Financial instruments I: classification, measurement and liability or equity

Financial instruments are where accounting meets legal drafting. Small changes in a contract's wording, such as a clause that links an interest rate to a sustainability target or a put option held by a minority owner, can change an instrument's classification, its measurement basis and the volatility of reported earnings. US GAAP spreads the rules across several topics: ASC 320 for debt securities, ASC 321 for equity securities, ASC 310 for loans, ASC 326 for credit losses, ASC 480 and ASC 815-40 for the boundary between liabilities and equity, and ASC 470-20 for convertible debt. This lesson takes Tamarind Bay's portfolio of financial assets, its convertible notes and the put option over the non-controlling interest in Harrow Creek, works through the classification judgments, and compares the answers under IFRS 9 and IAS 32.

Classifying financial assets

US GAAP classifies financial assets by legal form and intent rather than by a single business model and cash flow test. Debt securities are classified under ASC 320 as trading (fair value through net income), available-for-sale (fair value through OCI, recycled on sale) or held-to-maturity (amortized cost, only if the entity has the positive intent and ability to hold to maturity). Equity securities with readily determinable fair values are measured at fair value through net income under ASC 321, with no OCI option since ASU 2016-01; those without readily determinable fair values may use a measurement alternative of cost less impairment, adjusted for observable price changes. Loans that are not securities, such as Tamarind Bay's loan to a supplier, are held for investment at amortized cost under ASC 310 unless held for sale. IFRS 9 reaches broadly similar answers through its business model and SPPI tests, but with an FVOCI election for equity investments that US GAAP does not offer.

# Classifying Tamarind Bay's financial instruments under IFRS 9 and US GAAP (invented facts).
instruments = [
    # name, cash flows SPPI?, business model, equity?, FVOCI election?
    ("Loan to supplier, ESG-linked margin step", True, "hold to collect", False, False),
    ("Term deposits", True, "hold to collect", False, False),
    ("Government bonds, liquidity portfolio", True, "collect and sell", False, False),
    ("Listed shares, strategic stake", None, None, True, True),
    ("Unlisted fund units (puttable)", False, "hold to collect", False, False),
]
def ifrs9(sppi, bm, equity, oci):
    if equity: return "FVOCI (election, no recycling)" if oci else "FVTPL"
    if not sppi: return "FVTPL (fails SPPI)"
    return {"hold to collect": "Amortized cost", "collect and sell": "FVOCI (recycled)"}.get(bm, "FVTPL")
def usgaap(name, equity):
    if equity: return "Fair value through net income (ASC 321)"
    if "Loan" in name: return "Amortized cost, held for investment (ASC 310)"
    if "bonds" in name: return "Available-for-sale (ASC 320)"
    if "fund" in name: return "Fair value through net income (ASC 321)"
    return "Amortized cost (cash equivalent or deposit)"
for name, sppi, bm, eq, oci in instruments:
    print(f"{name}\n   IFRS 9 : {ifrs9(sppi, bm, eq, oci)}\n   US GAAP: {usgaap(name, eq)}")
# Convertible notes issued January 1, 2025: 300.0, 5 years, 4.5% coupon; straight debt rate 6.5%
face, coupon, n, mkt = 300.0, 0.045, 5, 0.065
liab = sum(face * coupon / (1 + mkt) ** t for t in range(1, n + 1)) + face / (1 + mkt) ** n
print("\nConvertible notes at issue")
print(f"  IAS 32 split: liability {liab:.2f}, equity component {face - liab:.2f}")
print(f"  ASC 470-20 after ASU 2020-06: single liability {face:.2f}, no equity component")
bal = liab
for yr in (2025, 2026):
    i = bal * mkt; bal += i - face * coupon
    print(f"  {yr}: IFRS interest {i:.2f} (liability {bal:.2f}); US GAAP interest {face * coupon:.2f}")

Loan to supplier, ESG-linked margin step
   IFRS 9 : Amortized cost
   US GAAP: Amortized cost, held for investment (ASC 310)
Term deposits
   IFRS 9 : Amortized cost
   US GAAP: Amortized cost (cash equivalent or deposit)
Government bonds, liquidity portfolio
   IFRS 9 : FVOCI (recycled)
   US GAAP: Available-for-sale (ASC 320)
Listed shares, strategic stake
   IFRS 9 : FVOCI (election, no recycling)
   US GAAP: Fair value through net income (ASC 321)
Unlisted fund units (puttable)
   IFRS 9 : FVTPL (fails SPPI)
   US GAAP: Fair value through net income (ASC 321)

Convertible notes at issue
  IAS 32 split: liability 275.07, equity component 24.93
  ASC 470-20 after ASU 2020-06: single liability 300.00, no equity component
  2025: IFRS interest 17.88 (liability 279.45); US GAAP interest 13.50
  2026: IFRS interest 18.16 (liability 284.11); US GAAP interest 13.50

The ESG-linked supplier loan

In 2026 Tamarind Bay lent 25.0 million to its largest packaging supplier, repayable over five years, to fund a plant that makes recyclable trays. The interest rate is a benchmark plus 3.00 percent, reduced by 0.25 percent if the supplier meets an annual target for recycled content verified by an independent auditor, and increased by 0.25 percent if it misses the target. Does a margin that varies with a sustainability target fail the SPPI test, forcing the loan to FVTPL?

