134 5 Equity and Shareholders’ Capital
Equity from a legal perspective. This raises the question what “equity” means
from a legal perspective.
There cannot be any general legal definition of “equity”. Different laws with
different objectives contain different definitions of equity-type capital. The cate-
gories into which capital and capital instruments are divided depend on the area of
law, and the distinction made between those categories depends on the applicable
regulatory objectives. Furthermore, those categories and the characteristics of
capital or capital instruments that fall within each category depend on the govern-
ing law.
However, laws can have identifiable objectives in this context, and “equity” is
typically governed by provisions belonging to various areas of law. As such rules
do not have to share the same objectives, they do not have to define “equity” in
the same way. This can be illustrated by IFRS, regulatory capital under Basel II,
and company laws.
Equity according to IFRS. Although equity can mean various things, the recog-
nition of assets as equity under the applicable accounting rules is important to all
parties. There can be fundamental differences between different accounting rules
in this respect. Whereas IFRS defines equity as assets that appear on a company’s
balance sheet after deducting all its liabilities, equity can be determined in other
ways under national accounting rules (for the existence of multiple accounting re-
gimes, see Volume I).^1
According to IFRS, equity is one of the five elements of financial statements.
The elements directly related to financial position (balance sheet) are assets, li-
abilities, and equity. The elements directly related to performance (income state-
ment) are income and expenses.
The IFRS Framework defines equity as the residual interest in the entity’s as-
sets after deducting its liabilities.^2 An asset is a resource controlled by the enter-
prise as a result of past events and from which future economic benefits are ex-
pected to flow to the enterprise.^3 A liability is a present obligation of the enterprise
arising from past events, the settlement of which is expected to result in an out-
flow from the enterprise of resources embodying economic benefits.^4
Depending on the governing law, equity is given various descriptions in finan-
cial statements. Corporate entities may refer to it as owners’ equity, shareholders’
equity, capital, shareholders’ funds, or proprietorship, among other things. Equity
includes various classes such as share capital, own equity instruments, and re-
serves.
The definition of equity according to the IFRS Framework is complemented by
rules on the characterisation of financial instruments. IAS 32 lays down the dis-
tinction between equity and liabilities in the context of financial instruments.
(^1) For accounting rules based on the HGB and the German Accounting Law Modernisation
Act (BilMoG), see Hommelhoff P, Modernisiertes HGB-Bilanzrecht im Wettbewerb der
Regelungssysteme. Konzeptionelle Bemerkungen aus Anlass des RefE BilMoG, ZGR
2008 pp 250–274.
(^2) Framework F.49(c).
(^3) Framework F.49(a).
(^4) Framework F.49(b).