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Chapter 10

1.2 Debt or equity?

When issuing finance, an entity must classify it as a financial liability or
as equity according to its substance.

The decision as to whether a financial instrument is a financial liability
or equity has a big impact on the financial statements.

The treatment of interest and dividends relating to a financial instrument must also
follow the treatment of the instrument itself.

For example:

 Dividends paid in respect of shares classified as a liability are charged as a
finance cost through profit or loss

 Dividends paid on shares classified as equity are charged directly against
retained earnings and reported in the statement of changes in equity.

Illustration 1

Debt or equity?

On 1 April 20X2 Wellington issues $30 million of 8% preference shares, to be
redeemed at par on 31 March 20X7.

Wellington has an obligation to repay the $30 million and also to pay 8%
dividend each year.

The existence of the obligation means that substance of the arrangement is
that the preference shares are a liability, and would therefore be included
within non-current liabilities on the statement of financial position.

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