International Accounting Standard (IAS) 32 Financial
Instruments: Presentation defines rules for when a financial
instrument is to be classified as equity or liability. Its revised
version was issued back in 2003 but, in recent years, its
instructions for classification have become less and less simple.
In this article I will provide some guidance insofar as that is
possible, given that case-by-case details can often alter the
classification.
The substance over form principle vs. legal form
According to IAS 32, preference shares can be classified as
equity, liability, or a combination of the two. The entity must
classify the financial instrument when initially recognising it
(IAS 32.15) based on the substance over form principle. In
general, this principle requires issuers to measure and present the
economic impact of the financial instrument and to state its
commercial purpose—but it does not oblige them to consider
local business laws. This can cause confusion
