Equity explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Ind AS 32 decides, at the moment an instrument is issued, whether the issuer has a liability or equity, or both. The label on the instrument does not decide it; the contractual terms do. The answer controls whether payments on the instrument are expense or distribution, and what the balance sheet shows.
An instrument is equity only if the issuer has no contractual obligation to deliver cash or another financial asset, and any settlement in its own shares is for a fixed number of shares for a fixed amount. A redeemable preference share or a mandatory dividend makes it a liability. A convertible debenture with a holder's option to convert into a fixed number of shares is split: the liability is measured first at the rate for similar debt without the option, and equity takes the residual.
Ind AS as on 1 April 2025 (ICAI Compendium of Ind AS 2025-26, the standards notified under the Companies (Indian Accounting Standards) Rules, 2015). Amendments notified after 1 April 2025 are not reflected in this article; check mca.gov.in before applying it to a later period.
What the paragraphs require
| Paragraph | Requirement | What it means in practice |
|---|---|---|
| Ind AS 32, 15 | Classify on initial recognition by substance, not legal form | Read the terms; "share" or "debenture" is not the test |
| 16 | Equity only if (a) no obligation to deliver cash or another financial asset, and (b) own-share settlement is fixed-for-fixed | Both limbs must be met |
| 17 and 19 | The critical feature is a contractual obligation; the entity needs an unconditional right to avoid payment | A legal or regulatory bar on paying does not remove the obligation |
| 18(a) | A preference share with mandatory redemption, or redeemable at the holder's option, is a financial liability | Common for redeemable preference shares |
| 21 | A contract settled in a variable number of own shares for a fixed value is a liability | Share-settled does not mean equity |
| 22 | A fixed number of own shares for a fixed amount is equity | Plain share warrants priced in rupees |
| 28 to 32 | Split a compound instrument; equity is the residual after the liability at market rate | No gain or loss on initial split |
| 35 to 38 | Interest and dividends on liabilities go to profit or loss; distributions on equity go to equity; costs allocated pro rata | The classification drives the profit or loss |
| AG25 and AG26 | Redeemable preference shares carry a liability; discretionary distributions on non-redeemable shares point to equity | Look at every right attached |
Term sheets and shareholder agreements are where the answer usually hides, which is why our financial statement preparation work starts with a read of the instrument terms.
Step 1: the contractual obligation test
If the issuer can be made to pay cash, or to hand over another financial asset, it holds a liability. Paragraph AG25 adds that an inability to redeem because of a lack of funds, statutory restrictions or insufficient profits does not cancel the obligation. A redemption that rests entirely with the issuer is not an obligation, until the issuer exercises it and notifies holders. For non-redeemable preference shares, paragraph AG26 points to the other rights: if distributions are at the issuer's discretion, whether cumulative or not, the shares are equity, regardless of the history or intention to pay.
Step 2: the fixed-for-fixed test
Where the instrument is settled in own shares, paragraph 16(b) asks whether the number of shares and the amount of cash are both fixed. Paragraph 21 says a contract to deliver shares worth a fixed rupee amount is a liability, because the number of shares floats. The Indian text adds a carve-out in paragraph 11(b)(ii): a conversion option in a convertible bond denominated in foreign currency is equity if the exercise price is fixed in any currency. The global standard would treat it as a derivative liability; the Ind AS carve-out is explained in the comparison text on Ind AS and IFRS.
Step 3: split a compound instrument
Paragraphs 28 and 29 require the liability and equity components of a convertible instrument to be recognised separately. Following AG31(a), the liability is the present value of the contractual cash flows at the market rate for comparable debt without the conversion option. The equity component is the residual (paragraph 31). The total always equals the proceeds, so there is no gain or loss. Transaction costs are allocated in proportion to the split (paragraph 38). The liability is then unwound using the effective interest method, which the classification guide explains from the holder's side. On conversion at maturity, the liability moves to equity and the original equity component stays in equity (AG32). No gain or loss arises.
Worked example
The entity and all figures in this example are invented for illustration. Amounts are in ₹ lakh and rounded to two decimals.
Indravati Pharma Limited issues two instruments on 1 April 2026.
Instrument 1: redeemable preference shares. It issues ₹100.00 lakh of 8 per cent cumulative preference shares, with a mandatory annual dividend of ₹8.00 lakh, redeemable at par after three years. Issue costs are ₹1.50 lakh. The mandatory redemption and dividend create an obligation to deliver cash, so the whole instrument is a financial liability (paragraphs 11, 18(a) and AG25). Under Ind AS 109, paragraph 5.1.1, the costs reduce the initial liability to ₹98.50 lakh. The effective rate that equates ₹98.50 lakh with the three payments is 8.588 per cent, used here as 8.59 per cent.
| Year to 31 March | Opening liability | Finance cost at 8.59% | Dividend paid | Closing |
|---|---|---|---|---|
| 2027 | 98.50 | 8.46 | 8.00 | 98.96 |
| 2028 | 98.96 | 8.50 | 8.00 | 99.46 |
| 2029 | 99.46 | 8.54 | 8.00 | 100.00 |
Check: total finance cost 8.46 + 8.50 + 8.54 = 25.50, which equals dividends of ₹24.00 lakh plus issue costs of ₹1.50 lakh. The closing balance of ₹100.00 lakh equals the redemption amount.
| Particulars | Debit (₹ lakh) | Credit (₹ lakh) |
|---|---|---|
| Bank | 98.50 | |
| To Redeemable preference share liability | 98.50 | |
| 2026-27: Finance cost (profit or loss) | 8.46 | |
| To Bank (dividend) | 8.00 | |
| To Redeemable preference share liability (unwinding) | 0.46 | |
| 2028-29: Redeemable preference share liability | 100.00 | |
| To Bank (redemption) | 100.00 |
Dividends here are expense, not a distribution (paragraphs 35 and 36). Had the shares been non-redeemable with fully discretionary dividends, the same ₹100 lakh would sit in equity (AG26).
