II - Total Equity (Share Capital + Reserves + Non-controlling interests): Specific points and examples 

1. Classification of a payment commitment in company shares

Scenario

A company issues zero coupon bonds with a 5-year maturity amounting 1 MEUR. This amount can be settled, depending on the choice of the issuer,

• • either in cash or
  • with its own shares at a market value of 1 MEUR at the end of the 5 years.

Solution

The bonds represent a debt because they expose their issuer to fluctuations in the share price between the issue and exercise dates. Conversely, they do not expose the bearer of the instrument to the risk of ordinary share price fluctuations.

To be classified in the equity of the issuer, an instrument should expose the bearer to equity risk. In this example, the purchaser of the bond receives cash or a given number of shares in an amount equal to that of the bonds.

2.  Issue of convertible preference shares, exchangeable for ordinary shares

Scenario

A company issues convertible preference shares with a zero coupon and 5-year maturity amounting 1 MEUR. The convertible preference shares shall be converted into ordinary shares. The preference shares shall be converted into ordinary shares with a market value of 1 MEUR at the conversion date.

Solution

The preference shares do not form part of equity. Convertible preference shares represent a debt for the issuer because they expose it to risks arising from share price movements between the issue and conversion dates. Conversely, exercise of the option does not expose the holder of the convertible preference shares to the risk of ordinary share price fluctuations.

To be classified in equity, an instrument should expose the purchaser of the preference shares to equity risk.

3. Dividends announced after the balance sheet date

Dividends announced after the balance sheet date may not be recognised as debt in the financial statements for the year since they do not represent any constructive obligation.

In contrast, information must be disclosed in the notes regarding events after the balance sheet date.

4. Dividends - preference shares

Scenario

An entity, A, is legally required to announce its preference share dividends at the latest 60 days after the balance sheet date, this being 31 December.

The entity issued preference shares on 1 January Y and classified them as debt.

The dividend is set at 10% of the face value of the preference shares.

The entity A has announced 200 kEUR in preference share dividends for Y on 5 February Y+1 and distributed them on 1 March Y+1.

Question

When should A recognise the 200 kEUR debt for these dividends and the corresponding interest expense on 31 December Y, 5 February Y+1, 1 March Y+1 and during the period?

Solution

Preference share dividends are considered as debt interest. The entity has a legal obligation to announce the preference share dividends when it issues these preference shares. A reliable estimate can be made as from when the dividend rate is set.

The costs of debt should be recognised as an expense in the period for which they accrue. Entity A should thus record a debt for the preference share dividends in the amount of 200 kEUR and the corresponding interest expenses accruing in the period from 1 January Y to 31 December Y.