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HMRC internal manual

Corporate Finance Manual

Accounting for corporate finance: liability and equity: overview

IAS 32 and Section 22 of FRS 102 deal with whether an instrument issued by an entity should be classified as debt or equity. The fundamental principle is that on initial recognition the instrument is classified either as a financial liability or as an equity instrument.

‘Financial liability’ and ‘equity instrument’ are defined at CFM21070 and CFM21100 respectively. Examples of what is debt and what is equity in particular circumstances are given at CFM21110 and CFM21120.

CFM21230 and CFM21240 explain when derivatives may be classed as equity and when they may not.

Guidance on the treatment of compound financial instruments is given at CFM21250 -CFM21270.

Treasury shares

’Treasury shares’ is the term used for a company’s own equity instruments that it has reacquired. The cost of such instruments is deducted from equity. No gain or loss is recognised on the purchase, sale, issue, or cancellation of treasury shares. Treasury shares may be acquired and held by the company or by other members of the consolidated group. Consideration paid or received is recognised directly in equity.

Interest, dividends, losses and gains

Interest, dividends, gains, and losses relating to an instrument classified as a liability should be reported in the income statement. This means that dividend payments on preference shares classified as liabilities are treated as expenses. On the other hand, distributions (such as dividends) to holders of a financial instrument classified as equity should be charged directly against equity, not against earnings.