Shedding light on the IASB’s activities*
IAS 32 from the issuer’s perspective – supplement • June 2007
What is meant by ‘fixed for
fixed’ in the determination
IAS 32 from the issuer’s
of an equity instrument? perspective
1 Foreign currency convertible In December 2003, the IASB published IAS 32, Financial Instruments:
Presentation and Disclosure, as amended by IFRS 7, Financial Instruments:
2 Foreign currency convertible Disclosures. The standard establishes principles for presenting instruments
bonds issued by the subsidiary as either financial liabilities, equity instruments or compound financial
convertible into the shares of the instruments (ie, an instrument with both a liability component and an equity
3 Bermudian options with fixed but
This series of supplements is published in response to issues faced in practice when
different strike prices
applying the principles of IAS 32. The distinction between the definition of a financial
4 Change in conversion ratio upon liability and an equity instrument is not necessarily intuitive and may not reflect the
a bonus issue economic substance of a particular instrument. However, no one wants inadvertent debt.
We highlight some of the more common financial instrument terms and conditions and
5 Change in conversion ratio upon explain how they affect the classification of an instrument through the application of the
a rights issue principles in IAS 32.
6 Change in conversion ratio upon This edition looks at what is meant by ‘fixed for fixed’ in the determination of an equity
a dividend payment
7 Contracts to exchange a fixed
number of equity instruments for The next in the series will address what is meant by ‘contractual obligation’. The final
a specified minority interest instalment will consider embedded derivatives, linkage of two or more contracts,
reclassification between liabilities and equity, and separation of a compound instrument
8 Contingent conversion bond into its components.
9 Call options where the underlying The supplements set out the present PwC position. Readers should be aware that some
is an exchange ratio of these issues may be referred to the IFRIC and/or the IASB in the future. Our views on
these questions may therefore change, depending on the IFRIC’s interpretation or the
10 Written warrant to buy a fixed IASB’s amendment of the standards.
percentage of fully diluted share
capital at a fixed price per share
Question 1 - Foreign currency convertible bonds
11 Instruments that are settled in a If a convertible bond is issued in a currency that is not the functional currency of the
variable number of shares but issuer, does this violate the ‘fixed for fixed’ requirement in IAS 32.16b(ii)?
subject to a cap
12 Instruments that are settled in a Yes. The IFRIC clarified that a convertible bond issued out of a single entity that is
fixed number of shares except
where the share price is in a denominated in a foreign currency has no equity component (that is, it is a liability with an
specific range embedded derivative). This is because the fixed amount of the foreign currency bond that
IAS 32 from the issuer’s perspective
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will be extinguished if the holder converts represents a variable therefore violated. The option is therefore a derivative and not
amount of cash in the functional currency of the issuer. It an equity instrument.
therefore fails the ‘fixed for fixed’ requirement and precludes the
conversion option being classified as equity. The whole of the Question 4 – Change in conversion ratio upon a bonus issue
convertible bond is classified as a financial liability under IAS 32 A convertible bonds provides for a change to the conversion
and is subject to IAS 39 for recognition and measurement. ratio upon a bonus issue of the issuer’s ordinary shares for nil
Under IAS 39, the convertible bond is assessed as having a consideration. Does this bonus issue adjustment violate the
host debt instrument and an embedded foreign exchange equity ‘fixed for fixed’ requirement in IAS 32.16b(ii)?
derivative. The latter is not closely related to the debt host so
will need to be separated if the debt host is carried at amortised Question 4
cost. No. Where the adjustment to the conversion ratio merely
preserves the rights of the convertible bondholders relative to
Question 2 – Foreign currency convertible bonds issued by ordinary shareholders – ie, it maintains their relative ownership
the subsidiary convertible into the shares of the parent interests – the adjustment would not violate the ‘fixed for fixed’
A subsidiary issues a convertible bond that (if converted) requirement.
converts into shares of the parent, where the subsidiary and
parent have different functional currencies. Which currency must Question 5 – Change in conversion ratio upon a rights issue
be looked to in the group’s consolidated financial statements A convertible bond provides for a change to the conversion ratio
when determining whether the ‘fixed for fixed’ requirement in upon a rights issue. Does an adjustment for a rights issue
IAS 32 is met? violate the ‘fixed for fixed’ requirement in IAS 32.16b(ii)?
