Two companies can raise the same ₦5 million and show it in different places: one as debt, which carries interest and must be repaid, and one as equity, which carries no obligation. Whether an instrument is a liability or equity changes gearing, profit and the covenants a lender looks at.
International Accounting Standard (IAS) 32 Financial Instruments: Presentation decides which it is, by looking at the substance of the contract and not its legal form. International Financial Reporting Standard (IFRS) 7 Financial Instruments: Disclosures then requires the entity to tell users about the instruments and the risks. This topic covers debt versus equity, preference shares, offsetting, the accounting for share issues (premium, issue costs, bonus issues and buy-backs), and the IFRS 7 disclosures. The next topic covers earnings per share.
Share issues appear inside the compulsory accounts question in almost every diet: November Diet, 2021, Question 1 (shares issued but not yet recorded), May Diet, 2023, Question 1 (shares issued at a premium, recorded in a suspense account) and November Diet, 2023, Question 1 (shares issued for cash with proceeds recorded separately). Preference shares classified as liabilities appeared in May Diet, 2022, Question 1. Read expected credit losses first.
In 30 seconds
A financial instrument is a financial liability if the issuer has a contractual obligation to deliver cash or another financial asset. Equity if it has no such obligation and shows a residual interest. Redeemable preference shares (mandatory redemption, or at the holder’s option) are liabilities and their dividends are finance costs; irredeemable preference shares with discretionary dividends are equity.
A share issue at a premium credits share capital at nominal value and share premium for the rest; issue costs are deducted from equity, not expensed. A bonus issue capitalises reserves with no cash. Offsetting needs a legal right and an intention to settle net. IFRS 7 requires disclosure of the significance of instruments and the credit, liquidity and market risks.
Liability or equity
A financial liability includes any contractual obligation to deliver cash or another financial asset to another entity, or to exchange financial instruments on potentially unfavourable terms. An equity instrument is a contract that evidences a residual interest in the assets of the entity after deducting all its liabilities. The classification is made at initial recognition by the substance of the arrangement.
- An instrument is a liability if the issuer can be required to pay cash, for example shares that must be redeemed on a fixed date or that the holder can require the issuer to redeem, or if the issuer must deliver a variable number of its own shares to settle a fixed amount.
- It is equity if the issuer can avoid delivering cash, for example irredeemable preference shares whose dividends are at the directors’ discretion, or ordinary shares.
- A compound instrument, such as convertible loan notes, is split into a liability and an equity part (see the topic on financial liabilities).
The classification affects where the returns go. Interest and dividends on liability instruments are finance costs in profit or loss; distributions on equity instruments are deducted from equity.
For example, ₦10,000,000 of 8% redeemable preference shares are a liability, and the annual dividend of ₦800,000 is a finance cost (ignoring any effective interest adjustment), whereas an irredeemable preference share with discretionary dividends is equity and its dividends are in the statement of changes in equity.
Offsetting
A financial asset and a financial liability are offset, and the net amount presented, only when the entity currently has a legally enforceable right to set off the recognised amounts and intends either to settle on a net basis or to realise the asset and settle the liability simultaneously.
A receivable of ₦2,500,000 and a payable of ₦2,000,000 with the same counterparty, with a legal right of set-off and an intention to settle net, are shown as a net asset of ₦500,000. Without both conditions they are shown gross. Offsetting income and expenses follows other standards.
Accounting for share issues
Issues for cash
Shares are issued at an issue price that is often above nominal value. Cash (or the receivable) is debited with the full proceeds. Share capital is credited at nominal value and the excess is credited to share premium. For example, 2,000,000 ordinary shares of ₦1 are issued at ₦2.50. Cash is 2,000,000 × ₦2.50 = ₦5,000,000, share capital ₦2,000,000 and share premium ₦3,000,000.
If issue costs (underwriting, legal, advertising) of ₦150,000 are paid, they are a deduction from equity, usually against share premium: Dr Share premium ₦150,000, Cr Cash ₦150,000, leaving premium of ₦2,850,000. Company law restricts how share premium may be used. If the proceeds were recorded in a suspense account, the entry transfers them to share capital and premium.
