Chapter 12

Indian Accounting Standard (Ind AS)

109, 32, 107: Financial Instruments
Questions from Study Material
Question 1
ABC Ltd. enters into a contract to buy 100 tonnes of cocoa beans at 1,000 per tonne for delivery
in 12 months. On the settlement date, the market price for cocoa beans is 1,500 per tonne. The
contract cannot be settled net in cash and this contract is entered for delivery of cocoa beans in
line with ABC Ltd.’s expected purchase/usage requirements. Identify applicable of Ind AS 109.
(Study Material)
Answer
In such case, the contract is considered to be an executory contract outside the scope of Ind AS
109 and hence, shall not be accounted as a derivative.

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Question 2
Entity XYZ enters into a fixed price forward contract to purchase 10,00,000 kilograms of copper in
accordance with its expected usage requirements.
The contract permits XYZ to take physical delivery of the copper at the end of 12 months or to
pay or receive a net settlement in cash, based on the change in fair value of copper. Is the
contract covered under Financial Instruments standard?
(Practice Manual)
Answer
The above contract needs to be evaluated to determine whether it falls within the scope of the
financial instruments standards.
The contract is a derivative instrument because there is no initial net investment, the contract is
based on the price of copper and it is to be settled at a future date.
However, if XYZ intends to settle the contract by taking delivery and has no history for similar
contracts of settling net in cash, or of taking delivery of the copper and selling it within a short
period after delivery for the purpose of generating a profit from short term fluctuations in price or
dealer's margin, the contract is not accounted for as a derivative under Ind AS 109.
Instead, it is accounted for as an executory contract and if it becomes onerous then Ind AS 37
would apply.

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Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 653
Question 3
Company owns an office building. Company enters into a put option with an investor that permits
the company to put the building to the investor for ` 150 million. The current value of the building
is ` 175 million. The option expires in 5 years. The option, if exercised, may be settled through
physical delivery or net cash, at company’s option. How do the Company and the investor
account for the option? (November 2015, 4 Marks)

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Question 4
A Company enters into a fixed price forward contract to purchase one million kilograms of copper
in accordance with its expected usage requirements. The contract permits the company to take
physical delivery of the copper at the end of 12 months or to pay or receive a net settlement in
cash, based on the change in fair value of copper. Is the contract accounted for as a derivative?
Explain. (November 2015, 4 Marks)

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Question 5
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
instrument.
(Study Material)
Answer
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 is to collect contractual cash flows.
Hence, this meets the definition of financial assets carried at amortised cost.

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Question 6
Z Ltd. (the ‘Company’) makes sale of goods to customers on credit. Goods are carried in large
containers for 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?
(Study Material)
Answer
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 sold. Hence, they meet the definition of
financial asset carried at amortised cost.

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654 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 7
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.
(Study Material)
Answer
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. Accordingly,
• 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.

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Question 8
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?
(Study Material)
Answer
Lack of access to foreign currency or the need to obtain approval for payment from a regulatory
authority, does not negate the entity's contractual obligation or the holder's contractual right under
the instrument.

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Question 9
On 1 January 20X1, Entity X writes a put option over 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 option can
only be settled through physical delivery of the shares (gross physical settlement). Examine the
nature of the financial instrument.
(Study Material)
Answer
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, Entity X has an
obligation to deliver cash which it cannot avoid.
The accounting for financial instrument in the above question 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 question 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.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 655
• 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 question will be measured at amortised
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 liability is
reclassified to equity. This means, in case of question above, an amount of `22,000,000
will be reclassified from financial liability to equity.

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Question 10
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.
(Study Material)
Answer
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 the difference between cash
received i.e. ` 1000 and the financial liability of ` 797 will be debited to equity.

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Question 11
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.
(Study Material)
Answer
As the contract will be settled by delivery of fixed number of instruments for a variable amount of
cash, it is a financial liability.

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Question 12
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.
(ICAI solution is not correct) (Study Material)
656 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Answer
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.

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Question 13
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 share (to determine total
number of equity shares to be issued) shall be determined based on the market price of the
shares of Target Ltd. at a future date, upon settlement of the contract. Evaluate this under
definition of financial instrument.
(Study Material)
Answer
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 are to be issued in a non-derivative contract for fixed amount of cash, it tant amounts to
use of equity shares as ‘currency’ and hence, this contract meets definition of financial liability in
books of Target Ltd.

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Question 14
A Ltd. (the ‘Company’) makes purchase of steel for its consumption in normal course of business.
The purchase terms provide for payment of goods at 30 days credit and interest payable @ 12%
per annum for any delays beyond the credit period. Analyse the nature of this financial
instrument.
(Study Material)
Answer
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.

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Question 15
A Ltd. (the ‘Company’) makes a borrowing for INR 10 lacs from RBC Bank 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 schedule 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.
(a) Does the above instrument meet definition of financial liability? Please explain.
(b) Analyse the differential amount to be exchanged for one-time settlement.
(Modified) (Study Material)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 657
Answer
(a) 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.
(b) Let’s compute the amount required to be settled and any differential arising upon one
time settlement at the 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)]
♦ 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 unfavorable 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’.

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Question 16
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 (‘American option’).
Evaluate this under definition of financial instrument.
(Incomplete Question) (Study Material)
Answer
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.

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Question 17
PQR Ltd. issues a call option (i.e. an option to buy) to ABC Ltd. to subscribe to PQR Ltd.’s equity
shares at a price of ` 100 per share. The call option is to be settled on a ‘net’ basis i.e. without
physical delivery of shares. If at the balance sheet date, market value of equity share of PQR Ltd.
is ` 110 per share, PQR Ltd. will be obliged to pay ` 10 to settle the option. Examine nature of
instrument.
(Study Material)
Answer
Such a condition is potentially unfavourable to PQR Ltd. and hence ` 10 represents a financial
liability for PQR Ltd.

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658 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 18
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.
(Study Material)
Answer
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.

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Question 19
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.
(Study Material)
Answer
Such preference shares are financial liability because the entity cannot avoid a transfer of cash or
another financial asset.

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Question 20
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.
(Study Material)
Answer
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.

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Question 21
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.
(Study Material)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 659
Answer
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.

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Question 22
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?
(Practice Manual)
Answer

Although there are no mandatory periodic interest payments, the instrument 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.

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Question 23
A company borrowed ` 50 lacs @ 12% p.a. Tenure of the loan is 10 years. Interest is payable
every year and the principal is repayable at the end of 10th year. The company defaulted in
payment of interest for the year 4, 5 and 6.
A loan reschedule agreement took place at the end of 7 year. As per the agreement the company
is required to pay ` 90 lacs at the end of 8th year. Calculate the additional amount to be paid on
account of rescheduling and also the book value of loan at the end of 8th year when reschedule
agreement took place. (Study Material)
Answer
Assumption: Interest is compounded in case of default.
Outstanding Amount at the end of 8th year
= ` 50,00,000 x 1.12 x 1.12 x 1.12 x 1.12 x 1.12
= ` 88,11,708 (i.e. adding interest for 4th to 8th year)
Rescheduled amount to be paid at the end of the 8th year = ` 90,00,000
Additional amount to be paid on rescheduling
= ` 90,00,000 - ` 88,11,7081 = ` 1,88,291

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660 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 24
A company borrowed a sum of `85 lakhs for its expansion. The terms of loan were as follows:
(i) Tenure of the loan will be 10 years.
(ii) Interest is payable @ 12% p.a. and the principal is repayable at the end of 10th year.
The company defaulted in the payment of interest for the year 4, 5 and 6.
A Loan reschedule agreement took place at the end of 7th year. As per the agreement the
company is required to pay `150 lakhs at the end of 8th year.
You are required to calculate the additional amount to be paid on account of rescheduling and
also the book value of the loan at the end of 8th year when reschedule took place assuming that
interest will be compounded in case of default. (May 2016, 4 Marks)

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Question 25
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.
(Study Material)
Answer
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.

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Question 26
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 repayment in the event of
liquidation. Accordingly, they constitute the most subordinate class of instruments. Examine the
nature of the financial instrument.
(Study Material)
Answer
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.
It may be noted that the most subordinate class of instruments may consist of two or more legally
separate types of instruments.

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Question 27
T Motors Ltd. has issued puttable ordinary shares and puttable ‘A’ ordinary shares 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.
(Study Material)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 661
Answer
Neither of the two classes of puttable shares can be classified as equity, as they do not have
identical features due to the difference in voting rights. It is not possible for T Motors Ltd. to
achieve equity classification of the ordinary shares by designating them as being more
subordinate than the ‘A’ ordinary shares, as this does not reflect the fact that the two classes of
share are equally entitled to share in entity’s residual assets on liquidation.

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Question 28
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.
(Study Material)
Answer
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.

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Question 29
P Ltd. has issued puttable ordinary shares to Q Ltd. Q Ltd. has also entered into an asset
management contract with P Ltd. whereby Q Ltd. is entitled to 50% of the profit of P Ltd. Normal
commercial terms for 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.
(Study Material)
Answer
The puttable ordinary shares cannot qualify for equity classification as (a) in addition to the put
option, there is another contract between the issuer (P Ltd.) and holder of puttable instrument (Q
Ltd.) whose cash flows 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 and (c) it has the
effect of substantially restricting return on puttable ordinary shares.
If the terms of asset management contract were assessed to be similar to terms of a contract
between a non-instrument holder and the issuer, it would not have precluded equity classification
for puttable shares, provided other conditions are met.
To summarise, the following conditions are required to be fulfilled in each of the two contexts set
out at the beginning of this paragraphs:
♦ Puttable instruments
♦ Instruments that create an obligation only on liquidation of the entity

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662 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 30
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?
(Study Material)
Answer
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 arrangement 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.

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Question 31
Entity A issues a bond with face value of USD 100 and carrying a fixed coupon rate of 6% p.a.
Each bond is convertible into 1,000 equity shares of the issuer. Examine the nature of the
financial instrument.
(Study Material)
Answer
While the number of equity shares is fixed, the amount of cash is not. The variability in cash
arises on account of fluctuation in exchange rate of INR-USD. Such a foreign currency
convertible bond (FCCB) will qualify the definition of “financial liability”.
However, Ind AS 32.11 provides, “the equity conversion option embedded in a convertible bond
denominated in foreign currency to acquire a fixed number of the entity’s own equity instruments
is an equity instrument if the exercise price is fixed in any currency.”
Accordingly, FCCB will be treated as an “equity instrument”.

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Question 32
In the following situations evaluate whether the preference shares are an equity instrument or a
financial liability to the issuer entity.
Situation 1: A company has issued 6% mandatorily redeemable preference shares with
mandatory fixed dividends.
Situation 2: A company issued non-redeemable preference shares with dividend payments
linked to ordinary shares. Also state whether your answer will differ if the dividend payments are
cumulative. (May 2016, 4 Marks)

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Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 663
Question 33
C Ltd wishes to purchase a new ride for their 'Animation Galaxy' theme park. In order to fund this,
they have had to obtain extra funding. On 30 September 20X3, C Ltd issued the following
preference shares:
• 1 million preference shares for `3 each. No dividends are payable. C Ltd will redeem the
preference shares in three years' time by issuing ordinary shares worth `3 million. The exact
number of ordinary shares issuable will be based on their fair value on 30 September 20X6.
• 2 million preference shares for `2.80 each. No dividends are payable. The preference
shares will be redeemed in two years' time by issuing 3 million ordinary shares.
• 4 million preference shares for `2.50 each. They are not mandatorily redeemable. A
dividend is payable if, and only if, dividends are paid on ordinary shares.
Required
Discuss whether these financial instruments should be classified as financial liabilities or equity in
the financial statements of C Ltd for the year ended 30 September 20X3.
(Dip. IFRS – UK)
Answer
IAS 32 States that a financial liability is any contract that may be settled in the entity's own equity
instruments and is a non-derivative for which I the entity is obliged to deliver a variable number of
its own equity instruments.
Therefore, a contract that requires the entity to deliver as many of the entity's own equity
instruments as are equal in value to a certain amount should be treated as debt.
C Ltd must redeem the first set of preference shares by issuing ordinary shares equal to the value
of `3 million. The `3 million received from the preference share issue should be classified as a
liability on the Balance Sheet.
2m preference shares
An equity instrument is any contract that evidences a residual interest in the net assets of an
entity after deducting all of its liabilities.
A contract that will be settled by the entity receiving (or delivering) a fixed number of its own
equity instruments in exchange for a fixed amount of cash or another financial asset is an equity
instrument.
C Ltd will redeem the second preference share issue with a fixed number of ordinary shares.
Therefore, the `5.6 million from the second preference share issue should be classified as equity
in the Balance Sheet.
4m preference shares
A financial liability exists if there is an obligation to deliver cash or another financial asset.
There is no obligation for C Ltd to repay the instrument.
Dividends are only payable if they are also paid on ordinary shares. There is no obligation to pay
dividends on ordinary shares so there is no obligation to pay dividends on these preference
shares.
The instrument is not a financial liability. The proceeds from the preference share issue should
therefore be classified as equity in the Balance Sheet.

  
664 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 34
A Company has issued 6% 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?
Answer
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 this example provides for mandatory periodic fixed dividend payments 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 entirety.
(Study Material)

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Question 35
A Company issued non-redeemable preference shares with mandatory fixed dividends. Evaluate
whether such preference shares are an equity instrument or a financial liability to the issuer
entity?
(Practice Manual)
Answer
When preference shares are non-redeemable, the appropriate classification is determined by the
other rights attached to them. Classification is based on an assessment of the contractual
arrangement's substance and the definitions of a financial liability and an equity instrument.
It is necessary to examine the particular contractual rights attaching to the instrument's principal
and return components. In this example, the shares are non-redeemable and thus the amount of
the principal has equity characteristics, but the entity has a contractual obligation to pay dividends
that provides the shareholders with a lender's return. This obligation is not negated if the entity is
unable to pay the dividends because of lack of funds or insufficient distributable profits.
Therefore, the obligation to pay the dividends meets the definition of a financial liability.
The overall classification is that the shares may be a compound instrument, which may require
each component to be accounted for separately. It would be a compound instrument if the
coupon was initially set at a rate other than the prevailing market rate or the terms specified
payment of discretionary dividends in addition to the fixed coupon. If the coupon on the
preference shares was set at market rates at the date of issue and there were no provisions for
the payment of discretionary dividends, the entire instrument would be classified as a financial
liability, because the stream of cash flows is in perpetuity.

  
Question 36
A company issued Non-redeemable preference shares with dividend payments linked to ordinary
shares. Evaluate whether such preference shares are an equity instrument or a financial liability
to the issuer entity?
(Study Material)
Answer
An entity issues a non-redeemable preference shares on which dividends are payable only if the
entity also pays a dividend on its ordinary shares.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 665
The dividend payments on the preference shares are discretionary and not contractual, because
no dividends can be paid if no dividends are paid on the ordinary shares, which are an equity
instrument. As the perpetual preference shares contain no contractual obligation ever to pay
dividends and there is no obligation to repay the principal, they should be classified as equity in
their entirety.
Where the dividend payments are also cumulative, that is, if no dividends are paid on the ordinary
shares, the preference dividends are deferred, the perpetual shares will be classified as equity
only if the dividends can be deferred indefinitely and the entity does not have any contractual
obligations whatsoever to pay those dividends.
A liability for the dividend payable would be recognised once the dividend is declared.

  
Question 37
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 dividend on equity shares. Analyse the nature of this instrument.
(Study Material)
Answer
In the above case, two main characteristics of the preference shares are:
(i) Preference shares carry dividend, which is payable only when Company declares
dividend on equity shares
(ii) Preference share are irredeemable.
Analysing the definition of equity, an instrument meets definition of equity if:
(a) It contains no contractual obligation to pay cash; and
(b) Where an instrument shall be settled in own equity instruments, it’s 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 –
(i) Face value is not redeemable (except in case of liquidation); and
(ii) 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 38
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.
(Wrong Solution) (Study Material)
Answer
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.
666 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
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 39
D Ltd. issues preference shares to G Ltd. The holder has an option to convert these preference
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.
(Study Material)
Answer
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.

  
Question 40
D Ltd. issues preference shares to G Ltd. The holder has an option to convert these preference
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.
(Study Material)
Answer
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.
The other component, conversion option with the holder, is an equity feature if the “fixed for fixed”
test is satisfied. If the conversion option does not fulfil that test, say, because the conversion ratio
varies in response to an underlying variable, it is a derivative liability.
Such an instrument is called a “hybrid instrument”.

  
Question 41
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
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.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 667
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.
(Study Material)
Answer
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

  
Question 42
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. using
a pre-determined formula. The formula is:
100 crores × (1 + 10%) A 5
———————————————
Fair value on date of conversion
Examine the nature of the financial instrument.
(Study Material)
Answer
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’.

  
Question 43
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.
(Study Material)
Answer
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. The preference shareholder is not entitled to residual
net assets of the issuer.

  
668 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 44
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.
(Study Material)
Answer
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 shareholders.

  
Question 45
On 1 January 20X1, RHT Ltd. subscribes to convertible preference shares of RDT Ltd.
The preference shares are convertible as below:
Convertible 1:1 if another strategic investor invests at an enterprise valuation (EV) of
USD 100 million.
Convertible 1.5:1: if another strategic investor invests at EV of USD 150 million
Convertible 2:1: if another strategic investor invests at EV of USD 200 million
Convertible 3:1: if no strategic investment is made within a period of 3 years
Examine the nature of the financial instrument.
(Study Material)
Answer
The four events are interdependent because the second event cannot be met without also
meeting the first event, and the third event cannot be met unless the first two are met.
Therefore, this contract should be treated as a single instrument when applying the “fixed for
fixed” test. The test is then failed because the number of shares to be exchanged for cash are
variable.

  
Question 46
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.
(Study Material)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 669
Answer
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 shareholders.
The conversion was always intended to be in a fixed ratio and hence the holder is exposed to the
change in equity value. The variability is brought in to maintain holder’s exposure in line with
other holders.

  
Question 47
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.
(Study Material)
Answer
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 48
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.
(Study Material)
Answer
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 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”.

  
670 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 49
A Ltd. invests 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 years. Such
CCPS carry dividend @ 12% per annum, payable only when declared at the discretion of B Ltd.
Evaluate this under definition of financial instrument.
(Study Material)
Answer
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 50
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.
(Study Material)
Answer
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 51
The amortisation schedule of the instrument is set out below:
Dates Cash flows Finance cost at effective interest rate Liability Equity
1July 20X1 1,000,000 - 9,24,061 75,939
30 June 20X2 (60,000) 83,165 9,47,226 75,939
30 June 20X3 (60,000) 85,250 9,72,476 75,939
30 June 20X4 (10,60,000) 87,524 - 75,939
Assume that D Ltd. has an early redemption option to prepay the instrument at ` 11 lakhs and on
30 June 20X3, it exercises that option. Calculate the value of the liability and equity components.
Assume Interest Rate has changed to 5% in market.
(Study Material)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 671
Answer
Ind AS 32 requires that the amount paid (of ` 11 lakhs) is split by the same method as is used in
the initial recording. However, at 30 June 20X3, the interest rate has changed. At that time, D Ltd.
could have issued a one-year (i.e. maturity 30 June 20X4) non-convertible instrument at 5%.
The split will be made as below:
Particulars Amount (`)
Present value of principal payable at 30 June 20X4 in one year’s time (`10 9,52,381
lakhs discounted at 5% for one year)
Present value of interest payable (` 60,000 discounted at 5% for one year) 57,142
Total liability component 10,09,523
Consideration paid 11,00,000
Residual – equity component 90,477
Accordingly, the difference between consideration allocated to liability component (` 10,09,523)
less carrying amount of financial liability on date of redemption i.e. 30 June 20X3 (` 9,72,476),
amounting to ` 37,047 is recognised in profit or loss.
The residual i.e. consideration allocated to equity component is debited to equity.
An entity may amend the terms of a convertible instrument to induce early conversion, for
example by offering a more favourable conversion ratio or paying other additional consideration in
the event of conversion before a specified date.
The difference, at the date the terms are amended, between:
• the fair value of the consideration the holder receives on conversion of the instrument
under the revised terms and
• the fair value of the consideration the holder would have received under the original
terms is recognised as a loss in profit or loss.

  
Question 52
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.
(Study Material)
Answer
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.

  
672 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 53
Neptune Ltd. issued 15,000, 12% convertible debentures for `15 lakhs of `100 each at face value
on 1st April 20X1 which will be converted into equity instruments on 31st March 20X6. Similar
debentures without conversion right carry interest rate of 15%.
The CFO of the company has advised to recognise the 12% debentures in the balance sheet
equivalent to the amount of face value of debentures issued i.e. `15 lakhs. The interest expense
for the period is recognised at the contracted rate in the Statement of Profit and Loss by the
company i.e. `1,80,000 (`15 lakhs x 12%).
Required:
Analyse whether the above accounting treatment advised by CFO is in compliance with the Ind
AS. If not, advise the correct treatment alongwith working for the same.
(Study Material)
Answer
The above treatment needs to be analysed from the purview of provisions given in Ind AS 32, Ind
AS 107 and Ind AS 109 on ‘Financial Instruments’.
The terms of a financial instrument may be structured such that it contains both equity and liability
components (i.e. by substance, the instrument is neither a liability nor an equity instrument in
entirety).
Para 11 of Ind AS 32 ‘Financial Instruments : Presentation’ states that:
“A financial liability is any liability that is:
(a) a contractual obligation:
(i) to deliver cash or …..
An equity instrument is any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities”.
Paragraph 28 of Ind AS 32 states that:
“The issuer of a non-derivative financial instrument shall evaluate the terms of the financial
instrument to determine whether it contains both a liability and an equity component. Such
components shall be classified separately as financial liabilities, financial assets or equity
instruments in accordance with paragraph 15.”
Further, paragraph 32 of Ind AS 32 which deals with separating the liability and equity
components, states that:
“The issuer of a bond convertible into ordinary shares first determines the carrying amount of
the liability component by measuring the fair value of a similar liability (including any
embedded non- equity derivative features) that does not have an associated equity
component. The carrying amount of the equity instrument represented by the option to
convert the instrument into ordinary shares is then determined by deducting the fair value of
the financial liability from the fair value of the compound financial instrument as a whole.”
Further, paragraph 5.1.1 of Ind AS 109 states that:
“at initial recognition, an entity shall measure a financial asset or financial liability at its fair value”.
Further, paragraph 5.1.1 of Appendix B to Ind AS 109 provides the guidance to determine the fair
value of liability:
The fair value of the liability component on initial recognition is the present value of the
contractual stream of future cash flows discounted at the market rate of interest that would have
been applied to an instrument of comparable credit quality with substantially the same cash flows,
on the same terms, but without the conversion option.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 673
Further, paragraph 4.2.1 of Ind AS 109 provides that:
The financial liability component will be subsequently measured depending on its classification
either as a financial liability at FVTPL, or as a Financial liability measured at amortised cost (using
the effective interest rate method).
As per the facts of the case study given in the question, the liability component is measured at
amortised cost using the effective interest rate method.
The equity component will not be required to remeasured.
The CFO of the Neptune Ltd. has advised to recognise 12% debenture in the balance sheet
equivalent to the amount of face value of debentures issued i.e. `15 lakhs without separating into
the liability and equity component and `1,80,000 as interest expense for the period is recognised
at the contracted rate in the Statement of Profit and Loss which is not correct and not in
accordance with Ind AS 32, 107 and 109.
Accordingly, the 12% debentures initially need to be separated between the liability and equity
component using the guidance given under Ind AS 32. The liability component shall be initially
measured at the fair value and subsequently at the amortised cost. The interest expense is
calculated by using the effective interest method. It may be noted that equity component will not
be remeasured.
(a) Calculation of Financial liability INR
Year Cash outflow Discounting Factor (15%) Present Value
1 1,80,000 0.870 1,56,600
2 1,80,000 0.756 1,36,080
3 1,80,000 0.658 1,18,440
4 1,80,000 0.572 1,02,960
5 1,80,000 0.497 89,460
Total 6,03,540
(b) Separating the liability and equity components
Equity component = Fair value of the instrument as whole – Financial liability
= `15,00,000 – `6,03,540
= `8,96,460
The following journal entry is required to pass on the initial recognition of the instrument:
` `
Bank Account Dr. 15,00,000
To Financial Liability 6,03,540
To Equity 8,96,460
(c) Amortisation table INR
Year Opening balance Interest (15%) Repayment Closing balance of
of liability liability
(a) (b) = (a) x 15% (c) (d) = (a +b -c)
1 6,03,540 90,531 1,80,000 5,14,071
2 5,14,071 77,111 1,80,000 4,11,182
3 4,11,182 61,677 1,80,000 2,92,859
4 2,92,859 43,929 1,80,000 1,56,788
5 1,56,788 23,212 (b.f.) 1,80,000 Nil
674 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Balance Sheet extracts showing the presentation of compounded financial instrument as
at 31st March 20X2
Ind AS compliant Division II of Schedule III needs to be referred for presentation requirement in
Balance Sheet on Ind AS. INR
Equity and Liabilities
Equity
Other Equity
Equity component of compound financial instrument 8,96,460
Liabilities
Non-Current liabilities
Financial Liabilities
(i) Borrowings (5,14,071 – 1,02,889) 4,11,182
Current liabilities
Financial Liabilities
(i) Other Financial Liabilities (5,14,071 – 4,11,182) 1,02,889
The Equity component of compound financial instrument needs to be shown as a separate
column in Statement of Changes in Equity as per Ind AS compliant Schedule III.

