Classification of Financial Instruments between Liability and Equity

Financial instruments are classified as liability or equity in accordance with the substance of the contractual arrangement. Interest, dividends, gains and losses relating to a financial instrument or a component that is a financial liability, are reported as expense or income. Distributions to holders of financial instruments classified as equity are charged directly to equity, net of any related income tax benefits. 

 

A financial instrument is classified as liability if it provides for a contractual obligation to:  


  • deliver cash or another financial asset to another entity;  
  • exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the company; or  
  • satisfy the obligation other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of own equity shares. 

If the entity does not have an unconditional right to avoid delivering cash or another financial asset to settle its contractual obligation, the obligation meets the definition of a financial liability. 

 

The components of issued financial instruments that contain both liability and equity elements are accounted for only, with the equity component being assigned the residual amount after deducting from the instrument as a whole or in part, the amount only determined as the fair value of the liability component on the date of issue.

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