Classifying a convertible note, compulsorily convertible preference share (CCPS) or SAFE-style instrument as a liability or as equity under Ind AS 32 turns on the actual contractual terms — specifically whether the instrument converts into a fixed number of equity shares for a fixed amount of cash (the 'fixed-for-fixed' test), and whether the issuer has any obligation to deliver cash or another financial asset instead of shares — not on what the term sheet or the company calls the instrument. A convertible note that converts at a valuation cap and discount, producing a variable number of shares depending on the next round's price, generally fails the fixed-for-fixed test and has a liability component even though everyone in the deal refers to it informally as equity-like.
Why this is the single highest-stakes classification call in a startup audit
Getting this wrong doesn't just misstate one line item — it misstates the balance sheet's debt-equity split, can trigger or avoid loan covenants and CARO reporting on default in borrowings, and changes whether a fair-value gain or loss on the instrument needs to flow through the income statement each period. Startups that have raised several rounds through different instrument types typically have more than one classification question live at once, and each instrument needs its own analysis against its own term sheet.
The fixed-for-fixed test in practice
| Instrument feature | Points toward | Why |
|---|---|---|
| Converts into a fixed number of shares for a fixed amount already paid in | Equity | No variability in shares issuable; satisfies fixed-for-fixed |
| Converts at a discount to the next round's price, or at a valuation cap | Liability component likely | Number of shares issuable varies with a future, unknown price — fails fixed-for-fixed |
| Includes a cash-redemption right or obligation (maturity date, repay-in-cash-if-no-round) | Liability | Any contractual obligation to deliver cash rather than shares is a liability feature regardless of conversion terms |
| CCPS with a fixed conversion ratio set at issue and no cash-redemption option | Can be equity | Fixed shares for fixed consideration, no obligation to pay cash |
| CCPS with a dividend that is cumulative and mandatory regardless of profits | Liability component likely | A mandatory payment obligation is a debt-like feature even if the instrument is styled as a preference share |
Regulatory requirement
Ind AS 32's definitions of a financial liability versus an equity instrument, and the specific fixed-for-fixed criterion, are detailed and have been the subject of interpretive guidance over time. This is a genuinely technical classification — confirm the current standard's exact wording and consider specialist input for a complex or hybrid instrument rather than relying on an informal read of the term sheet.
Auditing the classification
- 01Obtain the actual signed term sheet and share subscription or note agreement for each instrumentNot a summary from management, and not the pitch deck's description of the round — the legal document's conversion and redemption clauses are what govern the accounting.
- 02Separate liability and equity components where the instrument is a compound instrumentWhere an instrument has both a debt-like feature (e.g., a redemption option) and an equity-like conversion feature, Ind AS 32 requires splitting the proceeds between a liability component and an equity (or sometimes derivative) component at initial recognition.
- 03Check for consistency across instruments issued in the same roundDifferent investors in the same round sometimes negotiate slightly different terms. Confirm each instrument was classified on its own actual terms rather than copying the classification used for a different investor's instrument in the same round.
- 04Test subsequent measurement of any liability componentA liability-classified convertible instrument is typically measured and subsequently remeasured in a way that can produce a fair-value movement through profit or loss each period — confirm this is actually being tracked, not left at initial carrying value indefinitely.
A startup that classifies every convertible instrument it has ever issued as equity, regardless of differences in redemption and conversion terms across rounds, almost certainly has not actually performed this analysis instrument by instrument — ask to see the analysis for each round separately.
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.
- Related parties & disclosuresRelated-party transaction testing under AS 18 / Ind AS 24Testing related-party transactions means proving the population is complete before checking what management already disclosed.
- Bank, cash & treasuryLoans and borrowings audit checklistSanction letter checks, charge verification against ROC filings, covenant compliance, interest testing, and current/non-current classification.
- Audit workflow & automationSA 540: auditing accounting estimates, where judgment replaces a verifiable numberAn estimate can't be vouched to a source document the way an invoice can. SA 540 is about what replaces vouching when there's no single right answer to check against.
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.
- GSTR-2B reconcilerMatches your purchase register against GSTR-2B — missing invoices either side, amount mismatches.
- Bank reconciliation checkerMatches your cash book against a bank statement — what's outstanding on each side.
- 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.
- 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.