Commission Regulation (EC) No 1073/2005 of 7 July 2005 amending Regulation (EC) No 1725/2003 adopting certain international accounting standards in accordance with Regulation (EC) No 1606/2002 of the European Parliament and of the Council, as regards IFRIC 2 Text with EEA relevance
Date: 2005-07-07
Institutions: European Commission
Subjects: accounting, financial instrument, financial market, international standard, standardised accounting system

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COMMISSION REGULATION (EC) No 1073/2005

of 7 July 2005

amending Regulation (EC) No 1725/2003 adopting certain international accounting standards in
accordance with Regulation (EC) No 1606/2002 of the European Parliament and of the Council,
as regards IFRIC 2

(Text with EEA relevance)

THE COMMISSION OF THE EUROPEAN COMMUNITIES,

this interpretation is the same as that for IAS 32, as
already indicated in Recital 3 of Regulation (EC) No
2237/2004 as of 29 December 2004 adopting IAS 32.

Having regard to the Treaty
Community.

establishing the European

the
Having regard to Regulation (EC) No 1606/2002 of
European Parliament and of the Council of 19 July 2002 on
the application of international accounting standards (1), and in
particular Article 3 (1) thereof,

(5)

The consultation with technical experts in the field
support that IFRIC Interpretation 2 Members’ Shares in
Cooperative Entities and Similar Instruments meet the
technical criteria for adoption set out in Article 3(2) of
Regulation (EC) No 1606/2002.

Whereas:

(6)

Regulation (EC) No 1725/2003 should therefore be
amended accordingly.

(1)

(2)

(3)

(4)

By Commission Regulation (EC) No 1725/2003 (2)
certain international standards and interpretations that
were extant at 14 September 2002 were adopted.

(7)

On 17 December 2003 the International Accounting
Standard Board (IASB) published revised International
Accounting Standard (IAS) 32 Financial
Instruments:
Disclosure and Presentation. IAS 32 establishes basic prin-
ciples for the classification of instruments as liabilities or
equity and was adopted by the European Commission by
Commission Regulation (EC) No 2237/2004 (3) as of 29
December 2004.

Following bilateral discussions with representatives of the
cooperative world and due
request by the
Commission, the IASB invited its International Financial
Reporting Interpretation Committee (IFRIC), to develop
an interpretation to facilitate the application of
the
revised IAS 32.

to a

IFRIC 2 Members’ Shares in Cooperative Entities and Similar
Instruments was published on 25 November 2004. The
Interpretation clarifies that the classification of members’
shares as financial liabilities or as equity depends upon
the
the
redemption features. The effective date of application of

characteristics of

such shares,

especially

This amendment should exceptionally take effect
for
company’s financial year starting on or after 1 January
2005, i.e. from a point in time before the publication of
this regulation. The retrospective application is excep-
tionally justified as to enable cooperatives the preparation
of accounts in accordance with IAS 32, as construed by
IFRIC 2, and as the companies concerned could legiti-
mately expect such application already at the point of the
adoption of IAS 32.

(8)

The measures provided for in this Regulation are in
accordance with the opinion of the Accounting Regu-
latory Committee.

HAS ADOPTED THIS REGULATION:

Article 1

Annex to Regulation (EC) No 1725/2003 is amended as
follows:

(1) OJ L 243, 11.9.2002, p. 1.
(2) OJ L 261, 13.10.2003, p. 1. Regulation as last amended by Regu-

lation (EC) No 211/2005 (OJ L 41, 11.2.2005, p. 1).

(3) OJ L 393, 31.12.2004, p. 1.

The text of the Interpretation IFRIC 2 Members’ Shares in Coop-
erative Entities and Similar Instruments set out in the Annex to this
Regulation, is inserted.

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This Regulation shall enter into force on the third day following its publication in the Official Journal of the
European Union.

Article 2

It shall apply to each financial year of a company starting on or after 1 January 2005 at the latest.

This Regulation shall be binding in its entirety and directly applicable in all Member States.

Done at Brussels, 7 July 2005.