Bonus issues
A bonus (capitalisation) issue gives existing shareholders new shares free, in proportion to their holdings. No cash is received. Reserves, usually share premium or retained earnings, are converted into share capital, so total equity does not change. A one-for-four bonus issue on 8,000,000 shares of ₦1 creates 2,000,000 new shares: Dr Share premium (or retained earnings) ₦2,000,000, Cr Share capital ₦2,000,000.
Buy-backs and treasury shares
If an entity reacquires its own equity instruments, they are deducted from equity (as treasury shares) or cancelled. No gain or loss is recognised in profit or loss on buying, selling, issuing or cancelling them. Buying back 500,000 shares at ₦1.80 costs ₦900,000: Dr Treasury shares (equity) ₦900,000, Cr Cash ₦900,000.
IFRS 7 disclosures
The standard requires disclosures that help users evaluate the significance of financial instruments for the entity’s financial position and performance, and the nature and extent of the risks arising from them.
Significance
- The carrying amounts of each category of financial asset and liability: at fair value through profit or loss, at amortised cost, and at fair value through other comprehensive income.
- Net gains and losses by category, total interest income and expense, and fee income and expense.
- Accounting policies, collateral given and held, and the allowance account for credit losses.
- Fair values of each class, with the level in the fair value hierarchy (see the fair value topic), unless the carrying amount is a reasonable approximation.
- Compound instruments with several embedded features, defaults and breaches of loan terms, and hedge accounting information.
Risks
Qualitative disclosures describe the exposures to each risk, the objectives, policies and processes for managing them. Quantitative disclosures cover:
- Credit risk: the maximum exposure, credit quality, collateral and the expected credit loss information.
- Liquidity risk: a maturity analysis of financial liabilities, showing the remaining contractual maturities, and how the risk is managed.
- Market risk: a sensitivity analysis for each type of market risk (interest rate, currency and other price risk), showing the effect on profit or loss and equity of reasonably possible changes in the risk variable.
The ideas in more depth
Why substance over form
A preference share is legally a share, but if the holder can demand repayment, it works like a loan. Showing it as equity would understate debt and hide a real obligation. The test is whether the issuer can avoid paying cash.
Why issue costs are not expensed
The costs are incurred to obtain equity capital, which benefits the entity over its life. They are treated as a reduction of the amount raised, so the net proceeds are recognised in equity.
Sources and references
- IAS 32 Financial Instruments: Presentation: definitions, liabilities and equity, compound instruments, treasury shares and offsetting.
- IFRS 7 Financial Instruments: Disclosures: significance of instruments and the nature and extent of risks.
These points are stated as at 5 November 2026.
Worked examples
Example 1: a cash issue with costs. A company issues 2,000,000 ordinary shares of ₦1 at ₦2.50 and pays issue costs of ₦150,000. Required: the entries.
- Proceeds.
2,000,000 × ₦2.50 = ₦5,000,000.
Dr Cash ₦5,000,000. - Credits. Share capital ₦2,000,000 and share premium ₦3,000,000.
- Issue costs. Dr Share premium ₦150,000, Cr Cash ₦150,000.
- Share premium after costs.
₦3,000,000 − ₦150,000 = ₦2,850,000.
Example 2: classify preference shares. (a) ₦10,000,000 of 8% preference shares redeemable at par in five years. (b) ₦5,000,000 of 6% irredeemable preference shares with dividends at the directors’ discretion. Required: the classification and the treatment of dividends.
- (a) A contractual obligation to redeem: liability.
The dividend of 8% × ₦10,000,000 = ₦800,000 is a finance cost in profit or loss. - (b) No obligation to pay cash: equity. Dividends are deducted in the statement of changes in equity.
Example 3: a bonus issue. A one-for-four bonus issue is made on 8,000,000 ordinary shares of ₦1, out of share premium. Required: the entry.
- New shares.
