IAS 32 – Financial Instruments: Presentation

Introduction: Financial instruments are central to corporate finance. IAS 32 establishes how to present financial instruments in the financial statements, ensuring the substance over form principle and enabling users to distinguish between liabilities and equity.

When can you offset financial assets and liabilities under IAS 32’s strict rules?

Offsetting is not about convenience—it’s about accuracy. IAS 32 allows it only when rights and intentions align.

1. Objective of IAS 32

The primary objective is to set out principles for presenting financial instruments so that:

• the substance of instruments is reflected;
• users can differentiate liabilities from equity;
• comparability and consistency in presentation are improved.

2. Scope

IAS 32 applies to most financial instruments but excludes certain items covered by other standards:

• Interests in subsidiaries, associates, joint ventures (IFRS 10, IAS 28, IFRS 11).
• Employee benefits (IAS 19).
• Insurance contracts (IFRS 17).
• Share-based payments (IFRS 2).

3. Key definitions

• Financial Asset: Cash, equity instruments of another entity, contractual right to receive cash or another financial asset, or to exchange instruments on favourable terms.
• Financial Liability: Contractual obligation to deliver cash or another financial asset or to exchange instruments on unfavourable terms.
• Equity Instrument: Contract that evidences a residual interest in the entity's assets after deducting all liabilities (e.g., ordinary shares).

4. Classification principles

Classification under IAS 32 is based on the substance of the contractual arrangement.

4.1 Financial liability vs Equity

Determine whether the issuer is obliged to deliver cash or another financial asset:

• If yes → classify as a financial liability.
• If no and settlement is a residual interest → classify as equity.

4.2 Compound financial instruments

When an instrument contains both liability and equity elements (e.g., convertible bonds), IAS 32 requires separation into:

• Liability component — present value of contractual cash flows that are obligations;
• Equity component — residual amount (for conversion options that result in the issuer's own equity instruments).

5. Offsetting financial assets and liabilities

Offsetting (presenting net amounts) is permitted only if both criteria below are met:

• There is a legally enforceable right to set off the recognized amounts; and
• The entity intends either to settle on a net basis or to realize the asset and settle the liability simultaneously.

6. Treasury shares

Repurchased own equity instruments are treated as a deduction from equity. They are not recognized as assets. Resale or cancellation is treated as an equity transaction.

7. Disclosures (link with IFRS 7)

IAS 32 focuses on presentation; IFRS 7 – Financial Instruments: Disclosures covers the required disclosures about the nature and extent of risks arising from financial instruments, measurement bases, and other details.

8. Practical implications

• Classification affects key ratios such as debt-to-equity.
• Incorrect classification can distort users’ view of the entity’s financial position and performance.
• Entities must carefully evaluate contracts for hybrid or innovative instruments.

9. Common challenges in practice

• Distinguishing redeemable preference shares from equity.
• Accounting for contingent settlement provisions (liability may arise only on certain events).
• Treatment of perpetual debt — assessing whether it is liability or equity.
• Separating components in complex, compound instruments.

10. Conclusion

IAS 32 is essential for transparent and consistent presentation of financial instruments. By prioritizing the substance over legal form, IAS 32 helps prevent manipulation of financial statements and provides stakeholders with clearer insight into an entity’s obligations and capital structure.

Tip: For full compliance, combine IAS 32 presentation rules with IFRS 9 classification/measurement and IFRS 7 disclosures.

If you like, I can provide:

• A ready-to-use infographic decision tree (HTML + SVG) for Liability vs Equity classification;
• An example journal-entry walkthrough for compound instruments (convertible bonds);
• A printable one-page summary (PDF/HTML).