For the Commission

Charlie McCREEVY
Member of the Commission

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ANNEX

INTERNATIONAL FINANCIAL REPORTING STANDARDS

IFRIC 2

Members’ Shares in Cooperative Entities and Similar Instruments

Reproduction allowed within the European Economic Area. All existing rights reserved outside the EEA, with
the exception of the right to reproduce for the purposes of personal use or other fair dealing. Further infor-
mation can be obtained from the IASB at www.iasb.org.uk

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IFRIC INTERPRETATION 2
Members’ Shares in Cooperative Entities and Similar Instruments

References
— IAS 32 Financial Instruments: Disclosure and Presentation (as revised in 2003)

— IAS 39 Financial Instruments: Recognition and Measurement (as revised in 2003)

Background

1 Cooperatives and other similar entities are formed by groups of persons to meet common economic or social needs.
laws typically define a cooperative as a society endeavouring to promote its members’ economic
National
advancement by way of a joint business operation (the principle of self-help). Members’ interests in a cooperative
are often characterised as members’ shares, units or the like, and are referred to below as ‘members’ shares’.

2 IAS 32 establishes principles for the classification of

In
particular, those principles apply to the classification of puttable instruments that allow the holder to put those
instruments to the issuer for cash or another financial instrument. The application of those principles to members’
shares in cooperative entities and similar instruments is difficult. Some of the International Accounting Standards
Board’s constituents have asked for help in understanding how the principles in IAS 32 apply to members’ shares and
similar instruments that have certain features, and the circumstances in which those features affect the classification as
liabilities or equity.

instruments as financial

liabilities or equity.

financial

Scope

3 This Interpretation applies to financial instruments within the scope of IAS 32, including financial instruments issued
to members of cooperative entities that evidence the members’ ownership interest in the entity. This Interpretation
does not apply to financial instruments that will or may be settled in the entity’s own equity instruments.

Issue
4 Many financial instruments, including members’ shares, have characteristics of equity, including voting rights and
rights to participate in dividend distributions. Some financial
instruments give the holder the right to request
redemption for cash or another financial asset, but may include or be subject to limits on whether the financial
instruments will be redeemed. How should those redemption terms be evaluated in determining whether the financial
instruments should be classified as liabilities or equity?

Consensus
5 The contractual right of the holder of a financial instrument (including members’ shares in cooperative entities) to
request redemption does not, in itself, require that financial instrument to be classified as a financial liability. Rather,
the entity must consider all of the terms and conditions of the financial instrument in determining its classification as
a financial liability or equity. Those terms and conditions include relevant local laws, regulations and the entity’s
governing charter in effect at the date of classification, but not expected future amendments to those laws, regulations
or charter.

6 Members’ shares that would be classified as equity if the members did not have a right to request redemption are
equity if either of the conditions described in paragraphs 7 and 8 is present. Demand deposits, including current
accounts, deposit accounts and similar contracts that arise when members act as customers are financial liabilities of
the entity.

7 Members’ shares are equity if the entity has an unconditional right to refuse redemption of the members’ shares.

8 Local law, regulation or the entity’s governing charter can impose various types of prohibitions on the redemption of
members’ shares, e.g. unconditional prohibitions or prohibitions based on liquidity criteria. If redemption is uncon-
ditionally prohibited by local law, regulation or the entity’s governing charter, members’ shares are equity. However,
provisions in local law, regulation or the entity’s governing charter that prohibit redemption only if conditions —
such as liquidity constraints — are met (or are not met) do not result in members’ shares being equity.

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9 An unconditional prohibition may be absolute, in that all redemptions are prohibited. An unconditional prohibition
in that it prohibits redemption of members’ shares if redemption would cause the number of
may be partial,
members’ shares or amount of paid-in capital from members’ shares to fall below a specified level. Members’
shares in excess of the prohibition against redemption are liabilities, unless the entity has the unconditional right
to refuse redemption as described in paragraph 7. In some cases, the number of shares or the amount of paid-in
capital subject to a redemption prohibition may change from time to time. Such a change in the redemption
prohibition leads to a transfer between financial liabilities and equity.

10 At initial recognition, the entity shall measure its financial

liability for redemption at fair value. In the case of
members’ shares with a redemption feature, the entity measures the fair value of the financial liability for redemption
at no less than the maximum amount payable under the redemption provisions of its governing charter or applicable
law discounted from the first date that the amount could be required to be paid (see example 3).

