CONTENTS : MODULE III

(10 - 15 Marks)
TOPICS PAGE NO.

FINANCIAL INSTRUMENT
1. UNIT 1 : INTRODUCTION TO FINANCIAL INSTRUMENTS:
FINANCIAL ASSETS, FINANCIAL LIABILITIES & EQUITY 1-14

2. UNIT 2 : COMPOUND FINANCIAL INSTRUMENT 15-22

3. UNIT 3 : CLASSIFICATION OF FINANCIAL ASSETS

& MEASUREMENTS 23-48

4. UNIT 4 : CLASSIFICATION & MEASUREMENTS OF

FINANCIAL LIABILITIES 49-52

5. UNIT 5 : DERIVATIVES & EMBEDDED DERIVATIVES 53-62

6. UNIT 6 : RECLASSIFICATION & IMPAIRMENT OF

FINANCIAL ASSETS 63-68

7. UNIT 7 : HEDGE ACCOUNTING 69-70

8. UNIT 8 : DERECOGNITION OF FINANCIAL LIABILITIES 71-72

9. UNIT 9 : DERECOGNITION OF FINANCIAL ASSETS 73-76

10. PAST EXAMINATION QUESTIONS 77-124

 FINANCIAL
INSTRUMENT
 UNIT 1 : Introduction To Financial Instruments: Financial Assets, Financial Liabilities & Equity 1

UNIT 1 : INTRODUCTION TO FINANCIAL

INSTRUMENTS: FINANCIAL ASSETS, FINANCIAL
LIABILITIES & EQUITY

QUESTION 1 Trade receivables (Classification of financial assets)

A Ltd. makes sale of goods to customers on credit of 45 days. The customers are entitled
to earn a cash discount @ 2% per annum if payment is made before 45 days and an interest
@ 10% per annum is charged for any payments made after 45 days. Company does not have
a policy of selling its debtors and holds them to collect contractual cash flows. Evaluate the
financial instruments.
SOLUTION :
In the above case, the trade receivable recorded in books represents contractual cash
flows that are solely payments of principal (and interest if paid beyond credit period.)
Further, Company‘s business model in to collect contractual cash flows.
Hence, this meets the definition of financial assets carried at amortised cost.

QUESTION 2 Deposits (Classification of financial assets)

Z Ltd. (the ‘Company‛) makes sale of goods to customers on credit. Goods are carried in
large containers of delivery to the dealers‛ destinations. All dealers are required to deposit
a fixed amount of 10,000 as security for the containers, which is returned only when the
contract with company terminates. The deposits carry 8% per annum which is payable only
when the contract terminates. If the containers are returned by the dealers in broken
condition or any damage caused, then appropriate adjustments shall be made from the
deposits at the time of settlement. How would such deposits be treated in books of the
dealers?
SOLUTION :
In this case, deposits are receivable in cash at the end of contract period between the
dealer and the company. These deposits represent cash flows that are solely payments of
principal and interest. Moreover, these deposits normally cannot be Hold. Hence, They meet
the definition of financial asset carried at amortized cost.

QUESTION 3 Perpetual debt instruments (Classification)

A Ltd issues a bond at principal amount of CU 1000 per bond. The terms of bond require
annual payments in perpetuity at a stated interest rate of 8 per cent applied to the
principal amount of CU 1000. Assuming 8 per cent to be the market rate of interest for
the instrument when it was issued, The issuer assumers a contractual obligation to make a
 2 FINANCIAL REPORTING

stream of future interest payments having the issuer assumes a contractual obligation to
make a stream of future interest payments having a fair value (present value) of CU 1,000
on initial recognition. Evaluate the financial instruments in the hands of both the holder and
the issuer.
SOLUTION :
❖ For the Holder – right to receive cash in future – classifies to be a financial asset
❖ For the Issuer – contractual obligation to pay cash in future – classifies to be a financial
liability.

QUESTION 4 Creditors for sale or goods (classification of financial liability)

A Ltd. (the ‘Company‛) makes purchase of steel for its consumption in normal course of
business. The purchase terms provide for payments of goods at 30 days credit an interest
payable. @ 12% per annum for any delays beyond the credit period. Analyse the nature of
this financial instrument.
SOLUTION :
A Ltd. has entered into a contractual arrangement for purchase of goods at a fixed
consideration payable to the creditor. A contractual arrangement that provides for payment
in fixed amount of cash to another entity meets the definition of financial liability.

QUESTION 5 Contract for on unfavorable conditions (financial liability)

A Ltd. (the ‘Company‛) makes a borrowing for INR 10 lacs from RBC Bank, with bullet
repayment of INR 10 lacs and an annual interest rate of 12% per annum. Now, company
defaults at the end of 5th year and consequently, a rescheduling of the payment scheduled
is made beginning 6th year onwards. The Company is required to pay INR 1,300,000 at the
end of 6th year for one time settlement, in lieu of defaults in payments made earlier.
Does the above instrument meet definition of financial liability? Please explain.
Analyse the differential amount to be exchanged for one –time settlement.
SOLUTION :
A ltd. has entered into an arrangement wherein against the borrowing, A Ltd. has contractual
obligation to make stream of payments (including interest and principal.) this meets definition
of financial liability.
Let‛s computer the amount required to be settled and any differential arising upon one time
settlement at end of 6th year_
Loan principal amount = 10,00,000
 Amount payable at the end of 6th year = 12, 54,400 [10, 00,000 * 1.12* 1.12 (interest
for 5th & 6th year in default plus principal amount)
 UNIT 1 : Introduction To Financial Instruments: Financial Assets, Financial Liabilities & Equity 3

 One time settlement = INR 13,00,000

 Additional amount payable = 45,600
The above represents a contractual obligation to pay cash against settlement of a financial
liability under conditions that are unfavourable to A Ltd. (owing to additional amount payable
in comparison to amount that would have been paid without one time settlement.) Hence,
the rescheduled arrangement meets definition of ‘financial liability‛.

QUESTION 6 Settlement in variable number of shares (Definition of equity instrument)

Target Ltd. took a borrowing from Z Ltd. for 10, 00,000. Z Ltd. enters into an arrangement
with Target Ltd. for settlement of the loan against issue of a certain number of equity
shares of Target Ltd. whose value equals 10, 00,000 For this purpose, fair value per shares
(to determine total number of equity shares to be issued) shall be determined based on
the marked price of the shares of Target Ltd. at a future date, upon settlement of the
contract. Evaluate this under definition of financial instrument.
SOLUTION :
In the above scenario, target Ltd. is under an obligation to issue variable number of equity
shares equal to a total consideration of 10,00,000. Hence, equity shares are used as currency
for purpose of settlement of an amount payable by Target Ltd. since this is variable number
of shares to be issued in a non-derivative contract for fixed amount of cash, it tantamount
to use of equity shares as ‘currency‛ and hence, this contract meets definition of financial
liability in books of target Ltd.
This can be better understood better when we understand the definition of Equity
Instrument.

QUESTION 7 Preference shares with non-cumulative dividend

Silver Ltd. issued irredeemable preference shares with face value of 10 each and premium
of 90. These shares carry dividend @ 8% per annum, however dividend is paid only when
silver Ltd declares divided on equity shares. Analyse the nature of this instrument.
SOLUTION :
In the above case, two main characteristics of the preference shares are:
(a) Preference shares carry dividend, which is payable only when Company declares
dividend on equity shares
(b) Preference share are irredeemable.
Analyzing the definition of equity, an instrument meets definition of equity if;
(a) It contains no contractual obligation to pay cash; and
 4 FINANCIAL REPORTING

(b) Where an instrument shall be settled in own equity instruments, its, a non-derivative
contract that will be settled only by issue of fixed number of shares or a derivative contract
that will be settled by issue of fixed number of shares for a fixed amount of cash.
In the above instrument, there is no contractual obligation on the company to pay cash
since-
(a) Face value is not redeemable (except in case of liquidation); and
(b) Dividend is payable only if company declares dividend on equity shares. Since dividend
on equity shares is discretionary and the Company can choose not to pay, Company has
an unconditional right to avoid payment of cash on preference shares also.
Hence, preference shares meet definition of equity instrument.

QUESTION 8 Non-derivative contract to be settled in own equity instruments

(Definition of equity instruments)

A Ltd. invest in compulsorily convertible preference shares (CCPS) issued by its subsidiary
B Ltd. at 1,000 each ( 10 face value + 990 premium). Under the terms of the instrument.
Each CCPS is compulsorily convertible into one equity share of B Ltd at the end of 5 yea`
Such CCPS carry dividend @ 12% per annum, payable only declared at the discretion of B
Ltd. Evaluate this under definition of financial instrument.
SOLUTION :
B Ltd. has issued CCPS Which provide for-
(a) Conversion into fixed number of equity shares, i.e., one equity share for every CCPS
(b) Non-cumulative dividends.
Applying the definition of ‘equity‛ under Ind As 32-
(a) There is no contractual obligation to deliver cash or other financial asset. Dividends
are payable only when declared and hence, at the discretion of the issuer- B Ltd.,
thereby resulting in no contractual obligation over B Ltd.
(b) Conversion is into a fixed number of equity shares.
Hence, it, meets definition of equity instrument and shall be classified as such in books of
b Ltd.

QUESTION 9 (Definition of equity instruments)

A Ltd. issues warrants to all existing shareholders entitling them to purchase additional
equity shares of A Ltd. (with face value of 100 per share) at an issue price of 150 per
share. Evaluate whether this constitutes an equity instrument or a financial liability?
 UNIT 1 : Introduction To Financial Instruments: Financial Assets, Financial Liabilities & Equity 5

SOLUTION :
Applying definition of equity under Ind AS 32, a derivative contract that be settled by
exchange of fixed number of equity shares of fixed amount of cash meets definition of
equity instrument. The above contract is to be settled by issue of fixed number of own
equity instruments by A Ltd. hence, meets definition of equity instrument.

QUESTION 10 Redeemable preference shares with mandatory dividend

A Ltd. (issuer) issues preference shares to B Ltd. (holder). Those preference shares are
redeemable at the end of 10 years from the date of issue and entitle the holder to a
cumulative dividend of 15% p.a. The rate of dividend is commensurate with the credit risk
profile of the issuer. Examine the nature of the financial instrument.
SOLUTION :
This instrument provides for mandatory fixed dividend payments and redemption by the
issuer for a fixed amount at a fixed future date. Since there is a contractual obligation to
deliver cash (for both dividends and repayment of principal) to the preference shareholder
that cannot be avoided, the instrument is a financial liability in its entirety.

QUESTION 11 Redeemable debentures with discretionary dividend

X Co. Ltd. (issuer) issues debentures to Y Co. Ltd. (holder) . Those debentures are
redeemable at the end of 10 years from the date of issue. Interest of 15% p.a. is payable
at the discretion of the issuer. The rate of interest is commensurate with the credit risk
profile of the issuer. Examine the nature of the financial instrument.
SOLUTION :
This instrument has two components – (1) mandatory redemption by the issuer for a fixed
amount at a fixed future date, and (2) interest payable at the discretion of the issuer.
The first component is a contractual obligation to deliver cash (for repayment of principal
with or without premium, as per terms) to the debenture holder that cannot be avoided.
This component of the instrument is a financial liability.
 6 FINANCIAL REPORTING

QUESTION 12 Perpetual loan with mandatory interest

P Co. Ltd. (issuer) takes a loan from Q Co. Ltd. (holder). The loan is perpetual and entitles
the holder to fixed interest of 8% p.a. Examine the nature of the financial instrument.
SOLUTION :
This instrument has two components – (1) mandatory interest by the issuer for a fixed
amount at a fixed future date, and (2) perpetual nature of the principal amount.
The first component is a contractual obligation to deliver cash (for payment of interest) to
the lender that cannot be avoided. This component of the instrument is a financial liability.

QUESTION 13 Restriction on the ability of an entity to satisfy a contractual obligation

Does the lack of access to foreign currency or the need to obtain approval for payment
from a regulatory authority, will lead to contractual obligation?
SOLUTION :
Lack of access to foreign currency or the need to obtain approval for payment from a
regulatory authority, does not Lead the entity‛s contractual obligation or the holder‛s
contractual right under the instrument.

QUESTION 14 Settlement alternative is non-financial obligation

LMN Ltd. issues preference shares to PQR Ltd. These preference shares are redeemable
at the end of 5 years from the date of issue.
The instrument also provides a settlement alternative to the issuer whereby it can transfer
a particular commercial building to the holder, whose value is estimated to be significantly
higher than the cash settlement amount. Examine the nature of the financial instrument.
SOLUTION :
Such preference shares are financial liability because the entity can avoid a transfer of
cash or another financial asset only by settling the non-financial obligation.

QUESTION 15 Cap on amount payable on liquidation

ABC Ltd. has two classes of puttable shares – Class A shares and Class B shares. On
liquidation, Class B shareholders are entitled to a pro rata share of the entity‛s residual
assets up to a maximum of ` 10,000,000.
There is no limit to the rights of the Class A shareholders to share in the residual assets
on liquidation. Examine the nature of the financial instrument.
 UNIT 1 : Introduction To Financial Instruments: Financial Assets, Financial Liabilities & Equity 7

SOLUTION :
The cap of ` 10,000,000 means that Class B shares do not have entitlement to a pro rata
share of the residual assets of the entity on liquidation. They cannot therefore be classified
as equity.

QUESTION 16 Conversion into a variable number of equity instruments

S Ltd. has issued a class of puttable ordinary shares to T Ltd. Besides the put option (which
is consistent with other classes of ordinary shares), T Ltd. is also entitled to convert the
class of ordinary shares held by it into equity instruments of S Ltd. whose number will
vary as per the market value of S Ltd. Examine whether the financial instrument will be
classified as equity.
SOLUTION :
The shares cannot qualify for equity classification in their entirety as in addition to the put
option there is also a contractual obligation to settle the instrument in variable number of
entity‛s own equity instruments.

QUESTION 17 Conversion into a fixed number of equity instruments

DF Ltd. issues convertible debentures to JL Ltd. for a subscription amount of ` 100 crores.
Those debentures are convertible after 5 years into 15 crore equity shares of ` 10 each.
Examine the nature of the financial instrument.
SOLUTION :
This contract is an equity instrument because changes in the fair value of equity shares
arising from market related factors do not affect the amount of cash or other financial
assets to be paid or received, or the number of equity instruments to be received or
delivered.

QUESTION 18 Written option with multiple exercise prices

WC Ltd. writes an option in favour of GT Ltd. wherein the holder can purchase issuer‛s
equity instruments at prices that fluctuate in response to the share price of issuer.
As per the terms, if the share price of issuer is less than ` 50 per share, option can be
exercised at ` 40 per share. If the share price is equal to or more than ` 50 per
share, option can be exercised at ` 60 per share. Explain the nature of the financial
instrument.
SOLUTION : will be settled by delivery of fixed number of instruments for a variable
As the contract
amount of cash, it is a financial liability.
 8 FINANCIAL REPORTING

QUESTION 19 Share swap arrangements

Acquirer Ltd. enters into an arrangement with shareholders of Target Ltd. wherein Acquirer
Ltd. will purchase shares of Target Ltd. in a share swap arrangement. The share swap ratio
is agreed as 1:5 i.e. 1 equity share of Acquirer Ltd. for every 5 equity shares held in Target
Ltd. Examine whether the financial instrument will be classified as equity.
SOLUTION :
Such arrangements will not meet the condition for classification as “equity instrument”
since the contract will be settled by delivery of fixed number of Acquirer Ltd.‛s own equity
instruments against a variable amount of cash i.e. market value of Target Ltd.‛s equity
shares.
Such a contract will likely result in a derivative liability or asset for both the parties.

QUESTION 20 Conversion ratio changes with time

On 1 January 20X1, NKT Ltd. subscribes to convertible preference shares of VT Ltd. The
conversion ratio varies as below:
Conversion upto 31 March 20X1: 1 equity share of VT Ltd. for each preference share held
Conversion upto 30 June 20X1: 1.5 equity share of VT Ltd. for each preference share held
Conversion upto 31 December 20X1: 2 equity share of VT Ltd. for each preference share
held. Examine whether the financial instrument will be classified as equity.
SOLUTION :
The convertible preference shares can be classified as “equity instrument” in the books of the
issuer, VT Ltd. The conversion ratio doesn‛t change corresponding to any underlying variable,
it only varies in response to passage of time which is a certain event and hence fixed.

QUESTION 21 : Conversion ratio changes to protect rights of convertible instrument

holders

On 1 January 20X1, HT Ltd. subscribes to convertible preference shares of RT Ltd. The

preference shares are convertible in the ratio of 1:1.
The terms of the instrument entitle HT Ltd. to proportionately more equity shares of RT
Ltd. in case of a stock split or bonus issue. Examine whether the financial instrument will be
classified as equity.
SOLUTION :
The convertible preference shares can be classified as “equity instrument” in the books of
the issuer, RT Ltd. The variability in the conversion ratio is only to protect the rights of
the holder of convertible instrument vis-à-vis other equity shareholder
The conversion was always intended to be in a fixed ratio and hence the holder is exposed
 UNIT 1 : Introduction To Financial Instruments: Financial Assets, Financial Liabilities & Equity 9

to the change in equity value. The variability is brought in to maintain holder‛s exposure in
line with other holder

QUESTION 22 : Conversion ratio changes if issuer subsequently issues shares to

others at a lower price

On 1 January 20X1, PG Ltd. subscribes to convertible preference shares of BG Ltd. at `

100 per preference share. The preference shares are convertible in the ratio of 10:1 i.e. 10
equity shares for each preference share held. On a fully diluted basis, PG Ltd. is entitled
to 30% stake in BG Ltd.
If subsequent to the issuance of these convertible preference shares, BG Ltd. issues any
equity instruments at a price lower than ` 10 per share, conversion ratio will be changed to
compensate PG Ltd. for dilution in its stake below the expected dilution at a price of ` 10
per share. Examine the nature of the financial instrument.
SOLUTION :
The convertible preference shares will be classified as “financial liability” in the books
of the issuer, BG Ltd. The variability in the conversion ratio underwrites the return on
preference shares and not just protects the rights of convertible instrument holders vis-
à-vis equity shareholder

QUESTION 23 Conversion ratio is variable in a narrow range

On 1 January 20X1, NG Ltd. subscribes to convertible preference shares of AG Ltd. at ` 100

per preference share. On a fully diluted basis, NG Ltd. is entitled to 30% stake in AG Ltd.
The preference shares are convertible at fair value, subject to, NG Ltd.‛s stake not going
below 15% and not going above 40%. Examine the nature of the financial instrument.
SOLUTION :
The convertible preference shares will be classified as “financial liability” in the books
of the issuer, AG Ltd. The variability in the conversion ratio underwrites the return on
preference shares to an extent and also restricts that return.

QUESTION 24 Instrument convertible only at the option of issuer

XYZ Ltd. issues optionally convertible debentures with the following terms: The debentures
carry interest at the rate of 7% p.a.
Issuer has option to either:
Convert the instrument into a fixed number of its own shares at any time, or redeem the
 10 FINANCIAL REPORTING

instrument in cash at any time. The redemption price is the fair value of the fixed number
of shares into which the instrument would have converted if it had been converted.
The holder has no conversion or redemption options.
Debentures have a tenor of 12 years and, if not converted or redeemed earlier, will be
repaid in cash at maturity, including accrued interest, if any.
Examine the nature of the financial instrument.
SOLUTION :
The issuer has the ability to convert the debentures into a fixed number of its own shares
at any time. The issuer, therefore, has the ability to avoid making a cash payment or
settling the debentures in a variable number of its own shares. Therefore, such a financial
instrument is likely to be classified as equity.
However, it must be noted that mere existence of a right to avoid payment of cash is not
conclusive. The instrument is to be accounted for as per its substance and hence it needs
to be seen whether the conversion option is substantive.
In this particular situation, the issuer will need to determine whether it is favourable to
exercise the conversion option or redemption option. In case of latter, the instrument will
be classified as
a financial liability (a hybrid instrument, whose measurement is dealt with in a subsequent
section).
Practical situations do arise wherein the issuer has an option or obligation to issue own
equity instruments only in particular circumstances i.e. the instrument is contingent

QUESTION 25 Conversion ratio changes under independent scenarios

On 1 January 20X1, STAL Ltd. subscribes to convertible preference shares of ATAL Ltd.
The preference shares are convertible as below:
Convertible 1:1 if another strategic investor invests in the issuer within one year Convertible
1.5:1: if an IPO is successfully completed within 2 years
Convertible 2:1: if a binding agreement for sale of majority stake by equity shareholders is
entered into within 3 years
Convertible 3:1: if none of these events occur in 3 years‛ time. Examine whether the financial
instrument will be classified as equity.
SOLUTION :
In this case the four events can be viewed as discrete because the achievement of each one
of these can occur independently of the other (as they relate to different periods). The
arrangement can therefore be considered to be economically equivalent to four separate
contracts. The price per share and the amount of shares to be issued is fixed in each
 UNIT 1 : Introduction To Financial Instruments: Financial Assets, Financial Liabilities & Equity 11

of these discrete periods, with each event relating to a different year and therefore a
separate risk. The “fixed for fixed” test is therefore met.
The instrument is therefore classified as “equity instrument”.

QUESTION 26 Investment manager‛ share in a mutual fund

Mutual fund X has an investment manager Y. At the inception of the fund, Y had invested a
nominal or token amount in units of X. Such units rank last for the repayment in the event
of liquidation. Accordingly, they constitute the most subordinated class of instruments.
Examine the nature the financial instruments.
SOLUTION :
Resultantly, the units held by other unit holders are classified as financial liability as they
are not the most subordinate class of instruments- they are entitled to pro rate share of
net assets on liquidation, and their claim has a priority over claims of Y. But, units held by
Y can be classified as equity instruments.

QUESTION 27 DIFFERENTIAL VOTING RIGHTS

T motors limited has issued puttable ordinary shares “A” whereby holders of ordinary
shares are entitled to one vote per share whereas holders of A ordinary shares are not
entitled to any voting rights. The holders of two classes of shares are equally entitled to
receive share in net assets upon liquidation. Examine whether the financial instrument will
be classified as equity.
SOLUTION :
A puttable shares can not be classified as equity because these shares do not have identical
features which the most subordinated class have.

QUESTION 28 OTHER CONTRACTUAL OBLIGATION TO PUTTABLE SHARES

S ltd. Has issued a class of puttable ordinary shares to T limited besides the put option
(which is consistent with other class of ordinary shares), T limited is also entitled to convert
the class of ordinary shares held by it into equity instruments of S limited whose number
will vary as per the market value of S limited. Examine whether the financial instrument will
be classified as equity.
SOLUTION :
The shares can not qualify for equity classification in their entirety as in addition to the put
option there is also a contractual obligation to settle the instrument in variable number of
entity‛ own equity instruments.
 12 FINANCIAL REPORTING

QUESTION 29 CONTRACT BETWEEN COMPANY AND PUTTABLE INSTRUMENT

HOLDER

P limited has issued puttable ordinary shares of Q limited. Q limited has also entered into
an asset management contract with P limited whereby Q limited is entitled to 50% of profit
of P limited. Normal commercial terms for the similar contracts will entitle the service
provider to only 4%-6% of the net profits. Examine whether the financial instrument will be
classified as equity.
SOLUTION :
The puttable ordinary shares can not qualify for equity classification as (a) in addition to the
put option, there is another contract between the issuer and holder of puttable instrument
whose cash flow are based substantially on profit or loss of issuer, (b) whose contractual
terms are not similar to a contract between a non instrument holder and issuer (c) it has
the effect of substantially restricting return on puttable ordinary shares.

QUESTION 30 CONVERSION RATIO CHANGES UNDER INTER DEPENDENT

SCENARIOS

On 1 January 20x1, RHT limited subscribes to convertible preference shares of RDT limited.
The Preference shares are convertible as below:
Convertible 1:1: if another strategic investor invests at an enterprise valuation of USD 100
million
Convertible 1.5:1 : if another strategic investor invests USD 150 million
Convertible 2:1 : if another strategic investor invests USD 200 million
Examine the nature of financial instrument.
SOLUTION :
The given instrument should be classified as financial liability because there are variable
number of shares and these are not varying due to time factor but due to other facter

QUESTION 31

A Company has issued 9% mandatorily redeemable preference shares with mandatory fixed
dividends. Evaluate whether such preference shares are an equity instrument or a financial
liability to the issuer entity?
SOLUTION :
In determining whether a mandatorily redeemable preference share is a financial liability or
an equity instrument, it is necessary to examine the particular contractual rights attaching
to the instrument‛s principal and return components.
The Instrument in the question provides for mandatory periodic fixed dividend payments
 UNIT 1 : Introduction To Financial Instruments: Financial Assets, Financial Liabilities & Equity 13

and mandatory redemption by the issuer for a fixed amount at a fixed future date. Since
there is a contractual obligation to deliver cash (for both dividends and repayment of
principal to the shareholder that cannot be avoided, the instrument is a financial liability in
its entirely.

QUESTION 32

An entity issues a non-redeemable callable bond with a fixed 8% coupon. The coupon can
be deferred in perpetuity at the issuer‛s option. The issuer has a history of paying the
coupon each year and the current bond price is predicated on the holders expectation that
the coupon will continue to be paid each year. In addition the stated policy of the issuer
is that the coupon will be paid each year, which has been publicly communicated. Evaluate?
SOLUTION :
Although there is NO pressure on the issuer to pay the coupon, to maintain the bond price,
and a constructive obligation to pay the coupon, there is no contractual obligation to do so.
Therefore the bond is classified as an equity instrument.