Under US GAAP the loan is held for investment at amortized cost, and the question is not whether it passes a cash flow test but whether the sustainability feature is an embedded derivative that must be separated under ASC 815. A feature linked to a non-financial variable specific to a party to the contract, such as the supplier's own recycled content, is generally excluded from derivative accounting under the scope exception for non-financial variables specific to a party, or would not be separated because it is clearly and closely related to the host, though practice and analysis vary and the conclusion depends on the terms. Tamarind Bay concludes that no separation is required. Under IFRS 9, the IASB's May 2024 amendments, effective in 2026, now clarify that such a debtor-specific contingent feature does not fail the SPPI test if the cash flows are not significantly different from those without it, so a Canadian competitor would also carry a similar loan at amortized cost.

Getting this right matters for volatility. If the loan were at FVTPL, every change in market interest rates and in the supplier's credit spread would flow through profit each quarter. Many banks and corporates now issue and hold sustainability-linked loans, and their classification was one of the main reasons the IASB made the 2024 amendments.

Equity investments and the FVOCI election

Tamarind Bay holds a 4 percent stake in a listed company that develops compostable packaging, acquired in 2025 for 18.0 million as part of a strategic partnership. Under ASC 321, because the shares have a readily determinable fair value, every change in their fair value goes through net income, and Tamarind Bay excludes these gains and losses from its adjusted measures, explaining why. A Canadian or European competitor reporting under IFRS 9 could elect at initial recognition to present such changes in OCI, never recycled, which makes reported profit less volatile but means that gains on sale never reach profit at all. Analysts comparing the two companies' earnings need to know which treatment applies.

Liability or equity: the convertible notes

In January 2025 Tamarind Bay issued 300.0 million of five-year convertible notes with a 4.5 percent coupon. Each 1,000 note converts into 41.67 shares at the holder's option. After ASU 2020-06, effective for public companies from 2022, US GAAP no longer separates the conversion option of most convertible debt: unless the option must be bifurcated as a derivative under ASC 815, or the notes were issued at a substantial premium, the notes are a single liability at amortized cost. The beneficial conversion feature and cash conversion models were removed. Interest expense in 2026 is therefore the 13.5 million coupon, plus amortization of any issue costs. Under IAS 32 the same notes would be split, with a liability of 275.07 million and an equity component of 24.93 million, so a Canadian competitor would report interest of about 18.2 million in 2026, 4.7 million more than Tamarind Bay. This is one of the larger differences between US GAAP and IFRS in reported interest.

The fixed-for-fixed condition is central. The conversion option is equity only if it will be settled by exchanging a fixed amount of cash or another financial asset for a fixed number of the issuer's own equity instruments. Anti-dilution adjustments that preserve the relative rights of holders and shareholders, such as adjustments for share splits, are generally consistent with the condition, but adjustments that compensate holders for changes in the share price, or settlement options that allow the issuer to pay cash or a variable number of shares, can make the option a derivative liability measured at fair value through profit or loss. Drafting conversion terms without consulting the accounting team is a common source of surprises.

Puttable non-controlling interests

When Tamarind Bay bought 80 percent of Harrow Creek in 2024, it wrote a put option giving the founding family the right to sell their remaining 20 percent to Tamarind Bay in 2029 at a price based on a multiple of EBITDA. Under US GAAP for SEC registrants, ASC 480-10-S99 requires non-controlling interests that are redeemable at the option of the holder, or on an event outside the issuer's control, to be classified outside permanent equity, in temporary or mezzanine equity, at the greater of the carrying amount under the NCI rules and the redemption value, with subsequent changes in redemption value recognized in retained earnings or additional paid-in capital, and possibly in earnings per share. Tamarind Bay therefore presents a redeemable non-controlling interest of about 31 million between liabilities and equity. Under IAS 32, the same put would create a financial liability for the redemption amount.

The IASB's Financial Instruments with Characteristics of Equity (FICE) project may narrow some of these differences for IFRS reporters. At its September 2026 meeting, the IASB tentatively decided that remeasurement gains and losses on liabilities for NCI puts should be recognized in profit or loss and that the initial debit should reduce NCI without derecognizing it when the parent lacks access to ownership returns; measurement was still under discussion and no effective date had been set. US GAAP has no equivalent active project, so the temporary equity model will continue.

Supplier finance arrangements

Tamarind Bay's largest retail customers, and Tamarind Bay itself with its own suppliers, use supplier finance or reverse factoring programs: a bank pays the supplier early at a discount and Tamarind Bay pays the bank on an extended due date. The classification question is whether Tamarind Bay's obligation remains a trade payable, within working capital and operating cash flows, or has become a borrowing from the bank, within debt and financing cash flows. The answer depends on whether the terms are substantially different from ordinary trade payables, such as a payment term extended well beyond industry norms or security provided to the bank. Because these programs can make operating cash flow look better and hide debt, both boards added disclosure requirements effective from 2024: the terms of the arrangements, the carrying amounts of the related liabilities and the portion already paid by the finance providers, the range of payment due dates, and non-cash changes. Tamarind Bay's program extends payment terms from 60 to 90 days, within industry practice, so the liabilities, about 64 million at year end, remain trade payables with the required disclosures.

IFRS and ASPE compared

For comparison, Canadian private enterprises applying ASPE Section 3856 measure most financial assets and liabilities at amortized cost, equity investments quoted in an active market at fair value and other equity investments at cost less impairment, with an incurred loss model for credit losses. Harrow Creek's US GAAP statements, by contrast, apply the same ASC 326 CECL model as its parent, although ASU 2025-05 now gives private companies a further policy election for current receivables, discussed in lesson 8.