  
Question 54
C Ltd issues a `100,000 4% three-year convertible loan on 1 January 20X6. The market rate of
interest for a similar loan without conversion rights is 8%. The conversion terms are one equity
share (`1 nominal value) for every `2 of debt. Conversion or redemption at par takes place on 31
December 20X8.
Required:
How should this be accounted for:
(a) if all holders elect for the conversion?
(b) no holders elect for the conversion?
(Dip. IFRS – UK)
Answer
Up to 31 December 20X8, the accounting entries are the same under both scenarios.
(1) Splitting the proceeds
The cash payments on the bond should be discounted to their present value using the
interest rate for a bond without the conversion rights, i.e. 8%.
Date Cash flow Discount Present
factor value
` ` `
31/12/X6 Interest 4,000 1/1.08 3,704
31/12/X7 Interest 4,000 1/1.08 3,429
31/12/X8 Interest and principal 104,000 1/1.08 82,559
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 675

Date Cash flow Discount Present

factor value
` ` `
Liability component A 89,692
Net proceeds of issue were B 100,000
Equity component B-A 10,308

(2) The annual finance costs and year end carrying amounts

Opening Finance cost Cash paid Closing balance

balance (8%)
` ` ` `
X6 89,692 7,175 (4,000) 92,867
X7 92,867 7,429 (4,000) 96,296
X8 96,296 7,704 (4,000) 100,000
(3) (a) Conversion
The carrying amounts at 31 December 20X8 are:
`
Equity 10,308
Liability - bond 100,000
110,308
If the conversion rights are exercised, then 50,000 (`100,000 + 2) equity shares of `1 are issued
and `60,308 is classified as share premium.
(b) Redemption
The carrying amounts at 31 December 20X8 are the same as under 3a. On redemption, the
`100,000 liability is extinguished by cash payments. The equity component remains within
equity, probably as a non-distributable reserve.

  
Question 55
On 1 January 20X1 D Ltd issued a `50m three-year convertible bond at par.
• There were no issue costs.
• The coupon rate is 10%, payable annually in arrears on 31 December.
• The bond is redeemable at par on 1 January 20X4.
• Bondholders may opt for conversion in the form of shares. The terms of conversion are two
25 paise equity shares for every `1 owed to each bondholder on 1 January 20X4.
• Bonds issued by similar entities without any conversion rights currently bear interest at 15%.
• Assume that all bondholders opt for conversion in shares.
676 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Required
How will this be accounted for by D Ltd?
(Dip. IFRS – UK)
Answer
On initial recognition, the proceeds received must be split between liabilities and equity.
(1) Splitting the proceeds
The cash payments on the bond should be discounted to their present value using the
interest rate for a bond without the conversion rights, i.e. 15%.
Date Cash flow Discount factor Present value
(15%)
`000 `000
31-Dec-X1 Interest 5,000 1/1.15 4,347.8
31-Dec-X2 Interest 5,000 1/1.15 3,780.7
31-Dec-X3 Interest 5,000 1/1.15 3,287.6
1-Jan-X4 Principal 50,000 1/1.15 32,875.8
Liability component A 44,291.9
Net proceeds of issue B 50,000.0
Equity component B-A 5,708.1
(2) Measuring the liability at amortised cost
The liability component is measured at amortised cost. The working below shows the
finance costs recorded in the statement of profit or loss for each year as well as the carrying
value of the liability in the Balance Sheet at each reporting date.
Opening bal. Finance cost Payments Closing bal.
(15%)
`000 `000 `000 `000
20X1 44,291.9 6,643.8 (5,000) 45,935.7
20X2 45,935.7 6,890.4 (5,000) 47,826.1
20X3 47,826.1 7,173.9 (5,000) 50,000.0
(3) The conversion of the bond
The carrying amounts at 1 January 20X4 are:
`000
Equity 5,708.1
Liability - bond 50,000.0
55,708.1
The conversion terms are two 25-cent equity shares for every `1. Therefore 100m shares (`50m
x 2), will be issued which have a nominal value of `25m. The remaining `30,708,100 should be
classified as the share premium, also within equity. There is no remaining liability, because
conversion has extinguished it.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 677
The double entry is as follows:
`000
Dr Other components of equity 5,708.1
Dr Liability 50,000.0
Cr Share capital 25,000.0
Cr Share premium 30,708.1

  
Question 56
ABC Company issued 10,000 compulsory cumulative convertible preference shares (CCCPS) as
on 1 April 20X1 @ Rs 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 from 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-20X6
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%
Transaction Cost 30,000
Face value of equity share after conversion 10
Number of equity shares to be issued 5,000
Journalise
(Study Material)
Answer
This is a compound financial instrument with two components – liability representing present
value of future cash outflows and balance represents equity component.
(a) Computation of Liability & Equity Component
Date Particulars Cash Flow Discount Net present
Factor Value
01-Apr-20X1 0 1 0.00
31-Mar-20X2 Dividend 150,000 0.869565 130,434.75
31-Mar-20X3 Dividend 150,000 0.756144 113,421.6
31-Mar-20X4 Dividend 150,000 0.657516 98,627.4
31-Mar-20X5 Dividend 150,000 0.571753 85,762.95
678 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Date Particulars Cash Flow Discount Net present
Factor Value
31-Mar-20X6 Dividend 150,000 0.497177 74,576.55
Total Liability Component 502,823.25
Total Proceeds 1,500,000.00
Total Equity Component (Bal fig) 997,176.75

(b) Allocation of transaction costs

Particulars Amount Allocation Net Amount

Liability Component 502,823 10,056 492,767
Equity Component 997,177 19,944 977,233
Total Proceeds 1,500,000 30,000 1,470,000
(c) 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.
Assume the effective interest rate is 15.86%

Opening Interest Cash Closing

Financial B Flow Financial
Liability C Liability
A A+B-C
01-Apr-20X1 492,767 - - 4,92,767
31-Mar-20X2 492,767 78,153 150,000 4,20,920
31-Mar-20X3 420,920 66,758 150,000 3,37,678
31-Mar-20X4 337,678 53,556 150,000 2,41,234
31-Mar-20X5 241,234 38,260 150,000 1,29,494
31-Mar-20X6 129,494 20,506 150,000 -

(d) Journal Entries to be recorded for entire term of arrangement are as follows:
Date Particulars Debit Credit
01-Apr-20X1 Bank A/c Dr. 1,470,000
To Preference Shares A/c 492,767
To Equity Component of Preference shares A/c 977,233
(Being compulsorily convertible preference shares
issued. The same are divided into equity component
and liability component as per the calculation)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 679

Date Particulars Debit Credit

31-Mar-20X2 Preference shares A/c Dr. 150,000
To Bank A/c 150,000
(Being Dividend at the coupon rate of 10% paid to the
shareholders)
31-Mar-20X2 Finance cost A/c Dr. 78,153
To Preference Shares A/c 78,153
(Being interest as per EIR method recorded)
31-Mar-20X3 Preference shares A/c Dr. 150,000
To Bank A/c 150,000
(Being Dividend at the coupon rate of 10% paid to the
shareholders)
31-Mar-20X3 Finance cost A/c Dr. 66,758
To Preference Shares A/c 66,758
(Being interest as per EIR method recorded)
31-Mar-20X4 Preference shares A/c Dr. 150,000
To Bank A/c 150,000
(Being Dividend at the coupon rate of 10% paid to the
shareholders)
31-Mar-20X5 Finance cost A/c Dr. 53,556
To Preference Shares A/c 53,556
(Being interest as per EIR method recorded)
31-Mar-20X5 Preference shares A/c Dr. 150,000
To Bank A/c 150,000
(Being Dividend at the coupon rate of 10% paid to the
shareholders)
31-Mar-20X5 Finance cost A/c Dr. 38,260
To Preference Shares A/c 38,260
(Being interest as per EIR method recorded)
31-Mar-20X6 Preference shares A/c Dr. 150,000
To Bank A/c 150,000
(Being Dividend at the coupon rate of 10% paid to the
shareholders)
680 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Date Particulars Debit Credit

31-Mar-20X6 Finance cost A/c Dr. 20,506
To Preference Shares A/c 20,506
(Being interest as per EIR method recorded)
31-Mar-20X6 Equity Component of Preference shares A/c Dr. 977,233
To Equity Share Capital A/c 50,000
To Securities Premium A/c 927,233
(Being Preference shares converted in equity shares
and remaining equity component is recognised as
securities premium)

  
Question 57
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 years.
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.
(Study Material)
Answer
(a) Applying the guidance for compound instruments, the present value of the bond is
computed to identify the liability component and then difference between the present
value of these bonds & the issue price of INR 1 crore shall be allocated to the equity
component. In determining the present value, the rate of 8 per cent will be used, which is
the interest rate paid on debt of a similar nature and risk that does not provide an option
to convert the liability to ordinary shares.
Present value of bonds at the market rate of debt
Present value of principal to be received in eight years discounted at 8%
(10,000,000 × 0.5403) = 5,403,000
Present value of interest stream discounted at 8% for 8 years
(6,00,000 × 5.7466) = 3,447,960
Total present value = 8,850,960
Equity component = 1,149,040
Total face value of convertible bonds = 10,000,000
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 681
The accounting entries will be as follows:
Dr. Cr.
Amount Amount
(INR) (INR)
1 July 20X1
Cash Dr. 10,000,000
To Convertible bonds (liability) 8,850,960
To Convertible bonds (equity component) 1,149,040
(Being entry to record the convertible bonds and the recognition of
the liability and equity components)

30 June 20X2
Interest expense Dr. 708,077
To Cash 600,000
To Convertible bonds (liability) 108,077
(Being entry to record the interest expense, where the expense
equals the present value of the opening liability multiplied by the
market rate of interest).

(b) The stream of interest expense is 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 8 per cent.

Date Payment Interest expense Increase in Total bond

at 8% bond liability
liability
01 July 20X1 8,850,960
30 June 20X2 600,000 708,077 108,077 8,959,037
30 June 20X3 600,000 716,723 116,723 9,075,760
30 June 20X4 600,000 726,061 126,061 9,201,821
30 June 20X5 600,000 736,146 136,146 9,337,967
30 June 20X6 600,000 747,037 147,037 9,485,004
30 June 20X7 600,000 758,800 158,800 9,643,804
30 June 20X8 600,000 771,504 171,504 9,815,308
30 June 20X9 600,000 784,692* 184,692 10,000,000
* for rounding off
682 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(c) if the holders of the options elect to convert the options to ordinary shares at the end of
the third year of the debentures (after receiving their interest payments), the entries in the
third would be:

Dr. Cr.
Amount Amount
(INR) (INR)
30 June 20X4
Interest expense Dr. 726,061
To Cash 600,000
To Convertible bonds (liability) 126,061
(Being entry to record interest expense for the period)
30 June 20X4
Convertible bonds (liability) Dr. 9,201,821
Convertible bonds (equity component) Dr. 1,149,040
To Contributed equity 10,350,861
(Being entry to record the conversion of bonds into shares of A
Limited).

  
Question 58
K Ltd. issued 500,000, 6% convertible debentures@ ` 10 each on 01 April 20X1. The debentures
are due for redemption on 31 March 20X5 at a premium of 10%, 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 rights was 10%.
You are required to separate the debt and equity components at the time of issue and show the
accounting entries in Company’s books at initial recognition. The following present values of Re 1
at 6% and at 10% are provided:
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
(Study Material)
Answer
Computation of debt component of convertible debentures on 01 April 20X1
Particulars Amount
Present value of principal amount repayable after 4 years
(A) 5,000,000 × 50% × 1.10 × 0.68 (10% discount factor) 1,870,000
(B) Present value of interest [300,000 × 3.17] (4 years cumulative 10% 951,000
discount factor)
Total present value of debt component (A) + (B) 2,821,000
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 683

Particulars Amount
Issue proceeds from convertible debentures 5,000,000
Value of equity component 2,179,000
Journal entry at initial recognition –
Particulars Dr. Amount (`) Cr. Amount (`)
Bank A/c Dr. 5,000,000
To 6% debenture A/c (liability component) 2,821,000
To 6% debenture A/c (equity component) 2,179,000
(Being disbursement recorded at fair value)

  
Question 59
On 1 April 20X1, an 8% convertible loan with a nominal value of ` 6,00,000 was issued at par. It
is redeemable on 31 March 20X5 also at par. Alternatively, it may be converted into equity shares
on the basis of 100 new shares for each ` 200 worth of loan.
An equivalent loan without the conversion option would have carried interest at 10%. Interest of `
48,000 has already been paid and included as a finance cost.
Present value rates are as follows:
Year End @ 8% @ 10%
1 0.93 0.91
2 0.86 0.83
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 20X2.
(Study Material)
Answer
Step 1 There is an ‘option’ to convert the loans into equity i.e. the loan note holders do not
have to accept equity shares; they could demand repayment in the form of cash.
Ind AS 32 states that where there is an obligation to transfer economic benefits there
should be a liability recognised. On the other hand, where there is not an obligation to
transfer economic benefits, a financial instrument should be recognised as equity.
In the above illustration we have both – ‘equity’ and ‘debt’ features in the instrument.
There is an obligation to pay cash – i.e. interest at 8% per annum and a redemption
amount – this is ‘financial liability’ or ‘debt component’. The ‘equity’ part of the
transaction is the option to convert. So it is a compound financial instrument.
Step 2 Debt element of the financial instrument so as to recognise the liability is the present
value of interest and principal
684 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
The rate at which the same is to be discounted, is the rate of equivalent loan note
without the conversion option would have carried interest at 10%, therefore this is the
rate to be used for discounting
Step 3 Calculation of the debt element of the loan note as follows:
8% Interest discounted at a rate of 10% Present Value (6,00,000 x 8%)
S. No Year Interest amount PVF Amount
Year 1 20X2 48,000 0.91 43,680
Year 2 20X3 48,000 0.83 39,840
Year 3 20X4 48,000 0.75 36,063
1,19,583
Year 4 20X5 648,000 0.68 4,40,640
Amount to be recognised as a liability 5,60,223
Initial proceeds (6,00,000)
Amount to be recognised as equity 39,777
* In year 4, the loan note is redeemed therefore ` 6,00,000 + ` 48,000 = ` 6,48,000.
Step 4 The next step is to recognise the interest component equivalent to the loan that would
carry if there was no option to cover. Therefore, the interest should be recognised at
10%.
As on date ` 48,000 has been recognised in the statement of profit and loss i.e.
6,00,000 x 8% but we have discounted the present value of future interest payments
and redemption amount using discount factors of 10%, so the finance charge in the
statement of profit and loss must also be recognised at the same rate i.e. for the
purpose of consistency.
The additional charge to be recognised in the income statement is calculated as:
Debt component of the financial instrument ` 5,60,000
Interest charge (5,60,000 x 10%) ` 56,000
Already charged to the income statement (` 48,000)
Additional charge required ` 8,000
Journal Entries for recording additional finance cost for year ended 31 March 20X2:
Particulars Dr. Amount Cr. Amount
(`) (`)
Finance cost A/c Dr. 8,000
To Debt component A/c 8,000
(Being interest recorded for difference between amount
recorded earlier and that to be recorded per Ind AS 32)

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 685
Question 60
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 31.03.19 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.
(Practice Manual)
Answer
Liability 28,24,320, Equity 1,75,680

  
Question 61
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 settle d in cash to the debenture
holders. 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 Year3 Year 4
6% 0.94 0.89 0.84 0.79
10% 0.91 0.83 0.75 0.68
(Study Material)
Answer
Computation of Debt Component of Convertible Debentures as on 1.4.2015
Particulars `
Present value of the principal repayable after four years 18,70,000
[50,00,000 x 50%× 1.10 × 0.68 (10% Discount factor)] (a) 9,51,000
Present value of Interest [3,00,000 x 3.17 (4 years cumulative 10%
discount factor)](b) 28,21,000
Total present Value of debt component (I) (a + b) Issue proceeds
from convertible debenture (II) 50,00,000
Value of equity component (II – I) 21,79,000
Journal entry at initial recognition
Dr. (`) Cr. (`)
Cash/Bank A/c Dr. 50,00,000
To 6% Debenture (Liability component) A/c 28,21,000
To 6% Debenture (Equity component) A/c 21,79,000
(Being the disbursement recorded at fair value)

  
686 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 62
On 1 April, 2014 Omega Ltd. Issued ` 10,00,000, 6% convertible debentures of face value of
`100 per debenture at par. The debentures are redeemable at a premium of 10% on 31.03.2018
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%.
The present value of ` 1 receivable at the end of the end of each year based on discount rates of
6% and 10% can be taken as:
6% 10%
End of year 1 0.94 0.91
2 0.89 0.83
3 0.84 0.75
4 0.79 0.68
Being compound financial instrument, you are required to calculate the debt portion of the
debentures as on 01.04.2014. (Old Study Material)
Answer
Liability 9,38,200, Equity 61,800

  
Question 63
Mega Ltd. Issued ` 1,00,00,000 worth of 8% Debentures of face value `100 each on par value
basis on 1st January, 2014. These debentures are redeemable at 12% premium at the end of
2017 or exchangeable for ordinary shares of Mega Ltd. on 1:1 basis. The interest rate for similar
debentures that do not carry conversion entitlement is 12%. You are required to calculate the
value of the debt portion of the above compound financial instrument. The present value of the
rupee at the end of years 1 to 4 at 8% and 12% are supplied to you as:
8% 12%
End of year 1 0.926 0.893
End of year 2 0.857 0.797
End of year 3 0.794 0.712
End of year 4 0.735 0.636
(Old Study Material)

  
Question 64
On 1st April, 2015 Sigma Ltd issued 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 a compound financial
instrument, you are required to separate equity and debt portions as on 01-04-2015. Equity
portion is `1,85,400. Find out the debt portion (Debenture amount). The present value of `1
receivable at the end of each year based on discount rates of 6% and 10% can be taken as:
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 687

End of year 6% 10%

1 0.94 0.91
2 0.89 0.83
3 0.84 0.75
4 0.79 0.68
(Old Study Material)

  
Question 65
You are required to—
(i) Identify the Equity and Liability components;
(ii) Compute bond liability at the end of each year, and
(iii) Give necessary journal entries from the information given below:
Number, value and period of 4,000 bonds, issued at the beginning of year 1, face value is
convertible bonds `1,000 per bond (3 years validity)
Proceeds received `40 lacs
Interest rate on the bond 6% pa. payable annually
Conversion At the bond holders' discretion, conversion into 250 ordinary
shares for each bond of `1000
Prevailing market rate 9% per annum, for bonds issued without conversion option
Present value factors for 9% 0.917, 0.841, 0.772
(Old Study Material)

  
Question 66
At the beginning of year 1, an enterprise issued 20,000 convertible debentures with face value
`100 per debenture, at par. The debentures have six-year term. The interest at annual rate of 9%
is paid half-yearly. The bondholders have an option to convert half of the face value of
debentures into 2 ordinary shares at the end of year 3. The bondholders not exercising the
conversion option will be repaid at par to the extent of `50 per debenture at the end of year 3.
The non-convertible portion will be repaid at 10% premium at the end of year 6. At the time of
issue, the prevailing market interest rate for similar debt without conversion option was 10%.
Compute value of liability. (Old Study Material)

  
Question 67
K. Ltd. issued 5,00,000, 6% Convertible Debentures of ` 10 each on the First of April 2010. The
debentures are due for redemption on 31st March, 2014 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 holders
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.
688 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
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
(November 2013, 4 Marks)

  
Question 68
Adventure Limited issued 20,000, 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 year 3. The balance non-convertible portion will be repaid at
10% premium at the end of term of the debenture. At the time of issue, the prevailing market
interest rate for similar debt without convertibility option is 10%.
Present Value of annuity is as under:
Period 1-3 4-6 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 years 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 and equity component and pass necessary journal entries
recognizing the issue of debentures.
(Solution in suggested Answer is as per AS 30)
(November 2014, 4 Marks)

  
Question 69
You are required to
(i) Identify Equity and Liability Components.
(ii) Compute bond liability at the end of each year and
(iii) Pass necessary journal entries from the following information:
Number of convertible bonds : 5000 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
Proceeds Received : ` 25 Lacs
Conversion : At the bond holders’ discretion, conversion into
125 ordinary shares for each bond of ` 500.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 689

Prevailing Market Rate : 11% p.a., for bonds issued without conversion
option
Present Value factor for 11% : 0.900, 0.812, 0.731 (for one year, two years and
three years, respectively)
(November 2015, 8 Marks)

  
Question 70
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 years. If the option is not exercised by the holder, the
preference shares are redeemed at the end of 3 years. 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.
(Study Material)
Answer
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 71
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 years. If the option is not exercised by the holder, the preference
shares are redeemed at the end of 3 years. The preference shares carry a coupon of RBI base
rate plus 1% p.a.
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.
(Study Material)
Answer
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
690 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Present value of interest payable in arrears for 3 years (` 100,000 discounted at 13% for each of
3 years) = ` 2,36,115

  
Question 72
A Limited buys back 1,00,000 of its own equity shares in the market for ` 5 per share. The shares
will be held as treasury shares to enable A Limited to satisfy its obligations under its employee
share option scheme. The following entry will be made to recognise the purchase of the treasury
shares as a deduction from equity: Journalise
(Study Material)
Answer

Dr Equity ` 5,00,000
Cr Cash ` 5,00,000

  
Question 73
Company X owes Company Y `20 million at the end of 31 March. As part of another contract,
Company Y owes Company X `15 million at 31 March. Company X has the legal right to set off
the asset and liability but historically, Company X has settled one month after Company Y settles.
Can Company X offset the asset and liability?
(Practice Manual)
Answer
No, since Company X cannot demonstrate the intention to settle net or simultaneously for all
payments.

  
Question 74
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. are traded on a stock exchange.
Regular way delivery is two days. Assess the forward contract.
(Study Material)
Answer
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.
On the other hand, if the forward contract is a regular way transaction, such fair value changes
are recognised in other comprehensive income if share of ABC Ltd. are equity instruments and
not held for trading.

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 691
Question 75
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.
(Study Material)
Answer
In this case, the options contract is a regular way transaction as the settlement of the option is
governed by regulation or convention in the marketplace for options. Fair value changes between
the trade date and settlement date are recognised in other comprehensive income if share of VT
Ltd. are equity instruments and not held for trading by NKT Ltd.

