Ind AS 32 classifies a financial instrument as a liability if the issuer has a contractual obligation to deliver cash or another financial asset, or to exchange instruments under potentially unfavourable conditions — and as equity only where no such obligation exists, which means the legal label on the instrument (preference share, debenture) is irrelevant to the audit test; what matters is whether redemption, dividend, or conversion terms create an unconditional obligation. A frequent misclassification is compulsorily redeemable preference shares carried as equity, when a mandatory redemption date makes them a liability in substance.
Audit procedures
- 01Read the full instrument terms, not the balance sheet captionTrace through the share subscription or debenture trust deed for redemption triggers, cumulative dividend obligations, and any put option held by the holder — any of these can tip classification from equity to liability regardless of what the instrument is called.
- 02Apply the fixed-for-fixed test to convertible instrumentsA conversion option is an equity component only if it will be settled by the issuer delivering a fixed number of its own equity instruments for a fixed amount of cash — a conversion ratio that varies with the issuer's share price, a foreign currency exercise price, or other variable terms generally results in the entire instrument, or the conversion feature, being classified as a liability (or derivative liability) instead.
- 03Test the split accounting on compound instrumentsWhere an instrument genuinely has separate equity and liability components (e.g., a convertible bond meeting the fixed-for-fixed test), the liability component is measured first at the fair value of a similar liability without the conversion feature, with the residual allocated to equity — recompute this split rather than accept management's allocation.
- 04Test offsetting of financial assets and liabilitiesOffsetting on the balance sheet is permitted only where the entity currently has a legally enforceable right to set off the recognised amounts and intends either to settle net or to settle simultaneously — a mere intention to settle net without the enforceable legal right is not sufficient, and vice versa.
Classifying redeemable preference shares as equity because they are labelled 'shares' and sit in the capital structure, while the terms carry a mandatory redemption date the issuer cannot avoid, misstates gearing and understates liabilities — this is one of the most common Ind AS 32 findings in statutory audits of Indian private companies.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Revenue, receivables & cut-offInd AS 109: financial instruments and the expected credit loss modelThe old model waited for a loss to be incurred before providing for it. ECL is built the opposite way — provide for the loss you expect, before it happens.
- Audit documentationInd AS 113: fair value measurement, and the three-level hierarchy that ranks the inputsFair value isn't one method — it's a framework that ranks how reliable the inputs behind a number actually are, from an observable market price down to a pure internal estimate.
- Bank, cash & treasuryLoans and borrowings audit checklistSanction letter checks, charge verification against ROC filings, covenant compliance, interest testing, and current/non-current classification.
- Bank, cash & treasuryTreasury controls audit checklist for mid-market companiesSegregation of duties over payments, dual signatories, bank mandate review frequency, and whether cash flow forecasting is real or decorative.
Free tools, no signup
Each one reads a file entirely in your browser — or, for two of them, just answers a few questions — and nothing is ever uploaded.
- Purchase register checkDuplicate payments, round-sum amounts, weekend-dated invoices, incomplete records.
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- Fixed asset register checkDuplicate asset codes, missing location or useful life, negative net book value.
- Payroll red-flag scannerBank accounts shared across employees, and records missing an ID, PAN or salary.
- CARO applicability checkerAnswer a few questions about the company and see which CARO 2020 clauses likely apply.
- MSME payment delay checkerMSME-flagged invoices paid — or still unpaid — beyond the 45-day Section 22 limit.
- Related-party transaction screenerTransactions above a threshold you set with no approval reference, grouped by counterparty.
- Depreciation useful life checkerCompares a useful life in use against the Schedule II, Part C indicative figure.
- Materiality calculatorOverall and performance materiality against PBT, revenue, assets or equity, with reasoning shown.
- Sample size calculatorStatistical sample size for a test of controls or a substantive test of detail.