11 As required by paragraph 35 of IAS 32, distributions to holders of equity instruments are recognised directly in
equity, net of any income tax benefits. Interest, dividends and other returns relating to financial instruments classified
as financial liabilities are expenses, regardless of whether those amounts paid are legally characterised as dividends,
interest or otherwise.

12 The Appendix, which is an integral part of the consensus, provides examples of the application of this consensus.

Disclosure

13 When a change in the redemption prohibition leads to a transfer between financial liabilities and equity, the entity

shall disclose separately the amount, timing and reason for the transfer.

Effective date

14 The effective date and transition requirements of this Interpretation are the same as those for IAS 32 (as revised in
2003). An entity shall apply this Interpretation for annual periods beginning on or after 1 January 2005. If an entity
applies this Interpretation for a period beginning before 1 January 2005, it shall disclose that fact. This Interpretation
shall be applied retrospectively.

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Appendix

EXAMPLES OF APPLICATION OF THE CONSENSUS

This appendix is an integral part of the Interpretation.

A1 This appendix sets out seven examples of the application of the IFRIC consensus. The examples do not constitute an
exhaustive list; other fact patterns are possible. Each example assumes that there are no conditions other than those
set out in the facts of the example that would require the financial instrument to be classified as a financial liability.

UNCONDITIONAL RIGHT TO REFUSE REDEMPTION (paragraph 7)

Example 1

Facts
A2 The entity’s charter states that redemptions are made at the sole discretion of the entity. The charter does not
provide further elaboration or limitation on that discretion. In its history, the entity has never refused to redeem
members’ shares, although the governing board has the right to do so.

Classification
A3 The entity has the unconditional right to refuse redemption and the members’ shares are equity. IAS 32 establishes
principles for classification that are based on the terms of the financial instrument and notes that a history of, or
intention to make, discretionary payments does not trigger liability classification. Paragraph AG26 of IAS 32 states:

When preference shares are non-redeemable, the appropriate classification is determined by the other rights that
attach to them. Classification is based on an assessment of the substance of the contractual arrangements and the
liability and an equity instrument. When distributions to holders of the preference
definitions of a financial
the shares are equity
shares, whether cumulative or non-cumulative, are at
instruments. The classification of a preference share as an equity instrument or a financial
liability is not
affected by, for example:

the discretion of

the issuer,

(a) a history of making distributions;

(b) an intention to make distributions in the future;

(c) a possible negative impact on the price of ordinary shares of the issuer if distributions are not made (because
of restrictions on paying dividends on the ordinary shares if dividends are not paid on the preference shares);

(d) the amount of the issuer’s reserves;

(e) an issuer’s expectation of a profit or loss for a period; or

(f) an ability or inability of the issuer to influence the amount of its profit or loss for the period.

Example 2

Facts
A4 The entity’s charter states that redemptions are made at the sole discretion of the entity. However, the charter
further states that approval of a redemption request is automatic unless the entity is unable to make payments
without violating local regulations regarding liquidity or reserves.

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Classification
A5 The entity does not have the unconditional right to refuse redemption and the members’ shares are a financial
liability. The restrictions described above are based on the entity’s ability to settle its liability. They restrict
redemptions only if the liquidity or reserve requirements are not met and then only until such time as they are
met. Hence, they do not, under the principles established in IAS 32, result in the classification of the financial
instrument as equity. Paragraph AG25 of IAS 32 states:

Preference shares may be issued with various rights. In determining whether a preference share is a financial
liability or an equity instrument, an issuer assesses the particular rights attaching to the share to determine
whether it exhibits the fundamental characteristic of a financial liability. For example, a preference share that
provides for redemption on a specific date or at the option of the holder contains a financial liability because the
issuer has an obligation to transfer financial assets to the holder of the share. The potential inability of an issuer to
satisfy an obligation to redeem a preference share when contractually required to do so, whether because of a lack of funds, a
statutory restriction or insufficient profits or reserves, does not negate the obligation. [Emphasis added]

PROHIBITIONS AGAINST REDEMPTION (paragraphs 8 and 9)

Example 3

Facts

A6 A cooperative entity has issued shares to its members at different dates and for different amounts in the past as

follows:

(a) 1 January 20x1 100 000 shares at CU 10 each (CU 1 000 000);

(b) 1 January 20x2 100 000 shares at CU 20 each (a further CU 2 000 000, so that the total for shares issued is

CU 3 000 000).

