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Is Capital Charge a Financial Instrument or Expense?

NZ IFRS define what a financial instrument is and whether an instrument is a financial asset, financial liability or equity (these definitions are currently in NZ IAS 32). There are no equivalent definitions in current GAAP.

However, the definitions leave doubt as to whether capital charge is a financial instrument or related to a financial instrument.

The potential confusion surrounding capital charge was brought to the attention of the Financial Reporting Standards Board (FRSB). As a result, the FRSB (in its report to the Accounting Standards Review Board on NZ IAS 32 dated Oct 2004):

  • noted that public sector capital charges represent a charge on the net assets employed by public sector entities, and do not relate to any financial instrument, either debt or equity, and that such an interpretation would be inappropriate;
  • noted that the capital charge is designed to ensure that the costs of capital are included in the costs of services and to require that they be reported elsewhere would effectively thwart their purpose; and
  • agreed not to include additional guidance for public benefit entities

Accordingly, capital charge is to be treated as an expense when entities are reporting to Treasury.

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