Reference no: EM133000657

Ratcliffe is a listed company seeking to grow. In order to fund this expansion, Ratcliffe is looking to raise new long-term finance, but is concerned about breaching its existing loan covenants, which are based on gearing and interest cover.

• The directors are aware that classification of financial instruments as liabilities or equity can have a significant effect on the financial statements. Guidance is provided in IAS 32 Financial Instruments: Presentation (and other standards for items outside of the scope of IAS 32). However, many financial instruments have features of both debt and equity, which can result in inconsistency of reporting and confusion amongst investors. To aid investors in their analysis of Ratcliffe's financial statements, the directors have decided to disclose 'adjusted gearing' and 'adjusted interest cover' and to emphasise these figures in their management commentary. For the purposes of calculating this information, the directors have based the classification of financial instruments on their legal form. This has resulted in some financial instruments classified as debt under IAS 32 being treated as equity in the 'adjusted gearing' and 'adjusted interest cover' calculations.

Required

Problem 1: Discuss whether the classification of a financial instrument as a debt or equity under IAS 32 is relevant to investors in making economic decisions and give examples of further disclosures about financial capital in an annual report that may be useful to investors.