QUESTION 33

A zero coupon bond is an instrument where no interest is payable during the instrument‛s life
and that is normally issued at a deep discount to the value at which it will be redeemed Evaluate?
SOLUTION :
Although there are no mandatory periodic interest payments, the instruments provides for
mandatory redemption by the issuer for a determinable amount at a fixed or determinable
future date. Since there is a contractual obligation to deliver cash for the value at which
the bond will be redeemed, the instrument is classified as a financial liability.

QUESTION 34: Written put option on own equity instruments

On 1 January 20X1, Entity X writes a put option for 1,00,000 of its own equity shares for
which it receives a premium of ` 5,00,000.
Under the terms of the option, Entity X may be obliged to take delivery of 1,00,000 of its
own shares in one year‛s time and to pay the option exercise price of ` 22,000,000. The op-
tion can only be settled through physical delivery of the shares (gross physical settlement).
Examine the nature of the financial instrument and how it will be accounted.

SOLUTION :
This derivative involves Entity X taking delivery of a fixed number of equity shares for a
fixed amount of cash. Even though the obligation for Entity X to purchase its own equity
shares for ` 22,000,000 is conditional on the holder of the option exercising the option,
 14 FINANCIAL REPORTING

Entity X has an obligation to deliver cash which it cannot avoid.

The accounting for financial instrument in the above illustration is as below (Ind AS 32.23):
• The financial liability is recognised initially at the present value of the redemption
amount, and is reclassified from equity – In the illustration above, this would imply that
a financial liability for an amount of present value of ` 22,000,000, say `
20,000,000 will be recognised through a debit to equity. The initial premium received
(` 500,000) is credited to equity.
• Subsequently, the financial liability is measured in accordance with Ind AS 109. While
a subsequent paragraph will deal with measurement of financial liabilities, the financial
liability of ` 20,000,000 in the aforementioned illustration will be measured at amor-
tised cost and finance cost of ` 2,000,000 will be recognised over the exercise period.
• If the contract expires without delivery, the carrying amount of the financial liabil-
ity is reclassified to equity. This means, in case of illustration above, an amount of `
22,000,000 will be reclassified from financial liability to equity.

QUESTION 35: Written put option over non-controlling interests

Parent P holds a 70% controlling interest in Subsidiary S. The remaining 30% is held by
Entity
Z. On 1 January 20X1, P writes an option to Z which grants Z the right to sell its shares to
Parent P on 31 December 20X2 for ` 1,000. Parent P receives a payment of ` 100 for the
option. The applicable discount rate for the put liability is determined to be 12%. State by
which amount the financial instrument will be recognised and under which category.

SOLUTION :
On 1 January 20X1, the present value of the (estimated) exercise price is ` 797 (`
1,000 discounted over 2 years at 12%).
Accordingly, P will recognise a financial liability of ` 797 and ` 203 ie the difference
between cash paid i.e. ` 1000 and the financial liability of ` 797 will be recognised to
equity.
 UNIT 2 : Compound Financial Instrument 15

UNIT 2 : COMPOUND FINANCIAL INSTRUMENT

QUESTION 36 Redeemable debentures with discretionary dividend

X Co. Ltd. (issuer) issues debentures to Y Co. Ltd. (holder). Those debentures are redeemable
at the end of 10 years from the date of issue. Interest of 15% p.a. is payable at the
discretion of the issuer. The rate of interest is commensurate with the credit risk profile
of the issuer. Examine the nature of the financial instrument.
SOLUTION :
This instrument has two components – (1) mandatory redemption by the issuer for a fixed
amount at a fixed future date, and (2) interest payable at the discretion of the issuer.
The first component is a contractual obligation to deliver cash (for repayment of principal
with or without premium, as per terms) to the debenture holder that cannot be avoided.
This component of the instrument is a financial liability.
The other component, discretionary interest is an equity feature because issuer can avoid
payment of cash or another financial asset in this respect.
Therefore, this instrument is concluded to be a compound financial instrument.

QUESTION 37 Perpetual loan with mandatory interest

P Co. Ltd. (issuer) takes a loan from Q Co. Ltd. (holder). The loan is perpetual and entitles
the holder to fixed interest of 8% p.a. Examine the nature of the financial instrument.
SOLUTION :
This instrument has two components – (1) mandatory interest by the issuer for a fixed
amount at a fixed future date, and (2) perpetual nature of the principal amount.
The first component is a contractual obligation to deliver cash (for payment of interest) to
the lender that cannot be avoided. This component of the instrument is a financial liability.
The other component, perpetual principal, is an equity feature because issuer is not required
to pay cash or another financial asset in this respect.
Therefore, this instrument is concluded to be a compound financial instrument.

QUESTION 38 Perpetual loan with mandatory interest

P Co. Ltd. (issuer) takes a loan from Q Co. Ltd. (holder) for ` 12 lakhs. The loan is perpetual
and entitles the holder to fixed interest of 8% p.a. The rate of interest commensurate with
credit risk profile of the issuer is 12% p.a. Calculate the value of the liability and equity
components.
 16 FINANCIAL REPORTING

SOLUTION :
The values of the liability and equity components are calculated as follows:
Present value of interest payable in perpetuity (` 96,000 discounted at 12%) = ` 800,000
Therefore, equity component = fair value of compound instrument, say, ` 1,200,000 less
financial liability component i.e. ` 800,000 = ` 400,000.
In subsequent years, the profit and loss account is charged with interest of 12% on the
debt instrument.

QUESTION 39 Optionally convertible redeemable preference shares

On 1 July 20X1, D Ltd. issues preference shares to G Ltd. for a consideration of ` 10 lakhs.
The holder has an option to convert these preference shares to a fixed number of equity
instruments of the issuer anytime up to a period of 3 yea` If the option is not exercised
by the holder, the preference shares are redeemed at the end of 3 yea` The preference
shares carry a fixed coupon of 6% p.a. The prevailing market rate for similar preference
shares, without the conversion feature, is 9% p.a.
Calculate the value of the liability and equity components.
SOLUTION :
The values of the liability and equity components are calculated as follows:
Present value of principal payable at the end of 3 years (` 10 lakhs discounted at 9% for 3
years) = ` 772,183
Present value of interest payable in arrears for 3 years (` 60,000 discounted at 9% for
each of 3 years) = ` 151,878
Total financial liability = ` 924,061
Therefore, equity component = fair value of compound instrument, say, ` 1,000,000 less
financial liability component i.e. ` 924,061 = ` 75,939.
In subsequent years, the profit and loss account is charged with interest of 9% on the debt
instrument.

QUESTION 40 Optionally convertible preference shares with issuer‛s redemption option

D Ltd. issues preference shares to G Ltd. for a consideration of ` 10 lakhs. The holder has
an option to convert these preference shares to a fixed number of equity instruments of
the issuer anytime up to a period of 3 yea` If the option is not exercised by the holder,
the preference shares are redeemed at the end of 3 yea` The preference shares carry a
coupon of RBI base rate plus 1% p.a.
 UNIT 2 : Compound Financial Instrument 17

The prevailing market rate for similar preference shares, without the conversion feature
or issuer‛s redemption option, is RBI base rate plus 4% p.a. On the date of contract, RBI
base rate is 9% p.a.
Calculate the value of the liability and equity components.
SOLUTION :
The values of the liability and equity components are calculated as follows:
Present value of principal payable at the end of 3 years (` 10 lakhs discounted at 13% for
3 years) = ` 6,93,050
Present value of interest payable in arrears for 3 years (` 100,000 discounted at 13% for
each of 3 years) = ` 2,36,115
The liability component = Present value of principal + Present value of Interest
= ` 6,93,050 + ` 2,36,115 = ` 9,29,165
Equity Component = ` 10,00,000 – ` 9,29,165 = ` 70,835

QUESTION 41 OPTIONALLY CONVERTIBLE PREFERENCE SHARES (Q.34 CONTINUED)

The amortization schedule has been set out as follows:

Dates Cash Flows Interest at IRR Liability Equity

1.7.X1 10,00,000 - 9,24,061 75,939
30.6.X2 (60,000) 83,165 9,47,226 75,939
30.6.X3 (60,000) 85,250 9,72,476 75,939
306.X4 (10,60,000) 87,524 - 75,939

The holder has an option of early redemption at 11,00,000 and on 30.6.X3 holder exercised
this option. Show the adjustments in liability and equity component assuming market rate
5% on redemption date.

QUESTION 42

On 1 April, 2015, Delta Ltd., issued ` 30,00,000, 6% convertible debentures of face value
of ` 100 per debenture at par. The debentures are redeemable at a premium of 10% on
31.03.2019 or these may be converted into ordinary shares at the option of the holder, the
interest rate for equivalent debentures without conversion rights would have been 10%.
Being compound financial instrument, you are required to separate equity and debt portion
as on 01.04.15.
 18 FINANCIAL REPORTING

QUESTION 43

K Ltd. issued 5,00,000, 6% Convertible Debentures of `10 each on the 1st April, 2015. The
debentures are due for redemption on 31st March, 2019 at a premium of 10% convertible into
equity shares to the extent of 50% and the balance to be settled in cash to the debenture
holde` The interest rate on equivalent debentures without conversion rights was 10%. You
are required to separate the debt & equity components at the time of the issue and show
the accounting entry in the company‛s books at initial recognition.
The following Present Values of ` 1 at 6% and at 10% are supplied to you.

Interest Rate Year 1 Year 2 Year 3 Year 4

6% 0.94 0.89 0.84 0.79
10% 0.91 0.83 0.75 0.68

QUESTION 44

Adventure Limited issued 10,000, 9% Convertible Debentures of `100 each at par at the
beginning of the year. The Debentures are of 6 years term. The interest will be paid half
yearly. The debenture-holders have the option to get 50% of the Debentures converted
into 2 Ordinary Shares at the end of 3rd year. The Debenture holders who do not opt for
conversion will be paid 50% of their Face Value at the end of the year 3. The balance non-
convertible portion will be repaid at 10% premium ate the end of term of the Debentures. At
the time of issue, the prevailing market interest rate for similar Debt without Convertibility
Option is 10%.
Present Value of Annually is as under:

Period 1-3 4-5 7-12

Annuity factor @ 10% 2.487 1.868 2.459
Annuity factor @ 5% 2.723 2.353 3.787

Present Value of ` 1 at the end of 3 yeas at 10% and 5% is 0.565 and 0.747 respectively.
Present Value of ` 1 at the end of 6 years at 10% and 5% is 0.317 and 0.557 respectively.
Compute the Liability Component in this compound financial instruments.
SOLUTION :
1. Computation of Fair Value of Liability Component: PV of Cash Flows from debentures
discounted at market rate of 10%.
(a) Year 1 to 3 = Half yearly cash flow of 4.5 (i.e. ` 100 x 9% = 6/12)
(b) End of year 3 = 50% redemption = ` 50
(c) Year 4 to Year 6 = Half Yearly Cash Flow of 2.25 (i.e. 50 x 9% x 6/12).
 UNIT 2 : Compound Financial Instrument 19

(d) End of Year 6 =Balance + 10% Premium = 50 + 5 = ` 55

Half Year Cash Flow HYDF @ 5% DCF

1 4.50 0.9524 4.29

2 4.50 0.9070 4.08

3 4.50 0.8638 3.89

4 4.50 0.8227 3.70

5 4.50 0.7835 3.53

6 54.50 0.7462 40.67

7 2.25 0.7107 1.60

8 2.25 0.6768 1.52

9 2.25 0.6446 1.45

10 2.25 0.6139 1.38

11 2.25 0.5847 1.32

12 57.25 0.5568 31.88

99.30

QUESTION 45: Optionally convertible redeemable preference shares

D Ltd. issues preference shares to G Ltd. The holder has an option to convert these pref-
erence shares to equity instruments of the issuer anytime up to a period of 10 years. If the
option is not exercised by the holder, the preference shares are redeemed at the end of
10 years. Examine the nature of the financial instrument.
SOLUTION :
This instrument has two components – (1) contractual obligation that is conditional on holder
exercising its right to redeem, and (2) conversion option with the holder.
The first component is a financial liability because the entity does not have the unconditional
right to avoid delivering cash.
In the section “Compound financial instruments”, we will also analyse the other component
– the conversion option with the holder and we will explain the nature of the instrument in
its entirety.
 20 FINANCIAL REPORTING

QUESTOIN 46: Issue of variable number of shares against issue of CCPS

A Ltd. issued compulsorily convertible preference shares (CCPS) at ` 100 each (` 10 face
value + ` 90 premium per share) for ` 10,00,000. These are convertible into equity
shares at the end of 10 years, where the number of equity shares to be issued shall be
determined based on fair value per equity share to be determined at the time of
conversion.
Evaluate if this is financial liability or equity? What if the conversion ratio was fixed at the
time of issue of such preference shares?
SOLUTION :
i. As per Ind AS 109, non-derivative contracts which will be settled against issue of
variable number of own equity shares meet the definition of financial liability.
In this case, A Ltd. has issued CCPS which are convertible into variable number of
shares. Hence, it is akin to use of own equity shares as currency for settlement of the
liability of CCPS issued. Accordingly, it meets the definition of financial liability.
Measurement –
Initial measurement – This shall be measured at fair value on date of transaction.
Since A Ltd shall give shares worth ` 10 lacs at the end of 10 years which is equal to
the amount borrowed on day 1, the liability is recognised at fair value, determined by
discounting future settlement of the borrowed amount. For difference arising on day
1 between amount borrowed and that recognised as liability using level 3 inputs, it is
deferred and recognised on a systematic basis over the period of liability.
Subsequent measurement – Such liability shall be carried at fair value through profit
or loss.
i. Per Ind AS 109, a non-derivative contract that involves issue of fixed number of equity
shares shall be classified as equity.
In this case, if the conversion of CCPS was into a fixed number of equity shares at the
end of 10 years, then it meets the definition of equity and hence, shall be classified as
‘equity instrument‛.
An equity instrument is carried at cost and no further adjustments made to its carry-
ing value after initial recognition.
 UNIT 2 : Compound Financial Instrument 21

QUESTION 47: Conversion into a number of equity instruments equivalent to a fixed

value

CBA Ltd. issues convertible debentures to RQP Ltd. for a subscription amount of ` 100
crores. Those debentures are convertible after 5 years into equity shares of CBA Ltd. us-
ing a pre- determined formula. The formula is:
100 crores ×(1+10%)^5
Fair value on sale of conversion

Examine the nature of the financial instrument.

SOLUTION :
Such a contract is a financial liability of the entity even though the entity can settle it by
delivering its own equity instruments. It is not an equity instrument because the entity
uses a variable number of its own equity instruments as a means to settle the contract.
The underlying thought behind this conclusion is that the entity is using its own equity
instruments ‘as currency‛.
22 FINANCIAL REPORTING
 UNIT 3 : Classification Of Financial Assets & Measurements 23

UNIT 3: CLASSIFICATION OF FINANCIAL ASSETS &

MEASUREMENTS
PART A
PROBLEMS ON BUSINESS MODEL (DEBT INVESTMENTS)

QUESTION 48

An entity holds investments to collect their contractual cash flows. The funding needs of
the entity are predictable and the maturity of its financial assets is matched to the entity‛s
estimated funding needs.
The entity performs credit risk management activities with the objective of minimizing
credit losses. In the past, sales have typically occurred when the financial assets‛ credit
risk has increased such that the assets no longer meet the credit criteria specified in the
entity‛s documented investment policy. In addition, infrequent sales have occurred as a
result of unanticipated funding needs.
Reports to key management personnel focus on the credit quality of the financial assets and
the contractual return. The entity also monitors fair values of the financial assets, among
other information.
Evaluate the business model.
SOLUTION :
The business model of the company is to collect contractual cash flows and not realization
from sale of financial assets.

QUESTION 49

An entity‛s business model is to purchase portfolios of financial assets, such as loans. Those
portfolios may or may not include financial assets that are credit impaired.
If payment on the loans is not made on a timely basis, the entity attempts to realise the
contractual cash flows through various means—for example, by contacting the debtor by
mail, telephone or other methods. The entity‛s objective is to collect the contractual cash
flows and the entity does not manage any of the loans in this portfolio with an objective of
realising cash flows by selling them.
In some cases, the entity enters into interest rate swaps to change the interest rate on
particular financial assets in a portfolio from a floating interest rate to a fixed interest
rate.
Evaluate the business model.
 24 FINANCIAL REPORTING

SOLUTION :
The objective of the entity‛s business model is to hold the financial assets in order to
collect the contractual cash flows. The same analysis would apply even if the entity does
not expect to receive all of the contractual cash flows (eg some of the financial assets are
credit impaired at initial recognition).

QUESTION 50

Entity B sells goods to customers on credit. Entity B typically offers customers up to

60 days following the delivery of goods to make payment in full. Entity B collects cash in
accordance with the contractual cash flows of trade receivables and has no intention to
dispose of the receivables.
Evaluate the business model.
SOLUTION :
Entity‛s B objective is to collect contractual cash flows from trade receivables and therefore,
trade receivables meet the business model test for the purpose of classifying the financial
assets at amortized cost.

QUESTION 51

An entity has a business model with the objective of originating loans to customers and
subsequently selling those loans to a securitization vehicle. The securitization vehicle issues
instruments to investors The originating entity controls the securitization vehicle and thus
consolidates it.
The securitization vehicle collects the contractual cash flows from the loans and passes
them on to its investors In the consolidated balance sheet, loans continue to be recognized
because they are not derecognized by the securitization vehicle.
Evaluate the business model.
SOLUTION :
The entity originating loans to customers has the objective of realizing contractual cash flows
on the loan portfolio only through sale to securitization vehicle. However, the consolidated
group originates loans with the objective of holding them to collect the contractual cash
flows.
- Hence, the consolidated financial statements provide for a business model with the
objective of collecting contractual cash flows by holding to maturity.
- And in separate financial statements of the entity originating loans to customers,
business model is to collect cash flows through sale only.
 UNIT 3 : Classification Of Financial Assets & Measurements 25

QUESTION 52

An entity anticipates capital expenditure in a few yea` The entity invests its excess
cash in short and long term financial assets so that it can fund the expenditure when the
need arises. Many of the financial assets have contractual lives that exceed the entity‛s
anticipated investment period.
The entity will hold financial assets to collect the contractual cash flows and when an
opportunity arises, it will sell financial assets to re invest the cash in financial assets with
a higher return. The managers responsible for the portfolio are remunerated based on the
overall return generated by portfolio.
Evaluate the business model.
SOLUTION :
The objective of the business model is achieved by both collecting contractual cash flows
and selling financial assets. The entity will make decisions on an ongoing basis about whether
collecting contractual cash flows or selling financial assets will maximize the return on the
portfolio until the need arises for the invested cash.
In contrast, consider an entity that anticipates a cash outflow in five years to fund capital
expenditure and invests excess cash in short term financial assets. When the investments
mature, the entity reinvests the cash in new short term financial assets. The entity
maintains this strategy until the funds needed, at which time the entity uses the proceeds
from the maturing financial assets to fund the capital expenditure. Only sales that are
insignificant in value occur before maturity (unless there is an credit risk). The objective of
this contrasting business model is to hold financial assets to collect contractual cash flows.

QUESTION 53

A financial institution holds financial assets to meet liquidity needs in a stress case scenario
(eg, a run on the bank deposits). The entity does not anticipate selling these assets except
in such scenarios. The entity monitors the credit quality of the financial assets and its
objective in managing the financial assets is to collect the contractual cash flows. The
entity evaluates the performance of the assets on the basis of interest revenue earned
and credit losses realized.
However, the entity also monitors the fair value of the financial assets from a liquidity
perspective to ensure that the cash amount that would be realized if the entity needed to
sell the assets in a stress case scenario would be sufficient to meet the entity‛s liquidity
needs. Periodically, the entity makes sales that are insignificant in value to demonstrate
liquidity.
Evaluate the business model.
 26 FINANCIAL REPORTING

SOLUTION :
The objective of the entity‛ business model is to hold the financial assets to collect
contractual cash flows. The analysis would not change-
(a) If during a previous stress case scenario the entity had sales that were significant in
value in order to meet its liquidity needs or Recurring sales activity that is insignificant
in value is not inconsistent with holding financial assets to collect contractual cash
flows or
(b) If the entity is required by its regulator to routinely sell financial assets to demonstrate
that the assets are liquid, and the value of the assets sold is significant, the entity‛
business model is not to hold financial assets to collect contractual cash flows. Whether
a third party imposes the requirement to sell financial assets, or that activity is at the
entity‛ discretion is not relevant to the analysis.
(c) In contrast, if an entity holds financial assets to meet its everyday liquidity needs
and meeting that objective involves frequent sales that are significant in value, the
objective of the entity‛s business model is not to hold the financial assets to collect
contractual cash flows.

QUESTION 54

Instrument A is a bond with a stated maturity date Payments of principal and interest on
the principal amount outstanding are linked to and inflation index of the currency in which
the instrument is issued. The inflation link is not leveraged and the principal is protected.
Evaluate the Contractual cash flows characteristics test
SOLUTION :
The contractual cash flows are solely payments of principal and interest on the principal
amount outstanding. Linking payments of principal and interest on the principal amount
outstanding to an unleveraged inflation index resets the time value of money to a current
level. In other words, the interest rate on the instrument reflects real interest Thus, the
interest amounts are consideration for the time value of money on the principal amount
outstanding.
However, if the interest payments were indexed to another variable such as the debtor‛s
performance (e.g. the debtor‛s net income) or an equity index, the contractual cash flows
are not payments of principal and interest on the principal amount outstanding (unless the
indexing to the debtor‛s performance results in an adjustment that only compensates the
holder for changes in the credit risk of the instrument, such that contractual cash flows
are solely payments of principal and interest). That is because the contractual cash flows
reflect a return that is inconsistent with a basic lending arrangement.
 UNIT 3 : Classification Of Financial Assets & Measurements 27

QUESTION 55

Instrument F is a bond that is convertible into a fixed number of equity instruments of the
issuer. Analyse the nature of cash flows.
SOLUTION :
The holder would analyse the convertible bond in its entirely. The contractual cash flows
are not payments of principal and interest on the principal amount outstanding because they
reflect a return that is inconsistent with a basic lending arrangement; ie the return is linked
to the value of the equity of the issuer.

QUESTION 56

Instrument D is loan with recourse and is secured by collateral. Does the collateral affect
the nature of contractual cash flows?
SOLUTION :
The fact that a loan is collateralised (since with recourse) does not in itself affect the
analysis of whether the contractual cash flows are solely payments of principal and interest
on the principal amount outstanding. The collateral is only a security to recover does.

QUESTION 57

Instrument G is a loan that pays an inverse floating interest rate (i.e the interest rate has
an inverse relationship to market inters rates) Analyse the nature of cash flows.
SOLUTION :
Here, interest on the instrument has an inverse relationship to the market rate of interest.
Hence, it is unlike a basic, lending arrangement which normally comprise of interest payable
on any funds lent, as consideration for the time value of money, credit risk and profit
margin normally existing in such arrangements. This arrangement with an inverse floating
interest rate provides the lender with a return which may be higher or lower to the market
rate of interest and hence, is not necessarily a consideration for the time value of money
on the principal amount outstanding.
Thus, these do not represent contractual cash flows that are slowly payments principal; and
interest on the principal amount outstanding.
 28 FINANCIAL REPORTING

PART B
PRACTICAL QUESTIONS ON MEASUREMENT OF FINANCIAL
ASSETS UNDER AMORTISATION METHOD

QUESTION 58 (AT MARKET TERMS: AMORTISED METHOD)

A Company lends ` 100 Lacs to another company @ 12% p.a. interest on 1.4.2015.
It incurs ` 40,000 incremental cost for documentation.
Loan tenure = 5 years with interest charged annually.
Pass necessary Journal entries for initial recognition. Assume interest rate is based on
market rate of interest.

QUESTION 59 (OFF MARKET TERMS: AMORTISED COST)

XYZ Ltd. grants loans to its employees at 4% amounting to ` 10,00,000 at the beginning of
2015-16. The principal amount is repaid over a period of 5 years whereas the accumulated
interest computed on reducing balance at simple interest is collected in 2 equal annual
instalments after collection of the principal amount.
Assume the benchmark interest rate is 8%.
Show the accounting entries on 1.4.2015 and 31.3.2016.