8,000,000 ÷ 4 = 2,000,000, at nominal value ₦2,000,000. - Entry. Dr Share premium ₦2,000,000, Cr Share capital ₦2,000,000. No cash moves and total equity is unchanged.
How to answer in the exam
- Classify by substance. Can the issuer avoid paying cash? If not, it is a liability.
- Split a share issue. Nominal to capital, excess to premium, costs against premium.
- Recorded already? If the proceeds are in a suspense account, clear it into capital and premium.
- List disclosures. Say significance first, then credit, liquidity and market risk with the form of each.
Common mistakes in the exam
- Showing redeemable preference shares in equity and their dividends in the statement of changes in equity.
- Crediting the whole proceeds of a share issue to share capital.
- Expensing issue costs in profit or loss.
- Calling a bonus issue a source of cash.
- Recognising a gain or loss on a buy-back.
- Offsetting a receivable and a payable without a legal right of set-off.
Quick revision
- Obligation to deliver cash means liability; otherwise equity. Redeemable preference shares are liabilities.
- Share issue: capital at nominal, premium for the excess, costs against premium.
- Bonus issue: reserves to capital, no cash. Buy-back: treasury shares, no gain or loss.
- Offset only with a legal right and an intention to settle net.
- IFRS 7: significance, and credit, liquidity (maturity analysis) and market (sensitivity) risk.
Practice questions
These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.
Recall check: multiple choice
Question 1. An instrument is a financial liability if the issuer has:
- A contractual obligation to deliver cash or another financial asset
- A profit
- Shareholders
- No obligation to pay
Show the answer
A. The test is the substance of the contract.
Question 2. Preference shares that must be redeemed on a fixed date are:
- Equity
- Liabilities
- Reserves
- Revenue
Show the answer
B. The issuer has an obligation to pay cash.
Question 3. Dividends on preference shares classified as liabilities are:
- Deducted from retained earnings
- Ignored
- Finance costs in profit or loss
- Credited to equity
Show the answer
C. They are treated as interest.
Question 4. The costs of issuing equity shares are:
- Expensed in profit or loss
- Capitalised as an asset
- Added to share capital
- Deducted from equity, usually against share premium
Show the answer
D. They reduce the net amount raised.
Question 5. A bonus issue:
- Capitalises reserves into share capital, with no cash received
- Raises new cash
- Reduces equity
- Creates a liability
Show the answer
A. Total equity is unchanged.
Question 6. A financial asset and liability are offset only if the entity has:
- A large balance
- A legally enforceable right to set off and intends to settle net or simultaneously
- The same auditor
- The same year end
Show the answer
B. Both conditions are required.
Question 7. Treasury shares are:
- Shown as assets
- Cancelled with a gain
- Deducted from equity, with no gain or loss in profit or loss
- Shown as liabilities
Show the answer
C. They are an entity’s own equity instruments.
Question 8. IFRS 7 requires disclosure of:
- Only the cost of instruments
- The names of investors
- Tax rates
- The significance of instruments and the nature and extent of the risks arising from them
Show the answer
D. Credit, liquidity and market risk.
Question 9. Share premium is:
- The excess of the issue price over the nominal value
- The nominal value
- A profit
- The dividend
Show the answer
A. It is a reserve within equity.
Question 10. A liquidity risk disclosure includes:
- A sensitivity analysis
- A tax computation
- A maturity analysis of financial liabilities
- A profit forecast
Show the answer
C. It shows remaining contractual maturities.
Section B style: written questions
Question 11 (10 marks). (a) Explain how an instrument is classified as a liability or as equity. (4 marks) (b) State how redeemable and irredeemable preference shares are treated and how their dividends are shown. (4 marks) (c) State the conditions for offsetting. (2 marks)
Question 12 (15 marks). (a) A company issues 3,000,000 ordinary shares of ₦0.50 at ₦1.80 and pays issue costs of ₦200,000. Show the entries and the share premium. (6 marks) (b) A one-for-four bonus issue is made on 8,000,000 ordinary shares of ₦1 from share premium. Show the entry. (4 marks) (c) A company has ₦6,000,000 of 10% preference shares redeemable at par in five years. State the classification and the annual dividend treatment. (5 marks)
A further written question
Question 13 (20 marks). (a) Classify each:
- 8% preference shares redeemable at the holder’s option
- irredeemable preference shares with discretionary dividends
- ordinary shares
- a loan to be repaid in a variable number of the entity’s own shares worth a fixed amount
(8 marks)
(b) A company has a receivable of ₦2,500,000 and a payable of ₦2,000,000 with the same party. State when they may be offset and the amount shown. (4 marks)
(c) State the three risks that IFRS 7 requires disclosure of and one quantitative disclosure for each. (4 marks)
(d) A company buys back 500,000 of its own ₦1 shares at ₦1.80. State the entry and the effect on profit or loss. (4 marks)
Model answers
Show the model answer to Question 11
(a) Classification is by the substance of the contract (1). An instrument is a financial liability if the issuer has a contractual obligation to deliver cash or another financial asset (1.5). It is equity if it evidences a residual interest in the assets after deducting all liabilities and the issuer can avoid paying cash (1.5).
(b) Redeemable preference shares are liabilities (1) and their dividends are finance costs in profit or loss (1). Irredeemable preference shares with discretionary dividends are equity (1), and their dividends are deducted in equity (1).
(c) A currently legally enforceable right to set off (1) and an intention to settle net or to realise the asset and settle the liability simultaneously (1).
Show the model answer to Question 12
(a)
- Proceeds 3,000,000 × ₦1.80 = ₦5,400,000 (1).
- Share capital 3,000,000 × ₦0.50 = ₦1,500,000 (1).
- Share premium 3,000,000 × ₦1.30 = ₦3,900,000 (1).
- Issue costs ₦200,000 deducted from share premium (1.5), leaving premium of ₦3,700,000 (1).
- Net cash ₦5,200,000 (0.5).
(b)
- New shares 8,000,000 ÷ 4 = 2,000,000 (1).
- Dr Share premium ₦2,000,000 (1.5), Cr Share capital ₦2,000,000 (1.5).
- No cash is received and total equity is unchanged (0).
(c)
- The preference shares are a liability because the company must redeem them in cash (2.5).
- The dividend of 10% × ₦6,000,000 = ₦600,000 is a finance cost in profit or loss (2.5).
Show the model answer to Question 13
(a) (2 marks each) Redeemable at the holder’s option: liability. Irredeemable with discretionary dividends: equity. Ordinary shares: equity. A loan repaid in a variable number of shares worth a fixed amount: liability, because the entity must deliver a fixed value.
(b)
- They may be offset only if there is a legally enforceable right to set off and an intention to settle net or simultaneously (2).
- The net amount shown is ₦2,500,000 − ₦2,000,000 = ₦500,000 asset (2).
(c) Credit risk: maximum exposure or credit quality (1.33). Liquidity risk: maturity analysis (1.33). Market risk: sensitivity analysis for interest rate, currency or other price risk (1.34).
(d) Dr Treasury shares (equity) ₦900,000, Cr Cash ₦900,000 (3). No gain or loss is recognised in profit or loss (1).
Pathfinder on IAS 32 and IFRS 7: presentation and disclosure, including share issues
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
The compulsory accounts question includes ordinary shares issued and paid for but not yet recorded, and dividends on 12% preference shares. The other adjustments belong to other topics.
Revise first: Accounting for share issues
The question includes preference shares that are to be treated as liabilities. The other parts belong to other topics.
Revise first: Liability or equity
The compulsory accounts question includes a suspense account balance that represents shares issued at a premium. The other adjustments belong to other topics.
Revise first: Accounting for share issues
The compulsory accounts question includes new ordinary shares issued for cash at a premium, with the proceeds recorded in a separate account. The other adjustments belong to other topics.
Revise first: Accounting for share issues
Source: ICAN Pathfinder, Financial Reporting. Diets covered: Every diet in the Pathfinder, from November Diet, 2021 to May Diet, 2026, was reviewed here. The diets listed above include this topic within a longer question..
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