Shares are redeemable on demand at the amount for which they were issued.

A7 The entity’s charter states that cumulative redemptions cannot exceed 20 per cent of the highest number of its
members’ shares ever outstanding. At 31 December 20x2 the entity has 200 000 of outstanding shares, which is
the highest number of members’ shares ever outstanding and no shares have been redeemed in the past. On 1
January 20x3 the entity amends its governing charter and increases the permitted level of cumulative redemptions
to 25 per cent of the highest number of its members’ shares ever outstanding.

Classification

B e f o r e t h e g o v e r n i n g c h a r t e r i s a m e n d e d
A8 Members’ shares in excess of the prohibition against redemption are financial

liabilities. The cooperative entity
measures this financial liability at fair value at initial recognition. Because these shares are redeemable on demand,
the cooperative entity determines the fair value of such financial liabilities as required by paragraph 49 of IAS 39,
which states: ‘The fair value of a financial liability with a demand feature (e.g. a demand deposit) is not less than the
amount payable on demand …’ Accordingly, the cooperative entity classifies as financial liabilities the maximum
amount payable on demand under the redemption provisions.

A9 On 1 January 20x1 the maximum amount payable under the redemption provisions is 20 000 shares at CU 10
each and accordingly the entity classifies CU 200 000 as financial liability and CU 800 000 as equity. However, on
1 January 20x2 because of the new issue of shares at CU 20, the maximum amount payable under the redemption
provisions increases to 40 000 shares at CU 20 each. The issue of additional shares at CU 20 creates a new liability
that is measured on initial recognition at fair value. The liability after these shares have been issued is 20 per cent of
the total shares in issue (200 000), measured at CU 20, or CU 800 000. This requires recognition of an additional
liability of CU 600 000. In this example no gain or loss is recognised. Accordingly the entity now classifies
CU 800 000 as financial
liabilities and CU 2 200 000 as equity. This example assumes these amounts are not
changed between 1 January 20x1 and 31 December 20x2.

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A f t e r t h e g o v e r n i n g c h a r t e r i s a m e n d e d

A10 Following the change in its governing charter the cooperative entity can now be required to redeem a maximum of
25 per cent of its outstanding shares or a maximum of 50 000 shares at CU 20 each. Accordingly, on 1 January
20x3 the cooperative entity classifies as financial
liabilities an amount of CU 1 000 000 being the maximum
amount payable on demand under the redemption provisions, as determined in accordance with paragraph 49
of IAS 39. It therefore transfers on 1 January 20x3 from equity to financial liabilities an amount of CU 200 000,
leaving CU 2 000 000 classified as equity. In this example the entity does not recognise a gain or loss on the
transfer.

Example 4

Facts
A11 Local law governing the operations of cooperatives, or the terms of the entity’s governing charter, prohibit an entity
from redeeming members’ shares if, by redeeming them, it would reduce paid-in capital from members’ shares
below 75 per cent of the highest amount of paid-in capital from members’ shares. The highest amount for a
particular cooperative is CU 1 000 000. At the balance sheet date the balance of paid-in capital is CU 900 000.

Classification

A12 In this case, CU 750 000 would be classified as equity and CU 150 000 would be classified as financial liabilities.

In addition to the paragraphs already cited, paragraph 18(b) of IAS 32 states in part:

... a financial instrument that gives the holder the right to put it back to the issuer for cash or another financial
asset (a ‘puttable instrument’) is a financial liability. This is so even when the amount of cash or other financial
assets is determined on the basis of an index or other item that has the potential to increase or decrease, or when
the legal form of the puttable instrument gives the holder a right to a residual interest in the assets of an issuer.
The existence of an option for the holder to put the instrument back to the issuer for cash or another financial
asset means that the puttable instrument meets the definition of a financial liability.

