The IAS 32 Shock: When Your “Equity” Turned Into Debt and Destroyed Your Ratios

A fast-growing startup’s debt-to-equity ratio jumped from 0.5 to 3.0 overnight. No new borrowing—just their auditor reclassifying their “preferred shares” as debt. The credit facility breach that followed nearly killed the company.

The Equity Pretender Crisis

Think preferred shares are equity? IAS 32 has news for you: If there’s ANY obligation to pay cash, it’s debt. Period.

The features that kill:

• Mandatory redemption? Debt.
• Holder can demand payment? Debt.
• Dividend must be paid if profits exist? Debt.
• Converts to variable number of ordinary shares? Debt.

Startup disaster: A tech company issued “preferred equity” to investors: 8% cumulative dividend, redeemable at holder’s option after 5 years. They booked it as equity. Year 3 audit: That’s $50 million of debt. Debt covenants breached, emergency refinancing needed.

The Compound Instrument Chaos

Convertible bonds sound simple: Part debt, part equity. The accounting? A nightmare of splitting and valuing.

The valuation trap: $100 million convertible bond, 3% interest, converts to fixed number of shares. You must:

1. Value the debt without conversion option
2. Equity = Total proceeds minus debt component
3. Never remeasure equity, always remeasure debt

Math murder: Company values debt component at $100 million (wrong!). Correct value: $85 million (similar non-convertible would yield 5%). Equity component: $15 million. They overstated debt, understated equity, and interest expense was all wrong.

The Treasury Share Trick

Bought back your own shares? Congratulations, you just reduced equity. No gains, no losses, just less equity.

The profit illusion: Share price $10, company buys back at $8. Two years later, reissues at $15. Profit? No! Under IAS 32:

• Buy at $8: Reduce equity $8
• Sell at $15: Increase equity $15
• No P&L impact ever

One company tried routing this through P&L to show “trading profits.” Restatement required, management credibility shot.

The Derivative Disaster Zone

That “harmless” share buyback agreement? If it forces you to buy your own shares for cash, it’s a financial liability.

The forward contract fiasco: Company agrees to buy 1 million own shares in 12 months for $20 each. Share price rises to $30. They have a $10 million loss? No—they have a $20 million liability from day one! The share price changes affect P&L every quarter.

Your Takeaway as an Accountant

Read every instrument’s legal terms—not the marketing name. If cash might leave the company not at your discretion, it’s probably debt. Model the accounting before issuing instruments, not after. Create flowcharts for complex features.

Remember: Calling something “equity” doesn’t make it equity. IAS 32 looks at substance, and substance is about who controls the cash.

Navigate complex instruments with ACCOUNTANT MINDSET—where we see through the labels to the reality.