136 5 Equity and Shareholders’ Capital
some characteristics of equity. They also give the holder the right to request redemption for
cash, although that right may be subject to certain limitations. The rights to request redemp-
tion causes a problem. IAS 32 provides that a financial instrument cannot be regarded as an
equity instrument, where the instrument includes a contractual obligation to deliver cash to
its holder. This is a serious issue for co-operatives as it has fundamentally challenged the
whole basis of ownership in a co-operative enterprise. In the worst case, co-operative shares
previously regarded as equity could be regarded as debt, which would have a negative im-
pact on co-operative balance sheets and make it more difficult and expensive for co-
operative enterprises to raise funding. (3) For this reason, IFRIC 2^13 gives guidance on how
those redemption terms should be evaluated in determining whether the shares should be
classified as financial liabilities or as equity. Under IFRIC 2, shares for which the member
has the right to request redemption are normally liabilities. However, they are equity if: (a)
the entity has an unconditional right to refuse redemption; or (b) local law, regulation, or
the entity’s governing charter imposes prohibitions on redemption (but the mere existence
of law, regulation, or charter provisions that would prohibit redemption only if conditions
such as liquidity constraints are met, or are not met, does not result in members’ shares be-
ing equity). (4) For example, IFRS forced Metsäliitto, a Finnish forestry co-operative, to
change its rules. According to the new rules, no more than one-third of the distributable
surplus can be used to redeem owners’ shares. Two-thirds of the distributable surplus can
thus be regarded as equity.
Contributions from owners are typically economic benefits that are non-reciprocal
in nature. Contributions from owners are normally made in the form of cash, in
consideration for shares issued by the entity. Contributions by a parent to a sub-
sidiary may, however, take other forms, such as the contribution of non-monetary
assets, for example, property, plant and equipment or another entity, or the provi-
sion of services or interest-free loans.
Distributions by an entity to its owners are normally made in the form of divi-
dends or a return of capital, for example a share buyback. Like contributions, dis-
tributions by a subsidiary to its parent may take other forms.
The creation and use of reserves is often influenced by legal as well as account-
ing requirements. Legal requirements may restrict an entity’s ability to make dis-
tributions from specific reserves to its owners. Reserves will typically include: re-
tained earnings; asset revaluation reserve; fair value reserve arising from the effect
of adopting new IFRS and the subsequent remeasurement of certain financial in-
struments, and a foreign currency translation reserve.
Equity according to Basel II. A financial institution must have regulatory capi-
tal under the Basel II framework. The Basel II Accord contains its own definition
of “equity”.
For supervisory purposes, capital is defined in two tiers. Core capital (Tier 1) is
complemented by supplementary capital (Tier 2). At least 50% of a bank’s capital
(^13) IFRIC 2 Members’ Shares in Cooperative Entities and Similar Instruments. IFRIC
means the International Financial Reporting Interpretation Committee of the IASB. See
Regulation 1073/2005 amending Regulation 1725/2003 adopting certain international
accounting standards in accordance with Regulation 1606/2002, as regards IFRIC 2.