QUESTION 60 (STAFF WELFARE: OFF MARKET TERMS UNDER AMORTISATION

METHOD)

As point of staff welfare measures. Y Co. Ltd. has contracted to lend to its employees
sums of money at 5 percent per annum rate of interest. The amounts lent are to be repaid
alongwith the interest in five equal annual instalments. The market rate of interest is 10
per cent per annum.
Y lent ` 16,00,000 to its employees on 1st January, 2015.
Following the principles of recognition and measurement as laid down in Ind AS 109, you are
required to record the entries for the year ended 31st December, 2015 for the transaction
and also calculate the value of the loan initially to be recognized and the amortized cost for
all the subsequent yea`
For Purposes of calculation, the following discount factors at interest rate of 10 percent
may be adopted At the end of year.
1 .909
2 .827
3 751
 UNIT 3 : Classification Of Financial Assets & Measurements 29

4 .683
5 .620

QUESTION 61 (SIMILAR TO Q.53) (HOME WORK)

A Company lends `10 Lacs to another company @ 12% p.a. interest on 1.4.2017.
It incurs `4,000 incremental costs for documentation.
Loan tenure = 5 years with interest charged annually.
Pass necessary Journal entries when Financial Asset is accounted as Amortised Cost.
Assume that interest rate is based on market rate of interest.
SOLUTION :

Dates Particulars Amount (`) Amount (`)

1/4/2017 Loan A/c. Dr. 10,00,000
To Bank 10,00,000
1/4/2017 Loan Processing Expenses A/c. Dr. 4,000
To Bank A/c. 4,000
1/4/2017 Loan A/c. Dr. 4,000
To Loan Processing Exp. A/c. 4,000

QUESTION 62 (AMORTISED METHOD: OFF MARKET TERMS)

Lovely Limited has advanced Staff Loan of ` 50 Lakhs to its Employees on 1st July 2014 at
a concessional rate of 6% per annum, to be repaid in 5 semi-annual installments along with
interest thereon. The prevailing rate is 8% per annum.
Find out the value at which the Loan should initially be recognsied and its amortization till
closure thereof. Also give necessary journal entries with appropriate narration for financial
year 2014-2015. The Discounted Values at 8% and 4% are as under:-

Period 1 2 3 4 5
8% 0.9259 0.8573 0.7938 0.7350 0.6806
4% 0.9615 0.9246 0.8890 0.8548 0.8219
 30 FINANCIAL REPORTING

SOLUTION :
Computation of Initial Recognition Amount of Loan to Employees (Amount in `)

Cost Inflow Total PVF at Present

4% Value
Period Principal Interest at 6%
Jul to 10,00,000 50,00,000x 6% x ½ 11,50,000 0.9615 11,05,725
Dec. 2014 Yr = 1,50,000
Jan to Jun 10,00,000 40,00,000x6% x ½ 11,20,000 0.9246 10,35,552
2015 Yr = 1,20,000
Jul to 10,00,000 30,00,000 x 6% x ½ 10,90,000 0.8890 9,69,010
Dec. 2015 Yr. = 90,000
Jan to Jun 10,00,000 20,00,000 x 6% x ½ 10,60,000 0.8548 9,06,088
2016 yr. =60,000
Jul to 10,00,000 10,00,000 x 6% x ½ 10,30,000 0.8219 8,46,557
Dec. 2016 yr =30,000
Present Value or Fair Value at Initial Recognition 48,62,932

Note: Discounting is at 8% p.a. (or) 4% for the 6 Months period.

Computation of Amortised Cost of Loan to Employees (Amount in `)

Period Amortised Interest Repayment Amoritsed Cost

Cost to be (including (Closing Balance)
(Opening recognized Interest)
Balance) at 8%
(1) (2) (3) ((4)=(1)+(2) – (3)
Jul to Dec. 2014 48,62,932 1,94,517 11,50,000 39,07,449
Jan to Jun 2015 39,07,449 1,56,298 11,20,000 29,43,747
Jul to Dec. 2015 29,43,747 1,17,750 10,90,000 19,71,497
Jan to Jun 2016 19,71,497 78,860 10,60,000 9,90,357
Jul to Dec. 2016 9,90,347 ([Link].) 10,30,000 NIl
39,643
 UNIT 3 : Classification Of Financial Assets & Measurements 31

Journal Entries for first half year (regarding Loan to Employees)

[Link]. Particulars Dr.(`) Cr. (`)
1. Staff Loan A/c. Dr. 48,62,932
Prepaid staff cost Dr. 1,37,068
To Bank A/c. 50,00,000
(Being the disbursement of Loans to Staff)
2. Staff Loan A/c. Dr. 1,94,517
To Interest on Staff Loan A/c. 194,517
(Being Interest charged at market rate of 8% on
the Loan, for first 6 months period)
3. Bank A/c. Dr. 11,50,000
To Staff Loan A/c. 11,50,000
(Being amount received on repayment)
4. Interest on Staff Loan A/c. Dr. 1,94,517
To Profit & Loss A/c. 1,94,517
(Being transfer to bal. in Staff Loan Int. A/c. to
P&L)
NOTE: PREPAID STAFF COST WILL BE AMORTISED OVER THE PERIOD OF 2.5 YEARS
ON SLM BASIS.

QUESTION 63 (INITIAL RECOGNITION: AT MARKET TERMS) AMORTISATION

METHOD

ABC Bank gave loans to a customer – Target Ltd. that carry fixed interest rate @ 10%
per annum for a 5 year term and 12% per annum for a 3 year term. Additionally, the bank
charges processing fees@1% of the principal amount borrowed. Target Ltd borrowed loans
as follows:
- ` 10 lacs for a term of 5 years
- ` 8 lacs for a term of 3 yea`
Compute the fair value upon initial recognition of the loan in books of ABC BANK LIMITED
and how will loan processing fee be accounted?
SOLUTION :
The loans from ABC Bank carry interest@ 10% and 12% for 5 year term and 3 year term
respectively. Additionally, there is a processing fee payable @ 1% on the principal amount
on date of transaction. It is assumed that ABC Bank charges all customers in a similar
manner and hence, this is representative of the market rate of interest.
 32 FINANCIAL REPORTING

Amortised cost is computed by discounting all future cash flows at market rate of interest.
Further, any transaction fees that are an integral part of the transaction are adjusted in
the effective interest rate and recognised over the term of the instrument.
Hence, loan processing fees shall be reduced from the principal amount to arrive the value
on day 1 upon initial recognition.
Fair value (5 year term loan) = 10,00,000 – 10,000 (1%*10,00,000) = 9,90,000 Fair value
(3 year term loan) = 8,00,000 – 8,000 (1%*8,00,000) = 7,92,000.
Now, effective interest rate shall be higher than the interest rate of 10% and 12% on
5 year loan and 3 year loan respectively, so that the processing fees gets recognised as
interest over the respective term of loans.

QUESTION 64 Deposits carrying off-market rate of interest:

Containers Ltd provides containers for use by customers for multiple purposes. The
containers are returnable at the end of the service contract period (3 years) between
Containers Ltd and its customers In addition to the monthly charge, there is a security
deposit that each customer makes with Containers Ltd for ` 10,000 per container and
such deposit is refundable when the service contract terminates. Deposits do not carry
any interest. Analyse the fair value upon initial recognition in books of customers leasing
containers Market rate of interest for 3 year loan is 7% per annum.
SOLUTION :
In the above case, lessee (ie, customers leasing the containers) make interest free deposits,
which are refundable at the end of 3 year Now, this money if it was to lent to a third party
would fetch interest @ 7% per annum.
Hence, discounting all future cash flows (ie, ` 10,000)
Fair value on initial recognition = 10,000/ (1+0.07)3 = 8,163. Differential on day 1 = 10,000
– 8,163 = 1,837
Difference can be recognised as ‘‛prepaid lease rent‛. Prepaid rent shall be charged off
to profit or loss in a straight lined manner as ‘lease rent‛.

QUESTION 65 (AMORTISED METHOD: AT OFF MARKET TERMS)

A Ltd has made a security deposit whose details are described below. Make necessary
journal entries for accounting of the deposit. Assume market interest rate for a deposit
for similar period to be 12% per annum.

Particulars Details
Date of Security Deposit (Starting Date) 1-Apr-20X1
Date of Security Deposit (Finishing Date) 31-Mar-20X6
 UNIT 3 : Classification Of Financial Assets & Measurements 33

Description Lease
Total Lease Period 5 years
Discount rate 12.00%
Security deposit (A) 10,00,000
Present value factor at the 5th year 0.567427

QUESTION 66 (AMORTISATION METHOD: OFF MARKET TERMS)

A Ltd issued redeemable preference shares to a Holding Company – Z Ltd. The terms of the
instrument have been summarised below. Account for this in the books of Z Ltd.

Nature Non-cumulative redeemable preference shares

Repayment: Redeemable after 5 years
Date of Allotment: 1-Apr 20X1
Date of repayment: 31-Mar- 20X6
Total period: 5.00 years
Value of preference shares issued: 10,00,00,000
Dividend rate 0.0001%
Market rate of interest 12.00% per annum
Present value factor 0.56743

QUESTION 67

Wheel Co. Limited has a policy of providing subsidized loans to its employees for the purpose
of buying or building houses. Mr. X, who‛s executive assistant to the CEO of Wheel Co.
Limited, took a loan from the Company on the following terms:
Principal amount: 1,000,000
Interest rate: 4% for the first 400,000 and 7% for the next 600,000
Start date: 1 January 20X1
Tenure: 5 years
Pre-payment: Full or partial pre-payment at the option of the employee
The principal amount of loan shall be recovered in 5 equal annual instalments and will be
first applied to 7% interest bearing principal
The accrued interest shall be paid on an annual basis
Mr. X must remain in service till the term of the loan ends
 34 FINANCIAL REPORTING

The market rate of a comparable loan available to Mr. X, is 12% per annum.
Following table shows the contractually expected cash flows from the loan given to Mr. X:

Amount
Inflows
Date Outflows Principal Interest Interest Principal
income 7% income 4% Outstanding
1-Jan-20X1 (1,000,000) 1,000,000
31-Dec-20X1 200,000 42,000 16,000 800,000
31-Dec-20X2 200,000 28,000 16,000 600,000
31-Dec-20X3 200,000 14,000 16,000 400,000
31-Dec-20X4 200,000 — 16,000 200,000
31-Dec-20X5 200,000 — 8,000 —

Mr. S, pre-pays ` 200,000 on 31 December 20X2, reducing the outstanding principal as at

that date to ` 400,000.
Following table shows the actual cash flows from the loan given to Mr. X, considering the
pre-payment event on 31 December 20X2 :

Amount
Inflows
Date Outflows Principal Interest Interest Principal
income 7% income 4% Outstanding
1-Jan-20X1 (1,000,000) 1,000,000
31-Dec-20X1 200,000 42,000 16,000 800,000
31-Dec-20X2 400,000 28,000 16,000 400,000
31-Dec-20X3 200,000 — 14,000 200,000
31-Dec-20X4 200,000 — 8,000 —
31-Dec-20X5 — — — —
 UNIT 3 : Classification Of Financial Assets & Measurements 35

PART C
PRACTICAL QUESTIONS ON MEASUREMENT OF FINANCIAL
ASSETS UNDER EQUITY INSTRUMENTS (NORMAL)

QUESTION 68 (Financial Asset Accounted as FVTPL)

A Company invested in Equity shares of another entity on 15th March for `10,000. Transaction
Cost = ` 200 (not included in ` 10,000).
For value on Balance Sheet date i.e. 31st March 2015 = ` 12,000 Pass necessary Journal
Entries.

QUESTION 69 (Financial Asset Accounting as FVTOCI)

A Company invested in Equity Shares of another entity on 15th March for `10,000. Transaction
Cost = ` 200 (not included in `10,000). Fair Value on Balance Sheet date i.e. 31st March 2015
= ` 12,000 Pass necessary Journal entries.

QUESTION 70

A Company invested in Equity shares of another entity on 15th March for `20,000 Transaction
Cost = ` 400 (not included in ` 20,000).
Fair Value on Balance sheet date i.e. 31st March 2017 = ` 24,000 Pass necessary Journal
Entries when Financial Asset is accounted as FVTPL.
SOLUTION :

Dates Particulars Amount (`) Amount (`)

15/3/2017 Investment A/c. Dr. 20,000
Transaction Cost A/c. Dr. 400
To Bank 20,400
31/3/2017 Investment A/c. Dr. 4,000
To Fair value Gain A/c. 4,000
31/3/2017 P&L A/c. Dr. 400
To Transaction Cost A/c. 400
31/3/2017 Fair Value Gain A/c. Dr. 4,000
To P&L A/c. 4,000
 36 FINANCIAL REPORTING

QUESTION 71

A Company invested in Equity Shares of another entity on 15th March for `50,000. Transaction
Cost = ` 1,000 (not included in `50,000). Fair Value on Balance Sheet i.e. 31st March 2017
= ` 60,000 Pass necessary Journal entries when Financial Asset is accounted as FVTOCI.
SOLUTION :

Dates Particulars Amount (`) Amount (`)

15/3/2017 Investment A/c. Dr. 51,000
To Bank 51,000
31/3/2017 Investment A/c. Dr. 9,000
To Fair value Gain A/c. 9,000
31/3/2017 Fair value gain Dr. 9,000
To Fair value Reserve OCI 9,000

QUESTION 72 Accounting for assets at FVTPL

A Ltd. invested in equity shares of C Ltd. on 15th March for ` 10,000. Transaction costs were
` 500 in addition to the basic cost of ` 10,000. On 31 March, the fair value of the
equity shares was ` 11,200. Pass necessary journal entries. Analyse the measurement
principle and pass necessary journal entries.

QUESTION 73 Accounting for assets at FVOCI

Metallics Ltd. has made an investment in equity instrument of a company – Castor Ltd.
for 19% equity stake. Significant influence not exercised. The investment was made for
` 5,00,000 for 10,000 equity shares on 01 April 20X1. On 30 June 20X1 the fair value
per equity share is `45. The Company has taken an irrevocable option to measure such
investment at fair value through other comprehensive income.

QUESTION 74

Let us say on 30th March 2015 an entity enters into an agreement to purchase a Financial
Asset for `100 which is the Fair Value on that date.
On Balance Sheet date i.e. 31/3/2015 the Fair Value is 102 and on Settlement date i.e.
2/4/2015 Fair Value is 103.
Pass necessary Journal entries on trade date and settlement date when the asset acquired
is measured at
 UNIT 3 : Classification Of Financial Assets & Measurements 37

(a) Amortised cost

(b) FVTPL
(c) FVTOCI

QUESTION 75

On 30th March 2015 an entity enters into an agreement to purchase a Financial Asset for
`1,000 which is the Fair Value on that date.
On Balance Sheet date i.e. 31/3/2017 the Fair Value is ` 1,020 and on Settlement date i.e.
2/4/2017 Fair Value is ` 1,030.
Pass necessary Journal entries on trade date and settlement date when the asset acquired
is measured at
(a) Amortised cost
(b) FVTPL
(c) FVTOCI
SOLUTION :
Case (a)
(i) Financial Asset at Amortised Cost – Trade Date Accounting

Dates Journal Entry Amount (`) Amount (`)

30.3.2017 Financial Asset Dr. 1,000
To Payables 1,000
31.3.2017 No Entry
2.4.2017 Payables Dr. 1,000
To Cash 1,000

(ii) Financial Asset at Amortised Cost – Settlement Date Accounting

Dates Journal Entry Amount (`) Amount (`)

30.3.2017 No Entry
31.3.2017 No Entry
2.4.2017 Financial Asset Dr. 1,000
To Cash 1,000
 38 FINANCIAL REPORTING

Case (b)
(i) Financial Asset at FVTPL – Trade Date Accounting

Dates Journal Entry Amount (`) Amount (`)

30.3.2017 Financial Asset Dr. 1,000
To Payables 1,000
31.3.2017 Financial Asset Dr. 20
To P&L 20
2.4.2017 Financial Asset Dr. 10
To P&L 10
Payables Dr. 1,000
To Cash 1,000

(ii) Financial Asset a FVTPL – Settlement Date Accounting

Dates Journal Entry Amount (`) Amount (`)

30.3.2017 No Entry
31.3.2017 Fair Value changes Dr. 20
To P&L 20
2.4.2017 Fair value Change Dr. 10
To P&L 10
Financial Asset Dr. 1,030
To Cash 1,000
To Fair Value Change 30

Case (c)
(i) Financial Asset at FVTOCI – Trade Date Accounting

Dates Journal Entry Amount (`) Amount (`)

30.3.2017 Financial Asset Dr. 1,000
To Payables 1,000
31.3.2017 Financial Asset Dr. 20
To OCI 20
2.4.2017 Financial Asset Dr. 10
To OCI 10
 UNIT 3 : Classification Of Financial Assets & Measurements 39

Payables Dr. 1,000

To Cash 1,000

(ii) Financial Asst at FVTOCI – Settlement Date Accounting

Dates Journal Entry Amount (`) Amount (`)

30.3.2017 No Entry
31.3.2017 Fair Value changes Dr. 20
To OCI 20
2.4.2017 Fair value Change Dr. 10
To OCI 10
Financial Asset Dr. 1,030
To Cash 1,000
To Fair Value Change 30

QUESTION 76 (SELF READING)

REGULAR WAY CONTRACTS: FORWARD CONTRACTS

ST Ltd. enters into a forward contract to purchase 10 lakh shares of ABC Ltd. in a month‛s
time for ` 50 per share. This contract is entered into with a broker, Mr. AG and not
through regular trading mode in a stock, exchange. The contract requires Mr. AG to deliver
the shares to ST Ltd. upon payment of agreed consideration. Shares of ABC Ltd. traded on
a stock exchange. Regular way delivery is two days. Assess the forward contract.
SOLUTION :
In this case, the forward contract is not a regular way transaction and hence must be
accounted for as a derivative i.e. between the date of entering into the contract to the
date of delivery. All fair value changes are recognised in profit or loss.

QUESTION 77 (SELF READING)

REGULAR WAY CONTRACTS: OPTION CONTRACTS

NKT Ltd. purchases a call option in a public market permitting it to purchase 100 shares
of VT Ltd. at any time over the next one month at a price of ` 1,000 per share. If NKT
Ltd. exercises its option, it has 7 days to settle the transaction according to regulation or
convention in the options market. VT Ltd.‛s shares are traded in an active public market
that requires two-day settlement.
 40 FINANCIAL REPORTING

SOLUTION :
In this case, the option contract is regular way transaction as the settlement of the option
is governed by regulation or convention in the marketplace for options.

QUESTION 78 (SELF READING)

REGULAR WAY PURCHASE OF FINANCIAL ASSET

On 1 January 20X1, X Ltd. enters into a contract to purchase a financial asset for ` 10 lakhs,
which is its fair value on trade date. On 4 January 20X1 (settlement date), the fair value
of the asset is ` 10.5 lakhs. The amounts to be recorded for the financial asset will depend
on how it is classified and whether trade date or settlement date accounting is used, Pass
necessary journal entries.
SOLUTION :
Journal Entries in the Buyer‛s Books
Trade date accounting

Dr. / Cr. Particulars Amortised Fair value Fair value

cast through P&L through OCI
1 January 20X1
Dr. Financial asset 10,00,000 10,00,000 10,00,000
Cr. Financial liability (to pay) (10,00,000) (10,00,000) (10,00,000)
4 January 20X1
Dr. Financial asset - 50,000 50,000
Dr. Financial liability (to pay) 10,00,000 10,00,000 10,00,000
Cr. Profit or loss - (50,000) -
Cr. Other comprehensive - - (50,000)
income
Cr. Cash (10,00,000) (10,00,000) (10,00,000)

Settlement date accounting

Dr. /Cr. Particulars Amortised Fair value Fair value

cost through P&L through
OCI
4 January 20x1
Dr. Financial asset 10,00,000 10,50,000 10,50,000
Cr. Profit or loss - (50,000) -
 UNIT 3 : Classification Of Financial Assets & Measurements 41

Cr. Other comprehensive - - (50,000)

income
Cr. Cash (10,00,000) (10,00,000) (10,00,000)

The above mentioned accounting principles apply only to financial assets and Ind AS 109
does not contain any such principles for financial liabilities.
 42 FINANCIAL REPORTING

PART D
BASIC QUETSIONS FOR DISCUSSION ON CLASSIFICATION

QUESTION 79 : Hold-to-collect‛ business model test

An entity purchased a debt instrument for 1,00,000.

The instrument pays interest of 6,000 annually and has 10 years to maturity when purchased.
The entity intends to hold the asset to collect the contractual cash flows.
Evaluate the business model test.
SOLUTION :
Entity‛s objective is to hold the asset to collect the contractual cash flows and not to sell
the assets before the maturity period.
Thus, the debt instrument would meet the ‘hold-to-collect‛ business model test.

QUESTION 80 : Hold-to-collect‛ business model test

An entity purchased a debt instrument for 1,00,000.

The instrument pays interest of 6,000 annually and has 10 years to maturity when pur-
chased. The entity intends to hold the asset to collect the contractual cash flows.
Six years have passed and the entity is suffering a liquidity crisis and needs to sell the
asset to raise funds.
Evaluate the business model test.
SOLUTION :
Since the sale of financial assets was not expected on initial classification and therefore,
does not affect the classification (i.e. there is no retrospective reclassification).
Thus, the debt instrument would still meet the ‘hold-to-collect‛ business model test.

QUESTION 81 : SPPI or contractual cash flow test

SPPI test for loan with zero interest and no fixed repayment terms
Parent H Ltd. provides a loan to its Subsidiary S Ltd. The loan is classified as a current lia-
bility in Subsidiary S‛s financial statements and has the following terms:
– Interest free loan.
– No fixed repayment terms
– Repayable on demand of Parent H Ltd.
Does the loan meet the ‘SPPI‛ or contractual cash flows characteristic test?
 UNIT 3 : Classification Of Financial Assets & Measurements 43

SOLUTION :
Yes. The terms for the repayment of the principal amount of the loan on demand satisfies
the criterion of SPPI.

QUESTION 82 : SPPI Test for loan with zero interest repayable in ten years

Parent H Ltd. provides a loan of INR 100 million to Subsidiary B. The loan has the following
terms:
– No interest
– Repayable in ten years.
Does the loan meet the ‘SPPI‛ or contractual cash flows characteristic test?
SOLUTION :
Yes. The terms for the repayment of the principal amount of the loan on demand satisfies
the criterion of SPPI.

QUESTOIN 83 : SPPI Test for loan with interest rate

Entity A Ltd. lends Entity B Ltd. INR 5 million for ten years, subject to the following terms:
– Interest is based on the prevailing variable market interest rate.
– Variable interest rate is capped at 10%.
– Repayable in ten years.
Does the loan meet the ‘SPPI‛ or contractual cash flows characteristic test?
SOLUTION :
Contractual cash flows of both a fixed rate instrument and a floating rate instrument are
payments of principal and interest as long as the interest reflects consideration for the
time value of money and credit risk.
Therefore, a loan that contains a combination of a fixed and variable interest rate meets
the contractual cash flow characteristics test.

QUESTOIN 84: Trade receivables – Amortised cost

H Ltd. makes sale of goods to customers on credit of 60 days. The customers are entitled
to earn a cash discount @ 5% per annum if payment is made before 60 days and an interest
@ 12% per annum is charged for any payments made after 60 days. Company does not have
a policy of selling its debtors and holds them to collect contractual cash flows.
Evaluate the financial instrument.
 44 FINANCIAL REPORTING

SOLUTION :
In the above case, since H Ltd. has a contractual right to receive cash flows from its
customers and therefore such trade receivable are financial assets for H Ltd.
Further, H Ltd. business model test to collect will satisfy as the objective is to hold its trade
receivable to collect contractual cash flows till the end of maturity period and such trade
receivable recorded in books represents contractual cash flows that are solely payments of
principal and interest if paid beyond credit period.
Hence such trade receivables are classified at amortised cost.

QUESTION 85: Security Deposits – Amortized Costs

A Ltd. (the ‘Company‛) has obtained the premises from B Ltd. on lease to carry on its busi-
ness. The lease contract period is 5 years. As per the lease agreement, A Ltd. has paid
security deposits to B Ltd. amounting to ` 10 Lac which is refundable after the expiry of
lease agreement.
How would such deposits be treated in books of the A Ltd. ?
SOLUTION :
In the above case, since A Ltd. has a contractual right to receive cash flows from its Lessor,
B Ltd. and therefore such security deposits receivable are financial assets for A Ltd.
Further, A Ltd. business model test to collect will be satisfied as the objective is to hold
its security deposits receivable to collect contractual cash flows till the end of maturity
period. And such trade receivable recorded in books represents contractual cash flows that
are solely payments of principal and interest.
Hence such security deposits receivables are classified at amortised cost.

QUESTION 86 : Hold-to-collect‛ or ‘hold-to-collect & sell‛ business model test

Entity A has surplus funds – INR 50 million

A has not yet found suitable investment opportunity so it buys medium dated (5 year matu-
rity) high quality government bonds in order to generate interest income.
If a suitable investment opportunity arises before the maturity date, the entity will sell
the bonds and use the proceeds for the acquisition of a business operation. It is likely that
a suitable business opportunity will be found before maturity date.
Whether the investment opportunity will meet the ‘hold-to-collect‛ or ‘hold-to-collect & sell
business model test?
SOLUTION :
Government bonds would not meet the ‘hold-to-collect‛ business model test because it is
considered likely that the bonds will be sold well before their contractual maturity.
 UNIT 3 : Classification Of Financial Assets & Measurements 45

However, it is likely that such investment would meet the ‘hold-to-collect and sell‛ business
model test.

QUESTION 87: Accounting for transaction costs on initial and subsequent measurement
of a financial asset measured at fair value with changes through other comprehensive
income:

An entity acquires a financial asset for CU 100 plus a purchase commission of CU 2. Initially,
the entity recognises the asset at CU 102. The reporting period ends one day later, when
the quoted market price of the asset is CU 100. If the asset were sold, a commission of CU
3 would be paid. How would transaction costs be accounted in books of the entity?
SOLUTION :
- On that date, the entity measures the asset at CU 100 (without regard to the possible
commission on sale) and recognises a loss of CU 2 in other comprehensive income.
- If the financial asset is measured at fair value through other comprehensive income in
accordance with Ind AS 109.4.1.2A, the transaction costs are amortised to profit or
loss using the effective interest method.

