may be transferred or
settled separately. Therefore, the debt instrument and the swap must be classified separately. [IFRS 9.IG C.6].
It is asserted that these transactions differ from those discussed at 3.2 above because
those had no substance apart from the resulting interest rate swap. [IFRS 9.IG C.6].
3480 Chapter 42
Although some might argue that the substance of the two transactions above is the
resulting synthetic fixed rate debt instrument, this interpretation is clearly not allowed
under the standard.
Interestingly, the guidance does not address a much more common situation whereby
a company both borrows from, and transacts a related derivative with, the same
counterparty – typically the borrowing will be floating rate and the derivative a
perfectly matched pay-fixed, receive-floating interest rate swap.
In fact, the subject of linking transactions for accounting purposes is a difficult one,
especially in the context of financial instruments. The IASB’s Conceptual Framework
specifies that transactions should be reported in accordance with their substance and
economic reality and not merely their legal form, [CF(2010) 4.6], and linking transactions
can be seen as dealing with the question of how to interpret this principle.
IAS 32, and IFRS 9 deal with the subject in a piecemeal way. For example, in addition
to the synthetic instrument illustration above:
• two or more non-derivative contracts that are, ‘in substance’, no more than a single
derivative are treated as a single derivative (see 3.2 above);
• derivatives that are ‘attached’ to a non-derivative financial instrument may
sometimes be regarded as part of a single combined instrument (see 4 above);
• in classifying an instrument in consolidated financial statements as equity or a
financial liability, all terms and conditions agreed between members of the group
and holders of the instrument are considered (see Chapter 43 at 4.8);
• if a loan is guaranteed by a third party, the expected credit loss determined in
accordance with IFRS 9 should be calculated based on the combined credit risk of
the guarantor and the guaranteed party if the guarantee is ‘integral’ to the
contractual terms of the loan (see Chapter 47 at 5.8.1); and
• determining the appropriate accounting treatment for a transaction that involves
the transfer of some or all rights associated with financial assets, without the sale
of the assets themselves, inevitably involves linking separate contracts to assess
whether the transaction results in derecognition of the assets. For example, there
might be one contract defining the continued ownership of the asset and another
obliging the owner to transfer the rights associated with the asset to a third party
(see Chapter 45 at 2, Chapter 46 at 2 and Chapter 48 at 3 and 4).
The Interpretations Committee first considered the subject of linkage in 2002 and has,
in the past, made certain recommendations to the IASB. In fact, the requirement to take
account of linked terms when classifying instruments as debt or equity in consolidated
financial statements was introduced into IAS 32 in December 2003 following the
Interpretations Committee’s deliberations. In spite of agreeing proposed indicators for
when transactions should be linked, and proposed guidance on accounting for linked
transactions, these have never been published as an interpretation or standard.28
In August 2013 the Interpretations Committee received a request to clarify whether three
different transactions should be accounted for separately or be aggregated and treated as
a single derivative. The Committee decided not to add this issue to its agenda but noted
that in order to determine whether to aggregate and account for the three transactions as
Financial
instruments:
Derivatives and embedded derivatives 3481
a single derivative, reference should be made to B.6 (see 3.2 above) and C.6 (see
Example 42.20 above) of the Implementation Guidance to IFRS 9 and paragraph AG39
of IAS 32. The Interpretations Committee noted that the application of the guidance in
paragraph B.6 of IFRS 9 requires judgement and that the indicators in that paragraph may
help an entity to determine the substance of the transaction, but that the presence or
absence of any single specific indicator alone may not be conclusive.29
Consequently, in considering the borrowing and swap situation above, we are left
principally with the guidance in IFRS 9. It is likely that the swap and the loan have their
own terms and conditions and may be transferred or settled independently of each other.
Therefore, the principles in Example 42.20 above would suggest separate accounting for
the two instruments. Applying the guidance at 3.2 above (aggregating non-derivative
transactions and treating them as a derivative) would also suggest separate accounting in
most cases. Even though the instruments are transacted with the same counterparty, there
will normally be a substantive business purpose for transacting the instruments separately.