Answer 2 Answer 5
It depends. For the purposes of the group’s consolidated It depends. A rights issue is typically made up of two
accounts, a group must look to either the functional currency of components: a bonus issue of nil paid ordinary shares, and the
the parent (whose shares the bond is convertible into), or that of issue of new ordinary shares at market price. An adjustment for
the subsidiary (whose liability will be extinguished if the bond is the bonus issue component of a rights issue preserves the
converted). The choice to look to the functional currency of the relative rights of the convertible bondholders relative to the
subsidiary or the parent is a policy choice and must be applied ordinary shareholders (see Question 4). An adjustment for this
on a consistent basis for all similar instruments. IFRIC bonus issue component does not therefore violate the ‘fixed for
considered this issue (November 2006) and decided to give no fixed’ requirement.
However, an adjustment for the second component – the issue
In the individual financial statements of the subsidiary, the of new ordinary shares at market price – does not preserve the
convertible is classified completely as a financial liability, as the economic position of the convertible bondholders and the
conversion option relates to the shares of the parent and not the ordinary shareholders relative to each other. An adjustment for
equity of the subsidiary. In the individual financial statements of this new share issue component does not therefore meet the
the subsidiary, under IAS 39 the conversion option is an ‘fixed for fixed’ requirement.
embedded derivative that must be separated, as it is not closely
related to the debt host. Question 6 – Change in conversion ratio upon a dividend
Question 3 – Bermudian options with fixed but different A convertible bond contains a clause that adjusts the
strike prices conversion price for dividends paid. Does this violate the ‘fixed
An entity issues an option to buy or sell a fixed number of for fixed’ requirement in IAS 32.16b(ii)?
shares at a specified exercise price. The terms of the option
state that the specified exercise price varies with the share price Answer 6
of the entity such that: It depends. Generally the conversion price of a convertible bond
is initially set with the presumption that an anticipated level of
Share price Conversion ratio dividend will be paid each year. An adjustment to the conversion
0-10 CU 10 shares at 1 CU per share price based upon payment of that dividend would violate the
11-20 CU 10 shares at 1.50 CU per share ‘fixed for fixed’ requirement as the relative economic rights of
the convertible bondholders and the ordinary shareholders
Does this breach the ‘fixed for fixed’ settlement requirements in would not be preserved – ie, it would change the capital
IAS 32.16b(ii)? structure.
Answer 2 However an adjustment to the conversion ratio for a dividend in
Yes. The variability in the exercise price, as a function of the excess of the anticipated level – for example a special dividend
share price of the entity, results in a variable amount of cash for that is effectively a return of capital that is a proportional
a fixed number of shares. The ‘fixed for fixed’ requirement is reduction of all ordinary shares – is unlikely to violate the ‘fixed
IAS 32 from the issuer’s perspective
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for fixed’ requirement. Such an adjustment would be viewed as classified as an equity component, and the entire instrument
preserving the relative economic rights of the convertible would be a compound financial instrument.
bondholders and the ordinary shareholders.
Question 9 – Call options where the underlying is an
Question 7 – Contracts to exchange a fixed number of exchange ratio
equity instruments for a specified minority interest Companies A, B and X are listed companies. Company A
An entity issues an option that allows the holders to exchange a purchases an option to buy 5% of the share capital of
fixed number of one kind of the entity’s own equity for a fixed Company X from Company B, in return for Company A
number of a different kind of equity. An example is an option for delivering its own equity shares to Company B. The exchange
a minority shareholder to exchange its holding of shares in a ratio is fixed when the option is written (for example, Company
subsidiary for a fixed number of equity shares in the parent. Is a A pays B 0.8 of A’s own shares for the purchase of 1 share of
contract to exchange one type of equity for another type of Company X). Does the option violate the ‘fixed for fixed’
equity classified as equity under IAS 32? requirement in IAS 32.16(b)(ii) for Company A?
Answer 7 Answer 9
Yes. From the perspective of the group in preparing its Yes. The exchange ratio is not ‘fixed for fixed’. The fixed
consolidated accounts, the option is to exchange a fixed number of Company A’s shares that Company A may issue is
amount of one type of equity for a fixed amount of another type not equal to a fixed amount of cash, as the value of each share
of equity. The ‘fixed for fixed’ requirement in IAS 32.16(b)(ii) acquired in exchange can vary. Company A must treat its
does not cover this; it only deals with contracts to exchange purchased option as a derivative instrument under IAS 39.