QUESTOIN 88: Determining fair value upon initial measurement

The shareholders of Company C provide C with financing in the form of loan notes to enable
it to acquire investments in subsidiaries. The loan notes will be redeemed solely out of div-
idends received from these subsidiaries and become redeemable only when C has sufficient
funds to do so. In this context, ‘sufficient funds‛ refers only to dividend receipts from
subsidiaries. Analyse the initial measurement of loan notes.
SOLUTION :
In this case –
Loan notes are repayable only then C earns returns in form of dividends from subsidiaries.
Hence, C cannot be forced to obtain additional external financing or to liquidate its invest-
ments to redeem the shareholder loans. Consequently, the loan notes are not considered
payable on demand.
Accordingly –
- Loan notes shall be initially measured at their fair value (plus transaction costs), being
the present value of the expected future cash flows, discounted using a market-
related rate. The amount and timing of the expected future cash flows should be
determined on the basis of the expected dividend flow from the subsidiaries. Also, the
valuation would need to take into account possible early repayments of principal and
corresponding reductions in interest expense.
- Since the loan notes are interest-free or bear lower-than-market interest, there
 46 FINANCIAL REPORTING

will be a difference between the nominal value of the loan notes - i.e. the amount
granted - and their fair value on initial recognition. Because the financing is provided
by shareholders, acting in the capacity of shareholders, the resulting credit should
be reflected in equity as a shareholder contribution in C‛s balance sheet. Conversely,
in books of shareholders, the difference between amount invested and its fair value
shall be recorded as ‘investment in C Ltd‛ being representative of the underlying
relationship between shareholders and C Ltd.

QUESTION 89 : Use of cost v/s fair value determination for equity instruments

Silver Ltd. has made an investment in optionally convertible preference shares (OCPS) of
a Company – Bronze Ltd. at ` 100 per share (face value ` 100 per share). Silver Ltd. has
an option to convert these OCPS into equity shares in the ratio of 1:1 and if such option
not exercised till end of 9 years, then the shares shall be redeemable at the end of 10
years at a premium of 20%.
Analyse the measurement of this investment in books of Silver Ltd.
SOLUTION :
The classification assessment for a financial asset is done based on two characteristics:
i. Whether the contractual cash flows comprise cash flows that are solely payments of
principal and interest on the principal outstanding
ii. Entity‛s business model (BM) for managing financial assets – Whether the Company‛s
BM is to collect cash flows; or a BM that involves realisation of both contractual cash
flows & sale of financial assets;
In all other cases, the financial assets are measured at fair value through profit or loss.
In the above case, the Holder can realise return either through conversion or redemption
at the end of 10 years, hence it does not indicate contractual cash flows that are solely
payments of principal and interest. Therefore, such investment shall be carried at fair
value through profit or loss. Accordingly, the investment shall be measured at fair value
periodically with gain/ loss recorded in profit or loss.

QUESTOIN 90: Accounting for assets at Amortised Cost

XYZ Ltd. is a company incorporated in India. It provides INR 10,00,000 interest free loan
to its wholly owned Indian subsidiary (ABC). There are no transaction costs.
How should the loan be accounted for, in the Ind AS financial statements of XYZ, ABC and
consolidated financial statements of the group?
Consider the following scenarios:
a) The loan is repayable on demand.
 UNIT 3 : Classification Of Financial Assets & Measurements 47

a) The loan is repayable after 3 years. The current market rate of interest for similar
loan is 10% p.a. for both holding and subsidiary.
b) The loan is repayable when ABC has funds to repay the loan.

QUESTION 91

An entity is about to purchase a portfolio of fixed rate assets that will be financed by fixed
rate debentures. Both financial assets and financial liabilities are subject to the same in-
terest rate risk that gives rise to opposite changes in fair value that tend to offset each
other. Provide your comments.
SOLUTION :
The fixed rate assets provide for contractual cash flows and based on business model of
the entity, such fixed rate assets may be classified as ‘amortised cost‛ (if entity collects
contractual cash flows) or fair value through other comprehensive income (FVOCI) (if entity
manages through collecting contractual cash and sale of financial assets).
In the absence of fair value option, the entity can classify the fixed rate assets as FVOCI
with gains and losses on changes in fair value recognised in other comprehensive income and
fixed rate debentures at amortised cost. However, reporting both assets and liabilities at
fair value through profit and loss, ie, FVTPL corrects the measurement inconsistency and
produces more relevant information.
Hence, it may be appropriate to classify the entire group of fixed rate assets and fixed
rate debentures at fair value through profit or loss (FVTPL).

QUESTION 92: Issue of borrowings with fixed rate of interest

A Ltd has made a borrowing from RBC Bank for ` 10,000 at a fixed interest of 10% per an-
num. Loan processing fees were additionally paid for ` 500 and loan is payable after 5 years
in bullet repayment of principal. Details are as follows:

Particulars Details
Loan amount ` 10,000
Date of loan (Starting Date) 1-Apr-20X1
Date of repayment of principal 31-March-20X6
amount (Finishing Date)
Interest rate 10.00%
Interest charge Interest to be charged and paid yearly
Upfront fees ` 500

How would loan be accounted in books of A Ltd?

 48 FINANCIAL REPORTING

QUESTION 93 : Accounting treatment of prepayment premium and processing fees for

obtaining new loan to prepay old loan

PQR Limited had obtained term loan from Bank A in 20X1-20X2 and paid loan processing
fees and commitment charges.
In May 20X5, PQR Ltd. has availed fresh loan from Bank B as take-over of facility i.e. the
new loan is sanctioned to pay off the old loan taken from Bank A. The company paid prepay-
ment premium to Bank A to clear the old term loan and paid processing fees to Bank B for
the new term loan.
Whether the prepayment premium and the processing fees both will be treated as trans-
action cost (as per Ind AS 109, Financial
SOLUTION :
(a) Accounting treatment of prepayment premium
Ind AS 109, provides that if an exchange of debt instruments or modification of terms
is accounted for as an extinguishment, any costs or fees incurred are recognised as
part of the gain or loss on the extinguishment in the statement of profit and loss.
Since the original loan was prepaid, the prepayment would result in extinguishment of
the original loan. The difference between the CV of the financial liability extinguished
and the consideration paid shall be recognised in profit or loss as per Ind AS 109.
Accordingly, the prepayment premium shall be recognised as part of the gain or loss
on extinguishment of the old loan.
(a) Accounting treatment of Unamortised processing fee of old loan
Unamortised processing fee related to the old loan will also be required to be charged
to the statement of profit and loss.
(a) Accounting treatment of Processing fee for new loan
Transaction costs are “Incremental costs that are directly attributable to the acquisition,
issue or disposal of a financial asset or financial liability. An incremental cost is one that
would not have been incurred if the entity had not acquired, issued or disposed of the fi-
nancial instrument.”
It is assumed that the loan processing fees solely relates to the origination of the new loan
(i.e. does not represent loan modification/renegotiation fees). Hence, the processing fees
paid to avail fresh loan from Bank B will be considered as transaction cost in the nature
of origination fees of the new loan and will be included while calculating effective interest
rate as per Ind AS 109.
 UNIT 4: Classification & Measurements Of Financial Liabilities 49

UNIT 4: CLASSIFICATION & MEASUREMENTS OF

FINANCIAL LIABILITIES

QUESTION 94

A Limited issues INR 1 crore convertible bonds on 1 July 20X1. The bonds have a life of
eight years and a face value of INR 10 each, and they offer interest, payable at the end of
each financial year, at a rate of 6 per cent annum. The bonds are issued at their face value
and each bond can be converted into one ordinary share in A Limited at any time in the next
eight year Companies of a similar risk profile have recently issued debt with similar terms,
without the option for conversion, at a rate of 8 per cent per annum.
Required:
(a) Identify the present value of the bonds, and allocating the difference between the
present value and the issue price to the equity component, provide the appropriate
accounting entries.
(b) Calculate the stream of interest expenses across the eight years of the life of the
bonds.
(c) Provide the accounting entries if the holders of the option elect to convert the options
to ordinary shares at the end of the third year.

QUESTION 95

ABC Company issued 10,000 compulsory cumulative convertible preference shares (COCPS)
as on 1 April 20X1 @ ` 150 each. The rate of dividend is 10% payable every year. The
preference shares are convertible into 5,000 equity shares of the company at the end of
5th year form the date of allotment. When the CCCPS are issued, the prevailing market
interest rate for similar debt without conversion options is 15% per annum. Transaction
cost on the date of issuance is 2% of the value of the proceeds.
Key terms:

Date of Allotment 01-Apr 20X1

Date of Conversion 01-Apr-20X1
Number of preference Shares 10,000
Face Value of preference Shares 150
Total Proceeds 15,00,000
Rate Of dividend 10%
Market Rate for Similar Instrument 15%
 50 FINANCIAL REPORTING

Transaction Cost 30,000

Face value of equity share after conversion 10
Number of equity shares to be issued 5,000
Effective rate of return on amortized part due to transaction cost 15.86%

QUESTION 96 (CHANGE IN MARKET RATE OF INTEREST)

ABC Ltd. issued Debentures amounting to ` 100 Lacs.

As per the terms of the issue it has been agreed to issue equity shares amounting to `150
Lacs to redeem the debentures at the end of 3rd year.
Assume comparable market yield is 10% for year 0 and 1, and 10.5% for Year 2 end.
Show accounting entries.

QUESTION 97

An entity is about to purchase a portfolio of fixed rate assets that will be financed by
fixed rate debentures. Both financial assets and financial liabilities are subject to the same
interest rate risk that gives rise to opposite changes in fair value that tend to offset each
other. Comment?
SOLUTION :
Due to involvement of market risk in interest rate in financial asset and financial liability,
both should be considered under FVPL MODEL. If interest can be varied due to market
conditions then we cannot opt for amortization method.

QUESTION 98

You are required to –

(i) Identify Equity and Liability Components,
(ii) Compute Bond Liability at the end of each year, and
Number of Convertible Bonds 5,000 Bonds issued at the beginning of year 1
Value of Bonds` ` 500 per Bond
Period of Bonds 3 Years Validity
Interest Rate on the Bond 9% p.a. Payable Annually
Proceed Received ` 25 Lakhs
Conversion At the Bond Holders‛ discretion, conversion into
125 Shares for each Bond of `500
 UNIT 4: Classification & Measurements Of Financial Liabilities 51

Prevailing Market Rate 11% p.a. for Bonds issued without conversion
option.
Present value Factor for 11% 0.900, 0.8121, 0.731 (for One year two years and
three years respectively)
SOLUTION ::
1. Computation of Fair value of Liability Component
This is measured using the Interest Rteof11% for Non-Convertible Debt as the Benchmark
Discount Rate, as under:-

Nature Year Outflow Discount Factor at11% PV of Outflow

Annual Interest 2,25,000 (0.900+0.812+ 0.731) 5,49,675
(`25 Lakhs x 1 to3 2.443
9%)
Principal 3 25,00,000 18,27,500
repayment at
Maturity
Fair value of 23,77,175
Liability

2. Initial Recognition of Compound Financial Instrument (9% convertible Debentures)

Fair value of the Compound Instrument as a whole = Nominal value= ` 25,00,000
5,000x`500
23,77,175
Less: Fair Value of Liability Component as computed above.
Equity Component ` 1,22,175

3. Bond Liability at the end of each year by Amortised method

Particulars Year 1 Year 2 Year 3

Beginning 23,77,175 23,13,664 24,54,167
Add: Notional 2,61,489 2,65,503 2,70,833
Interest @ 11%
26,38,664 26,79,167 27,25,000
Less: Interest paid 2,25,000 2,25,000 2,25,000
@ 9%
23,13,664 24,54,167 25,00,000

Note: Rounding off adjustments made to 11% interest in year 3.

 52 FINANCIAL REPORTING

QUESTION 99 Issue of borrowings with fixed rate of interest

A Ltd has made a borrowing from RBC Bank for ` 10,000 at a fixed interest of 12% per
annum. Loan processing fees were additionally paid for ` 500 and loan is payable 4 half-
yearly installments of ` 2,500 each. Details are as follows:

Particulars Details
Loan amount ` 10,000
Date of loan (Starting Date) 1-Apr-20X1
Date of loan (Finishing Date) 31-March-20X3
Repayment of loan starts from 30-Sept-20X1
Description of repayment (To be paid half yearly)
Installment amount `2,500
Interest rate 12.00% (IRR 16.6%)
Interest charge Interest to be charged quarterly
Upfront fees ` 500

How would loan be accounted in books of A Ltd?

QUESTION 100 Trade creditors at market terms

A Company purchases its raw materials from a vendor at a fixed price of ` 1,000 per tonne
of steel. The payment terms provide for 45 days of credit period, after which an interest
of 18% per annum shall be charged. How would the creditors be classified.
SOLUTION :
In the above case, creditors for purchase of steel shall be carried at amortised cost, ie,
fair value of amount payable upon initial recognition plus interest (if payment is delayed).
Here, fair value upon initial recognition shall be the price per tonne, since the transaction
is at market terms between two knowledgeable parties in an arms-length transaction and
hence, the transaction price is representative of fair value.
 UNIT 5 : Derivatives & Embedded Derivatives 53

UNIT 5 : DERIVATIVES & EMBEDDED DERIVATIVES

QUESTION 101: Prepaid interest rate swap (fixed rate payment obligation prepaid at
inception)

Entity S enters into a ` 100 crores notional amount five-year pay-fixed, receive-variable
interest rate swap with Counterparty C.
 The interest rate of the variable part of the swap is reset on a quarterly basis to
three-month Mumbai Interbank Offer Rate (MIBOR).
 The interest rate of the fixed part of the swap is 10% p.a.
 Entity S prepays its fixed obligation under the swap of ` 50 crores (` 100 crores
× 10% × 5 years) at inception, discounted using market interest rates
 Entity S retains the right to receive interest payments on the ` 100 crores reset
quarterly based on three-month MIBOR over the life of the swap.
Analyse.
SOLUTION :
The initial net investment in the interest rate swap is significantly less than the notional
amount on which the variable payments under the variable leg will be calculated. The contract
requires an initial net investment that is smaller than would be required for other types of
contracts that would be expected to have a similar response to changes in market factors,
such as a variable rate bond.
Therefore, the contract fulfils the condition ‘no initial net investment or an initial net
investment that is smaller than would be required for other types of contracts that would
be expected to have a similar response to changes in market factors‛.
Even though Entity S has no future performance obligation, the ultimate settlement of the
contract is at a future date and the value of the contract changes in response to changes
in the LIBOR index. Accordingly, the contract is regarded as a derivative contract.

QUESTION 102: Prepaid pay-variable, receive-fixed interest rate swap

 Entity S enters into a ` 100 crores notional amount five-year pay-variable, receive-
fixed interest rate swap with Counterparty C.
 The variable leg of the swap is reset on a quarterly basis to three-month MIBOR.
 The fixed interest payments under the swap are calculated as 10% of the swap‛s
notional amount, i.e. ` 10 crores p.a.
 Entity S prepays its obligation under the variable leg of the swap at inception at
current market rates. Say, that amount is ` 36 crores.
 54 FINANCIAL REPORTING

 It retains the right to receive fixed interest payments of 10% on ` 100 crores every
year.
Analyse.
SOLUTION :
In effect, this contract results in an initial net investment of ` 36 crores which yields a
cash inflow of ` 10 crores every year, for five year By discharging the obligation to pay
variable interest rate payments, Entity S in effect provides a loan to Counterparty C.
Therefore, all else being equal, the initial investment in the contract should equal that of
other financial instruments that consist of fixed annuities. Thus, the initial net investment
in the pay-variable, receive-fixed interest rate swap is equal to the investment required in
a non-derivative contract that has a similar response to changes in market conditions.
For this reason, the instrument fails the condition ‘no initial net investment or an initial
net investment that is smaller than would be required for other types of contracts that
would be expected to have a similar response to changes in market factors‛. Therefore, the
contract is not accounted for as a derivative contract.

QUESTION 103: Prepaid forward

Entity XYZ enters into a forward contract to purchase 1 million ordinary shares of Entity
T in one year
 The current market price of T is ` 50 per share
 The one-year forward price of T is ` 55 per share
 XYZ is required to prepay the forward contract at inception with a ` 50 million payment.
Analyse.
SOLUTION :
Purchase of 1 million shares for current market price is likely to have the same response to
changes in market factors as the contract mentioned above. Accordingly, the prepaid forward
contract does not meet the initial net investment criterion of a derivative instrument.

QUESTION 104: EMBEDDED DERIVATIVES

On 1 January 20X1, ABG Pvt. Ltd., a company incorporated in India enters into a contract
to buy solar panels from A&A Associates, a firm domiciled in UAE, for which delivery is due
after 6 months i.e. on 30 June 20X1
The purchase price for solar panels is US$ 50 million.
The functional currency of ABG is Indian Rupees (INR) and of A&A is Dirhams.
The obligation to settle the contract in US Dollars has been evaluated to be an embedded
derivative which is not closely related to the host purchase contract.
 UNIT 5 : Derivatives & Embedded Derivatives 55

Exchange rates:
1. Spot rate on 1 January 20X1: USD 1 = INR 60
2. Six-month forward rate on 1 January 20X1: USD 1 = INR 65
3. Spot rate on 30 June 20X1: USD 1 = INR 66
Analyse

QUESTION 105

On 1st January 20X1, Sam Co. Ltd. agreed to purchase USD ($) 20,000 from JT Bank in
future on 31st December 20X1 for a rate equal to ` 68 per USD. Sam Co. Ltd did not pay
any amount upon entering into the contract. Sam Co Ltd. is a listed company in India and
prepares its financial statements on a quarterly basis.
Following the principles of recognition and measurement as laid down in Ind AS 109, you are
required to record the entries for each quarter ended till the date of actual purchase of
USD.
For the purposes of accounting, please use the following information representing market
to market fair value of forward contracts at each reporting date:
As at 31st March 20X1- `
As at 30th June 20X1- (25,000)
` (15,000)
As at 30th September 20X1-
` 12,000
Sport rate of USD on 31ST December 20X1 - ` 66per USD

QUESTION 106

Entity A (an INR functional currency entity ) enters into a USD 1,00,000 sale contract on
1 January 20X1 with Entity B (an INR functional currency entity ) to sell equipment on 30
June 20X1.

Sport rate on 1 January 20X1 INR/USD 45

Spot rate on 31 March 20X1 : INR/USD 57
Three months forward rate on 31 March 20X1: INR/USD 45
Six month forward rate on 1 January 20X1 INR/USD 55
Spot rate on 30 June 20X1 : INR/USD 60

Let‛s assume that contract has an embedded derivative that is not closely related and
requires separation. Please provide detailed journal entries in the books of Entity A for
accounting of such embedded derivative until sale is actually made.
 56 FINANCIAL REPORTING

QUESTION 107

On 1st January 20X1, Sam Co. Ltd. entered into a written put option for USD ($) 20,000
With JT Corp to settled in future on 31st December 20X1 for a rate equal to `
Equal to ` 68 per USD at the option of JT Corp. Sam co. Ltd. did not receive any amount
upon entering into contract. Sam Co Ltd. is a listed company in India and prepares its
financial statements on a quarterly basis.
Following the classification principles of recognition and measurement as laid down in Ind
AS 109, you are required to record the entries for each quarter ended till date of actual
purchase of USD.
For the purposes of accounting, please use the following information representing market
to market fair value of put option contracts at each reporting date:
As at 31st March 20X1- `
As at 30th June 20X1- (25,000)
` (15,000)
As at 30 the June September 20X1-
` NIL
Spot rate of USD on 31st December 20x1 - ` 66 per USD

QUESTION 108

Entity ABC Ltd., whose functional currency is Indian Rupees, sells products in France de-
nominated in Euro. ABC enters into a contract with an investment bank to convert Euro to
Indian Rupees at a fixed exchange rate. The contract requires ABC to remit Euro based on
its sales volume in France in exchange for Indian Rupees at a fixed exchange rate of 80.00.
Is that contract a derivative?
SOLUTION :
Yes. The contract has two underlying variables (the foreign exchange rate and the volume
of sales); no initial net investment or an initial net investment that is smaller than would be
required for other types of contracts that would be expected to have a similar response to
changes in market factors, and a payment provision.

QUESTION 109

The definition of a derivative requires that the instrument “is settled at a future date”. Is
this criterion met even if an option is expected not to be exercised, for example, because
it is out of the money?
SOLUTION :
Yes. An option is settled upon exercise or at its maturity. Expiry at maturity is a form of
settlement even though there is no additional exchange of consideration.
 UNIT 5 : Derivatives & Embedded Derivatives 57

QUESTION 110

Silver Ltd. has purchased 100 ounces of gold on 10 March 20X1. The transaction provides
for a price payable which is equal to market value of 100 ounces of gold on 10 April 20X1
and shall be settled by issue of such number of equity shares as is required to settle the
aforementioned transaction price at ` 10 per share on 10 April 20X1. Whether this is clas-
sified as liability or equity? Own use exemption does not apply.
SOLUTION :
In the above scenario, there is a contract for purchase of 100 ounces of gold whose consid-
eration varies in response to changing value of gold. Analysing this contract as a derivative –
(a) Value of contract changes in response to change in market value of gold;
(b) There is no initial net investment
(c) It will be settled at a future date, i.e. 10 April 20X1.
Since the above criteria are met, this is a derivative contract.
Now, a derivative contract that is settled in own equity other than exchange of fixed
amount of cash for fixed number of shares is classified as ‘liability‛. In this case, since the
contract results in issue of variable number of shares based on transaction price to be de-
termined in future, hence, this shall be classified as ‘derivative financial liability‛.
Per Ind AS [Link] – A derivative financial liability shall be carried at fair value through
profit or loss.

QUESTION 111 : Derivative contract:

Entity – B Ltd writes an option contract for sale of shares of Target Ltd. at a fixed price of
` 100 per share to C Ltd. This option is exercisable anytime for a period of 90 days (‘Amer-
ican option‛). Evaluate this under the definition of financial instrument.
SOLUTION :
In the above case – B Ltd has written an option, which if exercised by C Ltd. will result in B
Ltd. selling equity shares of Target Ltd. for fixed cash of ` 100 per share. Such option will
be exercised by C Ltd. only if the market price of shares of Target Ltd. increases beyond
` 100, thereby resulting in contractual obligation over B Ltd. to settle the contract under
potential unfavorable terms.
In the above case, if the market price is already ` 120 which means that if option is exer-
cised by C Ltd, then B Ltd shall buy shares from the market at ` 120 per share and sell at `
100, thereby resulting in a loss or exchange at unfavorable terms to B Ltd. Hence, it meets
the definition of financial liability in books of B Ltd.
 58 FINANCIAL REPORTING

The additional question that arises here is the nature of this financial liability and if it
meets the definition of derivative. A derivative is a financial instrument that meets follow-
ing conditions –
(a) Its value changes in response to change in specified variable like interest rate, equity
index, commodity price, etc. If the variable is non-financial, it is not specific to party
to the contract
(b) It requires no or little initial net investment
(c) It is settled at a future date.
Evaluating the above instrument, B Ltd. has written an option whose value changes based on
change in market price of equity share, it requires no initial net investment and is settled at
a future date (anytime in 90 days). Hence, it meets definition of derivative financial liability
in books of B Ltd.

QUESTION 112: Derivative contract to be settled in own equity instruments

A Ltd. issues warrants to all existing shareholders entitling them to purchase additional
equity shares of A Ltd. (with face value of ` 100 per share) at an issue price of ` 150
per share. Evaluate whether this constitutes an equity instrument or a financial liability?
SOLUTION :
In this case, Company A Ltd. has issued warrants entitling the shareholders to purchase
equity shares of the Company at a fixed price. Hence, it constitutes a contractual arrange-
ment for issuance of fixed number of shares against fixed amount of cash.
Now, evaluating this contract under definition of derivative –
(i) The value of warrant changes in response to change in value of underlying equity shares;
(ii) This involves no initial net investment
(iii) It shall be settled at a future date.
Hence, this warrant meets the definition of derivative.
Applying definition of equity under Ind AS 32, a derivative contract that will be settled by
exchange of fixed number of equity shares for fixed amount of cash meets definition of
equity instrument. The above contract is derivative contract that will be settled by issue
of fixed number of own equity instruments by A Ltd. for fixed amount of cash and hence
meets definition of equity instrument.

QUESTION 113

A lease contract contains a provision that rentals increase each year by ` 3 million. Is there
an embedded derivative in this contract?
 UNIT 5 : Derivatives & Embedded Derivatives 59

SOLUTION :
The price adjustment feature does not meet the definition of a derivative on a stand-alone
basis since its value does not change in response to changes of some underlying. There is no
underlying in this case; hence there is no embedded derivative in the lease contract.

