PAS 32 - Financial instruments - Presentation
Rationale:
PAS 32 sets the foundation for how companies present financial instruments in their financial
reports. Financial instruments are contracts that create a financial asset for one party and a
financial liability or an equity instrument for another.
This standard helps businesses clearly show whether the financial tool they are using is a form
of asset, liability, or equity. It brings consistency, transparency, and proper classification in
financial reporting. This is especially important when companies issue instruments that combine
both debt and equity elements, such as convertible bonds.
Recognition:
For an item to be classified as a financial instrument, the following conditions must be present:
1. There must be a contract between parties.
2. There are at least two different parties involved.
3. The agreement must create a financial asset for one party and a financial liability or
equity for the other.
Examples of Financial Assets:
● Cash, like bills and coins
● Deposits in banks
● Accounts receivable, which are amounts owed by customers
● Investments in shares of another company
● A right to receive cash or other financial assets in the future
Examples of Financial Liabilities:
● Accounts payable, or amounts owed to suppliers
● Notes payable, like loans that must be paid in the future
● Any agreement requiring a party to deliver cash or exchange assets under conditions
that are not favorable
Nonfinancial Assets:
Not all assets are financial. Some assets are physical or intangible and do not arise from
contracts:
● Inventory like goods for sale
● Property, plant, and equipment such as buildings or machinery
● Prepaid expenses like rent or insurance already paid in advance
NonFinancial Liabilities:
Some obligations are not financial instruments:
● Deferred revenue, like payments received in advance
● Income taxes payable
● Warranty obligations or other expected future costs not tied to financial contracts
Measurement:
One of the unique areas addressed by PAS 32 is compound financial instruments. These are
tools that have both a debt and an equity component.
Example:
A company may issue convertible bonds—bonds that can later be converted into shares. This
bond is a financial liability because the company is obligated to pay interest and principal. But
the option to convert the bond into shares is an equity component.
In this case, split accounting is required. The liability and equity parts are measured and
recorded separately to reflect the true nature of the instrument.
Presentation:
PAS 32 requires entities to classify instruments based on their substance, not just their legal
form. This ensures users of the financial statements understand the real economic impact of
each instrument.
● Financial assets and liabilities are presented in the statement of financial position under
their appropriate categories: either current or noncurrent, depending on their due date.
● Equity instruments, such as ordinary shares and preference shares, are presented in the
equity section of the balance sheet.
● For compound instruments, each part appears in its relevant category. The debt part
under liabilities, and the equity part under capital.
This classification affects ratios and performance measures, like debt to equity or return on
equity, making correct presentation essential for investors and stakeholders.
Disclosure:
Companies must also provide clear disclosures about their financial instruments to give users a
better understanding of their structure, risks, and potential impacts.
Disclosures should include:
● The nature of financial instruments held by the entity
● How the company has classified and measured each item
● Information on compound instruments, especially how they are split between debt and
equity
● Any significant terms, such as interest rates, maturity dates, or conversion features
● Risks involved, such as credit risk, liquidity risk, and market risk
