Companies often enter into financial instruments that straddle the line between liability and equity classification in the financial statements. These instruments are becoming increasingly common and complex as markets evolve. Although based on sound fundamentals, the model for distinguishing liabilities from equity can be difficult to apply determining classification challenges. This is, in part, because the model can result in different classification for instruments with minor differences in contractual terms. And, classification is not solely a balance sheet matter. It also drives whether or not the income statement is impacted.

Q1:

What effect does the classification of an instrument as either debt or equity have on a firm's capital structure (Balance Sheet and debt ratios, cost of borrowing)?

Q2:

What are some features of instruments that help classify as debt or equity?