  
Question 76
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.
(Study Material)
Answer
Journal Entries in the Buyer’s Books
Trade date accounting
Dr./ Particulars Amortised Fair value Fair value
Cr. cost 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 income - - (50,000)
Cr. Cash (10,00,000) (10,00,000) (10,00,000)
Settlement date accounting
Dr./ Particulars Amortised Fair value Fair value
Cr. 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) -
Cr. Other comprehensive income - - (50,000)
Cr. Cash (10,00,000) (10,00,000) (10,00,000)
692 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
The above mentioned accounting principles apply only to financial assets and Ind AS 109 does
not contain any such principles for financial liabilities.

  
Question 77
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
(a) Amortised cost
(b) FVTPL
(c) FVTOCI
(Practice Manual)
Answer
Financial Asset at Amortised Cost – Trade Date Accounting
Dates Journal Entry Amount Amount
30/3/2015 Financial Asset Dr. 100
To Payables 100
31/3/2015 No Entry
2/4/2015 Payables Dr. 100
To Cash 100
Financial Asset at Amortised Cost – Settlement Date Accounting
Dates Journal Entry Amount Amount
30/3/2015 No Entry
31/3/2015 No Entry
2/4/2015 Financial Asset Dr. 100
To Cash 100
Financial Asset at FVTPL – Trade Date Accounting
Dates Journal Entry Amount Amount
30/3/2015 Financial Asset Dr. 100
To Payables 100
31/3/2015 Financial Asset Dr. 2
To P&L 2
2/4/2015 Financial Asset Dr. 1
To P&L 1
Payables Dr. 100
To Cash 100
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 693
Financial Asset at FVTPL– Settlement Date Accounting
Dates Journal Entry Amount Amount
30/3/2015 No Entry
31/3/2015 Fair Value Change Dr. 2
To P&L 2
2/4/2015 Fair Value Change Dr. 1
To P&L 1
Financial Asset Dr. 103
To Cash 100
To Fair Value Change 3
Financial Asset at FVTOCI – Trade Date Accounting
Dates Journal Entry Amount Amount
30/3/2015 Financial Asset Dr. 100
To Payables 100
31/3/2015 Financial Asset Dr. 2
To OCI 2
2/4/2015 Financial Asset Dr. 1
To OCI 1
Payables Dr. 100
To Cash 100
Financial Asset at FVTOCI – Settlement Date Accounting
Dates Journal Entry Amount Amount
30/3/2015 No Entry
31/3/2015 Fair Value Change Dr. 2
To OCI 2
2/4/2015 Fair Value Change Dr. 1
To OCI 1
Financial Asset Dr. 103
To Cash 100
To Fair Value Change 3

  
694 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 78
Instrument D is loan with full recourse and is secured by collateral. Does the collateral affect the
nature of contractual cash flows?
(Study Material)
Answer
The fact that a full recourse loan is collateralised 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 dues.

  
Question 79
Instrument A is a bond with a stated maturity date. Payments of principal and interest on the
principal amount outstanding are linked to an 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
(Study Material)
Answer
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 (eg 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

  
Question 80
An entity has a business model with the objective of originating loans to customers and
subsequently selling those loans to a securitisation vehicle. The securitisation vehicle issues
instruments to investors. The originating entity controls the securitisation vehicle and thus
consolidates it.
The securitisation 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 recognised because they
are not derecognised by the securitisation vehicle.
Evaluate the business model.
(Study Material)
Answer
The entity originating loans to customers has the objective of realising contractual cash flows on
the loan portfolio only through sale to securitisation vehicle. However, the consolidated group
originates loans with the objective of holding them to collect the contractual cash flows.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 695
— 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.

  
Question 81
Instrument F is a bond that is convertible into a fixed number of equity instruments of the issuer.
Analyse the nature of cash flows.
(Study Material)
Answer
The holder would analyse the convertible bond in its entirety. 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 82
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 minimising 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.
(Study Material)
Answer

— Although the entity considers, among other information, the financial assets' fair values
from a liquidity perspective (ie the cash amount that would be realised if the entity needs
to sell assets), the entity's objective is to hold the financial assets in order to collect the
contractual cash flows.
— Sales would not contradict that objective if they were in response to an increase in the
assets' credit risk, for example if the assets no longer meet the credit criteria specified in
the entity's documented investment policy. Infrequent sales resulting from unanticipated
funding needs (e.g. in a stress case scenario) also would not contradict that objective,
even if such sales are significant in value.
Hence, the business model of the company is to collect contractual cash flows and not realisation
from sale of financial assets.

  
696 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 83
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.
(Study Material)
Answer
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 (e.g. some of the financial assets are credit impaired at
initial recognition).
Moreover, the fact that the entity enters into derivatives to modify the cash flows of the portfolio
does not in itself change the entity's business model.

  
Question 84
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.
(Study Material)
Answer
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
amortised cost.

  
Question 85
A financial institution holds financial assets to meet liquidity needs in a 'stress case' scenario (eg,
a run on the bank's 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 realised.
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 realised 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.
(Study Material)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 697
Answer
The objective of the entity's business model is to hold the financial assets to collect contractual
cash flows. The analysis would not change – 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. 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 86
Instrument H is a perpetual instrument but the issuer may call the instrument at any point and pay
the holder the par amount plus accrued interest due.
Instrument H pays a market interest rate but payment of interest cannot be made unless the
issuer is able to remain solvent immediately afterwards. Deferred interest does not accrue
additional interest. Analyse the nature of cash flows.
(Study Material)
Answer
The contractual cash flows are not payments of principal and interest on the principal amount
outstanding. That is because the issuer may be required to defer interest payments and
additional interest does not accrue on those deferred interest amounts. As a result, interest
amounts are not consideration for the time value of money on the principal amount outstanding.
If interest accrued on the deferred amounts, the contractual cash flows could be payments of
principal and interest on the principal amount outstanding.

  
Question 87
Instrument G is a loan that pays an inverse floating interest rate (ie the interest rate has an
inverse relationship to market interest rates). Analyse the nature of cash flows.
(Study Material)
Answer
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 comprises of interest payable on any
funds lent, as a 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 solely payments of principal and
interest on the principal amount outstanding.

  
698 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 88
An entity acquires a financial asset for CU100 plus a purchase commission of CU2. Initially, the
entity recognises the asset at CU102. The reporting period ends one day later, when the quoted
market price of the asset is CU100. If the asset were sold, a commission of CU3 would be paid.
How would transaction costs be accounted in books of the entity?
(Study Material)
Answer
— On that date, the entity measures the asset at CU100 (without regard to the possible
commission on sale) and recognises a loss of CU2 in other comprehensive income.
— If the financial asset is measured at fair value through other comprehensive income in
accordance with paragraph 4.1.2A, the transaction costs are amortised to profit or loss
using the effective interest method.

  
Question 89
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 years.
Compute the fair value upon initial recognition of the loan in books of Target Ltd. and how will
loan processing fee be accounted?
(Study Material)
Answer
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.
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 90
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 fee @ 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 years.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 699
Compute the fair value upon initial recognition of the loan in books of Target Ltd.
(Study Material)
Answer
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.
Accordingly, if the fair value is to be computed by discounting all future cash flows (including
principal and interest) at the market rate of interest (which is the same as that of the respective
loans), the fair value shall be the principal amount itself.
Further, any transaction costs like the aforementioned 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%*1,000,000) = 9,90,000
Fair value (3 year term loan) = 8,00,000 – 8,000 (1%*800,000) = 7,92,000.

  
Question 91
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 theses 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.
(Study Material)
Answer
The classification assessment for a financial asset is done based on two contractual
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.

  
Question 92
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. Journalise
(Study Material)
700 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Answer
The Company has made an irrecoverable option to carry its investment at fair value through other
comprehensive income. Accordingly, the investment shall be initially recognised at fair value and
all subsequent fair value gains/losses shall be recognised in other comprehensive income (OCI).
Journal entries
Particulars Amount Amount
Upon initial recognition –
Investment in equity shares of C Ltd. Dr. 5,00,000
To Bank a/c 5,00,000
(Being investment recognized at fair value plus transaction costs upon
initial recognition)

  
Question 93
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,[Link] 31 March, the fair value of the equity shares was
` 11,200 and market rate of interest is 10% per annum for a 10 year loan. Pass necessary journal
entries. Analyse the measurement principal and pass necessary journal entries.
(ICAI Solution is incorrect) (Study Material)
Answer
The above investment is in equity shares of C Ltd and hence, does not involve any contractual
cash flows that are solely payments of principal and interest. Hence, these equity shares shall be
measured at fair value through profit or loss. Also, an irrecoverable option exists to designate
such investment as fair value through other comprehensive income.
Journal Entries
Particulars Amount Amount
Upon initial recognition –
Investment in equity shares of C Ltd. Dr. 10,500
To Bank a/c 10,500
(Being investment recognized at fair value plus transaction costs upon
initial recognition)

Subsequently –
Investment in equity shares of C Ltd. Dr. 1,700
To Fair value gain on financial instruments 1,700
(Being fair value gain recognized at year end in P&L)

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 701
Question 94
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 assuming financial asset is accounted at FVTPL
(Practice Manual)
Answer

Date Particulars Dr Cr
15/3/2015 Investment A/c 10,000
Transaction Cost A/c 200
To Bank 10,200
31/3/2015 Investment A/c 2,000
To P&L A/c 2,000
31/3/2015 P&L A/c 200
To Transaction Cost A/c 200

  
Question 95
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. Assuming financial asset is accounted at FVTOCI
(Practice Manual)
Answer

Date Particulars Dr Cr
15/3/2015 Investment A/c 10,200
To Bank 10,200
31/3/2015 Investment A/c 1,800
To Fair Value Gain A/c 1,800
31/3/2015 Fair Value Gain A/c 1,800
To OCI A/c 1,800
31/3/2015 OCI A/c 1,800
To Fair Value Reserve A/c 1,800

  
Question 96
On April 1, 20X1, Pluto Ltd. has advance a loan for `10 lakhs to one of its employees for an
interest rate at 4% per annum (market rate 10%) which is repayable in 5 equal annual
installments along with interest at each year end. Employee is not required to give any specific
performance against this benefit.
702 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
The accountant of the company has recognised the staff loan in the balance sheet equivalent to
the amount disbursed i.e. `10 lakhs. The interest income for the period is recognised at the
contracted rate in the Statement of Profit and Loss by the company i.e. `40,000 (`10 lakhs x 4%).
Required:
Analyse whether the above accounting treatment made by the accountant is in compliance with
the Ind AS. If not, advise the correct treatment alongwith working for the same.
(Study Material)
Answer
The above treatment needs to be examined in the light of the provisions given in Ind AS 32 and
Ind AS 109 on Financial Instruments’ and Ind AS 19 ‘Employee Benefits’.
Para 11 (c) (i) of Ind AS 32 ‘Financial Instruments : Presentation’ states that:
“A financial asset is any asset that is:
(c) a contractual right:
(i) to receive cash or…..”
Further, paragraph 5.1.1 of Ind AS 109 states that:
“at initial recognition, an entity shall measure a financial asset or financial liability at its fair value”.
Further, paragraph 5.1.1 of Appendix B to Ind AS 109 states that:
“The fair value of a financial instrument at initial recognition is normally the transaction price (i.e.
the fair value of the consideration given or received. However, if part of the consideration given or
received is for something other than the financial instrument, an entity shall measure the fair
value of the financial instrument. For example, the fair value of a long term loan or receivable that
carries no interest can be measured as the present value of all future cash receipts discounted
using the prevailing market(s) of interest rate of similar instrument with a similar credit rating. Any
additional amount lent is an expense or reduction of income unless it qualifies for recognition as
some other type of asset”.
Further, paragraph 5.2.1 of Ind AS 109 states that:
“After initial recognition, an entity shall measure a financial asset at:
(a) amortised cost;
(b) fair value through other comprehensive income; or
(c) fair value through profit or loss.
Further, paragraph 5.4.1 of Ind AS 109 states that:
“Interest revenue shall be calculated by using the effective interest method. This shall be
calculated by applying the effective interest rate to the gross carrying amount of a financial asset”
Paragraph 8 of Ind AS 19 states that:
“Employee Benefits are all forms of consideration given by an entity in exchange for service
rendered by employees or for the termination of employment”.
The Accountant of Pluto Ltd. has recognised the staff loan in the balance sheet at `10 lakhs
being the amount disbursed and `40,000 as interest income for the period is recognised at the
contracted rate in the statement of profit and loss which is not correct and not in accordance with
Ind AS 19, Ind AS 32 and Ind AS 109.
Accordingly, the staff advance being a financial asset shall be initially measured at the fair value
and subsequently at the amortised cost. The interest income is calculated by using the effective
interest method. The difference between the amount lent and fair value is charged as Employee
benefit expense in statement of profit and loss.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 703
(a) Calculation of Fair Value of the Loan
Year Cash Inflow Discounting Factor (10%) Present Value
1 2,40,000 0.909 2,18,160
2 2,32,000 0.826 1,91,632
3 2,24,000 0.751 1,68,224
4 2,16,000 0.683 1,47,528
5 2,08,000 0.621 1,29,168
Total 8,54,712
Staff loan should be initially recorded at `8,54,712.
(b) Employee Benefit Expense
Loan Amount – Fair Value of the loan = `10,00,000 – `8,54,712 = `1,45,288
`1,45,288 shall be charged as Employee Benefit expense in Statement of Profit and Loss
for the year ended 31.03.20X2.
Amortisation table:
Year Opening balance of Interest (10%) Repayment Closing
Staff Advance balance of
(a) (b)= (a x 10%) (c) Staff Advance
(d) = a + b -c
1 8,54,712 85,471 2,40,000 7,00,183
2 7,00,183 70,018 2,32,000 5,38,201
3 5,38,201 53,820 2,24,000 3,68,021
4 3,68,021 36,802 2,16,000 1,88,823
5 1,88,823 19,177 (b.f.) 2,08,000 Nil
Balance Sheet extracts showing the presentation of staff loan as at 31st March
20X2
Ind AS compliant Division II of Sch III needs to be referred for presentation requirement in
Balance Sheet on Ind AS.
Assets
Non-Current Assets
Financial Assets
(i) Loan 5,38,201
Current Assets
Financial Assets
(i) Loans (7,00,183 - 5,38,201) 1,61,982

  
704 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 97
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 along with 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 years.
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
4 .683
5 .620
(Study Material)
Answer

(i) Calculation of initial recognition amount of loan to employees

Cash Inflow Total P.V. Present
Year end Principal Interest @ 5% factor value
` @10%
` `
`
2015 3,20,000 80,000 4,00,000 0.909 3,63,600
2016 3,20,000 64,000 3,84,000 0.827 3,17,568
2017 3,20,000 48,000 3,68,000 0.751 2,76,368
2018 3,20,000 32,000 3,52,000 0.683 2,40,416
2019 3,20,000 16,000 3,36,000 0.620 2,08,320
Present value or Fair value 14,06,272
(ii) Calculation of amortised cost of loan to employees
Year Amortised cost Interest to be Repayment Amortised Cost
(Opening balance) recognised@10% (including (Closing
[1] [2] interest) [3] balance) [4]=[1]+
[2]–[3]
` ` ` `
2015 14,06,272 1,40,627 4,00,000 11,46,899
2016 11,46,899 1,14,690 3,84,000 8,77,589
2017 8,77,589 87,759 3,68,000 5,97,348
2018 5,97,348 59,735 3,52,000 3,05,083
2019 3,05,083 30,917* 3,36,000 Nil
* ` 3,05,083 x 10% = ` 30,508. The difference of ` 409 (` 30,917 – ` 30,508) is due to
approximation in computation.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 705
(iii) Journal Entries in the books of Y Ltd.
For the year ended 31st December, 2015 (regarding loan to employees)
Dr. Amount Cr.
(`) Amount (`)
Staff loan A/c 16,00,000
To Bank A/c 16,00,000
(Being the disbursement of loans to staff)
Staff cost A/c ` (16,00,000 –14,06,272) [Refer part (ii]) 1,93,728
To Staff loan A/c
(Being the write off of excess of loan balance over present value 1,93,728
thereof in order to reflect the loan at its present value of `
14,06,272)
Staff loan A/c 1,40,627
To Interest on staff loan A/c 1,40,627
(Being the charge of interest @ market rate of 10% on the loan)
Bank A/c 4,00,000
To Staff loan A/c 4,00,000
(Being the repayment of first instalment with interest for the year)
Interest on staff loan A/c 1,40,627
To Profit and loss A/c 1,40,627
(Being transfer of balance of staff loan Interest account to profit
and loss account)

  
Question 98
Comforts Ltd. granted ` 10,00,000 loan to its employees on January 1, 2014 at a concessional
interest rate of 4% per annum. Loan is to be repaid in five equal annual instalments along with
interest. Market rate of interest for such loan is 10% per annum. Following the principles of
recognition and measurement as laid down in Ind AS 109 'Financial Instruments : Recognition
and Measurement', record the entries for the year ended 31st December, 2014 for the loan
transaction, and also calculate the value of loan initially to be recognised and amortised cost for
all the subsequent years. The present value of ` 1 receivable at the end of each year based on
discount factor of 10% can be taken as:
Year end 1 0.9090
2 0.8263
3 0.7512
4 0.6829
5 0.6208 (Old Study Material)

  
706 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 99
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, 2014.
Following the principles of recognition and measurement as laid down in AS 30, you are required
to record the entries for the year ended 31st December, 2014 for the transaction and also
calculate the value of the loan initially to be recognized and the amortized cost for all the
subsequent years.
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
4 .683
5 .620
(Old Study Material)

  
Question 100
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.
(Study Material)
Answer
Computation of Fair Value at Initial Recognition
Year Estimated Cash Flows PVIF @8% Present Value
1/4/2015 1 Nil
31/3/2016 2,00,000 0.9259 1,85,185
31/3/2017 2,00,000 0.8573 1,71,468
31/3/2018 2,00,000 0.7938 1,58,766
31/3/2019 2,00,000 0.7350 1,47,006
31/3/2020 2,00,000 0.6806 1,36,117
31/3/2021 60,000 0.6302 37,810
See Working note
31/3/2022 60,000 0.5835 35,009
See Working note
Fair Value of Loan 8,71,361
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 707
Working Notes:
Computation of Interest to be paid on 31/3/2021 and 31/3/2022
Year Cash Flows Principal Interest Cumulative
outstanding Interest
31/3/2016 2,00,000 8,00,000 40,000 40,000
31/3/2017 2,00,000 6,00,000 32,000 72,000
31/3/2018 2,00,000 4,00,000 24,000 96,000
31/3/2019 2,00,000 2,00,000 16,000 1,12,000
31/3/2020 2,00,000 Nil 8,000 1,20,000
31/3/2021 60,000
(1,20,000/2)
31/3/2022 60,000
(1,20,000/2)
Computation of Fair Value Loss
Fair Value of Loan 8,71,361
Loan Amount 10,00,000
Fair Value Loss 1,28,639
Journal Entry at Initial Recognition
Date Particulars Dr Cr
1/4/2015 Loans to Employee A/c 8,71,361
Employee Benefits A/c 1,28,639
To Bank A/c 10,00,000
Note: Employee benefit is transferred to Statement of Profit and Loss.
Computation of Interest on Amortised Cost
Year Opening Interest @ 8% Repayment Closing
Balance (2) Balance
(1) (3) (1+2-3)
1/4/2015 8,71,361
31/3/2016 8,71,361 69,709 2,00,000 7,41,070
31/3/2017 7,41,070 59,286 2,00,000 6,00,356
31/3/2018 6,00,356 48,028 2,00,000 4,48,384
31/3/2019 4,48,384 35,871 2,00,000 2,84,255
31/3/2020 2,84,255 22,740 2,00,000 1,06,995
31/3/2021 1,06,995 8,560 60,000 55,555
31/3/2022 55,555 4,445 60,000 Nil
708 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Journal Entry on 31/3/2016

Date Particulars Dr Cr
31/3/2016 Loans to Employee A/c 69,709
To Interest Accrued A/c 69,709
31/3/2016 Bank A/c 2,00,000
To Loan to Employees 2,00,000
Note: Similar entries would be done at the end of each year.

  
Question 101
Friendly Ltd granted `100 lakhs as loan to its employees on 1st January, 2014 at a concessional
rate of interest of 4 per cent per annum on the condition that the loan is to be repaid in five equal
annual installments along with interest thereon. You are informed that the prevailing lending rate
for such risk profiles is 10% pa. You are required to find out at what value the loan should be
recognized initially and the amount of annual amortization till closure thereof. Show Journal
Entries with appropriate narrations that will be recorded in the company's Books in the year 2014.
[Present value of an Indian Rupee at a discount rate of 10% per annum will be .9090, .8203,
.7512, .6829 and .6208 which is to be adopted for purposes of calculation]. (Old Study Material)

  
Question 102
Comforts Ltd. granted ` 10,00,000 loan to its employees on January 1, 2009 at a concessional
interest rate of 4% per annum. Loan is to be repaid in five equal instalments alongwith interest.
Market rate of interest for such loan is 10% per annum. Following the principles of recognition
and measurement record the entries for the year ended 31st December, 2009 for the loan
transaction, and also calculate the value of loan initially to be recognized and amortised cost for
all the subsequent years. The present value of Re. 1 receivable at the end of each year on
discount factor of 10% can be taken as:
Year end 1. 0.9090
2. 0.8263
3. 0.7512
4. 0.6829
5. 0.6208
(May 2010, 4 Marks)

  
Question 103
Lovely Limited has advanced staff loan of ` 50 lacs 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.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 709
Find out the value at which the loan should initially be recognized and its amortization till closure
thereof. Also give necessary journal entries with appropriate narration for financial year 2014-15.
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
(May 2015, 8 Marks)

  
Question 104
As part of staff welfare measures, Y Co Ltd. has contracted to lend to its employees sums of
money at 5% per annum rate of interest. The amounts lent are to be repaid along with the interest
in five equal instalments. The market rate of interest is 10% per annum for comparable loans. Y
lent ` 1,600,000 to its employees on 1st January 20X1.
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 31 December 20X1, for the transaction and also
compute the value of loan initially to be recognised and amortised cost for all subsequent years.
For the purpose of calculation, following discount factors at interest rate of 10% per annum may
be adopted –
At the end of year –
Year Present value factor
1 .909
2 .827
3 .751
4 .683
5 .620
(Study Material)
Answer
Calculation of initial recognition amount of loan to its employees:
Year end Cash flow Total PV Present
factor value
Principal Interest @ 5%
20X1 320,000 80,000 400,000 .909 363,600
20X2 320,000 64,000 384,000 .827 317,568
20X3 320,000 48,000 368,000 .751 276,368
20X4 320,000 32,000 352,000 .683 240,416
20X5 320,000 16,000 336,000 .620 208,320
1,406,272
710 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(ii) Calculation of amortised cost of loan to employees
Year Amortised Interest to be Repayment Amortised cost
end cost recognised (including interest) (closing balance)
(opening
balance)
20X1 1,406,272 140,627 400,000 1,146,899
20X2 1,146,899 114,690 384,000 877,589
20X3 877,589 87,759 368,000 597,348
20X4 597,348 59,735 352,000 305,083
20X5 305,083 30,917* 336,000 -
* 305,083 * 10% = 30,508. Difference of ` 409 is due to approximation in computation.
(iii) Journal Entries to be recorded of Y Ltd. for the year ended 31 December 20X1
Particulars Debit Credit
Staff loan A/c Dr. 16,00,000
To Bank A/c 16,00,000
(Being disbursement of loans to staff)
Prepaid staff cost A/c* Dr. [(1,600,000 – 1,406,272), Refer part (ii)] 1,93,728
To Staff loan A/c 1,93,728
(Being the excess loan balance over present value thereof in order to
reflect the loan at its present value booked as prepaid)
Staff loan A/c Dr. 1,40,627
To Interest expense A/c 1,40,627
(Being interest accrued on loans to staff)
Staff cost A/c Dr. 38,746
To Prepaid expense A/c 38,746
(Being interest accrued on loans to staff)
* Where the difference between the amount given by the Company to its employees and its fair
value represents another asset, then such asset shall be recognised. Accordingly, such
difference is recognised as prepaid employee cost and amortised over the period of loan.