QUESTION 114: Debt instrument with indexed repayments

Entity X issues a redeemable fixed interest rate debenture to Entity Y. Amount of interest
and principal is indexed to the value of equity instruments of Entity X.
Analyse.
SOLUTION :
In the given case, the host is a fixed interest rate debt instrument. The economic
characteristics and risks of a debt instrument are not closely related to those of an equity
instrument.
Hence, the exposure of this hybrid instrument to changes in value of equity instruments is
an embedded derivative which is required to be separated.
The response above will not change even if the interest payment and principal repayments
are indexed to a commodity index or similar underlying.

QUESTION 115: Lease contracts dependent on inflation index

A lease contract, between two Indian companies of an asset in India, includes contingent
lease rentals that are dependent upon an US inflation index. Can the entity treat inflation
linked features as closely related?
SOLUTION :
For inflation linked features, an embedded derivative in a lease contract is considered as
closely related to the host if it is an inflation—related index related to inflation in the
entity‛s own economic environment.
In this case, whilst the asset and the lessor and lessee are located in India, lease payment
are linked to US index. Hence, embedded derivative is not closely related and needs to be
separated.

QUESTION 116: Lease contracts dependent on inflation index

As per the contract entered between lease and lessor, lease rentals will increase by ` 3
million, if profit after tax is over ` 200 million. Can the entity treat inflation linked features
as closely related?
 60 FINANCIAL REPORTING

SOLUTION :
No. Whilst contingent rentals based on sales are closely related to a host lease contract,
the same is not true of contingent rentals based on profit after tax.
Prepayment options in debt instruments
It is very common to have debt prepayment options in ordinary borrowing arrangements.
Paragraph B4.3.5(e) of Ind AS 109 provides the guidance in this respect:
“A call, put, or prepayment option embedded in a host debt contract or host insurance con-
tract is not closely related to the host contract unless:
i. the option‛s exercise price is approximately equal on each exercise date to the
amortised cost of the host debt instrument or the carrying amount of the host
insurance contract;
or
i. the exercise price of a prepayment option reimburses the lender for an amount up
to the approximate present value of lost interest for the remaining term of the host
contract. Lost interest is the product of the principal amount prepaid multiplied by
the interest rate differential. The interest rate differential is the excess of the
effective interest rate of the host contract over the effective interest rate the
entity would receive at the prepayment date if it reinvested the principal amount
prepaid in a similar contract for the remaining term of the host contract.
The assessment of whether the call or put option is closely related to the host debt con-
tract is made before separating the equity element of a convertible debt instrument in
accordance with Ind AS 32.”
Ind AS 109 does not interpret the term “approximately equal”. Management of entities will
need to adopt a consistent accounting policy to apply this principle in general.

QUESTION 117: Debt instrument with prepayment option

Entity PQR borrows ` 100 crores from CFDH Bank on 1 April 20X1. Interest is payable at
12% p.a. and there is a bullet repayment of principal at the end of the term. Term of the
loan is 6 years.
The loan includes an option to prepay the loan at 1st April each year with a prepayment pen-
alty of 3%. There are no transaction costs. Without the prepayment option, the interest
rate quoted by bank is 11% p.a.
Analyse.
 UNIT 5 : Derivatives & Embedded Derivatives 61

QUESTION 118: Contracts for purchase or sale of non-financial item Key terms of
contracts to buy/sell non-financial items

Company Z is engaged in the business of importing oil seeds for further processing as well
as trading purposes. It enters into the following types of contracts as on 1 October 20X1:

Particulars Contract 1 Contract 2 Contract 3

Nature of Import of oil seeds Purchase of oil seeds Contract to sell oil
Contract from a foreign from a domestic seeds on the
supplier producer /
commodity exchange
supplier
100 MT at USD 50 MT at ` 30,000 50 MT at USD 450
Quantity 400 per MT to be per MT to be per MT, maturing as
and
rate delivered as delivered as on 31 on 15 January 20X2
January 20X2
on 31 March 20X2
Net settlement Yes Yes Yes
clause included
in the contract
Net settlement There have also been Yes – company Z has Yes – these contracts
in practice several instances of net settled some of are required to be
for similar the oil seeds being the domestic purchase net settled with the
contracts sold prior to or contracts. exchange on the
shortly after taking However, these maturity date.
delivery. instances constitute Company Z enters
These instances only 1 per cent of the into these types of
of net settlement total domestic purchase derivative contracts
c o n s t i t u t e contracts in value. to hedge the risks on
approximately 30 The remaining contracts its domestic oil seeds
per cent of the are settled by taking purchase contracts
value of total import delivery of oil seeds
contracts. which are used for
further processing.
Company Z is required to determine if the contracts entered into for purchase and sale of
oil seeds are derivatives within the scope of lnd AS 109 or are executory contracts outside
the scope of lnd AS 109.
 62 FINANCIAL REPORTING

QUESTION 119: Foreign currency embedded derivatives

Company A, an Indian company whose functional currency is `, enters into a contract to

purchase machinery from an unrelated local supplier, company B. The functional currency
of company B is also `. However, the contract is denominated in USD, since the machinery
is sourced by company B from a US based supplier. Payment is due to company B on delivery
of the machinery.
Key terms of the contract:

Contractual features Details

Contract/order date 9 September 20X1
Delivery/payment date 31 December 20X1
Purchase price USD 1,000,000
USD/` Forward rate on 9 September 20X1 for 31 December 20X1 67.8
maturity
USD/` Spot rate on 9 September 20X1 66.4
USD/` Forward rates for 31 December, on:
30 September 67.5
31 December (spot rate) 67.0

Company A is required to analyse if the contract for purchase of machinery (a capital asset)
from company B contains an embedded derivative and whether this should be separately ac-
counted for on the basis of the guidance in Ind AS 109. Also give necessary journal entries
for accounting the same.
 UNIT 6 : Reclassification & Impairment Of Financial Assets 63

UNIT 6: RECLASSIFICATION & IMPAIRMENT OF

FINANCIAL ASSETS

QUESTION 120 (AMORTISED COST TO FVOCI)

Bonds for ` 1,00,000 reclassified as FVOCI. Fair value on reclassification is ` 90,000. Pass
the required journal entry.
SOLUTION :

Particulars Amount Amount

Bonds at FVOCI Dr. 90,000
OCI (Loss on reclassification) Dr. 10,000
To Bonds at amortised cost 1,00,000

QUESTION 121 (FVTPL TO AMORTISED COST)

Bonds for ` 100,000 reclassified as Amortised cost. Fair value on reclassification is ` 90,000.
Pass the required journal entry.
SOLUTION :

Particulars Amount Amount

Bonds at Amortised cost Dr. 90,000
Loss on reclassification Dr. 10,000
To Bonds at FVTPL 1,00,000

QUESTION 122 (FVTPL TO FVOCI)

Bonds for ` 100,000 reclassified as FVOCI. Fair value on reclassification is ` 90,000. Pass
the required journal entry.
SOLUTION :

Particulars Amount Amount

Bonds at FVOCI Dr. 90,000
Loss on reclassification (OCI) Dr. 10,000
To Bonds at FVTPL 1,00,000
 64 FINANCIAL REPORTING

QUESTION 123 (FVOCI TO AMORTISED COST)

Bonds for ` 100,000 reclassified as Amortised cost. Fair value on reclassification is ` 90,000
and ` 10,000 loss was recognised in OCI till date of reclassification. Pass required journal
entry.
SOLUTION :

Particulars Amount Amount

Bonds at FVOCI Dr. 10,000
To OCI - Loss on reclassification 10,000
[Being loss recognized in OCI now reversed prior
to reclassification]
Bonds (Amortised cost) Dr. 100,000
To Bonds at FVOCI 100,000
[Being bonds reclassified from FVOCI to
Amortised cost]

QUESTION 124 (FVOCI TO FVPL)

Bonds reclassified as FVTPL. Fair value on reclassification is ` 90,000. Accumulated OCI till
date of reclassification is 10,000 Pass the required journal entry.
SOLUTION :

Particulars Amount Amount

P&L - Loss on reclassification Dr. 10,000
To OCI - Loss on reclassification 10,000
Bonds at FVTPL Dr. 90,000
To Bonds at FVOCI 90,000

QUESTION 125 Life time expected credit losses (provision matrix for short term
receivables)

Company M, a manufacturer, has a portfolio of trade receivables of CU30 million in 20X1

and operates only in one geographical region. The customer base consists of a large number
of small clients and the trade receivables are categorised by common risk characteristics
that are representative of the customers‛ abilities to pay all amounts due in accordance with
the contractual terms. The trade receivables do not have a significant financing component
in accordance with Ind AS 18. In accordance with paragraph 5.5.15 of Ind AS 109 the loss
allowance for such trade receivables is always measured at an amount equal to lifetime
expected credit losses.
Please use the following information of debtors outstanding:
 UNIT 6 : Reclassification & Impairment Of Financial Assets 65

Gross carrying amount

Current CU 15,000,000
1–30 days past due CU 7,500,000
31–60 days past due CU 4,000,000
61–90 days past due CU 2,500,000
More than 90 days past due CU 1,000,000
CU 30,000,000

Company M uses following default rates for making provisions:

Current 1–30 days 31–60 days 61–90 days More than 90 days
past due past due past due past due
Default rate 0.3% 1.6% 3.6% 6.6% 10.6%

Determine the expected credit losses for the portfolio

SOLUTION :
To determine the expected credit losses for the portfolio, Company M uses a provision
matrix. The provision matrix is based on its historical observed default rates over the
expected life of the trade receivables and is adjusted for forward-looking estimates. At
every reporting date the historical observed default rates are updated and changes in the
forward-looking estimates are analysed. In this case it is forecast that economic conditions
will deteriorate over the next year.
On that basis, Company M estimates the following provision matrix:

Current 1–30 days 31–60 days 61–90 days More than 90 days
past due past due past due past due
Default
rate 0.3% 1.6% 3.6% 6.6% 10.6%
 66 FINANCIAL REPORTING

The trade receivables from the large number of small customers amount to CU 30 million
and are measured using the provision matrix.

Gross carrying amount Lifetime expected credit

loss allowance (Gross
carrying amount x lifetime
expected credit loss
rate)
Current CU 15,000,000 CU 45,000
1–30 days past due CU 7,500,000 CU 120,000
31–60 days past due CU 4,000,000 CU 144,000
61–90 days past due CU 2,500,000 CU 165,000
More than 90 days past due CU 1,000,000 CU 106,000
CU 30,000,000 CU 580,000

QUESTION 126 (12 month expected credit loss – Probability of default approach)

Entity A originates a single 10 year amortising loan for CU1 million. Taking into consideration
the expectations for instruments with similar credit risk (using reasonable and supportable
information that is available without undue cost or effort), the credit risk of the borrower,
and the economic outlook for the next 12 months, Entity A estimates that the loan at initial
recognition has a probability of default (PoD) of 0.5 per cent over the next 12 months.
Entity A also determines that changes in the 12-month PoD are a reasonable approximation
of the changes in the lifetime PoD for determining whether there has been a significant
increase in credit risk since initial recognition. Loss given default (LGD) is estimated as 25%
of the balance outstanding. Calculate loss allowance.
SOLUTION :
At reporting date, no change in 12- month PoD and entity assesses that there is no significant
increase in credit risk since initial recognition – therefore lifetime ECL is not required to
be recognised.

Particulars Details
Loan ` 1,000,000 (A)
LGD 25% (B)
PoD – 12 months 0.5% (C)
Loss allowance (for 12-months ECL) ` 1,250 (A*B*C)
 UNIT 6 : Reclassification & Impairment Of Financial Assets 67

QUESTION 127: 12 month expected credit loss – Loss rate approach

Bank A originates 2,000 bullet loans with a total gross carrying amount of CU 500,000.
Bank A segments its portfolio into borrower groups (Groups X and Y) on the basis of shared
credit risk characteristics at initial recognition. Group X comprises 1,000 loans with a gross
carrying amount per client of CU 200, for a total gross carrying amount of CU 200,000.
Group Y comprises 1,000 loans with a gross carrying amount per client of CU 300, for a to-
tal gross carrying amount of CU 300,000. There are no transaction costs and the loan con-
tracts include no options (for example, prepayment or call options), premiums or discounts,
points paid, or other fees. Calculate loss rate when

Group Historic per annum average de- Present value of observed loss as-
faults sumed
X 4 CU 600
Y 2 CU 450

SOLUTION :
- Bank A measures expected credit losses on the basis of a loss rate approach for
Groups X and Y. In order to develop its loss rates, Bank A considers samples of its own
historical default and loss experience for those types of loans.
- In addition, Bank A considers forward-looking information, and updates its historical
information for current economic conditions as well as reasonable and supportable
forecasts of future economic conditions. Historically, for a population of 1,000 loans
in each group, Group X‛s loss rates are 0.3 per cent, based on four defaults, and
historical loss rates for Group Y are 0.15 per cent, based on two defaults.

Number Estimated Total esti- Historic Estimated Present L o s s

of cli- per client mated per an- total gross value of rate
ents in gross car- gross car- num av- carrying observed
sample r y i n g r y i n g e r a g e loss as-
amount at
amount at amount at defaults sumed
default
default default
Group A B C=A×B D E=B×D F G = F
÷C
X 1,000 CU 200 C U 4 CU 800 CU 600 0.3%
2,00,000
Y 1,000 CU 300 C U 2 CU 600 CU 450 0.15%
3,00,000
68 FINANCIAL REPORTING
 UNIT 7 : Hedge Accounting 69

UNIT 7: HEDGE ACCOUNTING

QUESTION 128

On 1 January 20X1 , Company D issuers a three-year 5.5% fixed rate bond USD 15 million
at par. D‛s functional currency is sterling. As part of its risk management policy, D decides
to eliminate the exposure arising from movements in the US dollar/GBP exchange rates on
the principal amount of the bond for three year G enters into a foreign currency forward
contract to buy USD 15 million and sell GBP 9,835,389 at December 20X3.
D designates and documents the forward contract as the hedging instrument in a cash flow
hedge of the variability in cash flows arising from the repayment of the principal amount of
the bond due to movement s in forward US dollar/sterling exchange rates.
D states in its hedge documentation that it will use the hypothetical derivative method to
assess hedge effectiveness. G identifies the hypothetical derivative as a forward contract
under which it sells USD 15 million and purchases GBP 9,835,389 At 31 December 20X3
(the repayment date of the bond). The hypothetical foreign currency forward contract has
a fair value of zero at 1 January 20X1. The sport and the forward exchange rates and the
fair value of the foreign currency forward contract are as follows:

Date Spot rate FWD rate FV OF FWD

forward points
1-Jan 20X1 0.6213 0.6557 - 0.0344 USD 15,000,000
31-Dec- 0.5585 0.5858 (957,205) 0.0273 Forward 516,000
20X1 points
31-Dec- 0.5209 0.528 (1,833,346) 0.0071
20X2
30-Dec- 0.5825 0.5825 (1,097,789)
20X3
 70 FINANCIAL REPORTING

QUESTION 129

The company has taken an external commercial borrowing of $1 million. The term of the loan
is 3 yea` The Company also bought a foreign currency swap to hedge the foreign currency
risk The Company paid premium of ` 1 million to purchase the swap with exercise INR/USD
price of 53. Other details are given below:

Date Spot Forward End of Spot Forward End of Sport Forward

Q1
Of Loan Price rate Price Rate Q2 Price rate
USD 31-Dec- 50 53 31- 52 56z 30- 55 60
to 20x1 Mar Jun-
INR 20X2 20X2
rate
MTM values of derivative contract
31-Dec-20x1 10,00,000
31-Mar -20X2 25,
25,00,000
30-Jun-20X2 65,00,000

Record journal entries if Company was to don hedge accounting and if the Company did not
opt for hedge accounting. Assume hedge is effective for this purpose.
 UNIT 8 : Derecognition Of Financial Liabilities 71

UNIT 8: DERECOGNITION OF FINANCIAL

LIABILITIES
QUESTION 130

On 1 January 20X0, XYZ Ltd. issues 10 year bonds for ` 10,00,000, bearing interest at 10%
(payable annually on 31st December each year). The bonds are redeemable on 31 December
20X9 for ` 10,00,000. No costs or fees are incurred. The effective interest rate is
therefore 10%. On 1 January 20X5 (i.e. after 5 years) XYZ Ltd. and the bondholders agree
to a modification in accordance with which:
• the term is extended to 31 December 2011;
• Interest payments are reduced to 5% p.a.;
• the bonds are redeemable on 31 December 20Y1 for ` 15,00,000; and
• legal and other fees of ` 1,00,000 are incurred.
XYZ Ltd. determines that the market interest rate on 1 January 20X5 for borrowings on
similar terms is 11%.

QUESTION 131

On 1 January 20X0, XYZ Ltd. issues 10 year bonds for ` 1,000,000, bearing interest at 10%
(payable annually on 31st December each year). The bonds are redeemable on 31 December
20X9 for ` 1,000,000. No costs or fees are incurred. The effective interest rate is
therefore 10%. On 1 January 20X5 (i.e. after 5 years) XYZ Ltd. and the bondholders agree
to a modification in accordance with which:
no further interest payments are made
the bonds are redeemed on the original due date (31 December 20X9) for ` 1,600,000;
LEGAL fees will be 50,000 on the date of modification
NEW IRR 10.99%

QUESTION 132

JK Ltd. has an outstanding unsecured loan of ` 90 crores to a bank. The effective interest
rate (EIR) of this loan is 10%. Owing to financial difficulties, JK Ltd. is unable to service the
debt and approaches the bank for a settlement.
The bank offers the following terms which are accepted by JK Ltd.:
2/3rd of the debt is unsustainable and hence will be converted into 70% equity interest in
JK Ltd. The fair value of net assets of JK Ltd. is ` 80 crores.
1/3rd of the debt is sustainable and the bank agrees to certain moratorium period and
decrease in interest rate in initial periods. The present value of cash flows as per these
 72 FINANCIAL REPORTING

revised terms calculated using original EIR is ` 25 crores. The fair value of the cash flows
as per these revised terms is ` 28 crores.

QUESTION 133

Wheel Co. Limited borrowed ` 500,000,000 from a bank on 1 January 20X1. The original
terms of the loan were as follows:
• Interest rate: 11%
• Repayment of principal in 5 equal instalments
• Payment of interest annually on accrual basis
• Upfront processing fee: ` 5,870,096
• Effective interest rate on loan: 11.50%
On 31 December 20X2, Wheel Co. Limited approached the bank citing liquidity issues in
meeting the cash flows required for immediate instalments and re-negotiated the terms of
the loan with banks as follows:
• Interest rate 15%
• Repayment of outstanding principal in 10 equal instalments starting 31 December 20X3
• Payment of interest on an annual basis
Record journal entries in the books of Wheel Co. Limited on 31 December 20X

QUESTION 134: Part of a financial asset

State whether the derecognition principles will be applied or not.

i. Interest strip of an interest-bearing financial asset i.e. the part entitles its holder to
interest cash flows of a financial asset
ii. Dividend strip of an equity share i.e. the part entitles its holder to only dividends
arising from an equity share
iii. Cash flows (principal and asset) upto a certain tenure or first right on a proportion of
cash flows of an amortising financial asset. Say, the part entitles its holder to first
80% of the cash flows or cash flows for first 4 of the 6 years‛ tenure.

QUESTION 135: Part of a financial asset

State whether the derecognition principles will be applied or not.

i. Entity Y transfers the rights to the first or the last 90 per cent of cash collections
from a financial asset (or a group of financial assets)
ii. Entity Z transfers the rights to 90 per cent of the cash flows from a group of
receivables, but provides a guarantee to compensate the buyer for any credit losses
up to 8 per cent of the principal amount of the receivables.
 UNIT 9: Derecognition Of Financial Assets 73

UNIT 9: DERECOGNITION OF FINANCIAL ASSETS

QUESTION 136 : Proportionate “pass through” arrangement

Entity A makes a five-year interest-bearing loan (the ‘original asset‛) of ` 100 crores to
Entity B. Entity A settles a Trust and transfers the loan to that Trust. The Trust issues
participatory notes to an investor, Entity C, that entitle the investor to the cash flows from
the asset.
As per Trust‛s agreement with Entity C, in exchange for a cash payment of ` 90 crores,
Trust will pass to Entity C 90% of all principal and interest payments collected from Entity
B (as, when and if collected). Trust accepts no obligation to make any payments to Entity
C other than 90% of exactly what has been received from Entity B. Trust provides no
guarantee to Entity C about the performance of the loan and has no rights to retain 90% of
the cash collected from Entity B nor any obligation to pay cash to Entity C if cash has not
been received from Entity B.
Compute the amount to be dercognised.
SOLUTION :
If the three conditions are met, the proportion sold is derecognised, provided the entity
has transferred substantially all the risks and rewards of ownership. Thus, Entity A would
report a loan asset of ` 10 crores and derecognise ` 90 crores.

QUESTION 137

Entity X (the transferor) holds a portfolio of receivables with a carrying value of `1,00,000.
It enters into a factoring arrangement with entity Y (the transferee) under which it
transfers the portfolio to entity Y in exchange for ` 90,000 of cash.
Entity Y will service the loans after their transfer and debtors will pay amounts due directly
to entity Y. Entity X has no obligations whatsoever to repay any sums received from the
factor and has no rights to any additional sums regardless of the timing or the level of
collection from the underlying debts. Evaluate.
SOLUTION :
Entity X derecognizes the entire portfolio. The difference between the carrying value
of `1,00,000 and cash received of `90,000 (i.e. `10,000 is recognised immediately as
a financing cost in profit or loss.

QUESTION 138

ST limited assigns its trade receivables to AT limited. The carrying amount of the receivables
is 10,00,000. The consideration received in exchange of this arrangement is 9,00,000.
Customers have been instructed to deposit the amounts directly in to a bank account of AT
 74 FINANCIAL REPORTING

limited. AT limited has no recourse to ST limited in case of any shortfalls in collections.

State whether the derecognition principles will be applied or not.
SOLUTION :
ST limited will derecognize the financial asset and recognizes 1,00,000 the difference
between consideration and carrying amount as an expense in the statement of profit and
loss account.

QUESTION 139: Repurchase agreements

A financial asset is sold under repurchase agreement. The repurchase price as per that
agreement is (a) fixed price or (b) sale price plus a lender‛s return. Let‛s look at three
alternate scenarios:
i. Repurchase agreement is for the same financial asset.
ii. Repurchase agreement is for substantially the same asset
iii. Repurchase agreement provides the transferee a right to substitute asset that are
similar and of equal fair value to the transferred asset at the repurchase date.
State whether the derecognition principles will applied or not
SOLUTION :
In each of these scenarios, the transferred financial asset is not derecognised because the
transferor retains substantially all the risks and rewards of ownership.

QUESTION 140 : Put options on transferred financial assets

A financial asset is sold and the transferee has a put option Let‛s look at some alternate
scenarios:
Put option is deeply in the money
Put option is deeply out of the money.
State whether the derecognition principles will be applied or not.
SOLUTION :
In the first scenario, the transferred asset does not qualify for derecognition because the
transferor has retained substantially all the risk and rewards of ownership. However, in the
second scenario, the transferor has transferred substantially all the risks and rewards of
ownership.
 UNIT 9: Derecognition Of Financial Assets 75

QUESTION 141 : Call options on transferred financial assets

A financial asset is sold and the transferor has a call option. Let‛s look at some alternate
scenarios:
i. Call option is deeply in the money
ii. Call option is deeply out of the money.
What is the transferor holds a call option on an asset that is readily obtainable in the market?
i. Call option is neither deeply in the money nor deeply out of the money
State whether the derecognition principles will be applied or not.
SOLUTION :
In the first scenario, the transferred asset does not qualify for derecognition because the
transferor has retained substantially all the risks and rewards of ownership. However in
the second scenario, the transferor has transferred substantially all the risk and rewards
of ownership.
In the third scenario, the asset is derecognised. This is because the entity (i) has neither
retained not transferred substantially all the risk and rewards of ownership, and (ii) has
not retained control.

QUESTION 142 : Debt factoring with recourse – continuing involvement asset

Entity C agrees with factoring company D to enter into a debt factoring arrangement.
Under the terms of the arrangement, the factoring company B agrees to pay ` 91.5 crores,
less a servicing charge of ` 1.5 crores (net proceeds of ` 90 crores), in exchange for
100% of the dash flows from short-terms receivables.
The receivables have a face value of ` 100 crores and carrying amount of ` 95 crores.
The customers will be instructed to pay the amounts owed into a bank account of the
factoring company, Entity C also writes a guarantee to the factoring company under which
it will reimburse any credit losses upto ` 5 crores, over and above the expected credit
losses of ` 5 crores and losses of up to ` 15 crores are considered reasonably possible.
The guarantee is estimated to have a fair value of ` 0.5 crores. Comment.

QUESTION 143: Debt factoring with recourse – associated liability

Continuing illustration 12A, the associated liability is recognised at ` 5.5 crores, as below:
the guarantee amount (i.e. ` 5 Crores) plus
the fair value of the guarantee (i.e. ` 0.5 crores). Comment

QUESTION 144: Debt factoring with recourse – gain or loss on derecognition

Pass the necessary Journal Entry

76 FINANCIAL REPORTING
 PAST EXAMINATION QUESTIONS 77

PAST EXAMINATION QUETSIONS

QUESTION 145

S Limited issued redeemable preference shares to its Holding Company – H Limited. The
terms of the instrument have been summarized below. Analyse the given situation, applying
the guidance in Ind AS 109 ‘Financial Instrument‛, and account for this in the books of H
Limited.

