A preference share, debenture and loan are classified into financial liability or equity instument based on their features namely:
- Income
- Redemability (Principal)
- Convertibility
Classification of various instuments into financial liability and equity instument :
When income from the said intrument is mandatory it becomes financial liabiilty otherwise it becomes equity instument.
When the instrument is redeemable it becomes financial liabiilty otherwise it becomes equity instrument.
When the instrument is convertible into variable number of equity shares it becomes a financial liability but when it is fixed and compulsorily convertible it is equity instrument otherwise it is compound financial instrument.
When there is a mix of features, such instrument is called as compound financial instrument.
The difference only happens from the point of view of the issuer of the instrument because in any case for the holder it is investment of their money which creates a financial asset in their books.