  
Question 105
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
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 711
• 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
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 in `)
Inflows
Date Outflows Principal Interest Interest Principal
income income outstanding
7% 4%
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., 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 in `)
Inflows
Date Outflows Principal Interest Interest Principal
income income outstanding
7% 4%
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 - 16,000 200,000
31-Dec-20X4 200,000 - 8,000 -
31-Dec-20X5 - - - -
Record journal entries in the books of Wheel Co. Limited considering the requirements of Ind AS
109.
(Study Material)
Answer
As per requirement of Ind AS 109, a financial instrument is initially measured and recorded at its
fair value. Therefore, considering the market rate of interest of similar loan available to Mr. X is
12%, the fair value of the contractual cash flows shall be as follows:
712 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Inflows Discount factor @12%

Date Principal Interest Interest PV
income 7% income 4%
31-Dec-20X1 200,000 42,000 16,000 0.8929 2,30,357
31-Dec-20X2 200,000 28,000 16,000 0.7972 1,94,515
31-Dec-20X3 200,000 14,000 16,000 0.7118 1,63,709
31-Dec-20X4 200,000 - 16,000 0.6355 1,37,272
31-Dec-20X5 200,000 - 8,000 0.5674 1,18,025
Total (fair value) 8,43,878
Benefit to Mr. X, to be considered a part of employee cost for Wheel Co. ` 1,56,121
The deemed employee cost is to be amortised over the period of loan i.e. the minimum period
that Mr. X must remain in service.
The amortization schedule of the ` 843,878 loan is shown in the following table:
Date Loan outstanding Total cash inflows Interest @
(principal repayment 12%
+ interest
1-Jan-20X1 843,878
31-Dec-20X1 687,143 258,000 101,265
31-Dec-20X2 525,600 244,000 82,457
31-Dec-20X3 358,672 230,000 63,072
31-Dec-20X4 185,713 216,000 43,041
31-Dec-20X5 (0) 208,000 22,287
Journal Entries to be recorded at every period end:
(a) 1 January 20X1 –
Particulars Dr. Cr.
Amount Amount
(`) (`)
Loan to employee A/c Dr. 843,879
Pre-paid employee cost A/c Dr 156,121
To Cash A/c 10,000,000
(being loan asset recorded at initial fair value)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 713
(b) 31 December 20X1 –
Particulars Dr. Cr.
Amount Amount
(`) (`)
Cash A/c Dr. 258,000
To Interest income (profit and loss) @12% A/c 101,265
To loan to employee A/c 156,735
(being first instalment of repayment of loan accounted for using
the amortised cost and effective interest rate of 12%)

Particulars Dr. Amount Cr. Amount

(`) (`)
Employee benefit (profit and loss) A/c Dr. 31,224
To Pre-paid employee cost A/c 31,224
(being amortization of pre-paid employee cost charged to profit
and loss as employee benefit cost)
On 31 December 20X2, due to pre-payment of a part of loan by Mr. X, the carrying value of the
loan shall be re-computed by discounting the future remaining cash flows by the original effective
interest rate.
There shall be two sets of accounting entries on 31 December 20X2, first the realisation of the
contractual cash flow as shown in (c) below and then the accounting for the pre-payment of `
200,000 included in (d) below:
(c) 31 December 20X2 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Cash A/c Dr. 244,000
To Interest income (profit and loss) @12% A/c 82,457
To loan to employee A/c 161,543
(being second instalment of repayment of loan accounted for
using the amortised cost and effective interest rate of 12%)

Particulars Dr. Amount Cr. Amount

(`) (`)
Employee benefit (profit and loss) A/c Dr 31,224
To Pre-paid employee cost A/c 31,224
(being amortization of pre-paid employee cost charged to profit
and loss as employee benefit cost)
714 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Computation of new carrying value of loan to employee:
Inflows Discount factor
@12%
Principal Interest Interest PV
Date income 7% income 4%
31-Dec-20X3 200,000 - 16,000 0.8929 192,857
31-Dec-20X4 200,000 - 8,000 0.7972 165,816
Total (revised carrying value) 358,673
Less: Current carrying value 525,601
Adjustment required 166,928
The difference between the amount of pre-payment and adjustment to loan shall be considered a
gain, though will be recorded as an adjustment to pre-paid employee cost, which shall be
amortised over the remaining tenure of the loan.
(d) 31 December 20X2 prepayment–
Particulars Dr. Cr.
Amount Amount
(`) (`)
Cash A/c Dr. 200,000
To Pre-paid employee cost A/c 33,072
To loan to employee A/c 166,928
(being gain to Wheel Co. Limited recorded as an adjustment to pre-
paid employee cost)
The amortisation schedule of the new carrying amount of loan shall be as follows:
Date Loan outstanding Total cash inflows Interest @
(principal repayment + 12%
interest
31-Dec-20X2 358,673
31-Dec-20X3 185,714 216,000 43,041
31-Dec-20X4 — 208,000 22,286
Amortisation of employee benefit cost shall be as follows:
Date Balance Amortised to P&L Adjustment
1-Jan-20X1 156,121
31-Dec-20X1 124,897 31,224
31-Dec-20X2 60,601 31,224 33,072
31-Dec-20X3 30,300 30,300
31-Dec-20X4 - 30,300
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 715
(e) 31 December 20X3 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Cash A/c Dr. 216,000
To Interest income (profit and loss) @12% A/c 43,041
To loan to employee A/c 172,959
(being third instalment of repayment of loan accounted for using
the amortised cost and effective interest rate of 12%)
Employee benefit (profit and loss) A/c Dr 30,300
To Pre-paid employee cost A/c 30,300
(being amortization of pre-paid employee cost charged to profit
and loss as employee benefit cost)
(f) 31 December 20X4 –
Particulars Dr. Amount Cr.
(`) Amount
(`)
Cash A/c Dr 208,000
To Interest income (profit and loss) @12% A/c 22,286
To loan to employee A/c 185,714
(being last instalment of repayment of loan accounted for using
the amortised cost and effective interest rate of 12%)

Particulars Dr. Amount Cr. Amount

(`) (`)
Employee benefit (profit and loss) A/c Dr 30,300
To Pre-paid employee cost A/c 30,300
(being amortization of pre-paid employee cost charged to profit
and loss as employee benefit cost)

  
Question 106
A Company lends ` 100 lacs to another company on 1/4/2015. It incurs ` 40,000 incremental
costs for documentation.
Loan tenure = 5 years
Pass necessary Journal entries. Assuming Financial Asset Accounted at Amortised Cost
(Practice Manual)
Answer
Date Particulars Dr Cr
1/4/2015 Loan A/c 100 lacs
To Bank A/c 100 lacs
716 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Date Particulars Dr Cr
1/4/2015 Loan Processing Expense A/c 40,000
To Bank A/c 40,000
1/4/2015 Loan A/c 40,000
To Loan Processing Expense A/c 40,000

  
Question 107
On 1 January 20X1 James issued a loan note with a `50,000 nominal value. It was issued at a
discount of 16% of nominal value. The costs of issue were `2,000. Interest of 5% of the nominal
value is payable annually in arrears. The bond must be redeemed on 1 January 20X6 (after 5
years) at a premium of `4,611.
The effective rate of interest is 12% p.a.
Required:
How will this be reported in the financial statements of James over the period to redemption?
(Dip. IFRS – UK)
Answer
The liability will be initially recognised at the net proceeds received:
`
Face value 50,000
Less: 16% discount (8,000)
Less: Issue costs (2,000)
Initial recognition of liability 40,000
The liability is then measured at amortised cost:
Year Opening balance Finance cost Cash payments Closing balance
(Liability × 12%) (`50,000 x 5%)
` ` ` `
1 40,000 4,800 (2,500) 42,300
2 42,300 5,076 (2,500) 44,876
3 44,876 5,385 (2,500) 47,761
4 47,761 5,731 (2,500) 50,992
5 50,992 6,119 (2,500) 54,611
27,111 (12,500)
To: Profit or loss To: Statement of cash To: BS
flows
The finance charge taken to profit or loss in each year is greater than the actual interest paid.
This means that the value of the liability increases over the life of the instrument until it equals the
redemption value at the end of its term.
In Years 1 to 4 the balance shown as a liability is less than the amount that will be payable on
redemption. Therefore the full amount payable must be disclosed in the notes to the accounts.

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 717
Question 108
Case A: H Ltd raised finance on 1 January 20X1 by the issue of a two-year 2% bond with a
nominal value of `10,000. It was issued at a discount of 5% and is redeemable at a premium of
`1,075. Issue costs can be ignored. The bond has an effective rate of interest of 10%.
Case B: W Ltd raised finance by issuing `20,000 6% four-year loan notes on 1 January 20X4.
The loan notes were issued at a discount of 10%, and will be redeemed after four years at a
premium of `1,015. The effective rate of interest is 12%. The issue costs were `1,000.
Case C: C Ltd raised finance by issuing zero coupon bonds at par on 1 January 20X5 with a
nominal value of `10,000. The bonds will be redeemed after two years at a premium of `1,449.
Issue costs can be ignored. The effective rate of interest is 7%.
The reporting date for each entity is 31 December.
Required:
Illustrate and explain how these financial instruments should be accounted for by each company.
(Dip. IFRS – UK)
Answer
H Ltd has a financial liability to be measured at amortised cost.
The financial liability is initially recorded at the fair value of the consideration received (the net
proceeds of issue). This amount is then increased each year by interest at the effective rate and
reduced by the actual repayments.
H Ltd has no issue costs, so the net proceeds of issue were `9,500 (`10,000 less 5%). The
annual cash payment is `200 (the 2% coupon rate multiplied by the `10,000 nominal value of the
debt).
Sal b/fwd Finance costs Cash paid Bal c/fwd
(10%)
Rep date ` ` ` `
31 Dec X1 9,500 950 (200) 10,250
31 Dec X2 10,250 1,025 (200)
(11,075)
1,975
W Ltd has a liability that will be classified and accounted for at amortised cost and thus initially
measured at the fair value of consideration received less the transaction costs:
`
Cash received (`20,000 x 90%) 18,000
Less the transaction costs (1,000)
Initial recognition 17,000
The effective rate is used to determine the finance cost for the year - this is charged to profit or
loss. The coupon rate is applied to the nominal value of the loan notes to determine the cash paid
to the holder of the loan notes:
718 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Bal b/fwd Finance costs Cash paid Bal c/fwd

(12%)
Rep date ` ` ` `
31 DecX4 17,000 2,040 (1,200) 17,840
31 Dec X5 17,840 2,141 (1,200) 18,781
31 Dec X6 18,781 2,254 (1,200) 19,835
31 Dec X7 19,835 2,380 (1,200)
(21,015)
8,815
C Ltd has a financial liability to be measured at amortised cost.
It is initially recorded at the fair value of the consideration received. There is no discount on issue,
nor is there any issue costs to deduct from the initial measurement.
The opening balance is increased each year by interest at the effective rate. The liability is
reduced by the cash repayments - there are no interest repayments in this example because it is
a zero rate bond.
Bal b/fwd Finance costs Cash paid Bal c/fwd
(7%)
Rep date ` ` ` `
31 Dec X5 10,000 700 Nil 10,700
31 Dec X6 10,700 749 (11,449)

  
Question 109
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 till 31 December 20X3, after giving
effect of the changes in the terms of the loan on 31 December 20X2
(Study Material)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 719
Answer
On the date of initial recognition, the effective interest rate of the loan shall be computed keeping
in view the contractual cash flows and upfront processing fee paid. The following table shows the
amortisation of loan based on effective interest rate:
Date Cash flows Cash flows Amortised cost Interest @ EIR
(principal) (interest (opening + interest (11.50%)
and fee) – cash flows)
1-Jan-20X1 (500,000,000) 5,870,096 494,129,904
31-Dec-20X1 100,000,000 55,000,000 395,954,843 56,824,939
31-Dec-20X2 100,000,000 44,000,000 297,489,650 45,534,807
31-Dec-20X3 100,000,000 33,000,000 198,700,959 34,211,310
31-Dec-20X4 100,000,000 22,000,000 99,551,570 22,850,610
31-Dec-20X5 100,000,000 11,000,000 (0) 11,448,430

(a) 1 January 20X1 –

Particulars Dr. Amount Cr. Amount
(`) (`)
Cash A/c Dr. 494,129,904
To Loan from bank A/c 494,129,904
(being loan recorded at its fair value less transaction costs on
the initial recognition date)
(b) 31 December 20X1 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Loan from bank A/c Dr. 98,175,061
Interest expense (profit and loss) Dr. 56,824,939
To Cash A/c 155,000,000
(being first instalment of loan and payment of interest
accounted for as an adjustment to the amortised cost of loan)
(c) 31 December 20X2 – Before Wheel Co. Limited approached the bank –
Particulars Dr. Amount Cr. Amount
(`) (`)
Interest expense (profit and loss) Dr. 45,534,807
To Loan from bank A/c 1,534,807
To cash A/c 44,000,000
(being loan payment of interest recorded by the Company
before it approached the Bank for deferment of principal)
Upon receiving the new terms of the loan, Wheel Co. Limited, 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 requirements of Ind AS 109, any
change of more than 10% shall be considered a substantial modification, resulting in fresh
accounting for the new loan:
720 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Date Cash flows Interest outflow Discount factor PV of cash

(principal) @15% flows
31-Dec-20X2 (400,000,000)
31-Dec-20X3 40,000,000 60,000,000 0.8969 89,686,099
31-Dec-20X4 40,000,000 54,000,000 0.8044 75,609,805
31-Dec-20X5 40,000,000 48,000,000 0.7214 63,483,092
31-Dec-20X6 40,000,000 42,000,000 0.6470 53,053,542
31-Dec-20X7 40,000,000 36,000,000 0.5803 44,100,068
31-Dec-20X8 40,000,000 30,000,000 0.5204 36,429,133
31-Dec-20X9 40,000,000 24,000,000 0.4667 29,871,422
31-Dec-20Y0 40,000,000 18,000,000 0.4186 24,278,903
31-Dec-20Y1 40,000,000 12,000,000 0.3754 19,522,235
31-Dec-20Y3 40,000,000 6,000,000 0.3367 15,488,493
PV of new contractual cash flows discounted at 11.50% 451,522,791
Carrying amount of loan 397,489,650
Difference 54,033,141
Percentage of carrying amount 13.59%
Note: Calculation above done on full decimal, though in the table discount factor is limited to 4
decimals.
Considering a more than 10% change in PV of cash flows compared to the carrying value 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:
(d) 31 December 20X2 – accounting for extinguishment
Particulars Dr. Amount Cr. Amount
(`) (`)
Loan from bank (old) A/c Dr 397,489,650
Finance cost (profit and loss) Dr 2,510,350
To Loan from bank (new) A/c 400,000,000
(being new loan accounted for at its principal amount in
absence of any transaction costs directly related to such loan
and correspondingly a de-recognition of existing loan)
(e) 31 December 20X3
Particulars Dr. Amount Cr. Amount
(`) (`)
Loan from bank A/c Dr. 40,000,000
Interest expense (profit and loss) Dr. 60,000,000
To cash A/c 100,000,000
(being first instalment of the new loan and payment of interest
accounted for as an adjustment to the amortised cost of loan)

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 721
Question 110
A Ltd issued redeemable preference shares to a Holding Company – Z Ltd. The terms of the
instrument have been summarized 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: 100,000,000
Dividend rate 0.0001%
Market rate of interest 12.00% per annum
Present value factor 0.56743
(Study Material)
Answer
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 the financial
instrument, an entity shall measure the fair value of the financial instrument.
In the above case, since A Ltd has issued preference shares to its Holding Company – Z Ltd, the
relationship between the parties indicates that the difference in transaction price and fair value is
akin to investment made by Z Ltd. in its subsidiary.
Following is the able summarising the computations on initial recognition:
Market rate of interest 12.00%
Present value factor 0.56743
Present value 56,742,686
Loan component 56,742,686
Investment in subsidiary 43,257,314
Subsequently, such preference shares shall be carried at amortised cost at each reporting date.
The computation of amortised cost at each reporting date has been done as follows:
Year Date Opening Asset Days Interest @ 12% Closing balance
1-Apr-20X1
1 31-Mar-20X2 56,742,686 364 6,790,467 63,533,153
2 31-Mar-20X3 63,533,153 365 7,623,978 71,157,131
3 31-Mar-20X4 71,157,131 365 8,538,856 79,695,987
4 31-Mar-20X5 79,695,987 366 9,589,720 89,285,707
5 31-Mar-20X6 89,285,707 365 10,714,285 100,000,000
722 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Journal Entries to be done at every reporting date

Date Particulars Amount Amount

Date of transaction
Investment - Equity portion Dr. 43,257,314
Loan receivable Dr. 56,742,686
To Bank (100,000,000)
Interest income - March 31, 20X2
Loan receivable Dr. 6,790,467
To Interest income (6,790,467)
Interest income - March 31, 20X3
Loan receivable Dr. 7,623,978
To Interest income (7,623,978)
Interest income - March 31, 20X4
Loan receivable Dr. 8,538,856
To Interest income (8,538,856)
Interest income - March 31, 20X5
Loan receivable Dr. 9,589,720
To Interest income (9,589,720)
Interest income - March 31, 20X6
Loan receivable Dr. 10,714,285
To Interest income (10,714,285)
Settlement of transaction
Bank Dr. 100,000,000
To Loan receivable (100,000,000)

  
Question 111
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. Should financial
asset & financial liabilities be measured at FVTOCI/FVTPL or Amortised Cost?
(Practice Manual)
Answer
The entity may have classified the fixed rate assets as FVTOCI with gains and losses on changes
in fair value recognised in other comprehensive income and the fixed rate debentures at
amortised cost. Reporting both the assets and the liabilities at fair value through profit and loss
i.e. FVTPL corrects the measurement inconsistency and produces more relevant information.

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 723
Question 112
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. Provide your
comments.
(Study Material)
Answer
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). 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, i.e., 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 113
B Ltd regularly invests in assets that are measured at fair value through profit or loss. These
asset purchases are funded by issuing bonds. If the bonds were not remeasured to fair value, an
accounting mismatch would arise. Therefore, B Ltd designates the bonds to be measured at fair
value through profit or loss.
Required:
How should the bonds be accounted for?
(Dip. IFRS – UK)
Answer
The value of B Ltd's liability will be reduced by `30 million.

  
Question 114
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.
(Study Material)
Answer
In the above case, lessee (ie, customers leasing the containers) make interest free deposits,
which are refundable at the end of 3 years. Now, this money if it was to lent to a third party would
fetch interest @ 7% per annum.
724 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
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

  
Question 115
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
Description Lease
Total Lease Period (Years) 5
Discount rate 12.00%
Security deposit (A) 10,00,000
Present value of deposit at beginning (B) 5,67,427
Prepaid lease payment at beginning (A-B) 4,32,573
Present value annuity factor 0.56743
(Study Material)
Answer
The above security deposit is an interest free deposit redeemable at the end of lease term for `
1,000,000. Hence, this involves collection of contractual cash flows and shall be accounted at
amortised cost.
Upon initial measurement –
Particulars Details
Security deposit (A) 10,00,000
Total Lease Period (Years) 5
Discount rate 12.00%
Present value annuity factor 0.56743
Present value of deposit at beginning (B) 5,67,427
Prepaid lease payment at beginning (A-B) 4,32,573
Journal Entries
Particulars Amount Amount
Security deposit a/c Dr. 5,67,427
Prepaid expenses Dr. 4,32,573
To Bank a/c 10,00,000
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 725
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.
For instance – year 1
Particulars Amount Amount
Security deposit a/c Dr. 68,091
To Interest income 68,091
Rent expense Dr. 86,515
To Prepaid expenses 86,515
At the end of 5 years, the security deposit shall accrue to ` 10,00,000 and prepaid expenses shall
be fully amortised. Journal entry for realisation of security deposit –
Particulars Amount Amount
Bank a/c Dr. 10,00,000
To Security deposit a/c 10,00,000

  
Question 116
Explain the conditions required to be met for a Financial Asset to be measured at Amortized Cost
(applicable to Debt Instruments only).
X Company invested in Equity Shares of another entity on 15th March, 2016 for ` 1,00,000.
Transaction Cost= ` 2,000 (not included in ` 1,00,000). Fair value on Balance Sheet date i.e. 31st
March 2016= ` 1,20,000.
Pass necessary Journal entries (narration not required) if Financial Asset to be accounted as Fair
Value Through Other Comprehensive Income (FVTOCI). (November 2016, 4 Marks)

  
Question 117
A Ltd holds the following financial assets:
(1) Investments in ordinary shares that are held for short-term speculation.
(2) Investments in ordinary shares that, from the purchase date, are intended to be held for the
long term.
Required:
How should A Ltd classify and account for its financial assets?
(Dip. IFRS – UK)
Answer

(1) Investments held for short-term speculative purposes must be classified and accounted for
as fair value through profit or loss. Such assets are initially recognised at fair value. Any
transaction costs are expensed to profit or loss. The assets are remeasured to fair value at
the reporting date with the gains and losses on remeasurement recognised in profit or loss.
726 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(2) Investments that, from the outset, are going to be held indefinitely may be irrevocably
designated upon initial recognition as fair value through other comprehensive income. Such
assets are initially recognised at fair value plus transaction costs. They are remeasured to
fair value at the reporting date and gains and losses on remeasurement are recognised in
other comprehensive income. If no such election on purchase is made then the investment
must be classified and accounted for as fair value through profit or loss (see (1) above).

  
Question 118
P Ltd purchased a new financial asset on 31 December 20X3. The asset is a bond that will
mature in three years. P Ltd buys debt investments with the intention of holding them to maturity
although has, on occasion, sold some investments if cash flow deteriorated beyond acceptable
levels. The bond pays a market rate of interest. The Finance Director is unsure as to whether this
financial asset can be measured at amortised cost.
Required:
Advise the Finance Director on how the bond will be measured.
(Dip. IFRS – UK)
Answer
A debt instrument can be held at amortised cost if
• the entity intends to hold the financial asset to collect contractual cash flows, rather than
selling it to realise fair value changes.
• the contractual cash flows of the asset are solely payments of principal and interest based
upon the principal amount outstanding.
P Ltd's objective is to hold the financial assets and collect the contractual cash flows. Making
some sales when cash flow deteriorates does not contradict that objective.
The bond pays a market level of interest, and therefore the interest payments received provide
adequate compensation for the time value of money or the credit risk associated with the principal
amount outstanding.
This means that the asset can be measured at amortised cost.

  
Question 119
On 1 January 20X1, T Ltd bought a `100,000 5% bond for `95,000, incurring issue costs of
`2,000. Interest is received in arrears. The bond will be redeemed at a premium of `5,960 over
nominal value on 31 December 20X3. The effective rate of interest is 8%.
The fair value of the bond was as follows:
31/12/X1 `110,000
31/12/X2 `104,000
Required;
Explain, with calculations, how the bond will have been accounted for over all relevant years if:
(a) T Ltd's business model is to hold bonds until the redemption date.
(b) T Ltd's business model is to hold bonds until redemption but also to sell them if investments
with higher returns become available.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 727
(c) T Ltd's business model is to trade bonds in the short-term. Assume that T Ltd sold this bond
for its fair value on 1 January 20X2.
The requirement to recognise a loss allowance on debt instruments held at amortised cost or fair
value through other comprehensive income should be ignored.
(Dip. IFRS – UK)
Answer
(a) The business model is to hold the asset until redemption. Therefore, the debt instrument will
be measured at amortised cost.
The asset is initially recognised at its fair value plus transaction costs of `97,000 (`95,000 +
`2,000).
Interest income will be recognised in profit or loss using the effective rate of interest.
Bfd Interest (8%) Receipt Cfd
` ` ` `
y/e 31/12/X1 97,000 7,760 (5,000) 99,760
y/e 31/12/X2 99,760 7,981 (5,000) 102,741
y/e 31/12/X3 102,741 8,219 (5,000) nil
(105,960)
In the year ended 31 December 20X1, interest income of `7,760 will be recognised in profit
or loss and the asset will be held at `99,760 on the Balance Sheet.
In the year ended 31 December 20X2, interest income of `7,981 will be recognised in profit
or loss and the asset will be held at `102,741 on the Balance Sheet.
In the year ended 31 December 20X3, interest income of `8,219 will be recognised in profit
or loss.
(b) The business model is to hold the asset until redemption, but sales may be made to invest in
other assets will higher returns. Therefore, the debt instrument will be measured at fair value
through other comprehensive income.
The asset is initially recognised at its fair value plus transaction costs of `97,000 (`95,000 +
`2,000).
Interest income will be recognised in profit or loss using the effective rate of interest.
The asset must be revalued to fair value at the year end. The gain will be recorded in other
comprehensive income.