It seems clear that in situations involving two separate legal contracts, in most cases, the
two instruments will be regarded as separate for accounting purposes. However, in
certain situations the linkage between those contracts (normally itself contractual) may
be such that for accounting purposes those contracts cannot be regarded as existing
independently of each other.
References
1 IGC Q&A 10-6. Whilst the IFRIC discussion
7
IFRIC Update, January 2007. Whilst the IFRIC
was held in the context of IAS
39, the
discussion was held in the context of IAS 39,
discuss
ion also holds true under IFRS 9.
the discussion also holds true under IFRS 9.
2
IFRIC Update, July 2007. Whilst the IFRIC
8
IFRIC Update, May 2009. Whilst the IFRIC
discussion was held in the context of IAS 39,
discussion was held in the context of IAS 39,
the discussion also holds true under IFRS 9.
the discussion also holds true under IFRS 9.
3
IFRIC Update, July 2006. Whilst the IFRIC
9
Staff
paper,
Term-extending options in fixed rate
discussion was held in the context of IAS 39,
debt instruments, IFRS Interpretations
the discussion also holds true under IFRS 9.
Committee, March 2012. Whilst the IFRIC
4
IFRIC Update, January 2007. Whilst the IFRIC
discussion was held in the context of IAS 39,
discussion was held in the context of IAS 39,
the discussion also holds true under IFRS 9.
the discussion also holds true under IFRS 9.
10 IFRIC Update, March 2012. Whilst the IFRIC
5
IASB Update, February 2007. Whilst the
discussion was held in the context of IAS 39,
IFRIC discussion was held in the context of
the discussion also holds true under IFRS 9.
IAS 39, the discussion also holds true under
11 Implementation of International Accounting
IFRS 9.
Standards, British Bankers’ Association,
6
IFRIC Update, July 2006. Whilst the IFRIC
July
2004, para.
10. Whilst the IFRIC
discussion was held in the context of IAS 39,
discussion was held in the context of IAS 39,
the discussion also holds true under IFRS 9.
the discussion also holds true under IFRS 9.
3482 Chapter 42
12 IFRIC Update, January 2016.
21 Information for Observers (December 2007
13 Information for Observers of March 2006 IFRIC
IASB meeting), Application of paragraph
meeting, Hedging Inflation Risk (Agenda Paper
AG33(d)(iii) – Bifurcation of embedded foreign
12), IASB, March 2006, para. 32. Whilst the
currency derivative (Agenda Paper 3C), IASB,
IFRIC discussion was held in the context of
December 2007, para. 11. Whilst the IFRIC
IAS 39, the discussion also holds true under
discussion was held in the context of IAS 39,
IFRS 9.
the discussion also holds true under IFRS 9.
14 Information for Observers (December 2008 22 Information for Observers (May 2007 IFRIC
IASB meeting), Clarification of accounting for
meeting), IAS
39: Financial Instruments:
investments in collateralised debt obligations
Recognition and Measurement AG33(d)(iii) of
(Agenda Paper 6E), IASB, December 2008 and
IAS 39 (Agenda Paper 11(v)), IASB, May
Q&As on accounting for some collateralised
2007, para. 44. Whilst the IFRIC discussion
debts obligations (CDOs) – prepared by staff of
was held in the context of IAS
39, the
the IASB, IASB, February 2009. Whilst the
discussion also holds true under IFRS 9.
IFRIC discussion was held in the context of
23 Information for Observers (December 2007 IASB
IAS 39, the discussion also holds true under
meeting), Application of paragraph AG33(d)(iii) –
IFRS 9.
Bifurcation of embedded foreign currency
15 IFRIC Update, May 2017.
derivative (Agenda Paper 3C), IASB, December
16 IFRIC Update, September 2014. Whilst the
2007, paras.
12 and
13. Whilst the IFRIC
IFRIC discussion was held in the context of
discussion was held in the context of IAS 39, the
IAS 39, the discussion also holds true under
discussion also holds true under IFRS 9.