Nature Non- cumulative redeemable preference shares

Repayment Redeemable after 3 years
Date of Allotment 1st April 2015
Date of Repayment 31st March 2018
Total period 3 Years
Value of Preference Shares issued 5,00,00,000
Dividend Rate 0.0001% Per Annum
Market rate of interest 12% Per Annum
Present value factor 0.7118

(CA-FINAL MAY 2018 EXAMS)

SOLUTION :
1. Analysis of the financial instrument issued by S Ltd. to its holding company H Ltd.
Applying the guidance in Ind AS 109, a ‘financial asset‛ shall be recorded at its fair
value upon initial recognition. Fair value is normally the transaction price. However,
sometimes certain type of instruments may be exchanged at off market terms (ie,
different from market terms for a similar instrument if exchanged between market
participants).
For example, a long-term loan or receivable that carries no interest while similar
instruments if exchanged between market participants carry interest, then fair value
for such loan receivable will be lower from its transaction price owing to the loss of
interest that the holder bears. In such cases where part of the consideration given or
received is for something other than financial instrument, an entity shall measure the
fair value or the financial instrument.
In the above case, since S Ltd has issued preference shares to its Holding Company- H
Ltd, the relationship between the parties indicates that the difference in transaction
price and fair value is akin to investment make by H Ltd. in its subsidiary. This can
further be substantiated by the nominal rate of dividend i.e. 0.000 1% mentioned in
the terms of the instrument issued.
 78 FINANCIAL REPORTING

COMPUTATIONS ON INITIAL RECOGNITION

`

Transaction value of the Redeemable preference shares 5,00,00,000

Less: Present value of loan component @ 12% (5,00,00,000 x.7118) (3,55,90,000)
Investment in subsidiary 1,44,10,000

Subsequently, such preference shares shall be carried at amortised cost at each

reporting date as follows:

Year Date Opening Balance Interest @12% Closing balance

1st April, 2015 3,55,90,000 - 3,55,90,000
1 31st March, 2016 3,55,90,000 42,70,800 3,98,60,800
2 31st March , 2017 3,98,60,800 47,83,296 4,46,44,096
3 31st March, 2018 4,46,44,096 53,55,904* 5,00,00,000

` 4,46,44,096 x 12% = ` 53, 57,292 The difference of ` 1,388 (` 53,57,292 –

`
53,55,904) is due to approximation in present value factor.
2. IN THE BOOKS OF H LTD.
JOURNAL ENTRIES TO BE DONE AT EVERY REPORTING DATE
Date Particulars Amount Amount
1st April Investment (Equity portion) Dr. 1,44,10,000
2015 Redeemable Preference Shares Dr. 3,55,90,000
To Bank 5,00,00,000
(Being initial recognition of transaction
recorded
31st March, Redeemable Preference Shares Dr. 42,70,800
2016
To Interest income 42,70,800
(Being interest income on loan component
recognized)
31st March Redeemable Preference Shares Dr. 47,83,296
2017
To Interest income 47,83,296
(Being interest income on loan component
recognized)
 PAST EXAMINATION QUESTIONS 79

31st March, Redeemable Preference Shares Dr. 53,55,904

2018
To Interest income 53,55,904
(Being interest income on loan component
recognized)
31st March, Bank Dr. 5,00,00,000
2018
To Redeemable Preference Shares 5,00,00,000
(Being settlement of transaction done
at the end of the third year)

QUESTION 146

On 1st January 2017, Expo Limited agreed to purchase USD ($) 40, 000 from E & I Bank
in future on 31st December 2017 for a rate equal to ` 65 per USD. Expo Limited did no pay
any amount upon entering into the contract. Expo Limited is a listed company in India and
prepares its financial statements on a quarterly basis.
Using the definition of derivative included in Ind AS 109 and following the principles of
recognition and measurement as laid down in Ind AS 109, you are required to record the
entries for each quarter ended till the date of actual purchases of USD.
For the purpose of accounting, use the following information representing market to market
fair value of forward contracts at each reporting date:
As at 31st March, 2017 ` (50,000)
As at 30th June, 2017 ` (30,000)
As at 30thSeptember, 2017 ` 24,000
Spot rate of USD on 31st December, 2017 ` 62 per USD

(CA-FINAL MAY 2018 EXAMS)

SOLUTION :
Assessment of the arrangement using the definition of derivative included under Ind
AS 109.
Derivative is a financial instrument or other contract within the scope of this Standard
with all three of the following Characteristics:
a) Its value changes in response to the change in foreign exchange rate (emphasis laid)
b) It requires no initial net investment or an initial net investment in smaller than would
be required for other types of contracts with similar response to changes in market
factors.
c) It is settled at a future date.
 80 FINANCIAL REPORTING

a) Upon evaluation of contract in question, on the basis of the definition of derivative, it

is noted that the contract meets the definition of a derivative as follows:
b) The value of the contract to purchase USD at a fixed price changes in response to
changes in foreign exchange rate.
c) The initial amount paid to enter into contract is zero. A contract which would give the
holder a similar response to foreign exchange rate changes would have required an
investment of USD 40,000 on inception.
d) The contract is settled in future
The derivative is forward exchange contract.
As per Ind AS 109, Derivatives are measured at fair value upon initial recognition and are
subsequently measured at fair value through profit and loss.
ACCOUNTING IN EACH QUARTER
(i) Accounting on 1st January 2017
As there was no consideration paid and without evidence to the contrary the fair value
of the contract on the date of inception is considered to be zero. Accordingly, no
accounting entries shall be recorded on the date of entering into the contract.
(i) Accounting on 31st March 2017

Particulars Dr. (`) Cr. (`)

Profit and loss A/c Dr. 50,000
To derivative financial liability 50,000
(Being mark to market loss on forward contract recorded)

(iii) Accounting on 30th June 2017

Particulars Dr. (`) Cr. (`)

Derivative financial liability A/c Dr. 20,000
To Profit and Loss A/c 20,000
(Being partial reversal of mark to market loss on forward
contract recorded)

(iv) Accounting on 30th September 2017

Particulars Dr. (`) Cr. (`)

 PAST EXAMINATION QUESTIONS 81

Derivative financial liability A/c Dr. 30,000

Derivative financial asset A/c Dr. 24,000
To Profit and Loss A/c 54,000
(Being gain on mark to market of forward contract booked
as derivative financial asset and reversal of derivative
financial liability)

(v) Accounting on 31st December 2017

The settlement of the derivative forward contract by actual purchase of USD 40,000

Particulars Dr. (`) Cr. (`)

Cash (USD) Account) USD 40,000x ` 62) Dr. 24,80,000
Profit and loss A/c Dr. 1,44,000
To Cash (USD 40,000 x ` 65) 26,00,000
To Derivative financial asset A/c 24,000
(Being loss on settlement of forward contract booked on
actual purchase of USD)

QUESTION 147

NAV Limited granted a loan of ` 120 lakh to Old limited for 5 years @ 10% p.a. which is
Treasury bond yield of equivalent maturity. But the incremental borrowing rate of OLD
Limited is 12% In this case, the loan is granted to OLD Limited a below market rate of
interest Ind AS 109 requires that a financial asset of financial liability to be measured at
fair value at the initial recognition. Should the transaction price be treated as fair value?
If not, find out the fair value. What is the accounting treatment of the difference between
the transaction price and the fair value on initial recognition, in book of NAV Ltd.
Present value factors at 12%

Year 1 2 3 4 5
PVR 0.892 0.797 0.712 0.636 0.567

(CA-FINAL NOV. 2018 EXAMS)

SOLUTION :
Since the loan is granted to OLD Ltd at 10% i.e below market rate of 12% It will be
considered as loan given at off market terms. Hence the fair value of the transaction will
be lower from its transaction price & not the transaction price
Calculation of fair value
 82 FINANCIAL REPORTING

Year Future cash flow Discounting factor Present value (in lakh)
(in lakh) @12%

1 12 0.892 10.704
2 12 0.797 9.564
3 12 0.712 8.544
4 12 0.636 7.632
5 120 + 12 = 132 0.567 74.844
111.288

The Fair value of the transaction be ` 111. 288 Lakh.

Since fair value is based on level 1 input or valuation technique that uses only date from
observable markets, difference between fair value and transaction price will be recognized
in Profit and Loss as fair value loss i.e. ` 120 lakh – ` 111.288 lakh = ` 8.712 lakh
Note: One many also calculate the above fair value by the way of annuity on interest amount
rather than separate calculation.

QUESTION 148

Veer Limited issued convertible bonds of ` 75,00,000 on 1st April, 2018. The bonds have a
life of five years and a face value of ` 20 each, and they offer interest payable at the end
of each financial year at a rate of 4.5 per cent annum. The bonds are issued at their face
value and each bond can be converted into one ordinary share in Veer Ltd at any time in the
next five years. Companies of a similar risk profile have recently issued debt at 6 percent
per annum with similar terms but without the option of conversion.
You are required to:
(i) Provide the appropriate accounting entries for initial recognition as per the relevant
Ind AS in the books of the company.
(ii) Calculate the stream of interest expenses across the five years of the life of the
bonds,
(iii) Provide the accounting entries if the holders of the bonds elect to convert the bonds
to ordinary shares at the end of the fourth year.
(CA-FINAL NOV. 2018 EXAMS)
SOLUTION :
Present value of bonds at the market rate of debt
Present value of principal to be received in 5 years discounted at 6%
(75,00,000 x 0.747) = 56,02,500
 PAST EXAMINATION QUESTIONS 83

Present value of interest stream discounted at 6% for 5 Year

(3,37,500 x 4.212) = 14,21,550
Total present value = 70,24,050
Equity component = 4,75,950
Total face value of convertible bonds = 75,00,000
(i) Journal Entries
Dr. Cr.
Amount Amount (`)
(`)
1st April, 2018
Cash Dr. 75,00,000
To Convertible bonds (liability) 70,24,050
To Convertible bonds (equity component) 4,75,950
(Being entity to record the convertible bonds and the
recognition of the liability and equity components)
31st March, 2019
Interest expense Dr. 4,21,443
To Cash 3,37,500
To Convertible bonds (liability) 83,943
(Being entity to record the interest expense)

(ii) The stream of interest expense in summarised below, where interest for a given year
is calculated by multiplying the present value of the liability at the beginning of the
period by the market rate of interest, this is being 6 per cent.

Date Payment Interest Increase Total bond liability

expense at in bond (e of previous year
6% (e of liability + d)
previous year (c-b)
x 6%)
(a) (b) (c) (d) (e)
1st April, 2018 70,24,050
31st March, 2019 3,37,500 4,21,443 83,943 71,07,993
31st March, 2020 3,37,500 4,26,480 88,980 71,96,973
31st March, 2021 3,37,500 4,31,818 94,318 72,91,291
 84 FINANCIAL REPORTING

31st March,2022 3,37,500 4,37,477 99,977 73,91,268

31st March, 2023 3,37,500 4,46,232 1,08,732 75,00,000

Difference is due to rounding off.

If the holders of the bond elect to convert the bonds to ordinary shares at the end
of the fourth year (after receiving their interest payments), the entries in the fourth
year would be;

Dr. (`) Cr. (`)

31st March ,2022
Interest expense A/c Dr. 4,37,477
To Cash A/c 3,37,500
To Convertible bonds (liability) A/c 99,977
(Being entity to record interest expense for the period)
31st March, 2022
Convertible bonds (liability) A/c Dr. 73,91,268
Convertible bonds (equity component) A/c Dr. 4,75,950
To Ordinary share capital A/c 78,67,218
(Being entry to record the conversion of bonds into
ordinary shares of Veer Limited).

QUESTION 149

Perfect Ltd. issued 50,000 Compulsory Cumulative Convertible preference Shares (CCCPS)
as on 1st April, 2017 @ `180 each. The rate of dividend is 10% payable at the end of every
year. The preference Shares are convertible into 12,500 equity shares (Face value ` 10
each) of the company at the end of 5th year from the date of allotment. When the CCCPS
are issued, the prevailing market interest rate for similar debt without conversion option
is 15% per annum.
Transaction cost on the date of issuance is 2% of the value of the proceeds. Effective
interest rate is 15.86% (Round off the figures to the nearest multiple of Rupee)
Discounting Factor @ 15%

Year 1 2 3 4 5
Discount Factor 0.8696 0.7561 0.6575 0.5718 0.4971

You are required to compute Liability and Equity Component and Pass Journal Entries for
entire term of arrangement i.e. from the issue of Preference Shares till their conversion
 PAST EXAMINATION QUESTIONS 85

into Equity Shares. Keeping in view the provisions of relevant Ind AS.
(CA-FINAL MAY 2019 EXAMS)
SOLUTION :
This is a compound financial instrument with two components- liability representing present
value of future cash outflows and balance represents equity component.
Total proceeds = 50,000 Shares x ` 180 each =`
90,00,000 Dividend @ 10% = ` 9,00,000
a. Computation of Liability & Equity Component
Date Particulars Cash Flow Discount Net present
Factor
Value
01-Apr-2017 0 1 0.00
31-Mar-2018 Dividend 9,00,000 0.8696 7,82,640
31-Mar-2019 Dividend 9,00,000 0.7561 6,80,490
31-Mar-2020 Dividend 9,00,000 0.6575 5,91,750
31-Mar-2021 Dividend 9,00,000 0.5718 5,14,620
31-Mar-2022 Dividend 9,00,000 0.4971 4,47,390
Total Liability Component 30,16,890
Total Proceeds 90,00,000
Total Equity Component
(Bal fig) 59,83,110

b. Allocation of transaction costs

Particulars Amount Allocation Net Amount

a b a-b
Liability Component 30,16,890 60,338 29,56,552
Equity Component 59,83,110 1,19,662 58,63,448
Total Proceeds 90,00,000 1,80,000 88,20,000

a. Accounting for liability at amortised cost

- Initial accounting = Present value of cash outflows less transaction costs
- Subsequent accounting = At amortised cost, ie initial fair value adjusted for
interest and repayments of the liability.
 86 FINANCIAL REPORTING

Interest @ Closing
Opening Cash Flow
15.86% Financial
Financial (Dividend
B Liability
Liability A payment) C
A+B-C
01-Apr-2017 29,56,552 29,56,552
31-Mar-2018 29,56,552 4,68,909 9,00,000 25,25,461
31-Mar-2019 25,25,461 4,00,538 9,00,000 20,25,999
31-Mar-2020 20,25,999 3,21,323 9,00,000 14,47,322
31-Mar-2021 14,47,322 2,29,545 9,00,000 7,76,867
31-Mar-2022 7,76,867 1,23,133* 9,00,000 -

- Difference of ` 78 (adjusted in the interest value of 31st March, 2022) is due to

approximation of figures in the earlier years.
d. Journal Entries to be recorded for entire term of arrangement are as follows:

Date Particulars Debit ` Credit `

01-Apr- Bank A/c Dr. 88,20,000
2017 To Preference Shares A/c 29,56,552
To Equity Component of Preference 58,63,448
shares A/c
(Being compulsorily convertible preference
shares issued. The same are divided into
equity component and liability component
as per the calculation)
31- Mar- Preference shares A/c Dr 9,00,000
2018 To Bank A/c 9,00,000
(Being dividend at the coupon rate of
10% paid to the shareholders)
31- Mar- Finance cost A/c Dr 4,68,909
2018 To Preference Shares A/c 4,68,909
(Being interest as per EIR method
recorded)
PAST EXAMINATION QUESTIONS 87

31- Mar- Preference shares A/c Dr. 9,00,000

2019 To Bank A/c 9,00,000
(Being dividend at the coupon rate of
10% paid to the shareholders)
31- Mar- Finance cost A/c DR. 4,00,538
2019 To Preference Shares A/c 4,00,538
(Being interest as per EIR method
recorded)
31- Mar- Preference shares A/c Dr. 9,00,000
2020 To Bank A/c 9,00,000
(Being dividend at the coupon rate of
10% paid to the shareholders)
31- Mar- Finance cost A/c Dr. 3,21,323
2020 To Preference Shares A/c 3,21,323
(Being interest as per EIR method
recorded)
31- Mar- Preference shares A/c Dr. 9,00,000
2021 To Bank A/c 9,00,000
(Being dividend at the coupon rate of
10% paid to the shareholders)
31- Mar- Finance cost A/c Dr. 2,29,545
2021 To Preference Shares A/c 2,29,545
(Being interest as per EIR method
recorded)
31- Mar- Preference shares A/c Dr. 9,00,000
2022 To Bank A/c 9,00,000
(Being dividend at the coupon rate of
10% paid to the shareholders)
31- Mar- Finance cost A/c Dr. 1,23,133
2022 To Preference Shares A/c 1,23,133
(Being interest as per EIR method
recorded)
 88 FINANCIAL REPORTING

31- Mar- Equity Component of Preference shares

2022 A/c Dr. 58,63,448
To Equity Share Capital A/c 1,25,000
To Securities Premium A/c 57,38,448
(Being preference shares converted
in equity shares and remaining equity
component is recognised as securities
premium)

QUESTION 150

Vedika Ltd. issued 80,000 8% convertible debentures of ` 100 each on 1st April, 2015. The
debentures are due for redemption on 31st March, 2019 at a premium of 20%, convertible
into equity shares to the extent of 50% and balance to be settled in cash to the debenture
holders. The interest rate on equivalent debentures without conversion right was 12%.
The conversion to equity qualifies as fixed for fixed.
You are required to separate the debt and equity components at the time of issue and
show the accounting entries in Vedika Ltd.‛s books at initial recognition only. The following
present values of Rupee 1 at 8% and 12% are provided for a period of 5 years.

Interest rate Year 1 Year 2 Year 3 Year 4 Years 5

8% 0.923 0.853 0.789 0.731 0.677
12% 0.887 0.788 0.701 0.625 0.557

(CA-FINAL NOV. 2019 EXAMS)

SOLUTION :
Computation of debt component of convertible debentures on 1st April, 2015

Particulars Amount (`)

Present value of principal amount repayable after 4 years
(A) 80,00,000 x 50% x 120% x 0.625 (12% discount factor) 30,00,000
(B) Present value of interest [8,00,000 x 80% x 3.001] (4 years 19,20,640
cumulative 10% discount factor)

Total present value of debt component (A) + (B) 49,20,640

Issue proceeds from convertible debentures 80,00,000
Value of equity component 30,79,360
 PAST EXAMINATION QUESTIONS 89

Journal entry at initial recognition

Particulars Dr. Amount Cr. Amount

(`) (`)
Bank A/c Dr. 80,00,000
To 8% Debentures A/c (liability component) 49,20,640
To 8% Debentures A/c (equity component) 30,79,360
(Being disbursement recorded at fair value)

Note: The question has been solved on the basis of the discounting factors given in the
question.

QUESTION 151

Make necessary journal entries for accounting of the security deposit made by Admire
Ltd., whose details are described below. Assume market interest rate for a deposit for
similar period to be 12% per annum.

Particulars Details
Date of Security Deposit (Starting Date) 1st April, 2014
Date of Security Deposit (Finishing Date) 31st March, 2019
Description Lease
Total Lease Period 5 years
Discount rate 12%
Security deposit (A) 20,00,000
Present value factor at the 5th year 0.567427

(CA-FINAL NOV. 2019 EXAMS)

SOLUTION :
The above security deposit is an interest free deposit redeemable at the end of lease
term for ` 20,00,000. Hence, this involves collection of contractual cash flows and shall be
accounted at amortised cost.
Upon initial measurement

Particulars Details
Security deposit (A) 20,00,000
Total lease period (Years) 5
Discount rate 12.00%
 90 FINANCIAL REPORTING

Present value annuity factor 0.567427

Present value of deposit at beginning (B) 11,34,854
Prepaid lease payment at beginning (A-B) 8,65,146

Journal entry at initial recognition

Particulars Amount Amount

Security deposit A/c Dr. 11,34,854
Prepaid lease expenses A/c Dr. 8,65,146
To Bank A/c 20,00,000

Subsequently, every annual reporting year, interest income shall be accrued @ 12% per
annum and prepaid expenses shall be amortised on straight line basis over the lease term.
Following table shows the amortisation of security deposit based on discount rate:

Year Opening balance Interest @ 12% Closing balance

(A) (B) (A) = (A) + (B)
1 11,34,854 1,36,183 12,71,037
2 12,71,037 1,52,524 14,23,561
3 14,23,561 1,70,827 15,94,388
4 15,94,388 1,91,327 17,85,715
5 17,85,315 2,14,685* 20,00,000

*Difference is due to approximation.

Journal entries for Year 1-5 For – Year 1

Particulars Amount Amount

Security deposit A/c Dr. 1,36,183
To Interest income 1,36,183
Lease expense (8,65,146 / 5 years) Dr. 1,73,029
To Prepaid lease expenses 1,73,029

For – Year 2

Particulars Amount Amount

 PAST EXAMINATION QUESTIONS 91

Security deposit A/c Dr. 1,52,524

To Interest income 1,52,524
Lease expense (8,65,146 / 5 years) Dr. 1,73,029
To Prepaid lease expenses 1,73,029

For – Year 3

Particulars Amount Amount

Security deposit A/c Dr. 1,70,827
To Interest income 1,70,827
Lease expense (8,65,146 / 5 years) Dr. 1,73,029
To Prepaid lease expenses 1,73,029

For – Year 4

Particulars Amount Amount

Security deposit A/c Dr. 1,91,327
To Interest income 1,91,327
Lease expense (8,65,146 / 5 years) Dr. 1,73,029
To Prepaid lease expenses 1,73,029

For – Year 5

Particulars Amount Amount

Security deposit A/c Dr. 2,14,685
To Interest income 2,14,685
Lease expense (8,65,146 / 5 years) Dr. 1,73,030
To Prepaid lease expenses 1,73,030

Journal entry for realisation of security deposit at the end of 5th year

Particulars Amount Amount

Bank A/c Dr. 20,00,000
20,00,000
 92 FINANCIAL REPORTING

QUESTION 152

X Ltd. issues ` 1.5 crore convertible bonds on 1st April, 2018. The bonds have a life of 8
years and a face value of ` 10 each and offer interest @ 5.5% p.a. payable at the end of
each financial year.
Bonds are issued at their face value and each bond can be converted into one ordinary share
of X Ltd. at any time in the next eight years.
Companies of a similar risk profile have recently issued debt with similar terms, without the
option for conversion, at a rate of 7% p.a.
You are required to:
(i) Provide the journal entries from financial year 2018-2019 to financial year 2021-2022;
(ii) Calculate the interest expenses across all eight years of the life of the convertible
bonds;
(iii) Give the accounting entries if the holders of the bonds elect to convert the bonds to
ordinary shares at the end of the fourth year (after receiving interest for the fourth
year).
(14 Marks)
(CA FINAL JULY 2021 EXAM)
SOLUTION :
(i) Journal Entries
Dr. (`) Cr. (`)
1st April, 2018
Bank A/c Dr. 1,50,00,000
To Convertible bonds A/c (liability) (Refer W.N.) 1,36,56,075
To Convertible bonds A/c (equity) (Refer W.N.) 13,43,925
(Being recognition of convertible bonds at the date
of issuance into liability and equity components)
31st March, 2019
Interest expense A/c Dr. 9,55,925
To Bank A/c 8,25,000
To Convertible bonds A/c (liability) 1,30,925
(Being interest expense recorded at market rate of
7% and actual interest paid @ 5.5%)
31st March, 2020
 PAST EXAMINATION QUESTIONS 93

Interest expense A/c Dr. 9,65,090

To Bank A/c 8,25,000
To Convertible bonds A/c (liability) 1,40,090
(Being interest expense recorded at market rate of
7% and actual interest paid @ 5.5%)
31st March, 2021
Interest expense A/c Dr. 9,74,896
To Bank A/c 8,25,000
To Convertible bonds A/c (liability) 1,49,896
(Being interest expense recorded at market rate of
7% and actual interest paid @ 5.5%)
31st March, 2022
Interest expense A/c Dr. 9,85,389
To Bank A/c 8,25,000
To Convertible bonds A/c (liability) 1,60,389
(Being interest expense recorded at market rate of
7% and actual interest paid @ 5.5%)

(ii) Table showing computation of interest expense at market rate and actual interest
outflow @ 5.5%

Year Date Opening Actual Interest Increase Closing

bond liability interest expense in liability bond liability
outflow @ @ 7%
5.5%
a b =1.5 cr c = a x 7% d = c-b e = a+d
x 5.5%
0 1st April, 2018 1,36,56,075
1 31st March, 2019 1,36,56,075 8,25,000 9,55,925 1,30,925 1,37,87,000
2 31st March, 2020 1,37,87,000 8,25,000 9,65,090 1,40,090 1,39,27,090
3 31st March, 2021 1,39,27,090 8,25,000 9,74,896 1,49,896 1,40,76,986
4 31st March, 2022 1,40,76,986 8,25,000 9,85,389 1,60,389 1,42,37,375
5 31st March, 2023 1,42,37,375 8,25,000 9,96,616 1,71,616 1,44,08,991
6 31st March, 2024 1,44,08,991 8,25,000 10,08,629 1,83,629 1,45,92,620
7 31st March, 2025 1,45,92,620 8,25,000 10,21,483 1,96,483 1,47,89,103
8 31st March, 2026 1,47,89,103 8,25,000 10,35,897* 2,10,897 1,50,00,000
 94 FINANCIAL REPORTING

*Difference of ` 660 (10,35,897 -10,35,237) is due to rounding off

(iii) When holders of the bonds elect to convert the bonds to ordinary shares at the
end of the fourth year (after receiving their interest payments), the entries
would be:

Dr. (`) Cr. (`)

31st March, 2022
Convertible bonds A/c (liability) Dr. 1,42,37,375
Convertible bonds A/c (equity) Dr. 13,43,925
To Ordinary share capital A/c 1,55,81,300
(Being bonds converted into ordinary shares of X
Ltd.)