Bfd Interest Receipt Total Gain/Cfd (loss)

(per (a))
` ` ` `
y/e 97,000 7,760 (5,000) 99,760 10,240110,000
31/12/X1
y/e 110,000 7,981 (5,000)112,981 (8,981)104,000
31/12/X2
y/e 104,000 8,219 (5,000) 1,259 (1,259) nil
31/12/X3 (105,960)
728 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Note that the amounts recognised in profit or loss as interest income must be the same as if
the asset was simply held at amortised cost. Therefore, the interest income figures are the
same as in part (a).
In the year ended 31 December 20X1, interest income of `7,760 will be recognised in profit
or loss and a revaluation gain of `10,240 will be recognised in other comprehensive income.
The asset will be held at `110,000 on the Balance Sheet.
In the year ended 31 December 20X2, interest income of `7,981 will be recognised in profit
or loss and a revaluation loss of `8,981 will be recognised in other comprehensive income.
The asset will be held at `104,000 on the Balance Sheet.
In the year ended 31 December 20X3, interest income of `8,219 will be recognised in profit
or loss and a revaluation loss of `1,259 will be recognised in other comprehensive income.
(c) The bond would be classified as fair value through profit or loss.
The asset is initially recognised at its fair value of `95,000. The transaction costs of `2,000
would be expensed to profit or loss.
In the year ended 31/12/X1, interest income of `5,000 (`100,000 x 5%) would be recognised
in profit or loss. The asset would be revalued to `110,000 with a gain of `15,000 (`110,000 -
`95,000) recognised in profit or loss.
On 1/1/X2, the cash proceeds of `110,000 would be recognised and the financial asset
would be derecognised.

  
Question 120
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 dividends
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.
(Incorrect Solution) (Study Material)
Answer
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 investments 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 (proceed less 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 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
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 729
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 121
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 in books of the Company?
(Study Material)
Answer
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.

  
Question 122
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 classified as liability or
equity? Own use exemption does not apply.
(Study Material)
Answer
In the above scenario, there is a contract for purchase of 100 ounces of gold whose consideration
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 determined 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 123
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.
730 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Evaluate if this is financial liability or equity? What if the conversion ratio was fixed at the time of
issue of such preference shares?
(Study Material)
Answer
(i) 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. Being a
transaction with third party and in the absence of any other indicators, the transaction
price is representative of fair value.
(ii) 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 carrying
value after initial recognition.

  
Question 124
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
Description of repayment Repayment of loan starts from 30-Sept-20X1 (To be
paid half yearly)
Installment amount ` 2,500
Interest rate 12.00%
Interest charge Interest to be charged quarterly
Upfront fees ` 500
How would loan be accounted in books of A Ltd?
(Study Material)
Answer
The loan taken by A Ltd shall be measured at amortised cost as follows:
— Initial measurement – At transaction price less processing fees
= 10,000 – 500 = 9,500
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 731
— Subsequently – interest to be accrued using effective rate of interest as follows:
Date Amount Repay- Upfront Amount Day IRR Revised Loan
of Loan ment fees of s Calcula- Interest Balance
paid Interest tion compu-
ted
1-Apr-20X1 10,000 - 500 - - 9,500 - -
30-Jun-20X1 - - - 300 90 (300) 389 9,589
30-Sep-20X1 - 2500 - 300 92 (2,800) 401 7,190
31-Dec-20X1 - - - 225 92 (225) 301 7,266
31-Mar 20X2 - 2500 - 225 90 (2,725) 297 4,838
30-Jun-20X2 - - - 150 91 (150) 200 4,888
30-Sep-20X2 - 2500 - 150 92 (2,650) 204 2,442
31-Dec-20X2 - - - 75 92 (75) 102 2,473
31-Mar-20X3 - 2500 - 75 91 (2,575) 102 0
IRR 16.60%

  
Question 125
M Ltd has two receivables that it has factored to a bank in return for immediate cash proceeds.
Both receivables are due from long standing customers who are expected to pay in full and on
time. M Ltd had agreed a three-month credit period with both customers.
The first receivable is for `200,000. In return for assigning the receivable, M Ltd has received
`180,000 from the factor. Under the terms of the factoring arrangement, M Ltd will not have to
repay this money, even if the customer does not settle the debt (the factoring arrangement is said
to be 'without recourse').
The second receivable is for `100,000. In return for assigning the receivable, M Ltd has received
`70,000 from the factor. The terms of this factoring arrangement state that M Ltd will receive a
further `5,000 if the customer settles the account on time.
If the customer does not settle the account in accordance with the agreed terms then the
receivable will be reassigned back to M Ltd who will then be obliged to refund the factor with the
original `70,000 (this factoring arrangement is said to be 'with recourse').
Required:
Discuss the accounting treatment of the two factoring arrangements.
(Dip. IFRS – UK)
Answer
The principle at stake with derecognition or otherwise of receivables is whether, under the
factoring arrangement, the risks and rewards of ownership pass from M Ltd to the factor. The key
risk with regard to receivables is the risk of bad debt.
In the first arrangement the `180,000 has been received as a one-off, non refundable sum. This
is factoring-without- recourse for bad debts. The risk of bad debt has clearly passed from M Ltd to
the factoring bank. Accordingly M Ltd should derecognise the receivable and there will be an
expense of `20,000 recognised.
732 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
In the second arrangement the `70,000 is simply a payment on account. More may be received
by M Ltd implying that M Ltd retains an element of reward. The monies received are refundable in
the event of default and as such represent an obligation. This means that the risk of slow
payment and bad debt remains with M Ltd who is liable to repay the monies so far received.
Despite the passage of legal title the receivable should remain recognised in the accounts of M
Ltd. In substance M Ltd has borrowed `70,000 and this loan should be recognised immediately.
This will increase the gearing of M Ltd.

  
Question 126
Case holds equity investments at fair value through profit or loss. Due to short-term cash flow
shortages, Case sold some equity investments for `5 million when the carrying amount was `4m.
The terms of the disposal state that Case has the right to repurchase the shares at any point over
the next two years at their fair value on the repurchase date. Case has not derecognised the
investment because its directors believe that a repurchase is highly likely.
Required:
Advise the directors of Case as to the acceptability of the above accounting treatment.
(Dip. IFRS – UK)
Answer
An entity has transferred a financial asset if it has transferred the contractual rights to receive the
cash flows of the asset.
If an entity has transferred an asset, it must evaluate the extent to which it has retained the
significant risks and rewards of ownership. If the entity transfers substantially all the risks and
rewards of ownership of the financial asset, the entity must derecognise the financial asset.
Gains and losses on the disposal of a financial asset are recognised in the statement of profit or
loss.
Case is under no obligation to buy back the shares and is therefore protected from future share
price declines. Moreover, If Case does repurchase the shares this will be at fair value rather than
a pre-fixed price and therefore Case does not retain the risks and rewards related to price
fluctuations.
The risks and rewards of ownership have been transferred and, as such, Case should
derecognise the financial asset. A profit of `1 m (`5m - `4m) should be recognised in profit or
loss.

  
Question 127
J Ltd bought an investment in equity shares for `40 million plus associated transaction costs of `1
million. The asset was designated upon initial recognition as fair value through other
comprehensive income. At the reporting date the fair value of the financial asset had risen to `60
million. Shortly after the reporting date the financial asset | was sold for `70 million.
Required:
(a) How should the investment be accounted for?
(b) How would the answer have been different if the investment had been classified to be
measured at fair value through profit and loss?
(Dip. IFRS – UK)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 733
Answer
(a) On purchase the investment is recorded at the consideration paid. The asset is classified as
fair value through other comprehensive income and, as such, transaction costs are included
in the initial value:
Dr Asset 41m
Cr Cash 41m
At the reporting date the asset is remeasured to fair value and the gain of `19m (`60m - `41
m) is recognised in other comprehensive income and taken to equity:
Dr Asset 19m
Cr Other components of equity 19m
On disposal, the asset is derecognised. The profit or loss on disposal, recorded in the
statement of profit or loss, is determined by comparing disposal proceeds with the carrying
value of the asset:
Dr Cash 70m
Cr Asset 60m
Cr OCI 10m
(b) If J Ltd had designated the investment as fair value through profit and loss, the transaction
costs would have been recognised as an expense in profit or loss. The entry posted on the
purchase date would have been:
Dr Asset 40m
Cr Cash 40m
Dr Profit or loss 1m
Cr Cash 1m
At the reporting date, the asset is remeasured to fair value and the gain of `20m (`60m -
`40m) is recognised in the statement of profit or loss:
Dr Asset 20m
Cr Profit or loss 20m
On disposal the asset is derecognised and the profit on disposal is recorded in the
statement of profit or loss:
Dr Cash 70m
Cr Asset 60m
Cr Profit or loss 10m

  
Question 128
Sea Ltd. has lent a sum of `10 lakhs @ 18% per annum for 10 years. The loan had a Fair Value
of ` 12,23,960 at the contracted interest rate of 13%. To mitigate prepayment risks but at the
same time retaining control over the loan. Sea Ltd. transferred its right to receive the Principal
amount of the loan on its maturity with interest, after retaining rights over 10% of principal and 4%
734 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
interest that carries Fair Value of ` 29,000 and ` 1,84,620 respectively. The consideration for the
transaction was ` 9,90,000. The interest component retained included a 2% fee towards
collection of principal and interest that has a Fair Value of ` 65,160. Defaults if any are deductible
to a maximum extent of the company‘s claim on Principal portion. You are required to show the
Journal Entries to record derecognition of the Loan.
(Study Material)
Answer
(i) Calculation of securitized component of loan
` `
Fair Value 12,23,960
Less: Principal strip receivable (fair value) 29,000
Less: Interest strip receivable (fair value) 1,19,460
Less: Value of service asset (fair value) 65,160 1,84,620 2,13,620
10,10,340
(ii) Appointment of carrying amount in the ratio of fair values
Fair value Apportionment
(`) (`)
Securitized 10,10,340 10,10,340 × 10,00,000 8,25,468
component of loan 12,23,960
Principal strip 29,000 29,000 × 10,00,000 23,694
receivable 12,23,960
Interest strip 1,19,460 1,19,460 × 10,00,000 97,601
receivable 12,23,960
Servicing asset 65,160 65,160 × 10,00,000 53,237
12,23,960

(iii) Entries to record the derecognition of the Loan

` ` `
Bank A/c Dr. 9,90,000
To Loan A/c 8,25,468
To Profit & Loss A/c 1,64,532
(Being entry for securitization of 90%
principal with 14% interest)
Interest strip a/c Dr. 97,601
Servicing asset A/c Dr. 53,237
Principal strip A/c Dr. 23,694
To Loan A/c 1,74,532
(Being entry for interest, servicing asset
and principal strips received)

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 735
Question 129
Entity A (the transferor) holds a portfolio of receivables with a carrying value of `1,000,000. It
enters into a factoring arrangement with entity B (the transferee) under which it transfers the
portfolio to entity B in exchange for ` 900,000 of cash.
Entity B will service the loans after their transfer and debtors will pay amounts due directly to
entity B. Entity A 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.
Should receivable be de-recognised?
(Practice Manual)
Answer

Entity A has transferred its rights to receive the cash flows from the asset via an assignment to
entity B. Furthermore, as entity B has no recourse to entity A for either late payment risk or credit
risk, entity A has transferred substantially all the risks and rewards of ownership of the portfolio.
Hence, entity A derecognises the entire portfolio. The difference between the carrying value of
`1,000,000 and cash received of ` 900,000 i.e. ` 100,000 is recognised immediately as a
financing cost in profit or loss.
Had Entity A not transferred its rights to receive the cash flows from the asset or there would
have been any credit default guarantee given by entity A, then it would have not led to complete
transfer of risk and rewards and entity A could not derecognise the portfolio due to the same.

  
Question 130
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.
(Study Material)
Answer
Derecognition requirements are applied to a part of a financial asset if that part meets any of the
following three conditions:
(a) The part comprises only specifically identified cash flows from a financial asset (or a
group of similar financial assets).
For example, when an entity enters into an interest rate strip whereby the counterparty
obtains the right to the interest cash flows, but not the principal cash flows from a debt
instrument, derecognition principles are applied to the interest cash flows
(b) The part comprises only a fully proportionate (pro rata) share of the cash flows from
a financial asset (or a group of similar financial assets).
For example, when an entity enters into an arrangement whereby the counterparty
obtains the rights to a 90 per cent share of all cash flows of a debt instrument,
derecognition principles are applied to 90 per cent of those cash flows.
736 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(c) The part comprises only a fully proportionate (pro rata) share of specifically
identified cash flows from a financial asset (or a group of similar financial assets).
For example, when an entity enters into an arrangement whereby the counterparty obtains the
rights to a 90 per cent share of interest cash flows from a financial asset, derecognition principles
are applied to 90 per cent of those interest cash flows.
The example of a part of a financial asset at (iii) in question above will not qualify conditions at (b)
and (c) above since it does not represent pro rata share of all or specifically identified cash flows.
In (b) and (c) above, if there is more than one counterparty, each counterparty is not required to
have a proportionate share of the cash flows provided that the transferring entity has a fully
proportionate share.
In all other cases, derecognition principles are applied to the financial asset in its entirety (or to
the group of similar financial assets in their entirety).

  
Question 131
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.
(Study Material)
Answer
In the above circumstances, Entity Z need to apply the derecognition requirements to the financial
asset (or a group of similar financial assets) for 90%.

  
Question 132
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 assets that are
similar and of equal fair value to the transferred asset at the repurchase date.
State whether the derecognition principles will be applied or not.
(Study Material)
Answer
In each of these scenarios, the transferred financial asset is not derecognised because the
transferor retains substantially all the risks and rewards of ownership.

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 737
Question 133
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.
(Study Material)
Answer
If the any of 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 134
A financial asset is sold and the transferee has a put option. Let’s look at some alternate
scenarios:
(i) Put option is deeply in the money
(ii) Put option is deeply out of the money.
State whether the derecognition principles will be applied or not.
(Study Material)
Answer
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 risks and rewards of
ownership.

  
Question 135
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 it the transferor holds a call option on an asset that is readily obtainable in the market? iii
Call option is neither deeply in the money nor deeply out of the money
State whether the derecognition principles will be applied or not.
(Study Material)
738 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Answer
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 risks and rewards of
ownership.
In the third scenario, the asset is derecognised. This is because the entity (i) has neither retained
nor transferred substantially all the risks and rewards of ownership, and (ii) has not retained
control.
  
Question 136
An entity may transfer to a transferee a fixed rate financial asset that is paid off over time, and
enter into an amortising interest rate swap with the transferee to receive a fixed interest rate and
pay a variable interest rate based on a notional amount.
Scenarios:
(i) Notional amount of the swap amortises so that it equals the principal amount of the
transferred financial asset outstanding at any point in time.
(ii) Amortisation of the notional amount of the swap is not linked to the principal amount
outstanding of the transferred asset.
State whether the derecognition principles will be applied or not.
(Study Material)
Answer
In the first scenario, the swap would generally result in the entity retaining substantial prepayment
risk, in which case the entity either continues to recognise all of the transferred asset or continues
to recognise the transferred asset to the extent of its continuing involvement.
Such a swap would not result in the entity retaining prepayment risk on the asset. Hence, it would
not preclude derecognition of the transferred asset provided the payments on the swap are not
conditional on interest payments being made on the transferred asset and the swap does not
result in the entity retaining any other significant risks and rewards of ownership on the
transferred asset.
  
Question 137
ST Ltd. assigns its trade receivables to AT Ltd. The carrying amount of the receivables is `
10,00,000. The consideration received in exchange of this assignment is ` 9,00,000. Customers
have been instructed to deposit the amounts directly in a bank account for the benefit of AT Ltd.
AT Ltd. has no recourse to ST Ltd. in case of any shortfalls in collections.
State whether the derecognition principles will be applied or not.
(Study Material)
Answer
In this situation, ST Ltd. has transferred the rights to contractual cash flows and has also
transferred substantially all the risks and rewards of ownership (credit risk being the most
significant risk in this situation).
Accordingly, ST Ltd. derecognises the financial asset and recognises ` 1,00,000, the difference
between consideration received and carrying amount, as an expense in the statement of profit or
loss.

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 739
Question 138
Entity C agrees with factoring company D to enter into a debt factoring arrangement. Under the
terms of the arrangement, the factoring company D 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 cash flows from
short-term 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.
(Study Material)
Answer
In this situation, the “continuing involvement asset” will be recognised at ` 5 crores i.e. lower of:
(i) the amount of the asset – ` 95 crores
(ii) the guarantee amount – ` 5 crores
 the entity also recognises an associated liability that is measured in such a way that the
net carrying amount of the transferred asset and the associated liability is:
♦ the amortised cost of the rights and obligations retained by the entity, if the
transferred asset is measured at amortised cost, or
♦ equal to the fair value of the rights and obligations retained by the entity when
measured on a stand-alone basis, if the transferred asset is measured at fair value.
Recognised changes in the fair value of the transferred asset and the associated
liability are accounted for consistently with each other and shall not be offset. If the
transferred asset is measured at amortised cost, the option in this Standard to
designate a financial liability as at fair value through profit or loss is not applicable to
the associated liability.
In case of guarantees, as per the application guidance in Ind AS 109, the associated
liability is initially measured at
♦ the guarantee amount plus
♦ the fair value of the guarantee (which is normally the consideration received for the
guarantee).

  
Question 139
Continuing above question, the associated liability is recognised at ` 5.5 crores, as below:
(i) the guarantee amount (i.e. ` 5 crores) plus
(ii) the fair value of the guarantee (i.e. ` 0.5 crores). Comment
(Study Material)
Answer
 If an entity's continuing involvement is in only a part of a financial asset, the entity
allocates the previous carrying amount of the financial asset between the part it
continues to recognise under continuing involvement, and the part it no longer
recognises on the basis of the relative fair values of those parts on the date of the
transfer. The difference between:
740 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
♦ the carrying amount (measured at the date of derecognition) allocated to the part that
is no longer recognised and
♦ the consideration received for the part no longer recognised
shall be recognised in profit or loss.

  
Question 140
Pass the necessary Journal Entry
(Study Material)
Answer
The journal entries passed by Entity C on the date of derecognition is as below:
Cash Dr. ` 90 crores
Loss on derecognition Dr. ` 5.5 crores
Continuing involvement asset Dr. ` 5 crores
To Receivables ` 95 crores
To Associated liability ` 5.5 crores
• the entity shall continue to recognise any income arising on the transferred asset to
the extent of its continuing involvement and shall recognise any expense incurred on
the associated liability
In the example above, the guarantee liability of ` 0.5 crores shall be amortised in profit or
loss over the underlying period.

  
Question 141
San Fran is a company that has issued a public bond. It reports to its shareholders on a bi-annual
basis.
T Ltd, a company which holds financial assets until maturity, is one of many investors in San
Fran's bond. On purchase, T Ltd deemed the bond to have a low credit risk due to San Fran's
strong capacity to fulfil its short-term obligations. It was perceived, however, that adverse
changes in the economic environment could have a detrimental impact on San Fran's liquidity.
At T Ltd's reporting date, it has access to the following information about San Fran:
• Sales have declined 15% over the past 6 months
• External agencies are reviewing its credit rating, but no changes have yet been made
Although market bond prices have remained static, San Fran's bond price has fallen dramatically.
Required:
Discuss the accounting treatment of the bond in T Ltd's financial statements at the reporting date.
(Dip. IFRS – UK)
Answer
Using available information, T Ltd needs to assess whether the credit risk on the bond has
increased significantly since inception.
It would seem that San Fran's performance has declined and this may have an impact on its
liquidity.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 741
The review of San Fran's credit rating by external agencies is suggestive of wider concerns about
the performance and position of San Fran.
The fact that market bond prices are static suggests that the decline in San Fran's bond price is
entity specific. This is likely to be a response to San Fran's increased credit risk.
Based on the above, it would seem that the credit risk of the bond is no longer low. As a result, it
can be concluded that credit risk has increased significantly since inception.
This means that T Ltd must recognise a loss allowance equal to lifetime expected credit losses on
the bond.

  
Question 142
On 1 February 20X6, E Ltd makes a four-year loan of `10,000 to Fern. The coupon rate on the
loan is 6%, the same as the effective rate of interest. Interest is received at the end of each year.
On 1 February 20X9, Fern tells E Ltd that it is in significant financial difficulties. At this time the
current market interest rate is 8%
E Ltd estimates that it will receive no more interest from Fern. It also estimates that only `6,000 of
the capital will be repaid on the redemption date.
Required:
How should this be accounted for?
(Dip. IFRS – UK)
Answer
Evidence about the significant financial difficulties of Fern mean that the asset is now credit
impaired.
Expected losses on credit impaired assets are calculated as the difference between the asset's
gross carrying amount and the present value of the expected future cash flows discounted using
the original effective rate of interest.
Because the coupon and the effective interest rate are the same, the carrying amount of the
asset will remain constant at `10,000.
The present value of the future cash flows discounted using the original effective rate is `5,660
(`6,000 * 1/1.06).
The expected losses are therefore `4,340 (`10,000 - `5,660). A loss allowance will be raised for
this amount and charged as an expense to the statement of profit or loss.
The asset is credit impaired and so interest income will now be calculated on the net carrying
amount of `5,660 (the gross amount of `10,000 less the loss allowance of `4,340). Consequently,
in the last year of the loan, interest income of `340 (5,660 x 6%) will be recognised in profit or loss.

  
Question 143
An entity purchases a debt instrument for `1,000 on 1 January 20X1. The interest rate on the
bond is the same as the effective rate. After accounting for interest for the year to 31 December
20X1, the carrying amount of the bond is still `1,000.
At the reporting date of 31 December 20X1, the fair value of the instrument has fallen to `950.
There has not been a significant increase in credit risk since inception so expected credit losses
should be measured at 12-month expected credit losses. This is deemed to amount to `30.
742 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Required:
Explain how the revaluation and impairment of the financial asset should he accounted for.
(Dip. IFRS – UK)
Answer
A loss of `50 (`1,000 - `950) arising on the revaluation of the asset to fair value will be
recognised in other comprehensive income.
Dr OCI `50
Cr Financial asset `50
The 12-month expected credit losses of `30 will be debited to profit or loss. The credit entry is not
recorded against the carrying amount of the asset but rather against other comprehensive
income:
Dr Impairment loss (P/L) `30
Cr OCI `30
There is therefore a cumulative loss in OCI of `20 (the fair value change of `50 offset by the
impairment amount of `30).

