The definition of equity relies on the definition of a liability. The current definition of equity is that it is the residual amount of the assets after deducting liabilities. Consequently, the definition of a liability is critical to determining what equity is. In addition, financial instruments are classified as equity, only if they do not meet the definition of a liability. FASB, however, has described three approaches for defining an equity instrument from a non-equity instrument: basic ownership, ownership-settlement, and reassessed expected outcomes. FASB decided on the use of “basic ownership” to define an equity instrument. From the perspective of the conceptual framework, discuss the validity of both this account and the Accumulated Other Comprehensive Income account.
Instructions
Using information available from the IASB website (www.iasb.org), answer the following questions. You may find the following document helpful with this analysis: “Discussion Paper—Financial Instruments with Characteristics of Equity— September 2008.”
(a). Explain the three approaches for identifying an equity instrument: basic ownership, ownership settlement, and reassessed expected outcomes.
(b). Explain the IASB’s preliminary decision on the characteristics of an equity instrument.
(c). Under each of the above three approaches, assess how a convertible bond that is convertible into a fixed number of shares (regardless of the current share price at the time of conversion) would be classified. How would a convertible bond that was convertible into a variable number of shares, depending on the current share price, be reported under each of the above approaches?