IFRS 9.
24 Information for Observers, para. 14. Whilst the
17 IFRIC Update, May 2007. Whilst the IFRIC
IFRIC discussion was held in the context of
discussion was held in the context of IAS 39,
IAS 39, the discussion also holds true under
the discussion also holds true under IFRS 9.
IFRS 9.
18 Information for Observers (May 2007 IFRIC
25 Information for Observers, para. 15. Whilst the
meeting), IAS 39: Financial Instruments:
IFRIC discussion was held in the context of
Recognition and Measurement AG33(d)(iii) of
IAS 39, the discussion also holds true under
IAS 39 (Agenda Paper 11(v)), IASB, May 2007,
IFRS 9.
paras. 12-14. Whilst the IFRIC discussion was
26 IGC Q&A 23-8. Whilst the IFRIC discussion
held in the context of IAS 39, the discussion
was held in the context of IAS
39, the
also holds true under IFRS 9.
discussion also holds true under IFRS 9.
19 Information for Observers, paras. 18 to 19. 27 IGC Q&A 23-8. Whilst the IFRIC discussion
Whilst the IFRIC discussion was held in the
was held in the context of IAS
39, the
context of IAS 39, the discussion also holds
discussion also holds true under IFRS 9.
true under IFRS 9.
28 IFRIC Update, April 2002, July 2002 and February
20 Information for Observers, paras. 20 to 28.
2003 and IASB Update, October 2002.
Whilst the IFRIC discussion was held in the
29 IFRIC Update, March 2014. Whilst the IFRIC
context of IAS 39, the discussion also holds
discussion was held in the context of IAS 39,
true under IFRS 9.
the discussion also holds true under IFRS 9.
3483
Chapter 43
Financial instruments:
Financial liabilities
and equity
1 INTRODUCTION .......................................................................................... 3489
1.1
Background ......................................................................................................... 3489
1.2
Development of IFRS on classification of liabilities and equity .............. 3490
2 OBJECTIVE AND SCOPE .............................................................................. 3491
2.1
Objective .............................................................................................................. 3491
2.2 Scope
..................................................................................................................... 3491
3 DEFINITIONS ............................................................................................... 3491
4 CLASSIFICATION OF INSTRUMENTS ......................................................... 3493
4.1
Definition of equity instrument ...................................................................... 3494
4.2
Contractual obligation to deliver cash or other financial assets .............. 3495
4.2.1
Relationship between an entity and its members ....................... 3496
4.2.2
Implied contractual obligation to deli
ver cash or other
financial assets .....................................................................................3497
4.3
Contingent settlement provisions .................................................................. 3499
4.3.1
Contingencies that are ‘not genuine’ ............................................. 3500
4.3.2
Liabilities that arise only on liquidation ......................................... 3501
4.3.3
Liabilities that arise only on a change of control ......................... 3501
4.3.4
Some typical contingent settlement provisions .......................... 3502
4.4
Examples of equity instruments ..................................................................... 3503
4.4.1
Issued instruments ............................................................................. 3503
4.4.2
Contracts to issue equity instruments ........................................... 3503
4.5
Preference shares and similar instruments ................................................... 3504
4.5.1
Instruments redeemable mandatorily or at the holder’s
option ................................................................................................... 3505
3484 Chapter 43
4.5.2
Instruments redeemable only at the issuer’s option or not
redeemable ......................................................................................... 3505
4.5.3 Instruments
with a ‘dividend blocker’ or a ‘dividend
pusher’ clause ..................................................................................... 3507
4.5.3.A
Instruments with a ‘dividend blocker’ ...................... 3507
4.5.3.B Instruments with a ‘dividend pusher’ ........................ 3508
4.5.4
Perpetual instruments with a ‘step-up’ clause ............................. 3509
4.5.5 Relative
subordination ..................................................................... 3509
4.5.6 Economic
compulsion
.......................................................................
3510
4.5.7 ‘Linked’
instruments
............................................................................
3511
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 688