  
Question 144
On 1 January 20X1, N Ltd purchased a bond for `1 m which is measured at amortised cost.
Interest of 10% is payable in arrears. Repayment is due on 31 December 20X3. The effective rate
of interest is 10%.
On 31 December 20X1, N Ltd received interest of `100,000. It was estimated that the probability
of default on the bond within the next 12 months would be 0.5%. If default occurs within the first
12 months then N Ltd estimated that no further interest will be received and that only 50% of the
capital will be repaid on 31 December 20X3.
The asset's credit risk at 31 December 20X1 is low.
Required:
Discuss the accounting treatment of the financial asset at 31 December 20X1.
(Dip. IFRS – UK)
Answer
The credit risk on the financial asset has not significantly increased. Therefore, a loss allowance
should be made equal to 12-month expected credit losses. The loss allowance should factor in a
range of possible outcomes, as well as the time value of money.
The credit loss on the asset is `586,777 (W1). This represents the present value of the difference
between the contractual cash flows and the expected receipts if a default occurs.
The expected credit loss is `2,934 (`586,777 credit loss x 0.5% probability of occurrence). A loss
allowance of `2,934 will be created and an impairment loss of `2,934 will be charged to profit or
loss in the year ended 31 December 20X1.
The net carrying amount of the financial asset on the Balance Sheet is `997,066 (`1,000,000 -
`2,934).
Note: Interest in future periods will continue to be charged on the asset's gross carrying amount
of `1,000,000.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 743

Date of receipt Expected cash shortfall Discount rate Present value

` `
31/12/X2 100,000 1/1.1 90,909
31/12/X3 100,000 1/1.12 82,645
31/12/X3 500,000 1/1.12 413,223
586,777

  
Question 145
Bonds on ACM for ` 1,00,000 reclassified as FVTPL. Fair value on reclassification is ` 90,000.
Pass the required journal entry.
(Study Material)
Answer

Particulars Amount Amount

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

  
Question 146
Bonds on ACM for ` 1,00,000 reclassified as FVOCI. Fair value on reclassification is ` 90,000.
Pass the required journal entry.
(Study Material)
Answer

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 147
Bonds on FVTPL for ` 100,000 reclassified as Amortised cost. Fair value on reclassification is `
90,000. Pass the required journal entry.
(Study Material)
744 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Answer
Particulars Amount Amount
Bonds at Amortised cost Dr. 90,000
Loss on reclassification Dr. 10,000
To Bonds at FVTPL 1,00,000

  
Question 148
Bonds on FVTPL for ` 100,000 reclassified as FVOCI. Fair value on reclassification is ` 90,000.
Pass the required journal entry.
(Study Material)
Answer
Particulars Amount Amount
Bonds at FVOCI Dr. 90,000
Loss on reclassification Dr. 10,000
To Bonds at FVTPL 1,00,000

  
Question 149
Bonds on FVTOCI for ` 100,000 reclassified as Amortised cost. Fair value on reclassification is `
90,000. Pass the required journal entry.
(Study Material)
Answer
Particulars Amount Amount
Bonds (Amortised cost) Dr. 90,000
OCI - Loss on reclassification Dr. 10,000
To Bonds at FVOCI 1,00,000

  
Question 150
Bonds on FVTOCI for ` 100,000 reclassified as FVTPL. Fair value on reclassification is ` 90,000.
Pass the required journal entry.
(Study Material)
Answer
Particulars Amount Amount
Bonds (Ptc) Dr. 90,000
OCI - Loss on reclassification Dr. 10,000
To Bonds at FVOCI 1,00,000

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 745
Question 151
Journalise for Reclassifications
1. Bonds for ` 1,25,000 at amortised cost is being reclassified as FVTPL
Reclassification date fair value ` 99,000 (Study Material)
Answer
Fair Value on reclassification ` 99,000
Bonds (FVTPL) A/c 99,000
P&L A/c 26,000
To Bonds (Amortised Cost) A/c 1,25,000
2. Bonds for ` 1,25,000 at amortised cost now being reclassified as FVTOCI
Answer

Bonds (FVTOCI) A/c 99,000

OCI A/c 26,000
To Bonds (Amortised Cost) A/c 1,25,000
3. Bonds for ` 1,25,000 at FVTPL now reclassified at amortised cost
Answer
Bonds (Amortised Cost) A/c 99,000
Impairment Loss (Charged to P&L A/c) 26,000
To Bonds (FVTPL) A/c 1,25,000
4. Bonds for ` 1,25,000 at FVTPL now reclassified at FVTOCI
Answer
Bonds (FVTOCI) A/c 99,000
Impairment loss (P&L) 26,000
To Bonds (FVTPL) A/c 1,25,000
5. Bonds for ` 1,25,000 at FVTOCI now reclassified at Amortised Cost
Answer
Bonds (Amortised Cost) A/c 99,000
Loss Allowance (Taken to OCI A/c) 26,000
To Bonds (FVTOCI) A/c 1,25,000
6. Bonds for ` 1,25,000 at FVTOCI now reclassified at FVTPL
Answer
Bonds (FVTPL) A/c Dr. 99,000
Reclassification Loss (Taken to OCI Dr. 26,000
A/c)
To Bonds (FVTOCI) A/c 1,25,000

  
746 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 152
♦ 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.
♦ It retains the right to receive fixed interest payments of 10% on ` 100 crores every year.
Analyse.
(Study Material)
Answer
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 years. 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 153
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.
(Study Material)
Answer
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.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 747
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 154
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.
(Study Material)
Answer
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 155
Mr. A bought a forward contract for three months of US$ 1,00,000 on Ist December at 1 US$ = `
47.10 when exchange rate was US$ 1 = ` 47.02. On 31st December when he closed his books,
exchange rate was US$ 1 = ` 47.15. On 31st January, he decided to sell the contract at ` 47.18
per dollar. Show how the profits from contract will be recognized in the books.
(May 2010, 5 Marks)

  
Question 156
Mr A written a call option (i.e. Sold Call option) details are as follows with a lot size of 1,000
shares of X Limited shares on 1st Feb 20X1 with premium of ` 5 per share. Exercise date is 31st
Dec 20X1 and Exercise price is ` 102 per share.
Market price on 1st Feb 20X1 =100 per share
Market price on 31st Mar 20X1 =104 per share
Market price on 31st Dec 20X1 =105 per share.
Calculate the fair value of the option and pass necessary journal entries.
(ICAI Solution is incorrect) (Study Material)
Answer
In this contract "A" Agrees to Buy shares at $ 102 despite whatever is the price on 31st Dec
20X1. So fair value of option in this case is as follows:
748 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
On 1st Feb 20X1 (Date on which contract entered) Fair value of option= ` 5,000 On 31st March
20X1 (Reporting date) = 5,000-(104-102) x 100= ` 3,000 On 31st Dec 20X1 (Expiry date) =
5,000-(105-102) x 100= ` 2,000
Accounting Entries
Date Particulars Debit Credit
1/02/20X1 Bank A/c Dr. 5,000 5,000
To Call Option Obligation
(Option premium received for writing call options)
31/3/20X1 Call Option Obligation Dr. 2,000 2,000
To Fair Value Gain A/c
(Increase in fair value ` 5000-3000)
31/12/20X1 Call Option obligation Dr. 1,000 1,000
To Fair Value Gain A/c
(Increase in fair value ` 3,000-2,000)
31/12/20X1 Call Option Obligation Dr. 2,000 2,000
To Bank A/c (5,000-2,000-1,000)
(Cash settlement on exercise of the call option)

  
Question 157
Mr A purchased a call option (I.e Bought call option) details are as follows with a lot size of 1000
shares of X Limited shares on 1st Feb 20X1 with premium of ` 5 per share. Exercise date is 31st
Dec 20X1 and Exercise price is ` 102 per share.
Market price on 1st Feb 20X1 =100 per share
Market price on 31st Mar 20X1 =104 per share
Market price on 31st Dec 20X1 =105 per share.
Calculate the fair value of the option and pass necessary journal entries.
(ICAI Solution is incorrect) (Study Material)
Answer
In this contract "A" purchased a call option to buy shares of X Ltd at ` 102 per share despite
whatever is the price on 31st Dec 20X1. If price of X ltd is more than 102 A will buy shares at `
102 otherwise if the shares are operating below ` 102 he can deny buying shares at ` 102.
So fair value of option in this case, is as follows:
On 1st Feb 20X1 (Date on which contract entered) Fair value of option= ` 5,000 On 31st March
20X1 (Reporting date) = 5,000-(104-102) x 100= ` 3,000 On 31st Dec 20X1 (Expiry date) =
5,000-(105-102) x 100= ` 2,000
Accounting Entries
Date Particulars Debit Credit
1/02/20X1 Call Option Asset A/c Dr. 5,000
To Bank A/c 5,000
(Option premium received for buying call options)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 749

Date Particulars Debit Credit

31/3/20X1 Fair Value Loss A/c Dr. 2,000
To Call Option Asset A/c 2,000
(Decrease in fair value of option ` 5,000-3,000)
31/12/20X1 Fair Value Loss A/c Dr. 1,000
To Call Option Asset A/c 1,000
(Decrease in fair value ` 3,000-2000)
31/12/20X1 Bank A/c Dr. 2,000
To Call Option Asset A/c 2,000
(Cash settlement on exercise of the call option)
(5,000-2,000-1,000)

  
Question 158
On 1st January 20X1, Sam Co. Ltd. entered into a written put option for USD ($) 20,000 with JT
Corp to be settled in future on 31st December 20X1 for a rate equal to ` 68 per USD at the option
of JT Corp. Sam Co. Ltd. did not receive 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 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 the date of actual purchase
of USD.
For the purposes of accounting, please use the following information representing marked to
market fair value of put option contracts at each reporting date:
As at 31st March 20X1 – ` (25,000)
As at 30th June 20X1 - ` (15,000)
As at 30th September 20X1 - ` NIL
Spot rate of USD on 31st December 20X1 - ` 66 per USD
(Study Material)
Answer

(i) 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 a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or rates, credit
rating or credit index, or other variable, provided in the case of a non-financial variable
that the variable is not specific to a party to the contract (sometimes called the
'underlying').
750 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(b) it requires 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.
(c) it is settled at a future date.
Upon evaluation of contract in question it is noted that the contract meets the definition of a
derivative as follows:
(a) the value of the contract to purchase USD at a fixed price changes in response to
changes in foreign exchange rate.
(b) the initial amount received to enter into the contract is zero. A contract which would give
the holder a similar response to foreign exchange rate changes would have required an
investment of by purchasing USD 20,000 on inception.
(c) the contract is settled in future
The derivative liability is a written put option 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.
(ii) Accounting on 1st January 20X1
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.
(iii) Accounting on 31st March 20X1
The value of the derivative put option contract shall be recorded as a derivative financial liability in
the books of SamCo Ltd. by recording the following journal entry:
Particulars Dr. Amount Cr. Amount
(`) (`)
Profit and loss A/c Dr. 25,000
To derivative financial liability 25,000
(being mark to market loss on the put option contract
recorded)
(iv) Accounting on 30th June 20X1
The change in value of the derivative put option contract shall be recorded as a derivative
financial liability in the books of SamCo Ltd. by recording the following journal entry:
Particulars Dr. Amount Cr. Amount
(`) (`)
Derivative financial liability A/c Dr. 10,000
To Profit and loss A/c 10,000
(being partial reversal of mark to market loss on the put option
contract recorded)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 751
(v) Accounting on 30th September 20X1
The change in value of the derivative option contract shall be recorded as a zero in the books of
SamCo Ltd. by recording the following journal entry:
Particulars Dr. Cr.
Amount Amount
(`) (`)
Derivative financial liability A/c Dr 15,000
To Profit and loss A/c 15,000
(being gain on mark to market of put option contract booked to
make the value the derivative liability as zero)
(vi) Accounting on 31st December 20X1
The settlement of the derivative put option contract by actual purchase of USD 20,000 shall be
recorded in the books of SamCo Ltd. upon exercise by JT Corp. by recording the following journal
entry:
Particulars Dr. Amount Cr. Amount
(`) (`)
Cash (USD Account) @ 20,000 × 66 Dr. 13,20,000
Profit and loss A/c Dr. 40,000
To Cash @ 20,000 × 68 13,60,000
(being loss on settlement of put option contract booked on
actual purchase of USD)

  
Question 159
On 1st January 20X1, SamCo. Ltd. agreed to purchase USD ($) 20,000 from JT Bank in future on
31st December 20X1 for a rate equal to ` 68 per USD. SamCo. Ltd. did not pay any amount upon
entering into the contract. SamCo 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 the date of actual purchase
of USD.
For the purposes of accounting, please use the following information representing marked to
market fair value of forward contracts at each reporting date:
As at 31st March 20X1 – ` (25,000)
As at 30th June 20X1 - ` (15,000)
As at 30th September 20X1 - ` 12,000
Spot rate of USD on 31st December 20X1 - ` 66 per USD
(Study Material)
Answer

(i) 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:
752 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(a) its value changes in response to the change in a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or rates, credit
rating or credit index, or other variable, provided in the case of a non-financial variable
that the variable is not specific to a party to the contract (sometimes called the
'underlying').
(b) it requires 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.
(c) it is settled at a future date.
Upon evaluation of contract in question it is noted that the contract meets the definition of
a derivative as follows:
(a) the value of the contract to purchase USD at a fixed price changes in response to
changes in foreign exchange rate.
(b) the initial amount paid to enter into the contract is zero. A contract which would give the
holder a similar response to foreign exchange rate changes would have required an
investment of by purchasing USD 20,000 on inception.
(c) the contract is settled in future
The derivative is a 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.
(ii) Accounting on 1st January 20X1:
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.
(iii) Accounting on 31st March 20X1:
Particulars Dr. Amount (`) Cr. Amount (`)
Profit and loss A/c Dr. 25,000
To derivative financial liability 25,000
(being mark to market loss on forward contract recorded)
(iv) Accounting on 30th June 20X1:
The change in value of the derivative forward contract shall be recorded as a derivative financial
liability in the books of SamCo Ltd. by recording the following journal entry:
Particulars Dr. Amount Cr. Amount
(`) (`)
Derivative financial liability A/c Dr. 10,000
To Profit and loss A/c 10,000
(being partial reversal of mark to market loss on forward
contract recorded)
(v) Accounting on 30th September 20X1:
The value of the derivative forward contract shall be recorded as a derivative financial asset in the
books of SamCo Ltd. by recording the following journal entry:
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 753

Particulars Dr. Cr.

Amount Amount
(`) (`)
Derivative financial liability A/c Dr 15,000
Derivative financial asset A/c Dr 12,000
To Profit and loss A/c 27,000
(being gain on mark to market of forward contract booked as
derivative financial asset and reversal of derivative financial liability)
(vi) Accounting on 31st December 20X1:
The settlement of the derivative forward contract by actual purchase of USD 20,000 shall be
recorded in the books of SamCo Ltd. by recording the following journal entry:
Particulars Dr. Amount Cr. Amount
(`) (`)
Cash (USD Account) @ 20,000 × 66 Dr. 13,20,000
Profit and loss A/c Dr. 52,000
To Cash @ 20,000 × 68 13,60,000
To Derivative financial asset A/c 12,000
(being loss on settlement of forward contract booked on actual
purchase of USD)

  
Question 160
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
(Study Material)
Answer
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 161
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 penalty
of 3%.
754 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
There are no transaction costs.
Without the prepayment option, the interest rate quoted by bank is 11% p.a.
Analyse
(Study Material)
Answer

Step 1: Identify the host contract and embedded derivative, if any

In the given case,
• Host is a debt instrument comprising annual interest payment at 12% p.a. and bullet
principal repayment at the end of 6 years.
• Option to prepay the debt at ` 103 crores is an embedded derivative
Step 2: Determine the amortised cost of the host debt instrument
Whether the prepayment option is likely to be exercised or not, the amortised cost of the host
debt instrument should be calculated as present value (PV) of expected cash flows using a fair
market interest rate for a debt without the prepayment option (11% p.a. in this case). This is
calculated below as ` 104.23 crores:
Year Cash outflow PV @ 11% p.a. Finance cost Amortised cost
` crores
1 12.00 10.81 11.46 103.68
2 12.00 9.74 11.41 103.09
3 12.00 8.77 11.34 102.43
4 12.00 7.90 11.27 101.70
5 12.00 7.12 11.20 100.90
6 112.00 59.88 11.10 -
104.22 67.78
Step 3: Compare the exercise price of the prepayment option with the amortised cost of the host
debt instrument
Year Amortised cost Exercise price of Difference
prepayment option
` Crores
1 103.68 103.00 0.7%
2 103.09 103.00 0.1%
3 102.43 103.00 -0.6%
4 101.70 103.00 -1.3%
5 100.90 103.00 -2.1%
6 - N/A

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 755
Question 162
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.
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
Journalise
(Study Material)
Answer
The accounting entries are as follows (all in INR crores):
1. Loss on derivative contract 5
To Derivative liability 5
(Being loss on currency forward)
2. Inventory 325
To Trade payables (financial liability) 325
(Being inventory recorded at forward exchange rate determined on date of contract)
3. Derivative liability 5
To Trade payables (financial liability) 5
(Being reclassification of derivative liability to trade payables upon settlement)

  
Question 163
Entity A (an INR functional currency entity) enters into a USD 1,000,000 sale contract on 1
January 20X1 with Entity B (an INR functional currency entity) to sell equipment on 30 June
20X1.
Spot rate on 1 January 20X1: INR/USD 45
Spot rate on 31 March 20X1: INR/USD 57
Three month 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

Please provide detailed journal entries for accounting of such embedded derivative until sale is
actually made.
(Study Material)
756 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Answer
The contract should be separated using the 6 month USD/INR forward exchange rate, as at the
date of the contract (INR/USD = 55). The two components of the contract are therefore:
• A sale contract for INR 55 Million
• A six-month currency forward to purchase USD 1 Million at 55
• This gives rise to a gain or loss on the derivative, and a corresponding derivative asset or
liability.
On delivery
1. Entity A records the sales at the amount of the host contract = INR 55 Million
2. The embedded derivative is considered to expire.
3. The derivative asset or liability (i.e. the cumulative gain or loss) is settled by becoming
part of the financial liability on delivery.
4. In this case the carrying value of the currency forward at 30 June 20X1 on maturity is =
INR (1,000,000 × 60-55 × 1,000,000)= ` 5,000,000 (profit/asset)
The table summarising the computation of gain/loss to be recorded at every period end -
Date Transaction Sales Debtors Derivative (Profit)
Asset Loss
(Liability)
INR INR INR INR
1-Jan- Embedded Derivative Nil Value
20X1
31- Change in Fair Value of (10,000,000) 10,000,000
Mar- Embedded Derivatives
20X1 MTM (55-45)*1Million
30-Jun- Change in Fair Value of 15,000,000 (15,000,000)
20X1 Embedded Derivatives
(60-45)*1Million
30-Jun- Recording sales at (55,000,000) 55,000,000
20X1 forward rate
30-Jun- Embedded derivative- 5,000,000 (5,000,000)
20X1 settled against debtors
Journal entries to be recorded at every period end
(a) 01 January 20X1 – No entry to be made
(b) 31 March 20X1 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Profit and loss A/c Dr. 10,000,000
To Derivative financial liability A/c 10,000,000
(being loss on mark to market of embedded derivative
booked)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 757
(c) 30 June 20X1 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Derivative financial asset A/c Dr. 5,000,000
Derivative financial liability A/c Dr. 10,000,000
To Profit and loss A/c 15,000,000
(being gain on embedded derivative based on spot rate at the
date of settlement booked)
(d) 30 June 20X1 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Trade receivable A/c Dr. 55,000,000
To Sales A/c 55,000,000
(being sale booked at forward rate on the date of
transaction)
(e) 30 June 20X1 –
Particulars Dr. Cr.
Amount (`) Amount (`)
Trade receivable A/c Dr 5,000,000
To Derivative financial asset A/c 5,000,000
(being derivative asset re-classified as a part of trade receivables,
bringing it to spot rate on the date of sale)

  
Question 164
H Ltd buys 100 options on 1 January 20X6 for `5 per option. Each option gives H Ltd the right to
buy a share in Rowling on 31 December 20X6 for `10 per share.
Required:
How should this be accounted for, given the following outcomes?
(a) The options are sold on 1 July 20X6 for `15 each.
(b) On 31 December 20X6, Rowling's share price is `8 and H Ltd lets the option lapse
unexercised.
(c) The option is exercised on 31 December when Rowling's share price is `25. The shares are
classified as held for trading.
(Dip. IFRS – UK)
Answer
In all scenarios the cost of the derivative on 1 January 20X6 is `500 (`5 x 100) and an asset is
recognised in the Balance Sheet.
Dr Asset – option `500
Cr Cash `500
758 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Outcome A
If the option is sold for `1,500 (100 * `15) before the exercise date, it is derecognised at a profit of
`1,000.
Dr Cash `1,500
Cr Asset - option `500
Cr Profit or loss `1,000
Outcome B
If the option lapses unexercised, then it is derecognised and there is a loss to be taken to profit or
loss:
Dr Profit or loss `500
Cr Asset - option `500
Outcome C
If the option is exercised then the option is derecognised, the entity records the cash paid upon
exercise, and the investment in shares is recognised at fair value. An immediate profit is
recognised:
Dr Asset - investment (100 * `25) `2,500
Cr Cash (100 x `10) `1,000
Cr Asset - option `500
Cr Profit or loss `1,000

  
Question 165
On 1 January 20X8 an entity purchased equity instruments for their fair value of `900,000. They
were designated upon initial recognition to be classified as fair value through other
comprehensive income.
At 30 September 20X8, the equity instrument was still worth `900,000 but the entity became
worried about the risk of a decline in value. It therefore entered into a futures contract to sell the
shares for `900,000 in six months' time. It identified the futures contract as a hedging instrument
as part of a fair value hedging arrangement. The fair value hedge was correctly documented and
designated upon initial recognition. All effectiveness criteria have been complied with.
By the reporting date of 31 December 20X8, the fair value of the equity instrument had fallen to
`800,000, and the fair value of the futures contract had risen by `90,000.
Required

Explain the accounting treatment of the fair value hedge arrangement based upon the available
information.
(Dip. IFRS – UK)
Answer
The hedged item is an investment in equity that is measured at fair value through other
comprehensive income (OCI). Therefore, the increase in the fair value of the derivative of
`90,000 and the fall in fair value of the equity interest of `100,000 since the inception of the
hedge are taken to OCI.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 759
Dr Derivative `90,000
Cr OCI `90,000
Dr OCI `100,000
Cr Equity investment `100,000
The net result is a small loss of `10,000 in OCI.

  
Question 166
C Ltd has a firm commitment to buy an item of machinery for CU2m on 31 March 20X2. The
Directors are worried about the risk of exchange rate fluctuations.
On 1 October 20X1, when the exchange rate is CU2:`1, C Ltd enters into a futures contract to
buy CU2m for `1 m on 31 March 20X2.
At 31 December 20X1, CU2m would cost `1,100,000. The fair value of the futures contract has
risen to `95,000. All effectiveness criteria have been complied with.
Required:
Explain the accounting treatment of the above in the financial statements for the year ended 31
December 20X1 if:
(a) Hedge accounting was not used.
(b) On 1 October 20X1, the futures contract was designated as a fair value hedge of the
movements in the fair value of the firm commitment to purchase the machine.
(Dip. IFRS – UK)
Answer
(a) The futures contract is a derivative and is measured at fair value with all movements being
accounted for through profit or loss.
The fair value of the futures contract at 1 October 20X1 was nil. By the year end, it had risen
to `95,000. Therefore, at 31 December 20X1, C Ltd will recognise an asset at `95,000 and a
gain of `95,000 will be recorded in profit or loss.
(b) If the relationship had been designated as a fair value hedge then the movement in the fair
value of the hedging instrument (the future) and the fair value of the hedged item (the firm
commitment) since inception of the hedge are accounted for through profit or loss.
The derivative has increased in fair value from `nil at 1 October 20X1 to `95,000 at 31
December 20X1. Purchasing CU2 million at 31 December 20X1 would cost C Ltd `100,000
more than it would have done at 1 October 20X1. Therefore the fair value of the firm
commitment has fallen by `100,000.
At year end, the derivative will be held at its fair value of `95,000, and the gain of `95,000
will be recorded in profit or loss.
The `100,000 fall in the fair value of the commitment will also be accounted for, with an
expense recognised in profit or loss.
In summary, the double entries are as follows:
Dr Derivative `95,000
Cr Profit or loss `95,000
Dr Profit or loss `100,000
Cr Firm commitment `100,000
760 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
The gain on the derivative and the loss on the firm commitment largely net off. There is a
residual `5,000 (`100,000 - `95,000) net expense in profit or loss due to hedge
ineffectiveness. Nonetheless, financial statement volatility is far less than if hedge
accounting had not been used.