A13 The redemption prohibition described in this example is different from the restrictions described in paragraphs 19
and AG25 of IAS 32. Those restrictions are limitations on the ability of the entity to pay the amount due on a
financial liability, i.e. they prevent payment of the liability only if specified conditions are met. In contrast, this
example describes an unconditional prohibition on redemptions beyond a specified amount, regardless of the
entity’s ability to redeem members’ shares (e.g. given its cash resources, profits or distributable reserves).
In
effect, the prohibition against redemption prevents the entity from incurring any financial
liability to redeem
more than a specified amount of paid-in capital. Therefore, the portion of shares subject to the redemption
prohibition is not a financial liability. While each member’s shares may be redeemable individually, a portion of
the total shares outstanding is not redeemable in any circumstances other than liquidation of the entity.

Example 5

Facts

A14 The facts of this example are as stated in example 4. In addition, at the balance sheet date, liquidity requirements
imposed in the local jurisdiction prevent the entity from redeeming any members’ shares unless its holdings of cash
and short-term investments are greater than a specified amount. The effect of these liquidity requirements at the
balance sheet date is that the entity cannot pay more than CU 50 000 to redeem the members’ shares.

Classification

A15 As in example 4, the entity classifies CU 750 000 as equity and CU 150 000 as a financial liability. This is because
the amount classified as a liability is based on the entity’s unconditional right to refuse redemption and not on
conditional restrictions that prevent redemption only if liquidity or other conditions are not met and then only until
such time as they are met. The provisions of paragraphs 19 and AG25 of IAS 32 apply in this case.

Example 6

Facts
A16 The entity’s governing charter prohibits it from redeeming members’ shares, except to the extent of proceeds
received from the issue of additional members’ shares to new or existing members during the preceding three
years. Proceeds from issuing members’ shares must be applied to redeem shares for which members have requested
redemption. During the three preceding years, the proceeds from issuing members’ shares have been CU 12 000
and no member’s shares have been redeemed.

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Classification
A17 The entity classifies CU 12 000 of the members’ shares as financial liabilities. Consistently with the conclusions
described in example 4, members’ shares subject to an unconditional prohibition against redemption are not
financial
liabilities. Such an unconditional prohibition applies to an amount equal to the proceeds of shares
issued before the preceding three years, and accordingly, this amount is classified as equity. However, an amount
equal to the proceeds from any shares issued in the preceding three years is not subject to an unconditional
prohibition on redemption. Accordingly, proceeds from the issue of members’ shares in the preceding three years
give rise to financial liabilities until they are no longer available for redemption of members’ shares. As a result the
entity has a financial liability equal to the proceeds of shares issued during the three preceding years, net of any
redemptions during that period.

Example 7

Facts

‘outstanding liabilities’

A18 The entity is a cooperative bank. Local law governing the operations of cooperative banks state that at least 50 per
cent of the entity’s total
(a term defined in the regulations to include members’ share
accounts) has to be in the form of members’ paid-in capital. The effect of the regulation is that if all of a
cooperative’s outstanding liabilities are in the form of members’ shares,
is able to redeem them all. On
31 December 20x1 the entity has total outstanding liabilities of CU 200 000, of which CU 125 000 represent
members’ share accounts. The terms of the members’ share accounts permit the holder to redeem them on demand
and there are no limitations on redemption in the entity’s charter.

it

Classification
A19 In this example members’ shares are classified as financial liabilities. The redemption prohibition is similar to the
restrictions described in paragraphs 19 and AG25 of IAS 32. The restriction is a conditional limitation on the ability
of the entity to pay the amount due on a financial liability, i.e. they prevent payment of the liability only if specified
conditions are met. More specifically, the entity could be required to redeem the entire amount of members’ shares
(CU 125 000) if it repaid all of its other liabilities (CU 75 000). Consequently, the prohibition against redemption
does not prevent the entity from incurring a financial liability to redeem more than a specified number of members’
shares or amount of paid-in capital. It allows the entity only to defer redemption until a condition is met, i.e. the
repayment of other liabilities. Members’ shares in this example are not subject to an unconditional prohibition
against redemption and are therefore classified as financial liabilities.