equity for financial assets. Both legs of the contract are a fixed
number of shares, and in both cases the shares are a residual Question 10 – Written warrant to buy a fixed percentage of
interest in some or all of the entity (ie, are equity). The contract fully diluted share capital at a fixed price per share
does not violate the part of the definition of a financial liability in Company A writes a call option over its own ordinary shares to
IAS 32.11(b)(i) because, although it is a non-derivative contract, Bank B. The option grants Bank B the right to subscribe for
it does not oblige the entity to deliver a variable number of its 2.5% of the fully diluted ordinary share capital of Company A at
own equity instruments. The entity is not therefore using its own a fixed price per share. The amount of the fully diluted ordinary
equity instruments as ‘currency’. share capital is unknown. Is the written call option over
Company A’s own shares considered an equity instrument in
From the perspective of the parent in preparing its separate the hands of Company A?
financial statements, the contract is a derivative (as it is over an
asset investment in subsidiary) rather than an equity instrument. Answer 10
Yes, as long as the price for one share is fixed and any
Question 8 – Contingent conversion bond variation in the number of shares preserves the relative
Company A issues a contingently convertible bond; the debt economic rights of the various shareholders. It makes no
host becomes convertible into common shares of A at a fixed difference if the contract grants the right to an absolute
ratio of 1:1.25 only if the contingent event occurs. The number of ordinary shares or a percentage of the diluted
contingent event meets the definition of a contingent settlement ordinary share capital, as long as the price for one share is
event in accordance with IAS 32.25 and is ‘genuine’ – for fixed. The above contract does represent an exchange of a
example, a change in control event (see Question B.4). There fixed amount of cash for a fixed number of shares (as per
are no adjustments to the conversion ratio upon the contingent share the price is fixed). The ‘fixed for fixed’ requirement is met
event occurring, and there are no other put or call options. Is and the option is an equity instrument of Company A provided
the conversion option an equity component, as it meets the that the cash to be paid by Bank B is always the result of
‘fixed for fixed’ criteria, even though it can only be exercised multiplying the number of ordinary shares issued by Company
based on the occurrence of a contingent event? A by the fixed price per share stipulated in the contract and the
option holder’s proportionate interest in the company is
Answer 8 preserved.
Yes. The instrument is first separated into its component parts,
namely a debt host and equity conversion option. The fact that If the cash amount to be paid by Bank B is constant in absolute
the option is only contingently convertible will not cause liability terms and does not change proportionately with changes in the
classification of the conversion option under IAS 32.25 provided number of shares to be issued, the contract fails the ‘fixed for
that, upon occurrence of the contingent event, it would be fixed’ requirement. The option is not an equity instrument of
settled in such a way as to require classification as equity. If the Company A. This is because the price per share is not fixed.
contingent event were to occur in the example above, the Other adjustments to the price per share fail the ’fixed for fixed’
conversion to own shares would still satisfy the ‘fixed for fixed’ requirement unless they preserve the relative economic rights of
requirement in IAS 32.16(b)(ii). The conversion option would be the various shareholders. For example, an adjustment to the
IAS 32 from the issuer’s perspective
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amount of cash that Bank B has to pay to reflect an issue of Question 12 – Instruments that are settled in a fixed
new ordinary shares by Company A for cash fail the ‘fixed for number of shares except where the share price is in a
fixed’ requirement. specific range
An entity issues an instrument that is settled in a fixed number
Question 11 – Instruments that are settled in a variable of shares except where the share price is in a specified range.
number of shares but subject to a cap Within that range, settlement could be in a variable number of
An entity issues an instrument that is settled in a variable shares to the value of a specified amount, or an adjusted
number of shares but is subject to a cap to prevent excessive number of shares determined at inception based on a sliding
dilution of the existing shareholders through the issue of new scale. It is unknown at inception whether the share price will be
shares. The cap is out of the money on issuance. Given that the within this range and hence how many shares will be delivered
host instrument is a liability (as it is settled in a variable number in settlement. Is this instrument a financial liability on the
of shares), is the cap an equity instrument, on the grounds that grounds that the ‘fixed for fixed’ requirement in IAS 32.16(b)(ii)
a similar stand-alone cap would be classified as equity? is not met?
Answer 11 Answer 12
No. The entire instrument is a liability on the grounds that the Yes. The fact that the number of shares varies when the share
‘fixed for fixed’ requirement in IAS 32.16(b)(ii) is not met for the price is in a specific range means that the ‘fixed for fixed’
instrument as a whole (ie, the instrument is settled in a variable requirement is violated.
number of shares).
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IAS 32 from the issuer’s perspective
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