Working Note:
Computation of equity and liability component of convertible bond at 7% market rate

`
Present value of principal to be received at the end of eight year dis-
counted at 7% (1,50,00,000 x 0.582) 87,30,000
Annuity of annual interest discounted at 7% for 8 years (1,50,00,000 x
5.5% x 5.971) 49,26,075
Total present value (a) 1,36,56,075
Equity component (balancing figure) (a-b) 13,43,925
Total proceeds received from issuance of convertible bonds (b) 1,50,00,000

QUESTION 153

X Ltd. has made a borrowing from RGD Bank for ` 20,000 at a fixed interest of 12% per
annum. Loan processing fees were paid additionally amounting to ` 1,000 and the loan is pay-
able in 4 half-yearly installments of ` 5,000 each.
Details are as follows:

Particulars Details
Loan amount ` 20,000
Date of loan (Starting Date) 1st April, 2020
Date of loan (Finishing Date) 31st March, 2022
Description of repayment Repayment of loan starts from 30th September, 2020
(To be paid on half yearly basis)
 PAST EXAMINATION QUESTIONS 95

Installment amount ` 5,000

Interest rate 12% per annum
Interest charge Interest to be charged and paid quarterly
Upfront fees ` 1,000

Compute the interest to be charged to the statement of profit & loss every quarter over
the period of loan. The effective interest rate is 16.60% per annum.
(5 Marks)
(CA FINAL JULY 2021 EXAM)
SOLUTION :
The loan taken by X Ltd. shall be measured at amortised cost as follows:
Initial measurement = At transaction price less processing fee ie. ` 19,000 (20,000 – 1,000)
Subsequent measurement = Interest to be accrued using effective rate of interest as
follows:

Quar- Opening Interest @ Cash flows Closing bal-

ter balance (A) 16.60% (B)=[(A) x (C) = [Refer column of ance
16.60%/4] (A) + (B) -
D of W.N.]
(C)
1 19,000.00 789.00 600.00 19,189.00
2 19,189.00 796.00 5,600.00 14,385.00
3 14,385.00 597.00 450.00 14,532.00
4 14,532.00 603.00 5,450.00 9,685.00
5 9,685.00 402.00 300.00 9,787.00
6 9,787.00 406.00 5,300.00 4,893.00
7 4,893.00 203.00 150.00 4,946.00
8 4,946.00 204.00* 5,150.00 -

* Difference is due to approximation.

 96 FINANCIAL REPORTING

Working Note:

Quar- Opening Interest @ Principal repay- Total Cash Closing bal-

ter balance 12% p.a. ment at quarter flow ance
(A) (B) = [(A) x end (E) = (A) -
(D) = (B) +
12%/4] (C) (C) (C)

1 20,000.00 600.00 - 600.00 20,000.00

2 20,000.00 600.00 5,000.00 5,600.00 15,000.00
3 15,000.00 450.00 - 450.00 15,000.00
4 15,000.00 450.00 5,000.00 5,450.00 10,000.00
5 10,000.00 300.00 - 300.00 10,000.00
6 10,000.00 300.00 5,000.00 5,300.00 5,000.00
7 5,000.00 150.00 - 150.00 5,000.00
8 5,000.00 150.00 5,000.00 5,150.00 -

QUESETION 154

KUPA Ltd. borrowed ` 95 lakh as loan from XYZ Bank on 1st April, 2018 at an interest rate
of 10% p.a. KUPA Ltd. spent ` 1,80,912 as loan processing charges. Principal amount of loan
is to be repaid in 5 equal instalments and the interest to be paid annually on accrual basis.
Effective interest rate on loan is 10.8%.
On 31st March, 2020, KUPA Ltd. faced challenges in business because of sudden change in
the technology. It approached XYZ Bank and renegotiated the terms of the loan. Interest
rate changed to 15% p.a. Principal amount of loan is to be repaid in 8 equal instalments pay-
able annually starting 31st March, 2021 and the interest is to be paid annually on accrual
basis. Before approaching bank, KUPA Ltd. made the interest payment on 31st March, 2020.
You are required to record Journal entries in the books of KUPA Ltd. till 31 st March, 2021,
after giving effect of the changes in the terms of the loan on 31st March, 2020. Workings
should form part of the SOLUTION :.

PV of ` 1 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467
10.8% 0.903 0.815 0.735 0.664 0.599 0.540 0.488 0.440
15% 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327

(12 Marks)
(CA FINAL DEC. 2021 EXAM)
 PAST EXAMINATION QUESTIONS 97

SOLUTION :
The following table shows the amortisation of loan based on effective interest rate:
Date Opening Cash flows Cash Total Interest @ Closing
Amortised (Principal) outflows cash flows EIR 10.80% Amortised
cost (Interest cost
@ 10% and
fee)

(1) (2) (3) (4) (3 + 4 = (2 x 10.80% (2- 5 +

5) = 6) 6=
7)
1st April, 2018 (95,00,000) 1,80,912 93,19,088
31st March, 2019 93,19,088 19,00,000 9,50,000 28,50,000 10,06,462 74,75,550
31st March, 2020 74,75,550 19,00,000 7,60,000 26,60,000 8,07,359 56,22,909
31st March, 2021 56,22,909 19,00,000 5,70,000 24,70,000 6,07,274 37,60,183
31st March, 2022 37,60,183 19,00,000 3,80,000 22,80,000 4,06,100 18,86,283
31st March, 2023 18,86,283 19,00,000 1,90,000 20,90,000 2,03,717*

* Difference of ` 2 (2,03,719 – 2,03,717) is due to approximation.

(i) On 1st April, 2018

Particulars Dr. (`) Cr. (`)

Bank A/c Dr. 93,19,088
To Loan from bank A/c 93,19,088
(Being loan recorded at its fair value less transaction
costs on the initial recognition date)

(ii) On 31st March, 2019

Particulars Dr. (`) Cr. (`)

Loan from bank A/c Dr. 18,43,538
Interest expense Dr. 10,06,462
To Bank A/c 28,50,000
(Being first instalment of loan and payment of inter-
est accounted for as an adjustment to the
amortised cost of loan)
 98 FINANCIAL REPORTING

(iii) On 31st March, 2020– Before KUPA Ltd. approached the bank

Particulars Dr. (`) Cr. (`)

Interest expense Dr. 8,07,359
To Loan from bank A/c To Bank A/c 47,359
(Being loan payment of interest recorded by the 7,60,000
Company before it approached the Bank for defer-
ment of principal)

Reason for treating the modification as a fresh loan:

Upon receiving the new terms of the loan, KUPA Ltd., re-computed the carrying value
of the loan by discounting the new cash flows with the original effective interest rate
and comparing the same with the current carrying value of the loan. As per require-
ments of Ind AS 109, any change of more than 10% shall be considered a substantial
modification, resulting in fresh accounting for the new loan.
The following table shows the present value (PV) of new contractual cash flows and
percentage of variation:

Date Cash flows Interest Total cash Discounting PV of cash

(principal) outflow @ outflow factor @ flows
15% 10.80%
31st March, 2020 (76,00,000)
31st March, 2021 9,50,000 11,40,000 20,90,000 0.903 18,87,270
31st March, 2022 9,50,000 9,97,500 19,47,500 0.815 15,87,213
31st March, 2023 9,50,000 8,55,000 18,05,000 0.735 13,26,675
31st March, 2024 9,50,000 7,12,500 16,62,500 0.664 11,03,900
31st March, 2025 9,50,000 5,70,000 15,20,000 0.599 9,10,480
31st March, 2026 9,50,000 4,27,500 13,77,500 0.540 7,43,850
31st March, 2027 9,50,000 2,85,000 12,35,000 0.488 6,02,680
31st March, 2028 9,50,000 1,42,500 10,92,500 0.440 4,80,700
PV of new contractual cash flows discounted @ 10.80% 86,42,768
Carrying amount of loan (93,19,088 - 18,43,538 + 47,359) (75,22,909)
Difference 11,19,859
Percentage of carrying amount 14.89%

Decision Making:
Considering a more than 10% change in PV of cash flows compared to the carrying value
 PAST EXAMINATION QUESTIONS 99

of the loan, the existing loan shall be considered to have been extinguished and the
new loan shall be accounted for as a separate financial liability.
The accounting entries for the same are included below:
On 31st March, 2020 – Accounting for extinguishment

Particulars Dr. (`) Cr. (`)

Loan from bank (old) A/c Dr. 75,22,909
Finance cost Dr. 77,091
To Loan from bank (new) A/c 76,00,000
(Being new loan accounted for at its principal amount
in absence of any transaction costs directly related to
such loan and corresponding derecognition of existing
loan)

(iv) On 31st March, 2021

Particulars Dr. (`) Cr. (`)

Loan from bank A/c Dr. 9,50,000
Interest expense Dr. 11,40,000
To Bank A/c 20,90,000
(Being first instalment of the new loan and payment
of interest accounted for as an adjustment to the
amortised cost of loan)

QUESTOIN 155

Ram Limited is a company incorporated In India. It provides ` 25,00,000 interest free loan
to its wholly owned Indian subsidiary Balram Limited. There are no transaction costs.
How should the loan be accounted for, in the light of provisions of related lnd AS, in the
books of Ram Limited, Balram Limited and Consolidated Financial Statements of the group,
considering the following scenarios:
(i) The loan is repayable on demand.
(ii) The loan is repayable after 3 years. The current market rate of interest for similar
loan is 12% p.a. for both holding and subsidiary.
(iii) The loan is repayable when Balram Limited has funds to repay the loan.
Briefly, analyse the above scenarios. Also pass Journal Entries in the books of Ram Limited
and Balram Limited in case of Scenario (i) and (ii).
Present value of ` 1 payable in 3 years‛ time at an annual discount rate of 12% is 0.7118.
(CA FINAL DEC. 2021 EXAM) (12 Marks)
100 FINANCIAL REPORTING

SOLUTION :
Requirement of Ind AS: Ind AS 109 requires that financial assets and liabilities are recog-
nized on initial recognition at its fair value, as adjusted for the transaction cost. In accor-
dance with Ind AS 113 ‘Fair Value Measurement‛, the fair value of a financial liability with
a demand feature (e.g., a demand deposit) is not less than the amount payable on demand,
discounted from the first date that the amount could be required to be paid.
Using the guidance, the loan will be accounted for as below in various scenarios:
Scenario (i)
Since the loan is repayable on demand, it has fair value equal to cash consideration given.
The parent and subsidiary recognize financial asset and liability, respectively, at the amount
of loan given. Going forward, no interest is accrued on the loan.
Upon repayment, both the parent and the subsidiary reverse the entries made at origina-
tion.
Accounting in the books of Ram Ltd. (Parent)

S. Particulars Amount Amount

No.
1. On the date of loan
Loan to Balram Ltd. (Subsidiary) Dr. 25,00,000
To Bank 25,00,000
(Being the loan is given to Balram Ltd. and recognised
at fair value)
2. At the time the Loan is received back:
Bank Dr. 25,00,000
To Loan to Balram Ltd. (Subsidiary) 25,00,000
(Being demand loan received)

Accounting in the books of Balram Ltd. (Subsidiary)

 PAST EXAMINATION QUESTIONS 101

2. On repayment of loan
Loan from Ram Ltd. Dr. 25,00,000
To Bank 25,00,000
(Being demand loan paid)

Scenario (ii)
Both parent and subsidiary recognize financial asset and liability, respectively, at fair value
on initial recognition. The difference between the loan amount and its fair value is treated
as an equity contribution to the subsidiary. This represents a further investment by the
parent in the subsidiary.
Accounting in the books of Ram Ltd. (Parent)

S. Particulars Amount Amount

No.
1. On the date of loan
Loan to Balram Ltd. (Subsidiary) Dr. 17,79,500
Deemed Investment (Capital Contribution) in Balram 7,20,500
Ltd. Dr.
To Bank 25,00,000
(Being the loan is given to Balram Ltd. and recognised
at fair value)
2. Accrual of Interest income
Loan to Balram Ltd. Dr. 2,13,540
To Interest income 2,13,540
(Being interest income accrued) – Year 1
3. Loan to Balram Ltd. Dr. 2,39,165
To Interest income 2,39,165
(Being interest income accrued) – Year 2
4. Loan to Balram Ltd. Dr. 2,67,795
To Interest income 2,67,795
(Being interest income accrued) – Year 3
5. On receipt of loan
Bank Dr. 25,00,000
To Loan to Balram Ltd. (Subsidiary) 25,00,000
(Being term loan received)
102 FINANCIAL REPORTING

Accounting in the books of Balram Ltd. (Subsidiary)

S. Particulars Amount Amount

No.
1. On the date of loan
Bank Dr. 25,00,000
To Loan from Ram Ltd. 17,79,500
To Equity (Deemed Capital Contribution 7,20,500
from Ram Ltd.)
(Being the loan is taken from Ram Ltd. and
recognised at fair value)
2. Accrual of Interest
Interest expense Dr. 2,13,540
To Loan from Ram Ltd. 2,13,540
(Being interest expense recognised) – Year 1
3. Interest expense Dr. 2,39,165
To Loan from Ram Ltd. 2,39,165
(Being interest expense recognised) – Year 2
4. Interest expense Dr. 2,67,795
To Loan from Ram Ltd. 2,67,795
(Being interest expense recognised) – Year 3
5. On repayment of loan
Loan from Ram Ltd. (Payable) Dr. 25,00,000
To Bank 25,00,000
(Being term loan paid)

Working Notes:

1. Computation of present value of loan

Rate 12%
Amount of Loan 25,00,000
Year 3
Present Value 17,79,500
2. Computation of interest for Year I
Present Value 17,79,500
 PAST EXAMINATION QUESTIONS 103

Rate 12%
Period of interest - for 1 year 1
Closing value at the end of year 1 19,93,040
Interest for 1st year 2,13,540
3. Computation of interest for Year 2
Value of loan as at the beginning of Year 2 19,93,040
Rate 12%
Period of interest - for 2nd year 1
Closing value at the end of year 2 22,32,205
Interest for 2nd year 2,39,165
4. Computation of interest for Year 3
Value of loan as at the beginning of Year 3 22,32,205
Rate 12%
Period of interest - for 3rd year 1
Closing value at the end of year 3 25,00,000
Interest for 3rd year (25,00,000 – 22,32,205) 2,67,795*

* Difference of ` 70 [(22,32,205 x 12%) – 2,67,795] is due to approximation.

Scenario (iii)
Generally, a loan, which is repayable when funds are available, can‛t be stated to be repay-
able on demand. Rather, the entities need to estimate repayment date and determine its
measurement accordingly. If the loan is expected to be repaid in three years, its measure-
ment will be the same as in scenario (ii).
In the Consolidated Financial Statements (CFS) for all three scenarios (i), (ii) and (iii)
In the Consolidated Financial Statements (CFS), the loan and interest income / expense
will get knocked-off as intra-group transaction in all the three scenarios. Hence the above
accounting will not have any impact in the CFS.

QUESTION 156

M Limited has made a security deposit whose details are given below:

Particulars Details
Date of security deposit (starting date) 1st April, 2016
Date of security deposit (finishing date) 31st March, 2021
104 FINANCIAL REPORTING

Description Lease
Total lease period 5 years
Security deposit ` 20,00,000
Present value factor at the end of the 5th year 0.6499

Determine, how above financial asset should be measured and briefly explain measurement
determined as such. Make necessary journal entries for accounting of the security deposit
in the first year and last year. Assume market rate for a deposit for similar period to be
9% p.a.
(5 Marks)
(CA FINAL DEC. 2021 EXAM)
SOLUTION :
The given security deposit is an interest free deposit redeemable at the end of lease term
for ` 20,00,000. Hence, this involves collection of contractual cash flows and shall be ac-
counted at amortised cost.
Upon initial measurement
Particulars `
Security deposit (A) 20,00,000
Present value of deposit at beginning (20,00,000 x 0.6499) (B) (12,99,800)
Prepaid lease payment at beginning (A-B) 7,00,200

Journal Entries
Year 1 - beginning

Particulars ` `
Security deposit A/c Dr. 12,99,800
Prepaid lease rent (ROU Asset) Dr. 7,00,200
To Bank A/c 20,00,000
(Recognised present value of security deposit and prepaid
lease)

Subsequently, every annual reporting year, interest income shall be accrued @ 9% per an-
num and prepaid expenses shall be amortised on straight line basis over the lease term.
 PAST EXAMINATION QUESTIONS 105

Year 1 - end

Particulars ` `
Security deposit A/c (12,99,800 x 9%) Dr. 1,16,982
To Interest income A/c 1,16,982
(Recognised interest on security deposit)
Depreciation (7,00,200 / 5 years) Dr. 1,40,040
To Prepaid lease rent (ROU Asset) 1,40,040
(Prepaid lease depreciated for the year)

Year 5- end
At the end of 5th year, the security deposit shall accrue ` 20,00,000 and prepaid lease ex-
penses shall be fully amortised (i.e. depreciated as per Ind AS 116, this prepaid lease rent
would be shown as ROU asset).
Journal entry for realisation of security deposit

Particulars ` `
Security deposit A/c (Refer W.N.) Dr. 1,65,227
To Interest income A/c 1,65,227
(Recognised interest on security deposit)
Depreciation (7,00,200 / 5 years) Dr. 1,40,040
To Prepaid lease rent (ROU Asset) 1,40,040
(Prepaid lease depreciated for the year)
Bank A/c Dr. 20,00,000
To Security deposit A/c 20,00,000
(Security deposit paid back at the end of the lease term)

Working Note:
Amortisation schedule

Year end Opening balance Interest income Closing balance

1 12,99,800 1,16,982 14,16,782
2 14,16,782 1,27,510 15,44,292
3 15,44,292 1,38,986 16,83,278
4 16,83,278 1,51,495 18,34,773
5 18,34,773 1,65,227* 20,00,000

* Difference is due to approximation.

 106 FINANCIAL REPORTING

QUESTION 157

X Ltd. issues ` 1.5 crore convertible bonds on 1st April, 2018. The bonds have a life of 8
years and a face value of ` 10 each and offer interest @ 5.5% p.a. payable at the end of
each financial year.
Bonds are issued at their face value and each bond can be converted into one ordinary share
of X Ltd. at any time in the next eight years.
Companies of a similar risk profile have recently issued debt with similar terms, without the
option for conversion, at a rate of 7% p.a.
You are required to:
(i) Provide the journal entries from financial year 2018-2019 to financial year 2021-2022;
(ii) Calculate the interest expenses across all eight years of the life of the convertible
bonds;
(iii) Give the accounting entries if the holders of the bonds elect to convert the bonds to
ordinary shares at the end of the fourth year (after receiving interest for the fourth
year).
(14 Marks)
(CA FINAL MAY 2022 EXAM)
SOLUTION :
(i) Journal Entries
Dr. (`) Cr. (`)
1st April, 2018
Bank A/c Dr. 1,50,00,000
To Convertible bonds A/c (liability) (Refer W.N.) 1,36,56,075
To Convertible bonds A/c (equity) (Refer W.N.) 13,43,925
(Being recognition of convertible bonds at the date of
issuance into liability and equity components)
31st March, 2019
Interest expense A/c Dr. 9,55,925
To Bank A/c 8,25,000
To Convertible bonds A/c (liability) 1,30,925
(Being interest expense recorded at market rate of
7% and actual interest paid @ 5.5%)
31st March, 2020
Interest expense A/c Dr. 9,65,090
To Bank A/c 8,25,000
 PAST EXAMINATION QUESTIONS 107

To Convertible bonds A/c (liability) 1,40,090

(Being interest expense recorded at market rate of
7% and actual interest paid @ 5.5%)
31st March, 2021
Interest expense A/c Dr. 9,74,896
To Bank A/c 8,25,000
To Convertible bonds A/c (liability) 1,49,896
(Being interest expense recorded at market rate of
7% and actual interest paid @ 5.5%)
31st March, 2022
Interest expense A/c Dr. 9,85,389
To Bank A/c 8,25,000
To Convertible bonds A/c (liability) 1,60,389
(Being interest expense recorded at market rate of
7% and actual interest paid @ 5.5%)

(ii) Table showing computation of interest expense at market rate and actual interest
outflow @ 5.5%

Year Date Opening Actual Interest Increase Closing

bond liability interest expense in liability bond liability
outflow @ @ 7%
5.5%
a b =1.5 cr c = a x 7% d = c-b e = a+d
x 5.5%
0 1st April, 2018 1,36,56,075
1 31st March, 2019 1,36,56,075 8,25,000 9,55,925 1,30,925 1,37,87,000
2 31st March, 2020 1,37,87,000 8,25,000 9,65,090 1,40,090 1,39,27,090
3 31st March, 2021 1,39,27,090 8,25,000 9,74,896 1,49,896 1,40,76,986
4 31st March, 2022 1,40,76,986 8,25,000 9,85,389 1,60,389 1,42,37,375
5 31st March, 2023 1,42,37,375 8,25,000 9,96,616 1,71,616 1,44,08,991
6 31st March, 2024 1,44,08,991 8,25,000 10,08,629 1,83,629 1,45,92,620
7 31st March, 2025 1,45,92,620 8,25,000 10,21,483 1,96,483 1,47,89,103
8 31st March, 2026 1,47,89,103 8,25,000 10,35,897* 2,10,897 1,50,00,000

*Difference of ` 660 (10,35,897 -10,35,237) is due to rounding off

108 FINANCIAL REPORTING

(iii) When holders of the bonds elect to convert the bonds to ordinary shares at the
end of the fourth year (after receiving their interest payments), the entries
would be:

Dr. (`) Cr. (`)

31st March, 2022
Convertible bonds A/c (liability) Dr. 1,42,37,375
Convertible bonds A/c (equity) Dr. 13,43,925
To Ordinary share capital A/c 1,55,81,300
(Being bonds converted into ordinary shares of X
Ltd.)

Working Note:
Computation of equity and liability component of convertible bond at 7% market rate

`
Present value of principal to be received at the end of eight year dis-
counted at 7% (1,50,00,000 x 0.582) 87,30,000
Annuity of annual interest discounted at 7% for 8 years (1,50,00,000 x
5.5% x 5.971) 49,26,075
Total present value (a) 1,36,56,075
Equity component (balancing figure) (a-b) 13,43,925
Total proceeds received from issuance of convertible bonds (b) 1,50,00,000

QUESTION 158

X Ltd. has made a borrowing from RGD Bank for ` 20,000 at a fixed interest of 12% per
annum. Loan processing fees were paid additionally amounting to ` 1,000 and the loan is pay-
able in 4 half-yearly installments of ` 5,000 each.
Details are as follows:

Particulars Details
Loan amount ` 20,000
Date of loan (Starting Date) 1st April, 2020
Date of loan (Finishing Date) 31st March, 2022
Description of repayment Repayment of loan starts from 30th September, 2020
(To be paid on half yearly basis)
Installment amount ` 5,000
 PAST EXAMINATION QUESTIONS 109

Interest rate 12% per annum

Interest charge Interest to be charged and paid quarterly
Upfront fees ` 1,000

Compute the interest to be charged to the statement of profit & loss every quarter over
the period of loan. The effective interest rate is 16.60% per annum.
(5 Marks)
(CA FINAL MAY 2022 EXAM)
SOLUTION :
The loan taken by X Ltd. shall be measured at amortised cost as follows:
Initial measurement = At transaction price less processing fee ie. ` 19,000 (20,000 – 1,000)
Subsequent measurement = Interest to be accrued using effective rate of interest as
follows:

Quar- Opening Interest @ Cash flows Closing bal-

ter balance (A) 16.60% (B)=[(A) x (C) = [Refer column of ance
16.60%/4] (A) + (B) -
D of W.N.]
(C)
1 19,000.00 789.00 600.00 19,189.00
2 19,189.00 796.00 5,600.00 14,385.00
3 14,385.00 597.00 450.00 14,532.00
4 14,532.00 603.00 5,450.00 9,685.00
5 9,685.00 402.00 300.00 9,787.00
6 9,787.00 406.00 5,300.00 4,893.00
7 4,893.00 203.00 150.00 4,946.00
8 4,946.00 204.00* 5,150.00 -

* Difference is due to approximation.