  
Question 167
A company enters into a derivative contract in order to protect its future cash inflows relating to a
recognised financial asset. At inception, when the fair value of the hedging instrument was nil, the
relationship was documented as a cash flow hedge.
By the reporting date, the loss in respect of the future cash flows amounted to `9,100 in fair value
terms. It has been determined that the hedging relationship meets all effectiveness criteria.
Required:
Explain the accounting treatment of the cash flow hedge if the fair value of the hedging instrument
at the reporting date is:
(a) `8,500
(b) `10,000
(Dip. IFRS – UK)
Answer
(a) The movement on the hedging instrument is less than the movement on the hedged item.
Therefore, the instrument is remeasured to fair value and the gain is recognised in other
comprehensive income.
Dr Derivative `8,500
Cr OCI `8,500
(b) The movement on the hedging instrument is more than the movement on the hedged item.
The excess movement of `900 (`10,000 - `9,100) is recognised in the statement of profit or
loss.
Dr Derivative `10,000
Cr Profit or loss `900
Cr OCI `9,100

  
Question 168
On 31 October 20X1, B Ltd had inventories of gold which cost `6.4m to buy and which could be
sold for `7.7m. The management of B Ltd are concerned about the risk of fluctuations in future
cash inflows from the sale of this gold.
To mitigate this risk, B Ltd entered into a futures contract on 31 October 20X1 to sell the gold for
`7.7m. The contracts mature on 31 March 20X2. The hedging relationship was designated and
documented at inception as a cash flow hedge. All effectiveness criteria are complied with.
On 31 December 20X1, the fair value of the gold was `8.6m. The fair value of the futures contract
had fallen by `0.9m.
There is no change in fair value of the gold and the futures contract between 31 December 20X1
and 31 March 20X2. On 31 March 20X2, the inventory is sold for its fair value and the futures
contract is settled net with the bank.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 761
Required:
(a) Discuss the accounting treatment of the hedge in the year ended 31 December 20X1,
(b) Outline the accounting treatment of the inventory sale and the futures contract settlement on
31 March 20X2.
(Dip. IFRS – UK)
Answer
(a) Between 1 October 20X1 and 31 December 20X1, the fair value of the futures contract had
fallen by `0.9m. Over the same time period, the hedged item (the estimated cash receipts
from the sale of the inventory) had increased by `0.9m (`8.6m — `7.7m).
Under a cash flow hedge, the movement in the fair value of the hedging instrument is
accounted for through other comprehensive income. Therefore, the following entry is
required:
Dr Other comprehensive income `0.9m
Cr Derivative `0.9m
The loss recorded in other comprehensive income will be held within equity.
(b) The following entries are required:
Dr Cash `8.6m
Cr Revenue `8.6m
Dr Cost of sales `6.4m
Cr Inventory `6.4m
To record the sale of the inventory at fair value
Dr Derivative `0.9m
Cr Cash `0.9m
To record the settlement of the futures contract
Dr Profit or loss `0.9m
Cr OCI `0.9m
To recycle the losses held in equity through profit or loss in the same period as the hedged item
affects profit or loss.

  
Question 169
In January, G Ltd, whose functional currency is the (`), decided that it was highly probable that it
would buy an item of plant in one year's time for KR 200,000. As a result of being risk averse, it
wished to hedge the risk that the cost of buying KRs would rise and so entered into a forward rate
agreement to buy KR 200,000 in one year's time for the fixed sum of `100,000. The fair value of
this contract at inception was zero and it was designated as a hedging instrument.
At G Ltd's reporting date on of 31 July, the KR had depreciated and the value of KR 200,000 was
`90,000. The fair value of the derivative had declined by `10,000. These values remained
unchanged until the plant was purchased.
Required:
How should this be accounted for?
(Dip. IFRS – UK)
762 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Answer
The forward rate agreement has no fair value at its inception so is initially recorded at `nil.
This is a cash flow hedge. The derivative has fallen in value by `10,000 but the cash flows have
increased in value by `10,000 (it is now `10,000 cheaper to buy the asset).
Because it has been designated a cash flow hedge, the movement in the value of the hedging
instrument is recognised in other comprehensive income:
Dr Other comprehensive income `10,000
Cr Derivative `10,000
(Had this not been designated a hedging instrument, the loss would have been recognised
immediately in profit or loss.)
The forward contract will be settled and closed when the asset is purchased.
Property, plant and equipment is a non-financial item. The loss on the hedging instrument held
within equity is adjusted against the carrying amount of the plant
The following entries would be posted:
Dr Liability - derivative `10,000
Dr Plant `90,000
Cr Cash `100,000
Being the settlement of the derivative and the purchase of the plant.
Dr Plant `10,000
Cr Cash flow hedge reserve `10,000
Being the recycling of the losses held within equity against the carrying amount of the plant.
Notice that the plant will be held at `100,000 (`90,000 + `10,000) and the cash spent in total was
`100,000. This was the position that the derivative guaranteed.

  
Question 170
On 24 January, 2006 Chinnaswamy of Chennai sold goods to Watson of Washington, USA for an
invoice price of $40,000 when the spot market rate was `44.20 per U.S.$. Payment was to be
received after three months on 24th April, 2006 To mitigate the risk of loss from decline in the
exchange rate on the date of receipt of payment, Chinnaswamy immediately acquired a forward
contract to sell on 24th April, 2006 US$ 40,000 @ `43.70. Chinnaswamy closed his books of
account on 31st March, 2006 when the spot rate was `43.20 per US $. On 24th April, 2006 the
date of receipt of money by Chinnaswamy, the spot rate was `42.70 per US$.
Pass Journal entries in the books of Chinnaswamy to record the effect of all the above mentioned
events. (Old Study Material)

  
Question 171
XYZ Ltd. needs $ 3,00,000 on May 1, 2000 for repayment of loan installment and interest. As on
December 1, 1999, it appears to the company that the dollar may be dearer as compared to the
exchange rate prevailing on that date, $ 1 = `43.50. Accordingly, XYZ Ltd. enter into a forward
contract with a banker for $ 3,00,000. Assume forward rate as on December 1, 1999 was $ 1 =
`44 as against the spot rate of `43.50. Assume the spot rate as on 1st May, 2000 is $ 1 = `44.80.
Journalize in the books of XYZ Ltd. (Old Study Material)

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 763
Question 172
On 1st February, 2008, an Indian Company sold goods to an American Company at an invoice
price of US $20,000 when the spot market rate was `48.10 to a U.S. dollar. Payment was to be
made in three months time, namely, by 1st May, 2008.
To avoid the risk of foreign exchange fluctuations the Indian exporter acquired a forward contract
to sell U.S. $20,000 at `47.90 per U.S. dollar on 1st May, 2008.
The Indian company’s accounting year ended on 31st March, 2008 and the spot rate on this date
was `47.20 per U.S. dollar. The spot rate on 1st May, 2008, the date by which the money was
due from the American buyer, was `50 per dollar.
Show what accounting entries will have to be made in the books of the Indian exporter at the
relevant period of time.

  
Question 173
Company Z is a producer and wholesaler of copper with annual reporting period ending on March
31 each year. On January 1, 2014, Company Z forecasts sales of 100 tonnes of copper expected
to occur in September 2014. It is highly probable that the sales will occur based on historical and
expected sales. In order to hedge its exposure on the variability of copper prices, Company Z
enters into a ‘sell’ futures contract on the Commodity Exchange to sell 100 tonnes of copper
(same grade) with maturity of September 30, 2014. As per its risk management policies,
Company Z designates this futures contract as a cash flow hedge of highly probable forecasted
sales of 100 tonnes of copper inventory in September 2014.
(Guidance Note on Derivatives)
Answer
Since the commodity future does not fall within the scope of AS 11 and has been entered into to
hedge the exposure of variability in cash flows arising from price risk, this would fall within the
scope of this Guidance Note.
According to Guidance Note, Company Z will record the following on March 31, 2014
Record a derivative asset/liability based on the fair value (MTM) of the commodity future contract
with a corresponding credit/debit to Cash Flow Hedging Reserve.
As at March 31, 2014, the Balance Sheet of Company Z will carry the following items:
 Derivative asset/liability – MTM of the commodity future contract.
 Cash Flow Hedging Reserve - MTM of the commodity future contract. Assuming that the
sales in future occur as expected, the MTM carried in the Cash Flow Hedging Reserve
will be reclassified to the statement of profit and loss when the sales are booked in the
statement of profit and loss. In this case, this will happen in September 2014, along with
the maturity of the commodity futures contract. Such reclassification can be made in the
sales line item in the statement of profit and loss, which potentially records the sales at
the hedged price.

  
Question 174
Entity A wants to hedge a highly probable forecast coffee purchase (which is expected to occur at
the end of Period 5). Entity A's functional currency is its Local Currency (LC). Coffee is traded in
Foreign Currency (FC). Entity A has the following risk exposures:
(a) commodity price risk: the variability in cash flows for the purchase price, which results
from fluctuations of the spot price of coffee in FC; and
764 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(b) foreign currency (FX) risk: the variability in cash flows that result from fluctuations of the
spot exchange rate between LC and FC.
Analyse the hedge possibilities.
(Study Material)
Answer
Entity A hedges its risk exposures using the following risk management strategy:
(a) Entity A uses benchmark commodity forward contracts, which are denominated in FC, to
hedge its coffee purchases four periods before delivery. The coffee price that Entity A
actually pays for its purchase is different from the benchmark price because of
differences in the type of coffee, the location and delivery arrangement. This gives rise to
the risk of changes in the relationship between the two coffee prices (sometimes referred
to as 'basis risk'), which affects the effectiveness of the hedging relationship. Entity A
does not hedge this risk because it is not considered economical under cost/benefit
considerations.
For the purpose of this scenario it is assumed that the hedged risk is not designated
based on a benchmark coffee price risk component. Consequently, the entire coffee price
risk is hedged.
(b) Entity A also hedges its FX risk. However, the FX risk is hedged over a different
horizon—only three periods before delivery. Entity A considers the FX exposure from the
variable payments for the coffee purchase in FC and the gain or loss on the commodity
forward contract in FC as one aggregated FX exposure. Hence, Entity A uses one single
FX forward contract to hedge the FX cash flows from a forecast coffee purchase and the
related commodity forward contract.
The following table sets out the parameters used for this question (the 'basis spread' is
the differential, expressed as a percentage, between the price of the coffee that Entity A
actually buys and the price for the benchmark coffee):
Parameters
Period 1 2 3 4 5
Interest rates for remaining maturity [FC] 0.26% 0.21% 0.16% 0.06% 0.00%
Interest rates for remaining maturity [LC] 1.12% 0.82% 0.46% 0.26% 0.00%
Forward price [FC/lb] 1.25 1.01 1.43 1.22 2.15
Basis spread -5.00% -5.50% -6.00% -3.40% -7.00%
FX rate (spot) [FC/LC] 1.3800 1.3300 1.4100 1.4600 1.4300
(Study Material)

  
Question 175
On 1 January 20X1, Company D issues a three-year 5.5% fixed rate bond of 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 years. D enters into a foreign currency forward contract to
buy USD 15 million and sell GBP 9,835,389 at 31 December 20X3.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 765
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 movements 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. D 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 spot and the forward exchange rates and the fair value of the foreign currency forward
contract are as follows:
Date Spot FWD FV of FWD
rate rate forward points
1-Jan-20X1 0.6213 0.6557 - 0.0344 USD 15,000,000
31-Dec-20X1 0.5585 0.5858 (957,205) 0.0273 Forward 516,000
points
31-Dec-20X2 0.5209 0.528 (1,833,346) 0.0071
30-Dec-20X3 0.5825 0.5825 (1,098,000) -
Pass necessary journal entries.
(Study Material)
Answer
The hedge remains effective for the entire period, with changes in the fair value of the forward
contract and the hedging instrument being perfectly offset. Because D has designated the
variability in cash flows arising from movements in the forward rates as the hedged risk, the entire
change in the fair value of the forward contract is recognised in OCI.
At each reporting date, G reclassifies from equity an amount equal to the movement in the spot
rate on the principal amount of the bond.
In addition, to ensure that the forward points recognised in OCI are reclassified fully to profit or
loss over the life of the hedge, D reclassifies from equity the forward points recognised in OCI
amortised over the life of the hedging relationship. Assuming that all criteria for hedge accounting
have been met, D records the following journal entries:
Particulars Dr Cr
Cash Dr. 93,19,500
To Bond 93,19,500
31 December 20X1
Hedging Reserve (OCI) Dr. 9,57,205
To Derivative 9,57,205
Bond Dr. 9,42,000
To Foreign currency (P&L) 9,42,000
Foreign currency (P&L) Dr. 9,42,000
To Hedging Reserve (OCI) 9,42,000
766 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Particulars Dr Cr
Foreign currency (P&L) Dr. 1,72,000
To Hedging Reserve (OCI) 1,72,000
Interest expense Dr. 4,60,763
To Cash 4,60,763
31 December 20X2
Hedging Reserve (OCI) Dr. 8,76,141
To Derivative 8,76,141
Bond Dr. 5,64,000
To Foreign currency (P&L) 5,64,000
Foreign currency (P&L) Dr. 5,64,000
To Hedging Reserve (OCI) 5,64,000
Foreign currency (P&L) Dr. 1,72,000
To Hedging Reserve (OCI) 1,72,000
Interest expense Dr. 4,29,743
To Cash 4,29,743
31 December 20X3
Derivative Dr. 7,35,346
To Hedging Reserve (OCI) 7,35,346
Foreign currency (P&L) Dr. 9,24,000
To Bond 9,24,000
Hedging Reserve (OCI) Dr. 9,24,000
To Foreign currency (P&L) 9,24,000
Foreign currency (P&L) Dr. 1,72,000
To Hedging Reserve (OCI) 1,72,000
Interest expense Dr. 4,80,563
To Cash 4,80,563
Bond Dr. 87,37,500
To Cash 87,37,500
Derivative Dr. 10,98,000
To Cash 10,98,000
Movement of hedging reserve is summarised below:
Opening (1,56,795) (16,654)
Derivative 9,57,205 8,76,141 (7,35,346)
MTM on loans (9,42,000) (5,64,000) 9,24,000
Forward point (1,72,000) (1,72,000) (1,72,000)
Closing balance (1,56,795) (16,654) -

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 767
Question 176
The Company has taken an external commercial borrowing of $1 million. The term of the loan is 3
years. 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 Spot Forward End Spot Forward
of Price rate of Q1 Price rate of Q2 Price rate
Loan
USD 31- 50 53 31- 52 56 30- 55 60
to Dec- Mar- Jun-
INR 20X1 20X2 20X2
rate
MTM values of derivative contract
31-Dec-20X1 10,00,000
31-Mar-20X2 25,00,000
30-Jun-20X2 65,00,000
Record journal entries if Company was to do hedge accounting and if the Company did not opt for
hedge accounting. Assume hedge is effective for this purpose.
(Study Material)
Answer

Ind-AS (without hedge Ind-AS (with hedge

accounting) accounting)
Balance Sheet Entry Carrying Entry Carrying
required value required value
As on 31
December
20X1
Bank a/c 49,000,000 49,000,000 49,000,000 49,000,000
Loan a/c (50,000,000) (50,000,000) (50,000,000) (50,000,000)
Derivative a/c (Ind 1,000,000 1,000,000 1,000,000 1,000,000
AS)
As on 31 Balance Sheet
March
20X2
Bank a/c - 49,000,000 - 49,000,000
Loan a/c (2,000,000) (52,000,000) (2,000,000) (52,000,000)
Derivative a/c 1,500,000 2,500,000 1,500,000 2,500,000
768 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Ind-AS (without hedge Ind-AS (with hedge

accounting) accounting)
Balance Sheet Entry Carrying Entry Carrying
required value required value
Profit & Loss
Account
(Profit)/loss on 2,000,000 2,000,000 2,000,000 2,000,000
restatement of
loan
(Profit)/loss on (1,500,000) (1,500,000) (2,000,000) (2,000,000)
derivative
Amortisation of - - 83,333 83,333
forward element
(Ind AS hedge
accounting)
Other
Comprehensive
Income
Forward element - - 416,667 416,667
of hedging
instrument
As on 30 Balance Sheet
June 20X2
Bank a/c - 49,000,000 - 49,000,000
Loan a/c (3,000,000) (55,000,000) (3,000,000) (55,000,000)
Derivative a/c (Ind 4,000,000 6,500,000 4,000,000 6,500,000
AS)
Profit & Loss
Account
Profit/loss on 3,000,000 5,000,000 3,000,000 5,000,000
restatement of
loan
Profit/loss on (4,000,000) (5,500,000) (3,000,000) (5,000,000)
derivative
Amortisation of - - 83,333 166,667
forward element
(Ind AS hedge
accounting)
Other
Comprehensive
Income
Forward element - - (1,083,333) (666,667)
of hedging
instrument

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 769
Question 177
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.
(Study Material)
Answer
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.

  
Question 178
An entity anticipates capital expenditure in a few years. 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
the portfolio.
Evaluate the business model.
(Study Material)
Answer
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 maximise 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 are 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 increase in credit risk). The objective of this contrasting
business model is to hold financial assets to collect contractual cash flows.

  
Question 179
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 other 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.
770 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
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 rates. 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.
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.
(RTP November 2019)
Answer
On Initial recognition
Debit (`) Credit (`)
Financial asset-FVOCI Dr. 1,000
To Cash 1,000
On Impairment of debt instrument
Debit Credit (`)
(`)
Impairment expense (P&L) Dr. 30
Other comprehensive income Dr. 20
To Financial asset-FVOCI 50
The cumulative loss in other comprehensive income at the reporting date was `20. That amount
consists of the total fair value change of `50 (that is, `1,000-`950) offset by the change in the
accumulated impairment amount representing 12-month ECL, that was recognized (`30).
On Sale of debt instrument
Debit Credit
(`) (`)
Cash 950
To Financial asset –FVOCI 950
Loss on sale (P&L) 20
To Other comprehensive income 20

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 771

QUESTIONS BANK
Question 180
Growth Limited on 1st April, 2015 issued 50,000, 7% convertible debentures of face value of `100
per debenture at par. The debentures are redeemable at a premium of 10% on 31st March, 2020
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%. The date of transition to
Ind AS is 1st April, 2017.
Suggest how Growth Limited should account for this compound financial instrument on the date
of transition. Also discuss Ind AS on 'Financial Instrument' presentation in the above context.
The present value of ` 1 receivable at the end of each year based on discount rates of 7% and
10% can be taken as:
End of Year 1 2 3 4 5
7% 0.94 0.87 0.82 0.76 0.71
10% 0.91 0.83 0.75 0.68 0.62
(November 2018) (8 Marks)
Answer
Since the liability is outstanding on the date of Ind AS transition, Growth Ltd. is required to split
the convertible debentures into debt and equity portion on the date of transition. Accordingly, first
the liability component will be measured discounting the contractually determined stream of future
cash flows (interest and principal) to present value by using the discount rate of 10% p.a. (being
the market interest rate for similar debentures with no conversion option).
Calculation of Equity & Liability component on initial recognition
(`)
Present Interest payments for 5 years on debentures by applying annuity factor 13,26,500
[(50,000 x 7% x 100) x 3.79]
PV of principal repayment (including premium) (50,000x110x0.62) 34,10,000
Total liability component 47,36,500
Total equity component (Balancing figure) 2,63,500
Total proceeds from issue of Debentures 50,00,000
Thus, on the date of transition, the amount of `50,00,000 being the amount of debentures will
split as under:
Debt `47,36,500
Equity `2,63,500

  
Question 181
On 1 April 2018, an 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 100 new shares for each `200 worth of loan.
An equivalent loan without the conversion option would have carried interest at 10%. Interest of
`48,000 has already been paid and included as a finance cost.
772 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Present value rates are as follows:
Year End @ 8% @ 10%
1 0.93 0.91
2 0.86 0.83
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) (8 Marks)
Answer
Step 1 There is an 'option' to convert the loans into equity i.e. the loan note holders do not have
to accept equity shares; they could demand repayment in the form of cash.
Ind AS 32 states that where there is an obligation to transfer economic benefits there should be a
liability recognised. On the other hand, where there is not an obligation to transfer economic
benefits, a financial instrument should be recognised as equity.
In the above illustration we have both - 'equity and 'debt features in the instrument. There is an
obligation to pay cash - i.e. interest at 8% per annum and a redemption amount - this is 'financial
liability or 'debt component. The'equity part of the transaction is the option to convert. So it is a
compound financial instrument.
Step 2 Debt element of the financial instrument so as to recognise the liability is the present value
of interest and principal
The rate at which the same is to be discounted, is the rate of equivalent loan note without the
conversion option would have carried interest at 10%, therefore this is the rate to be used for
discounting
Step 3 Calculation of the debt element of the loan note as follows:
8% Interest discounted at a rate of 10% Present Value (6,00,000 x 8%)
S. No Year Interest amount PVF Amount
Year 1 2019 48,000 0.91 43,680
Year 2 2020 48,000 0.83 39,840
Year 3 2021 48,000 0.75 36,063
1,19,583
Year 4 2022 648,000 0.68 4,40,640
Amount to be recognised as a liability 5,60,223

Initial proceeds (6,00,000)

Amount to be recognised as equity 39,777
* In year 4, the loan note is redeemed therefore `6,00,000 + `48,000 = `6,48,000.
Step 4 The next step is to recognise the interest component equivalent to the loan that would
carry if there was no option to cover. Therefore, the interest should be recognised at 10%. As on
date `48,000 has been recognised in the statement of profit and loss i.e. 6,00,000 x 8% but we
have discounted the present value of future interest payments and redemption amount using
discount factors of 10%, so the finance charge in the statement of profit and loss must also be
recognised at the same rate i.e. for the purpose of consistency.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 773
The additional charge to be recognised in the income statement is calculated as:
Debt component of the financial instrument `5,60,000
Interest charge (5,60,000 x 10%) `56,000
Already charged to the income statement (`48,000)
Additional charge required `8,000
Journal Entries for recording additional finance cost for year ended 31 March 2019
Particulars Dr. Amount Cr. Amount
(`) (`)
Finance cost A/c Dr. 8,000
To Debt component A/c 8,000
(Being interest recorded for difference between amount recorded
earlier and that to be recorded per Ind AS 32)