Instrument 2: optionally convertible debentures. It issues 5,000 debentures of ₹10,000 each (₹500.00 lakh) at par, carrying 4 per cent interest (₹20.00 lakh a year, paid on 31 March), repayable after three years, convertible at the holder's option into 10,00,000 equity shares of ₹10 each at maturity, or redeemed at par. The shares are a fixed number, so the option is equity (paragraph 16(b)). The market rate for similar debt with no conversion option is assumed at 9 per cent, for arithmetic only.
| Cash flow | Amount | Discount factor at 9% | Present value |
|---|---|---|---|
| Interest year 1 | 20.00 | 0.9174 | 18.35 |
| Interest year 2 | 20.00 | 0.8417 | 16.83 |
| Principal and interest year 3 | 520.00 | 0.7722 | 401.54 |
| Liability component | 436.72 |
Equity component (paragraph 31): 500.00 - 436.72 = ₹63.28 lakh. Issue costs of ₹10.00 lakh are shared in the same proportion (paragraph 38): liability 10.00 x 436.72 / 500.00 = 8.73; equity 10.00 - 8.73 = 1.27. The net liability is 436.72 - 8.73 = ₹427.99 lakh and the net equity is 63.28 - 1.27 = ₹62.01 lakh. The effective rate on the net liability, with flows of 20, 20 and 520, is 9.77 per cent.
| Year to 31 March | Opening liability | Finance cost at 9.77% | Interest paid | Closing |
|---|---|---|---|---|
| 2027 | 427.99 | 41.81 | 20.00 | 449.80 |
| 2028 | 449.80 | 43.95 | 20.00 | 473.75 |
| 2029 | 473.75 | 46.25 | 20.00 | 500.00 |
Check: year 3 finance cost is the balancing figure (500.00 + 20.00 - 473.75), as 9.77 per cent is rounded. Total finance cost 41.81 + 43.95 + 46.25 = 132.01, which equals coupons ₹60.00 lakh plus the gap between ₹500.00 lakh and ₹427.99 lakh (₹72.01 lakh).
| Particulars | Debit (₹ lakh) | Credit (₹ lakh) |
|---|---|---|
| Bank (500.00 less costs 10.00) | 490.00 | |
| To Debentures, liability component | 427.99 | |
| To Other equity, conversion option | 62.01 | |
| On conversion in 2029: Debentures (liability) | 500.00 | |
| To Equity share capital (10,00,000 shares of ₹10) | 100.00 | |
| To Other equity, premium on conversion | 400.00 |
The ₹62.01 lakh equity component stays in equity after conversion (AG32).
Presentation and disclosure
The liability component and the equity component are presented separately in the balance sheet (paragraph 29); for the Schedule III Division II line items, see our posts on compound instruments and instruments entirely equity. Transaction costs deducted from equity are disclosed separately (paragraph 39). The standard's own summary is in our Ind AS 32 post.
Common mistakes
- Classifying a redeemable preference share as equity because it is legally "share capital" (paragraph 18(a)).
- Treating shares settled for a fixed rupee value as equity (paragraph 21).
- Putting the conversion option at a fair value that is not the residual (paragraphs 31 and 32).
- Leaving issue costs wholly against the liability (paragraph 38).
- Revising the split later because conversion looks more or less likely (paragraph 30).
Need help with equity and liability classification?
Instrument terms in term sheets and shareholder agreements often hide put options, dividend blockers and variable conversion ratios. Our financial statement preparation team can read them with your finance team and settle the classification before the statements are drafted.
Key takeaways
- Substance and contractual terms decide the class, not the name.
- Any unavoidable obligation to deliver cash makes the instrument a liability.
- A fixed number of shares for a fixed amount is equity; a variable number is not.
- Convertible debentures are split: liability first at the market rate, equity as residual.
- Costs are allocated pro rata; the liability is unwound through finance cost.
- Conversion at maturity involves no gain or loss.
Read next
- Classification and measurement of financial assets under Ind AS 109
- ITFG clarifications on Ind AS 32 and 33: preference shares, convertible bonds and earnings per share
- Compound financial instruments under Ind AS 32 paragraph 28 split
- Instruments entirely equity under Ind AS 32 and Schedule III
Disclaimer: Based on the Indian Accounting Standards as on 1 April 2025 (ICAI Compendium of Ind AS 2025-26, the standards notified under the Companies (Indian Accounting Standards) Rules, 2015) and, where named, the ITFG clarification bulletins of ICAI, as consulted on 4 October 2026. The worked example uses invented figures. Amendments notified after 1 April 2025 should be checked on mca.gov.in. This article is general information, not legal advice; check the official text before acting.