Working Note:

Quar- Opening Interest @ Principal repay- Total Cash Closing bal-

ter balance 12% p.a. ment at quarter flow ance
(A) (B) = [(A) x end (E) = (A) -
(D) = (B) +
12%/4] (C) (C) (C)

1 20,000.00 600.00 - 600.00 20,000.00

2 20,000.00 600.00 5,000.00 5,600.00 15,000.00
 110 FINANCIAL REPORTING

3 15,000.00 450.00 - 450.00 15,000.00

4 15,000.00 450.00 5,000.00 5,450.00 10,000.00
5 10,000.00 300.00 - 300.00 10,000.00
6 10,000.00 300.00 5,000.00 5,300.00 5,000.00
7 5,000.00 150.00 - 150.00 5,000.00
8 5,000.00 150.00 5,000.00 5,150.00 -

QUESTION 159

On 1st April, 2021, Mohan Ltd. has sold goods to Hari Ltd. at a consideration of ` 7,50,000.
The receipt of this is receivable in three equal instalments of ` 2,50,000 each over a two-
year period (receipts on 1st April, 2021; 31st March 2022 and 31st March 2023).
The company is offering a discount of 5% (i.e. ` 37,500), if payment is made in full at the
time of sale. The sale agreement reflects an implicit interest rate of 5.358% p.a.
The total consideration to be received from such sale is at ` 7,50,000 and hence, the man-
agement has recognized the revenue from sale of goods for ` 7,50,000.
You are required to analyse whether the above accounting treatment made by the accoun-
tant is in compliance of Ind AS. If not, advise the correct treatment alongwith journal
entries and extracts of Statement of Profit & Loss and Balance Sheet.
(6 Marks)
(CA FINAL NOV 2022 EXAM)
SOLUTION :
The revenue from sale of goods shall be recognised at the fair value of the consideration
received or receivable. The fair value of the consideration is determined by discounting all
future receipts using an imputed rate of interest where the receipt is deferred beyond
normal credit terms. The difference between the fair value and the nominal amount of the
consideration is recognised as interest revenue. Hence, the accounting treatment of recog-
nizing revenue of ` 7,50,000 by the accountant is not correct.
The fair value of consideration (cash price equivalent) of the sale of goods to be recognised
on the date of sale should be calculated as follows:

Period Consideration (In- Present value Present value of

stallment) factor consideration

` `
Time of sale 2,50,000 - 2,50,000
End of 1st year 2,50,000 0.949 2,37,250
 PAST EXAMINATION QUESTIONS 111

End of 2nd year 2,50,000 0.901 2,25,250

7,50,000 7,12,500

Mohan Ltd. will recognise the revenue from sale of goods and finance income as follows:

Particulars ` `
Initial recognition of sale of goods
Cash / Bank A/c Dr. 2,50,000
Trade Receivable A/c Dr. 4,62,500
To Sale A/c 7,12,500
Recognition of interest expense and receipt of second in-
stallment
Cash / Bank A/c Dr. 2,50,000
To Interest Income A/c (4,62,500 x 5.358%) 24,781
To Trade Receivable A/c 2,25,219
Recognition of interest expense and payment of final in-
stallment
Cash / Bank A/c Dr. 2,50,000
To Interest Income A/c (Balancing figure) 12,719
To Trade Receivable A/c (4,62,500 – 2,25,319) 2,37,281

Statement of Profit and Loss (Extracts) for the year ended 31st March, 2022 and
31st March, 2023

As at 31st March, As at 31st March,

2022 2023
` `
Income
Sale of Goods 7,12,500 -
Other Income (Finance income) 24,781 12,719

Balance Sheet (extracts) as at 31st March, 2022 and 31st March, 2023

As at 31st March, 2022 As at 31st March,

2023
` `
Assets
 112 FINANCIAL REPORTING

Current Assets
Financial Assets
Trade Receivables 2,37,281 XXX

QUESTION 160

On 1st April, 2021 “Fortunate Bank” has provided a loan of ` 25,00,000 to Mohan Limit-
ed for 4 years at 10% p.a. and the loan has been guaranteed by Surya Limited, which is a
holding company for Mohan Limited. Interest payments are made at the end of each year
and the principal is repaid at the end of the loan term. If Surya Limited had not issued a
guarantee, ‘Fortunate Bank‛ would have charged Mohan Limited an interest rate of 14% p.a.
Surya Limited does not charge Mohan Limited for providing the guarantee.
On 31st March 2022, there is 2% probability that Mohan Limited may default on the loan in
the next 12 months. If Mohan Limited defaults on the loan, Surya Limited does not expect
to recover any amount from Mohan Limited.
On 31st March 2023, there is 4% probability that Mohan Limited may default on the loan in
the next 12 months. If Mohan Limited defaults on the loan, Surya Limited does not expect
to recover any amount from Mohan Limited.
On 31st March 2024, there is 5% probability that Mohan Limited may default on the loan in
the next 12 months. If Mohan Limited defaults on the loan, Surya Limited does not expect
to recover any amount from Mohan Limited.
You are required to provide accounting treatment of financial guarantee as per Ind AS
109 in the books of Surya Limited on initial recognition and in subsequent periods till 31st
March, 2024.
(12 Marks)
(CA FINAL NOV 2022 EXAM)
 PAST EXAMINATION QUESTIONS 113

SOLUTION :
1st April 2021
A financial guarantee contract is initially recognised at fair value. The fair value of the
guarantee will be the present value of the difference between the net contractual cash
flows required under the loan, and the net contractual cash flows that would have been re-
quired without the guarantee.

Particulars Year 1 Year 2 Year 3 Year 4 Total

(`) (`) (`) (`) (`)
Cash flows based on inter- 3,50,000 3,50,000 3,50,000 3,50,000 14,00,000
est rate of 14% (A)

Cash flows based on inter-

est rate of 10% (B)
2,50,000 2,50,000 2,50,000 2,50,000 10,00,000
Interest on differential 1,00,000 1,00,000 1,00,000 1,00,000 4,00,000
rate

(C) = (A-B)
Discount factor @ 14% 0.877 0.769 0.675 0.592
Interest on differential
rate discounted @ 14% 87,700 76,900 67,500 59,200 2,91,300
Fair value of financial guar-
anteed contract (at incep-
tion)
2,91,300

Alternative manner of presentation for the calculation of fair value of financial guaran-
teed contract (at inception)
(i) Interest on loan @ 10% = ` 2,50,000
Present value of cash flow of loan at concessional rate with guarantee @ 14%
= ` 2,50,000 x 2.9138 + ` 25,00,000 x 0.5921
= ` 7,28,450 + ` 14,80,250 = ` 22,08,700
(i) Interest on loan at normal rate of 14% = ` 3,50,000 Present Value of Cash flow of
loan at 14%
= ` 3,50,000 x 2.9138 + ` 25,00,000 x 0.5921
= ` 25,00,080 or ` 25,00,000
Difference (ii) – (i) = ` 25,00,000 - ` 22,08,700
Fair value of financial guaranteed contract (at inception) = ` 2,91,300
 114 FINANCIAL REPORTING

Journal Entry

Particulars Debit (`) Credit (`)

Investment in subsidiary Dr. 2,91,300
To Financial guarantee (liability) 2,91,300
(Being financial guarantee initially recorded)

31st March 2022

Subsequently at the end of the reporting period, financial guarantee is measured at the
higher of:
- the amount of loss allowance; and
- the amount initially recognised less cumulative amortization, where appropriate.
At 31st March 2022, there is 2% probability that Mohan Limited may default on the loan
in the next 12 months. If Mohan Limited defaults on the loan, Surya Limited does not ex-
pect to recover any amount from Mohan Limited. The 12-month expected credit losses are
therefore ` 50,000 (` 25,00,000 x 2%).
The initial amount recognised less amortisation is ` 2,32,082 (Refer table below). The
unwound amount is recognised as income in the books of Surya Limited, being the benefit
derived by Mohan Limited not defaulting on the loan during the period.

Year ended on Opening bal- EIR @ 14% Benefits provid- Closing balance
31st March ance (b) = (a x ed
(a) 14%) (c) (d) = (a) + (b)
-(c)
` ` `
2022 2,91,300 40,782 (1,00,000) 2,32,082
2023 2,32,082 32,491 (1,00,000) 1,64,573
2024 1,64,573 23,040 (1,00,000) 87,613
2025 87,613 12,387* (1,00,000) -

* Difference of ` 121 (` 12,387 – ` 12,266) is due to approximation.

The carrying amount of the financial guarantee liability after amortisation is therefore `
2,32,082, which is higher than the 12-month expected credit losses of ` 50,000. The liabil-
ity is therefore adjusted to ` 2,32,082 (the higher of the two amounts) as follows:

Particulars Debit (`) Credit (`)

Financial guarantee (liability) Dr. 59,218
 PAST EXAMINATION QUESTIONS 115

To Profit and loss 59,218

(Being financial guarantee subsequently adjusted)

31st March 2023

At 31st March 2023, there is 4% probability that Mohan Limited will default on the loan
in the next 12 months. If Mohan Limited defaults on the loan, Surya Limited does not ex-
pect to recover any amount from Mohan Limited. The 12-month expected credit losses are
therefore ` 1,00,000 (` 25,00,000 x 4%).
The carrying amount of the financial guarantee liability after amortisation is ` 1,64,573,
which is higher than the 12-month expected credit losses of ` 1,00,000. The liability is
therefore adjusted to ` 1,64,573 (the higher of the two amounts) as follows:

Particulars Debit (`) Credit (`)

Financial guarantee (liability) Dr. 67,509
To Profit and loss 67,509
(Being financial guarantee subsequently adjusted)

31st March 2024

At 31st March 2024, there is 5% probability that Mohan Limited will default on the loan
in the next 12 months. If Mohan Limited defaults on the loan, Surya Limited does not ex-
pect to recover any amount from Mohan Limited. The 12-month expected credit losses are
therefore ` 1,25,000 (` 25,00,000 x 5%).
The initial amount recognised less accumulated amortisation is ` 87,613, which is lower than
the 12-month expected credit losses (` 1,25,000). The liability is therefore adjusted to
` 1,25,000 (the higher of the two amounts) as follows:

Particulars Debit (`) Credit (`)

Financial guarantee (liability) Dr. 39,573*
To Profit and loss (Refer Note below) 39,573*
(Being financial guarantee subsequently adjusted)

* Note: The carrying amount at the end of 31st March 2023 will be ` 1,25,000 (i.e. `
1,64,573 less 12-month expected credit losses of ` 39,573).

QUESTION 161

ENG Ltd. has developed model to measure the expected credit loss based on the lifetime
expected credit loss model. Accordingly, the company has estimated the following provi-
sioning matrix:
 116 FINANCIAL REPORTING

Current 1-30 days 31-60 days 61-90 days More than 90

past due past due past due days past due
Default Rate 0.3% 1.6% 3.6% 6.6% 10.6%

The Company has a portfolio of trade receivables of ` 6 crores as on 31st March, 2022 and
operates in only one geographical region. The customer base of the company consists of
large number of small clients and trade receivables are categorized by common risk char-
acteristics that are representative of customer‛s abilities to pay all amounts due as per the
contractual terms.
The trade receivables do not have significant financing component. The above provision ma-
trix is based on its historically observed default rate over the expected life of the trade
receivables and is adjusted for forward looking estimate.
The company has asked you to suggest whether the above system of making the provision
for the expected credit loss is in accordance with the applicable Ind AS? If yes, then de-
termine the expected credit loss for the Trade Receivables outstanding as on 31st March,
2022 on the following basis:

Current 1-30 days 31-60 61-90 More than 90

past due days past days past days past due
due due
% of Trade Re- 50% 25% 13% 8% 4%
ceivables

(5 Marks)
(CA FINAL NOV 2022 EXAM)
SOLUTION :
To determine the expected credit losses for the portfolio, ENG Ltd. should use a provision
matrix. The provision matrix will be based on its historical observed default rates over the
expected life of the trade receivables and shall be adjusted for forward-looking estimates.
At every reporting date the historical observed default rate shall be updated and changes
in the forward-looking estimates shall be analysed. In this case, it is forecast that economic
conditions will deteriorate over the next year. Therefore, as per para 5.5.15 of Ind AS 109,
the loss allowance for trade receivables shall be measured at an amount equal to lifetime
expected credit losses. On that basis, ENG Ltd. estimates the provision matrix.
The trade receivables from the large number of small customers amount to ` 6,00,00,000
and are measured using the provision matrix:
 PAST EXAMINATION QUESTIONS 117

Provisio n % Gross carrying Default Lifetime expected

age amount rate credit loss allow-
ance (Gross carrying
amount x lifetime
expected
credit loss rate)
a b C=`6 d e=cxd
crore x b
` `
Current 50% 3,00,00,000 0.3% ` 90,000
1–30 days past due 25% 1,50,00,000 1.6% ` 2,40,000
31–60 days past due 13% 78,00,000 3.6% ` 2,80,800
61–90 days past due 8% 48,00,000 6.6% ` 3,16,800
More than 90 days past due
4% 24,00,000 10.6% ` 2,54,400
6,00,00,000 ` 11,82,000

QUESTION 162

Autumn Limited has a policy of providing subsidized loans to its employees for their per-
sonal purposes. Mrs. Jama Bai, a senior HR manager in the Company, took a loan of ` 12.00
lakhs on the following terms:
• Interest rate 4% per annum
• Loan disbursement date: 1st April 2019
• The principal amount of the loan shall be recovered in 4 equal annual installments com-
mencing from 31st March 2020
• The accumulated interest computed on reducing balance at simple interest is collected
in 3 equal annual installments after collection of the principal amount
• Mrs. Jama Bai must remain in service till the principal and interest are paid
• The market rate of a comparable loan to Mrs. Jama Bai is 9% per annum
• The present value of ` 1 at 9% per annum at the end of respective years is as follows:
Year ending 31st 2020 2021 2022 2023 2024 2025 2026
March
Present Value 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.5470
 118 FINANCIAL REPORTING

Under the assumption that no probable future economic benefits except the return of loan
has been guaranteed by the employee, You are required to:
i. Provide the journal entries at the time of initial recognition of loan on 1st April 2019
and as at 31st March 2020; and
ii. Prepare ledger account of ‘Loan to Mrs. Jama Bai‛ from the inception of the loan till its
final payment.
(CA FINAL MAY 2023 EXAM)

QUESTION 163

Weak Limited, which is a fully owned subsidiary company of strong Limited approached
Strong Limited for an interest free loan for mitigation of its financial difficulties. Strong
Limited Provided the loan to Weak Limited on the following terms & conditions:

Nature of loan Interest Free

Amount of Loan ` 60,00,000
Date of disbursement of loan April 1, 2021
Loan period 3 years
Loan repayable by Weak Ltd. On March 31, 2024
Market rate of interest for similar loan 8% (both for holding and subsidiary) per
annum
P.V factor of ` 1 at the end of 3rd year at 0.7938
8% per annum is

Assuming that there are no transaction costs, you are required to pass necessary account-
ing entries in the books of Weak Limited for all the three years.
(CA FINAL MAY 2023 EXAM)

QUESTION 164

On 1 April 2018, 8% convertible loan with a nominal value of ` 6,00,000 was issued at par. It
is redeemable on 31 March 2022 also at par. Alternatively, it may be converted into equity
shares on the basis of 1 new share for each of 200 worth of loan.
An equivalent loan without the conversion option would have carried interest at 10% .Interest
of Ra 48,000 has already been paid and included as a finance Cost.

Year End @8% @10%

1 0.93 0.91
2 0.86 0.83
 PAST EXAMINATION QUESTIONS 119

3 0.79 0.75
4 0.73 0.68
How will the Company present the above loan notes in the financial statements for the year
ended 31 March 2019?
(MTP MARCH 2019)

QUESTION 165

QA Ltd issued 10,00,000 of 8% long term bond-A Series of ` 1 each on 1st April, 2016 the
bond tenure is 3 years. Interest in payable annually at the end of each year. The investors
expect an effective interest rate on the loan at 10% .
QA Ltd. Wants you to suggest the suitable accounting entries for the issue of these bonds
as per applicable IND AS. Consider the discounting factor 3 years, 10% discounting factor
is 0.751315 and 3 years cumulative discounting factor is 2.48685.
(i) What is the principal value of the bond at the initial recognition at the time of issue
or bond as per applicable Ind AS?
(ii) What is the present value of the interest payment to be recognized as part of the sale
price of the bond as per applicable Ind AS?
(iii) What are the proceeds of the sale of the bond to be recognized at the time of initial
recognition as per applicable Ind AS?
(iv) What is the accounting entry to be passed at the time of accounting for payment of
interest for the first year?
(MTP MARCH 2019)

QUESTION 166

On 1St April,2014 Shelter Ltd. issued 5,000 8% convertible debentures with a face value
of ` 100 each maturing on 31st March, 2019. The debentures can be converted into equity
shares of Shelter Ltd at a conversion price of ` 105 per share, interest is payable annually
in cash. At the date of issue, shelter Ltd. could have issued non-convertible debt with a 5
year term bearing a coupon interest rate of 12%. On 1St April, 2017 convertible debenture
have a fair value of ` 5,25,000. Shelter Ltd makes a tender offer to debenture holders
to repurchase the debentures for ` 5,25,000 which the holders accepted. At the date of
repurchase, Shelter Ltd. could have issued non-convertible debt with a 2 year term bearing
a coupon interest rate of 9%.
Show accounting entries in the books of Shelter Ltd. for recording of equity and liability
component:

(i) At the time of initial recognition and

(ii) At the time of repurchase of the convertible debentures.
120 FINANCIAL REPORTING

The following present values of ` 1 at 8%,9% & 12% are supplied to you:

Interest Year 1 Year 2 Year 3 Year 4 Year 5

Rate
8% 0.926 0.857 0.794 0.735 0.681
9% 0.917 0.842 0.772 0.708 0.650
12% 0.893 0.797 0.712 0.636 0.567
(MTP APRIL 2019)
(Repurchase Option)

QUESTION 167

Blueberry Ltd entered into following transaction during the year ended 31st March 20X2:
(a) Entered into a speculative interest rate option costing ` 10,000 on 1st April 20X0 to
borrow ` 6,000,000 from Exon Bank Commencing 30th June 20X2 for 6 months at
4%.The value of the option at 31st March, 20X2 was ` 15,250.
(b) Purchased 6% debentures in Fox Ltd. on 1st April, 20X1 (their issue date) for ` 150,000
as an investment. Blueberry Ltd. intends to hold the debentures, until their redemption
at a premium, in 5 years‛ time The effective rate of interest of the bond is 8%
(c) Purchased 50,000 shares in Cox Ltd. on 1st October, 20X2 for ` 3,50 each as an
investment. The share price oh 31st March, 20X2 was ` 3.75.
(d) Show the accounting treatment and relevant extracts from the financial statements
for the year ended 31st March, 20X2 of transaction related to financial instruments
Blueberry Ltd. designates financial assets at fair value through Profit or loss only
when this is unavoidable.
(MTP MAY 2020)
(Repurchase Option)
QUESTION 168

An entity purchases a debt instrument with a fair value of ` 1,000 on 15th March, 20X1 and
measures the debt instrument at fair value through comprehensive income. The instrument
has an interest rate of 5% over the contractual term of 10 years, and has a 5% effective
interest rate. At initial recognition, the entity determines that the asset is not a purchased
or original credit-impaired asset.
On 31st March 20X1 (the reporting date), the fair value of the debt instrument has decreased
to ` 950 as a result of changes in market interest rate. The entity determines that there
has not been a significant increase in credit risk since initial recognition and that ECL should
be measured at an amount equal to 12 month ECL, which amounts to ` 30.
On 1st April 20X1, the entity decides to sell the debt instrument for ` 950, which is its fair
value at that date.
 PAST EXAMINATION QUESTIONS 121

Pass journal entries for recognition, impairment and sale of debt instruments as per Ind AS
109, Entries relating to interest income are not to be provided
(MTP OCTOBER 21)

QUESTION 169

XYZ issued ` 4,80,000 4% redeemable preference shares on 1st April 20X5 at par. Interest
is paid annually in arrears, the first payment of interest amounting ` 19,200 was made
on 31st March 20X6 and it is debited directly to retained earnings by accountant. The
preference shares are redeemable for a cash amount of ` 7,20,000 on 31st March 20X8.
The effective rate of interest on the redeemable preference shares is 18% per annum. The
proceeds of the issue have been recorded within equity by accountant as this reflects the
legal nature of the shares. Board of directors intends to issue new equity shares over the
next two years to build up cash resources to redeem the preference shares.
Mukesh, Accounts manager of XYZ has been told to review the accounting of aforesaid
issue. CFO has asked from Mukesh the closing balance of preference shares at the year
end. If you were Mukesh, then how much balance you would have shown to CFO on analysis
of the stated issue. Prepare necessary adjusting journal entry in the books of account, if
required.
(RTP VIDEO MAY 2020)

QUESTION 170 (MIXED WITH FOREIGN CURRENCY IND AS21)

(BEST QUESTION)

An Indian entity, whose functional currency is rupees, purchases USD dominated bond at
its fair value of USD 1,000. The bond carries stated interest @ 4.7% p.a. on its face value.
The said interest is received at the year end. The bond has maturity period of 5 years and
is redeemable at its face value of USD 1,250. The fair value of the bond at the end of year
1 is USD 1,060. The exchange rate on the date of transaction and at the end of year 1 are
USD 1 = ` 40 and USD 1 = ` 45, respectively. The weighted average exchange rate for the
year is 1 USD = ` 42.
The entity has determined that it is holding the bond as part of an investment portfolio
whose objective is met both by holding the asset to collect contractual cash flows and
selling the asset. The purchased USD bond is to be classified under the FVTOCI category.
The bond results in effective interest rate (EIR) of 10% p.a.
Calculate gain or loss to be recognised in Profit & Loss and Other Comprehensive Income
for year 1. Also pass journal entry to recognise gain or loss on above. (Round off the figures
to nearest rupees)
(RTP VIDEO NOV. 2020)
 122 FINANCIAL REPORTING

QUESTION 171 (GOOD QUESTION ON GUARANTEE)

On 1 April 20X1, Sun Limited guarantees a `10,00,000 loan of Subsidiary – Moon Limited,
which Bank STDK has provided to Moon Limited for three years at 8%.
Interest payments are made at the end of each year and the principal is repaid at the end
of the loan term.
If Sun Limited had not issued a guarantee, Bank STDK would have charged Moon Limited an
interest rate of 11%. Sun Limited does not charge Moon Limited for providing the guarantee.
On 31 March 20X2, there is 1% probability that Moon Limited may default on the loan in
the next 12 months. If Moon Limited defaults on the loan, Sun Limited does not expect to
recover any amount from Moon Limited.
On 31 March 20X3, there is 3% probability that Moon Limited may default on the loan in
the next 12 months. If Moon Limited defaults on the loan, Sun Limited does not expect to
recover any amount from Moon Limited.
Provide the accounting treatment of financial guarantee as per Ind AS 109 in the books of
Sun Ltd., on initial recognition and in subsequent periods till 31 March 20X3.
(RTP VIDEO MAY 2021)

QUESTION 172

On 1st April, 20X1, PS Limited issued 6,000, 9% convertible debentures with a face value of
` 100 each maturing on 31st March, 20X6. The debentures are convertible into equity shares
of PS Limited at a conversion price of ` 105 per share. Interest is payable annually in cash.
At the date of issue, non-convertible debt could have been issued by the company at coupon
rate of 13%. On 1st April, 20X4, the convertible debentures have a fair value of ` 6,30,000.
PS Limited makes a tender offer to debenture-holders to repurchase the debentures for
` 6,30,000 which the debenture holders accepted. At the date of repurchase, PS Limited
could have issued non-convertible debt with a 2 year term bearing coupon interest @ 10%.
Show accounting entries in the books of PS Limited for recording of equity and liability
component:
(i) At the time of initial recognition
(ii) At the time of repurchase of the convertible debentures
(RTP VIDEO NOV. 2021)

QUESTION 173

On 1st April, 2X01, Entity X issued a 10% convertible debenture with a face value of `
1,000 maturing on 31st March, 2X11. The debenture is convertible into ordinary shares of
Entity X at a conversion price of ` 50 per share. Interest is payable yearly in cash. On 1st
April, 2X02, to induce the holder to convert the convertible debenture promptly, Entity X
 PAST EXAMINATION QUESTIONS 123

reduces the conversion price to ` 40 if the debenture is converted before 1st June, 2X02
(ie, within 60 days). The market price of Entity X‛s ordinary shares on the date the terms
are amended is ` 80 per share. How will the revised terms be accounted?
(RTP VIDEO MAY 2022)

QUESTION 174

ABC Ltd. issues 4% 1,00,000 OCPS at a face value of ` 100 per share on 1st April, 20X1 and
these are redeemable after 5 years, ie, on 31st March, 20X6. Dividend is non-cumulative.
Each preference shares entitles the holders to 10 equity shares and the preference shares
are optionally convertible by the holder at any time until maturity.
How will the preference shares be classified at initial recognition assuming that a comparable
instrument carries a market interest rate of 7%? Provide journal entries for year 1. Will
this classification be changed subsequently in case there is likelihood that OCPS will be
encashed at the end of the maturity period?
(RTP VIDEO MAY 2022)

QUESTION 175

On 1st April, 20X1 an entity granted an interest-free loan of ` 5,00,000 to an employee for
a period of three years. The market rate of interest for similar loans is 5% per year.
On 31st March, 20X3, because of financial difficulties, the employee asked to extend the
interest-free loan for further three years. The entity agreed. Under the restructured
terms, repayment will take place on 31st March, 20X7. However, the entity only expects to
receive a payment of ` 2,50,000, given the financial difficulty of the employee.
Explain the accounting treatment on initial recognition of loan and after giving effect of
the changes in the terms of the loan as per Ind AS 109. Support your answer with Journal
entries and amortised cost calculation, as on the date of initial recognition and on the date
of change in terms of loan.
(RTP VIDEO NOV. 2022)