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Executive summary
Both IFRS and US GAAP have definitions for financial instruments that are classified as a
liability or as equity. Under IFRS, classification of certain instruments with characteristics of
both debt and equity focuses on the contractual obligation to deliver cash, assets or an entitys
own shares. US GAAP specifically identifies certain instruments with characteristics of both
debt and equity that must be classified as liabilities.
Under IFRS, hybrid financial instruments (e.g., convertible bonds) are required to be split into
a debt and equity component and, if applicable, a derivative component. The derivative
component may be subject to fair value accounting. Under US GAAP, hybrid financial
instruments are not split into debt and equity components unless certain specific conditions
are met, but they may be bifurcated into debt and derivative components, with the derivative
components subject to fair value accounting.
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Progress on convergence
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Definitions
US GAAP
IFRS
Similar
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Definitions
US GAAP
IFRS
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Definitions
US GAAP
IFRS
A financial instrument,
per IAS 32, paragraph
11, is any contract
that gives rise to a
financial asset of one
entity and a financial
liability or equity
instrument of another
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Definitions
US GAAP
IFRS
A financial liability, per IAS 32, paragraph 11, is any liability that
is:
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Definitions
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Definitions
US GAAP
IFRS
An equity instrument,
according to IAS 32,
paragraph 11, is any
contract that
evidences a residual
interest in the assets
of an entity after
deducting all of its
liabilities. This
includes common
shares and certain
preferred shares.
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Definitions
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US GAAP
IFRS
Similar
Similar
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US GAAP
IFRS
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IFRS
US GAAP
IFRS
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$2,000,000
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151,878
Liability and equity hybrids
$ 303,721
1,544,401
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$19,900,000
100,000
$20,000,000
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Cash flow
NPV at 8%
Year 1
$ 1,200,000
$ 1,111,000
Year 2
$ 1,200,000
1,029,000
Year 3
$ 1,200,000
953,000
Year 4
$ 1,200,000
882,000
Year 5
$21,200,000
14,428,000
Cash flow for year 5 includes the proceeds of $20 million and
interest of $1.2 million.
Based on the NPV of these cash flows, the liability component
is calculated as $18,403,000 as shown in the table.
Fair value
of liability
component
$18,403,000
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$20,000
$1,200,000
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$18,311,000
Year 2
$18,599,000
Year 3
$18,910,000
Year 4
$19,246,000
Year 5
$19,609,000
Interest
expense
at 8.125%
$
1,488,000
1,511,000
1,536,000
1,563,000
Interest paid
Ending
liability
$(1,200,000)
$18,599,000
(1,200,000)
$18,910,000
(1,200,000)
$19,246,000
(1,200,000)
$19,609,000
1,591,000
(1,200,000)
$20,000,000
Journal entries:
Year 1:
Interest expense
Cash
Liability
Year 2:
Interest expense
Cash
Liability
Year 3:
Interest expense
Cash
Liability
Year 4:
Interest expense
Cash
Liability
Year 5:
Interest expense
Cash
Liability
$1,488,000
$1,200,000
288,000
$1,511,000
$1,200,000
311,000
$1,536,000
$1,200,000
336,000
$1,563,000
$1,200,000
363,000
$1,591,000
$1,200,000
391,000
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Stock or shares with settlement options that are contingent upon another event
US GAAP
IFRS
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$100
$100
$100
Liability and equity hybrids
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$100
$100
2012
There are no journal entries necessary.
Liability and equity hybrids
Academic Resource Center
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US GAAP
IFRS
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Explain how RSR should account for the preferred stock using US
GAAP and IFRS. (No journal entries required.)
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The repayment of the principal would be considered an equity instrument as payment is at the issuers
option and there is no present obligation to transfer financial assets to the holder.
The dividend is fixed and payment is not at the discretion of the issuer, thus this represents a mandatory or
potential obligation to transfer assets or cash to the holder. Accordingly, the dividend component of the
financial instrument would be a liability.
Liability and equity hybrids
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The fair value of the stream of perpetual dividends would be substantially equivalent to the
face value of the preferred stock. Therefore, little to no value will actually be ascribed to the
residual equity component, and the preferred stock issuance would be classified as a liability.
Also, if the principal amount is paid at some point after issuance, then this would be an
indication that the issuance was debt and was classified appropriately as a liability.
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