Full explanation
Overview
Is what you raised from investors debt, or is it equity?
The IASB has argued over that question for more than a decade — and in 2026, they're STILL not finished fixing it. Today, the one rule that decides it, every time.
Debt, or equity ? One test decides.
A financial instrument is a contract that creates a financial asset for one party and a financial liability or equity instrument for another — you met this in IFRS 9. IAS 32 answers the harder question: which side of that line is it on? The test is blunt: does the issuer have a contractual obligation to deliver cash, or another financial asset? Yes — it's a liability. No — it's equity. Not what you call it. Not how it's labelled. What you're contractually obliged to do.
The fixed-for-fixed test
One sharp exception worth knowing: the fixed-for-fixed test. A contract to issue your OWN shares is equity only if it's for a fixed number of shares, for a fixed amount of cash — no floating, no formula. Change either side, and it usually becomes a liability. And a narrow carve-out: some puttable instruments — common in partnerships and co-operatives — are classified as equity even though holders can force a cash payout, if strict conditions are met.
Definitions are one thing. Let's put this to work on the trickiest instrument there is: a convertible bond.
One instrument, two natures
Meet Meridian Limited again. It issues a three-year convertible bond: one million euros face value, paying a below-market coupon of just four percent — because investors are also buying the RIGHT to convert into Meridian shares later. A plain bond, with no conversion right, would need to pay seven percent to attract the same investors. That gap is the clue.
Split it: liability + equity
IAS 32 says: split it. Discount the bond's cash flows — the coupons AND the principal — at the market rate for a plain bond WITHOUT the conversion option: seven percent. That present value is the liability component: nine hundred twenty-one thousand, two hundred seventy-one euros. Whatever's left of the one million proceeds — seventy-eight thousand, seven hundred twenty-nine euros — is the equity component. One instrument. Two components.
Recognise what it is
Day one: debit cash, one million. Credit the liability component, nine hundred twenty-one thousand two hundred seventy-one. Credit equity — a separate reserve, not share capital — seventy-eight thousand, seven hundred twenty-nine. Two sides of one contract, recognised as what they actually are.
Here's what's easy to miss: after day one, only ONE of those two components ever moves again.
The liability accretes to face value
The liability component behaves exactly like the debt you already know from IFRS 9 — it accretes at the market rate, seven percent, using the effective interest method. Year one: interest expense sixty-four thousand, four hundred eighty-nine; cash coupon paid, forty thousand; the gap — twenty-four thousand, four hundred eighty-nine — adds to the liability. Run it three years, and the liability grows to exactly one million — the full face value, right on maturity. The equity component? It NEVER moves. Once split, it's fixed for the life of the instrument.
Two more traps worth knowing — and then one rule that lets you show two numbers as one.
Treasury shares: no gain, ever
First: treasury shares. If Meridian buys back its own shares, they're deducted straight from equity — at cost. No gain, no loss, ever, no matter what price it buys or later resells at. You cannot make a profit trading your own shares — IAS 32 shuts that door completely.
Offsetting: net, or gross?
Second: offsetting. Meridian has a five hundred thousand euro loan with its bank, and a two hundred thousand euro deposit with that SAME bank, under a legally enforceable netting agreement, intending to settle net. Show it as one number: a three hundred thousand euro net liability. Change either condition — no legal right, or no intention to net — and both show GROSS, full amounts, side by side. You can't net two accounts just because you feel like it.
Interest hits profit. Dividends don't.
One more thread that ties it together: interest, dividends, gains and losses follow the classification you just made. Pay interest on the liability component — it's an expense, straight through profit or loss. Pay a dividend on equity — it's a distribution OF profit, never a cost against it. Same cash leaving the business. Completely different effect on the numbers investors read.
So why is the IASB still fighting over this, in 2026? Because the line isn't always this clean.
The IASB is still fighting this
The current battleground: instruments that carry BOTH debt and equity features at once — perpetual bonds, some preference shares. The IASB proposed sharper rules in twenty twenty-three, closed consultation in March twenty twenty-four, and as of early twenty twenty-six is STILL redeliberating the details. No final amendment yet — but when it lands, it'll tighten exactly the test you just learned.
Present. Measure. Disclose.
And IAS 32 never stands alone. It answers ONE question: is it debt or equity? Once you know that, IFRS 9 tells you how to MEASURE it — amortised cost, or fair value. And IFRS 7 tells you what you must DISCLOSE about it. Present, measure, disclose — three standards, one story.
The label moves gearing and profit
Why does any of this matter to an investor? Because classification moves gearing. Reclassify a permanent instrument as debt, and leverage ratios jump overnight — nothing about the business changed, only the label. And it moves profit: interest is an expense, dividends aren't. Two companies raising the identical amount of capital can report completely different profit margins, purely from how they structured the deal.
On Meridian's own accounts
Let's land it on Meridian's own accounts. Non-current liabilities: the bond's liability component, growing each year toward one million. Equity: a separate convertible bond equity reserve line, a fixed seventy-eight thousand seven hundred twenty-nine, untouched. Two numbers, from one contract, exactly where IAS 32 says they belong.