  
Question 182
On April 1, 20X1, Pluto Ltd. has advance a loan for `10 lakhs to one of its employees for an
interest rate at 4% per annum (market rate 10%) which is repayable in 5 equal annual
installments along with interest at each year end. Employee is not required to give any specific
performance against this benefit.
The accountant of the company has recognised the staff loan in the balance sheet equivalent to
the amount disbursed i.e. `10 lakhs. The interest income for the period is recognised at the
contracted rate in the Statement of Profit and Loss by the company i.e. `40,000 (`10 lakhs x 4%).
Analyse whether the above accounting treatment made by the accountant is in compliance with
the Ind AS. If not, advise the correct treatment alongwith working for the same.
(MTP March, 2019) (8 Marks)
Answer
The above treatment needs to be examined in the light of the provisions given in Ind AS 32 and
Ind AS 109 on Financial Instruments' and Ind AS 19 'Employee Benefits'.
Para 11 (c) (i) of Ind AS 32 'Financial Instruments : Presentation' states that:
"A financial asset is any asset that is:
(c) a contractual right:
(i) to receive cash or....."
Further, paragraph 5.1.1 of Ind AS 109 states that
"at initial recognition, an entity shall measure a financial asset or financial liability atits fair
value".
Further, paragraph 5.1.1 of Appendix B to Ind AS 109 states that:
"The fair value of a financial instrument at initial recognition is normally the transaction price
(i.e. the fair value of the consideration given or received. However, if part of the consideration
given or received is for something other than the financial instrument, an entity shall measure
the fair value of the financial instrument. For example, the fair value of a long term loan or
receivable that carries no interest can be measured as the present value of all future cash
receipts discounted using the prevailing market(s) of interest rate of similar instrument with a
similar credit rating. Any additional amount lent is an expense or reduction of income unless it
qualifies for recognition as some other type of asset."
774 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Further, paragraph 5.2.1 of Ind AS 109 states that
"After initial recognition, an entity shall measure a financial asset at:
(a) amortised cost;
(b) fair value through other comprehensive income; or
(c) fair value through profit or toss.
Further, paragraph 5.4.1 of Ind AS 109 states that:
"Interest revenue shall be calculated by using the effective interest method. This shall be
calculated by applying the effective interest rate to the gross carrying amount of a financial
asset"
Paragraph 8 of Ind AS 19 states that:
"Employee Benefits are all forms of consideration given by an entity in exchange for service
rendered by employees or for tfie termination of employment."
The Accountant of Pluto Ltd. has recognised the staff loan in the balance sheet at `10 lakhs
being the amount disbursed and `40,000 as interest income for the period is recognised at the
contracted rate in the statement of profit and loss which is not correct and not in accordance with
Ind AS 19, Ind AS 32 and Ind AS 109.
Accordingly, the staff advance being a financial asset shall be initially measured at the fair value
and subsequently at the amortised cost. The interest income is calculated by using the effective
interest method. The difference between the amount lent and fair value is charged as Employee
benefit expense in statement of profit and loss.
(a) Calculation of Fair Value of the Loan
Year Cash Inflow Discounting Factor (10%) Present Value
1 2,40,000 0.909 2,18,160
2 2,32,000 0.826 1,91,632
3 2,24,000 0.751 1,68,224
4 2,16,000 0.683 1,47,528
5 2,08,000 0.621 1,29,168
Total 8,54,712
Staff loan should be initially recorded at `8,54,712.
(b) Employee Benefit Expense
Loan Amount - Fair Value of the loan = `10,00,000 - `8,54,712 = `1,45,288
`1,45,288 shall be charged as Employee Benefit expense in Statement of Profit and Loss for the
year ended 31.03.20X2.
Amortisation table:
Year Opening balance of Interest (10%) Repayment Closing balance of
Staff Advance Staff Advance
(a) (b)= (ax 10%) (c) (d) = a + b -c
1 8,54,712 85,471 2,40,000 7,00,183
2 7,00,183 70,018 2,32,000 5,38,201
3 5,38,201 53,820 2,24,000 3,68,021
4 3,68,021 36,802 2,16,000 1,88,823
5 1,88,823 19,177 (b.f.) 2,08,000 Nil
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 775
Balance Sheet extracts showing the presentation of staff loan as at 31st March 20X2
Ind AS compliant Division II of Sch III needs to be referred for presentation requirement in
Balance Sheet on Ind AS.
Assets
Non-Current Assets
Financial Assets
(i) Loan 5,38,201
Current Assets
Financial Assets
(i) Loans (7,00,183 - 5,38,201) 1,61,982

  
Question 183
(1) 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 is payable annually on 1st April 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 of
bond as per applicable Ind AS?
(ii) What is the present value of the interest payment to be recognised 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?
(2) QA Ltd. has also issued 10,00,000 of 8% Long Term Bond-B Series of `1 each on 1st
April, 2016. The bond tenure is 3 years. Interest is payable annually on 1st April each
year. However, the bond holders of this series are entitled to convert the bonds to shares
of `1 each on the date of maturity, instead of receiving the principal repayment. Interest
rate on the similar bond without conversion option is 10%. QA Ltd. has requested you to
suggest the following for this type of instrument:
(a) What is entry to be passed at the date of issuance of the bond as per applicable Ind
AS?
(b) What is entry to be passed at the date of conversion of the bond as per applicable
Ind AS?
(MTP March, 2019) (8 Marks)
Answer
(1) (i) Option (C): `7,51,315
(ii) Option (C): `1,98,948
(iii) Option (B) : `9,50,263
(iv) Option (B) : Bond Interest Expenses A/c Dr. `95,026
To Discount on Bond A/s `15,026
To Cash/Bank A/c `80,000
776 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Workings for the above
Since the Effective interest rate on the loan is 10% while the Bond has been issued at 8%, the
financial liability will be recognized affair value determined as follows:
Calculation of initial recognition amount of 8% Long term Loan Bond A Series
Particulars `
Present value of the principal repayable after 3 years (10,00,000 × .751315) 7,51,315
Present value of Interest [(10,00,000 x 8%) x 2.48685] 9,50,263
Total Present Value of Long term Loan Bond 1,98,948
Interest for the first year recognized in the books as per effective interest rate method
= `9,50,263 x 10% = `95,026
However, interest paid is @ 8% i.e. `10,00,000 x 8% = `80,000
(2) (a) Option (B): Cash/Bank A/c `10,00,000
To 8% LT Bond Series B A/c `9,50,263
To Share Option A/c `49,737
Workings for the above
It is a compound instrument.
Calculation of initial recognition amount of 8% Long term Loan Bond B Series liability and
equity component
Particulars `
Present value of the principal repayable after 3 years (10,00,000 x .751315) 7,51,315
Present value of Interest [(10,00,000 x 8%) x 2.48685] 1,98,948
Total Present Value of Long term Loan Bond B I
Issue proceeds from convertible bond II 9,50,263
Value of equity component (II - I) 10,00,000
49,737
(b) 8% LT Bond Series B A/c `10,00,000
Share Option A/c `49,737
To Share Capital A/c `10,00,000
To Share Premium A/c `49,737
Reasoning:
As per para AG32 of Ind AS 32, on conversion of a convertible instrument at maturity, the
entity derecognises the liability component and recognises it as equity. The original
equity component remains as equity (although it may be transferred from one line item
within equity to another). There is no gain or loss on conversion at maturity.

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 777
Question 184
Hello Limited borrowed ` 500,000,000 from a bank on 1 January 2017. 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, Hello 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 31st December 2018.
• Payment of interest on an annual basis
Record journal entries in the books of Hello Limited till 31st December 2018, after giving effect of
the changes in the terms of the loan on 31st December 2017.
(MTP October, 2018) (14 Marks)
Answer
On the date of initial recognition, the effective interest rate of the loan shall be computed keeping
in view the contractual cash flows and upfront processing fee paid. The following table shows the
amortisation of loan based on effective interest rate:
Date Cash flows Cash flows Amortised cost Interest @ EIR
(principal) (interest and (opening + interest - (11.50%)
fee) cash flows)
1-Jan-2016 (500,000,000) 5,870,096 494,129,904
31-Dec-2016 100,000,000 55,000,000 395,954,843 56,824,939
31-Dec-2017 100,000,000 44,000,000 297,489,650 45,534,807
31-Dec-2018 100,000,000 33,000,000 198,700,959 34,211,310
31-Dec-2019 100,000,000 22,000,000 99,551,570 22,850,610
31-Dec-2020 100,000,000 11,000,000 (0) 11,448,430
a. 1 January 2016
Particulars Dr. Amount ( `) Cr. Amount (
`)
Cash A/c Dr. 494,129,904
To Loan from bank A/c 494,129,904
(Being loan recorded at its fair value less transaction costs on
the initial recognition date)
b. 31 December 2016
Particulars Dr. Amount ( `) Cr. Amount (
`)
Loan from bank A/c Dr. 98,175,061
Interest expense (profit and loss) Dr. 56,824,939
To Cash A/c 155,000,000
(Being first instalment of loan and payment of interest
accounted for as an adjustment to the amortised cost of loan)
778 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
c. 31 December 2017 - Before Hello Limited approached the bank -
Particulars Dr. Amount Cr. Amount (
( `) `)
Interest expense (profit and loss) Dr. 45,534,807
To Loan from bank A/c 1,534,807
To cash A/c 44,000,000
(Being loan payment of interest recorded by the Company before it
approached the Bank for deferment of principal)
Upon receiving the new terms of the loan, Hello Limited, 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 requirements of Ind AS 109, any change
of more than 10% shall be considered a substantial modification, resulting in fresh accounting for
the new loan:
Date Cash flows Interest outflow Discount PV of cash
(principal) @15% factor flows
31-Dec-2017 (400,000,000)
31-Dec-2018 40,000,000 60,000,000 0.8969 89,686,099
31-Dec-2019 40,000,000 54,000,000 0.8044 75,609,805
31-Dec-2020 40,000,000 48,000,000 0.7214 63,483,092
31-Dec-2021 40,000,000 42,000,000 0.6470 53,053,542
31-Dec-2022 40,000,000 36,000,000 0.5803 44,100,068
31-Dec-2023 40,000,000 30,000,000 0.5204 36,429,133
31-Dec-2024 40,000,000 24,000,000 0.4667 29,871,422
31-Dec-2025 40,000,000 18,000,000 0.4186 24,278,903
31-Dec-2026 40,000,000 12,000,000 0.3754 19,522,235
31-Dec-2027 40,000,000 6,000,000 0.3367 15,488,493
PV of new contractual cash flows discounted at 11.50% 451,522,791
Carrying amount of loan 397,489,650
Difference 54,033,141
Percentage of carrying amount 13.59%
Note: Above calculation have been done on full decimal, though in the table discount factor is
limited to 4 decimals.
Considering a more than 10% change in PV of cash flows compared to the carrying value 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:
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 779
d. 31 December 2017 - accounting for extinguishment
Particulars Dr. Amount ( `) Cr. Amount (
`)
Loan from bank (old) A/c Dr 397,489,650
Finance cost (profit and loss) Dr 2,510,350
To Loan from bank (new) A/c 400,000,000
(Being new loan accounted for at its principal amount in
absence of any transaction costs directly related to such loan
and correspondingly a de-recognition of existing loan)
e. 31 December 2018
Particulars Dr. Amount ( `) Cr. Amount ( `)
Loan from bank A/c Dr. 40,000,000
Interest expense (profit and loss) Dr. 60,000,000
To cash A/c 100,000,000
(Being first instalment of the new loan and payment of
interest accounted for as an adjustment to the amortised
cost of loan)

  
Question 185
Discuss the need of hedge accounting and types of various hedges?
(MTP October, 2018) (8 Marks)
Answer
Hedge accounting may be required due to accounting mismatches in:
• Measurement - some financial instruments (non-derivative) are not measured at fair
value with changes being recognised in the statement of profit and loss whereas all
derivatives, which commonly are used as hedging instruments, are measured at fair
value
• Recognition - unsettled or forecast transactions that may be hedged are not recognised
on the balance sheet or are included in the statement of profit and loss only in a future
accountin g period, whereas all derivatives are recognised at inception.
Recognition mismatches include the hedge of a contracted or expected but not yet
recognised sale, purchase or financing transaction in a foreign currency and future
committed variable interest payments.
Types of hedge accounting
1. Fairvalue hedge accounting model
• A fair value hedge seeks to offset the risk of changes in the fair value of an
existing asset or liability or an unrecognised firm commitment that may give rise
to a gain or loss being recognised in the statement of profit and loss.
• A fair value hedge is a hedge of the exposure to changes in fair value of a
recognised asset or liability or an unrecognised firm commitment, or an identified
portion of such an asset, liability or firm commitment, that is attributable to a
particular risk and could affect the statement of profit and loss.
780 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
2. Cash flow hedge accounting model
• A cash flow hedge seeks to offset certain risks of the variability of cash flows in
respect of an existing asset or liability or a highly probable forecast transaction
that may be reflected in the statement of profit and loss in a future period.
• A cash flow hedge is a hedge of the exposure to variability in cash flows that (i) is
attributable to a particular risk associated with a recognised asset or liability

(such as all or some future interest payments on variable rate debt) or a highly
probable forecast transaction or a firm commitment in respect of foreign currency
and (ii) could affect the statement of profit and loss.
3. Net investment hedging
• An investor in a non-integral operation is exposed to changes in the carrying
amount of the net assets of the foreign operation (the net investment) arising
from the translation of those assets into the reporting currency of the investor.

  
Question 186
On 1st April, 2014, S Ltd. issued 5,000, 8% convertible debentures with a face value of `100
each maturing on 31st March, 2019. The debentures are convertible into equity shares of S Ltd.
at a conversion price of `105 per share. Interest is payable annually in cash. At the date of issue,
S Ltd. could have issued non-convertible debentures with a 5 year term bearing a coupon interest
rate of 12%. On 1st April, 2017, the convertible debentures have a fair value of `5,25,000. S 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, S Ltd. could have issued non-convertible debt with a
2 year term bearing a coupon interest rate of 9%.
Examine the accounting treatment in the books of S Ltd., by passing appropriate journal entries,
for recording of equity and liability component:
(1) At the time of initial recognition and
(2) At the time of repurchase of the convertible debentures.
The following present values of Re. 1 at 8%, 9% & 12% are supplied to you:
Interest Rate Year l Year 2 Year 3 Year 4 Year 5
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 August 2018) (10 Marks)
(ii) On 1 January 2018, 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.
Answer
(i) (1) At the time of initial recognition
`
Liability component
Present value of 5 yearly interest payments of `40,000, discounted at 12% annuity 1,44,200
(40,000 x 3.605)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 781

`
Present value of `5,00,000 due at the end of 5 years, discounted at 12%, 2,83,500
compounded yearly (5,00,000 x 0.567)
4,27,700
Equity component
(` 5,00,000 - `4,27,700) 72,300
Total proceeds 5,00,000
Note: Since `105 is the conversion price of debentures into equity shares and not the redemption
price, the liability component is calculated @ `100 each only.
Journal Entry
` `
Bank Dr. 5,00,000
To 8% Debentures (Liability component) 4,27,700
To 8% Debentures (Equity component) 72,300
(Being Debentures are initially recorded a fair value)
(2) At the time of repurchase of convertible debentures
The repurchase price is allocated as follows:
Carrying Value Fair Value Difference
@ 12%
` ` `
Liability component
Present value of 2 remaining yearly interest 67,600 70,360
payments of `40,000, discounted at 12% and
9%, respectively
Present value of `5,00,000 due in 2 years, 3,98,500 4,21,000
discounted at 12% and 9%, compounded yearly,
respectively
Liability component 4,66,100 4,91,360 (25,260)
Equity component (5,25,000 - 4,91,360) 72,300 33,640* 38,660
Total 5,38,400 5,25,000 13,400
*(5,25,000 - 4,91,360) = 33,640
Journal Entries
` `
8% Debentures (Liability component) Dr. 4,66,100
Profit and loss A/c (Debt settlement expense) Dr. 25,260
To Bank A/c 4,91,360
(Being the repurchase of the liability component recognised)
782 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

` `
8% Debentures (Equity component) Dr. 72,300
To Bank A/c 33,640
To Reserves and Surplus A/c 38,660
(Being the cash paid for the equity component recognised)

  
Question 187
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 option 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 assuming that the present value of
option exercise price is `2,00,000?
(MTP August 2018) (5 Marks)
Answer
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, Entity X has an
obligation to deliver cash which it cannot avoid.
As per para 23 of Ind AS 32 'Financial Instruments: Presentation', the accounting for financial
instrument will be as below:
• The financial liability is recognised initially at the present value of the redemption amount,
and is reclassified from equity. 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 (` 5,00,000) 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 will be measured at amortised cost as per Ind AS 109 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 liability is
reclassified to equity ie. an amount of `22,000,000 will be reclassified from financial
liability to equity.

  
Question 188
On 1st April, 2017, XYZ Ltd., a company incorporated in India enters into a contract to buy solar
panels from Good Associates, a firm domiciled in UAE, for which delivery is due after 6 months
i.e. on 30lh September, 2017.
The purchase price for solar panels is US$ 50 million.
The functional currency of XYZ is Indian Rupees (INR) and of Good Associates 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.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 783
Exchange rates:
1. Spot rate on 1st April 2017: USD 1 = `60
2. Six-month forward rate on 1st April, 2017: USD 1 = `65
3. Spot rate on 30th September, 2017: USD 1 = `66
Analyse the contract and pass the necessary journal entries.
(MTP, April 2018) (14 Marks)
Answer
This contract comprises of two components:
• Host contract to purchase solar panels denominated in `i.e. a notional payment in `at 6-
month forward rate (`3,250 million or `325 crores)
• Forward contract to pay US Dollars and receive `i.e. a notional receipt in `In other words,
a forward contract to sell US Dollars at `65 per US Dollar.
It may be noted that the notional Rupees payment in respect of host contract and the notional
Rupees receipt in respect of embedded derivative create an offsetting position.
Subsequently, the host contract is not accounted for until delivery. The embedded derivative is
recorded at fair value through profit or loss. This gives rise to a gain or loss on the derivative, and
a corresponding derivative asset or liability.
On delivery XYZ records the inventory at the amount of the host contract (`325 crores). The
embedded derivative is considered to expire. The derivative asset or liability (i.e. the cumulative
gain or loss) is settled by becoming part of the financial liability that arises on delivery.
In this case the carrying value of the currency forward at 30lh September 2017 on maturity is `50
million X (66 minus 65) = `5 crores (liability/loss). The loss arises because XYZ has agreed to sell
US Dollars at' 65 per US Dollar whereas in the open market, US Dollar can be sold at `66 per US
Dollar.
No accounting entries are passed on the date of entering into purchase contract. On that date,
the forward contract has a fair value of zero (refer section "option and non-option based
derivatives" below).
Subsequently, say at 30th September 2017, the accounting entries are as follows:
(all ` in crores):
1. Loss on derivative contract 5
To Derivative liability 5
(Being loss on currency forward)
2. Inventory 325
To Trade payables (financial liability) 325
(Being inventory recorded at forward exchange rate determined on date of contract)
3. Derivative liability 5
To Trade payables (financial liability) 5
(Being reclassification of derivative liability to trade payables upon settlement)
The effect is that the financial liability at the date of delivery is `330 crores (`325 crores + `5
crores), equivalent to US$ 50 million at the spot rate on 30th September 2017.
Going forward, the financial liability is a US$ denominated financial instrument. It is retranslated
at the dollar spot rate in the normal way, until it is settled.

  
784 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Question 189
On 1 January 20X0, Preet 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 10%. On 1
January 20X5 (i.e. after 5 years) Preet Ltd. and the bondholders agree to a modification in
accordance with which:
• the term is extended to 31 December 20Y1;
• 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.
Preet Ltd. determines that the market interest rate on 1 January 20X5 for borrowings on similar
terms is 11%.
Analyse whether the extinguishment accounting will apply or not as per Ind AS. If yes, determine
the fair value of the modified liability and compute the gain or loss on modification.
(MTP March, 2018) (14 Marks)

Answer
The repayment schedule for the original debt till the date of renegotiation is as below:
Date/year ended Opening Interest accrual Cash flows Closing balance
balance
1 January 20X0 10,00,000 10,00,000
31 December 20X0 10,00,000 1,00,000 (1,00,000) 10,00,000
31 December 20X1 10,00,000 1,00,000 (1,00,000) 10,00,000
31 December 20X2 10,00,000 1,00,000 (1,00,000) 10,00,000
31 December 20X3 10,00,000 1,00,000 (1,00,000) 10,00,000
31 December 20X4 10,00,000 1,00,000 (1,00,000) 10,00,000
On 1 January 20X5, the discounted present value of the remaining cash flows of the original
financial liability is `10,00,000.
On this date, Preet Ltd. will compute the present value of:
• cash flows under the new terms - i.e. `15,00,000 payable on 31 December 20Y1 and
`50,000 payable for each of the 7 years ending 31 December 20Y1.
• any fee paid (net of any fee received) - i.e. `1,00,000
using the original effective interest rate of 10%.
The total of these amounts to `11,13,158 (Refer Working Note). This differs from the discounted
present value of the remaining cash flows of the original financial liability by 11.32% i.e. by more
than 10%. Hence, extinguishment accounting applies.
The next step is to estimate the fair value of the modified liability. This is determined as the
present value of the future cash flows (interest and principal), using an interest rate of 11% (the
market rate at which Preet Ltd. could issue new bonds with similar terms). The estimated fair
value on this basis is `958,097 (Refer Working Note). A gain or loss on modification is then
determined as:
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 785
Gain (loss) = carrying value of existing liability - fair value of modified liability - fees and costs
incurred i.e. `10,00,000 - `9,58,097 - `1,00,000 = Loss of t 58,097
Working Note:
Year Discount factor @ 10% Discount factor @ 11%
1 0.909091 0.900901
2 0.826446 0.811622
3 0.751315 0.731191
4 0.683013 0.658731
5 0.620921 0.593451
6 0.564474 0.534641
7 0.513158 0.481658
Annuity 4.868418 4.712195
Amount Discounting Present Discounting Present
factor® 10% value factor @ 11% value
15,00,000 0.513158 7,69,737 0.481658 7,22,487
1,00,000 1,00,000
50,000 for 7 years 4.868418 2,43,421 4.712195 2,35,610
11,13,158 9,58,097
PV of original cash flows @ original (10,00,000)
EIR
Difference 1,13,158
Difference % 11.32%

  
Question 190
On 1st April 2017, A Ltd. lent ` 2 crores to a supplier in order to assist them with their expansion
plans. The arrangement of the loan cost the company ` 10 lakhs. The company has agreed not to
charge interest on this loan to help the supplier's short-term cash flow but expected the supplier
to repay ` 2.40crores on 31st March 2019. As calculated by the finance team of the company, the
effective annual rate of interest on this loan is 6.9% On 28th February 2018, the company
received the information that poor economic climate has caused the supplier significant problems
and in order to help them, the company agreed to reduce the amount repayable by them on 31st
March 2019 to ` 2.20 crores. Suggest the accounting entries as per applicable Ind AS.
(RTP November 2018)
Answer
The loan to the supplier would be regarded as a financial asset. The relevant accounting standard
Ind AS 109 provides that financial assets are normally measured at fair value.
If the financial asset in which the only expected future cash inflows are the receipts of principal
and interest and the investor intends to collect these inflows rather than dispose of the asset to a
third party, then Ind AS109 allows the asset to be measured at amortised cost using the effective
interest method.
786 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
If this method is adopted, the costs of issuing the loan are included in its initial carrying value
rather than being taken to profit or loss as an immediate expense. This makes the initial carrying
value ` 2,10,00,000.
Under the effective interest method, part of the finance income is recognised in the current period
rather than all in the following period when repayment is due. The income recognised in the
current period is ` 14,49,000 (` 2,10,00,000 x 6.9%)
In the absence of information regarding the financial difficulties of the supplier the financial asset
at 31stMarch, 2018 would have been measured at ` 2,24,49,000 (` 2,10,00,000 + 14,49,000).
The information regarding financial difficulty of the supplier is objective evidence that the financial
asset suffered impairment at 31st March 2018.
The asset is re-measured at the present value of the revised estimated future cash inflows, using
the original effective interest rate. Under the revised estimates the closing carrying amount of the
asset would be ` 2,05,79,981 (` 2,20,00,000/1.069). The reduction in carrying value of `
18,69,019 (` 2,24,49,000 – 2,05,79,981) would be charged to profit or loss in the current period
as an impairment of a financial asset.
Therefore, the net charge to profit or loss in respect of the current period would be
` 4,20,019 (18,69,019 – 14,49,000).

  
Question 191
On 1st April, 20X4, Shelter Ltd. issued 5,000, 8% convertible debentures with a face value of `
100 each maturing on 31st March, 20X9. The debentures are convertible 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, 20X7, the convertible debentures 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.
The following present values of ` 1 at 8%, 9% & 12% are supplied to you:
Interest Rate Year 1 Year 2 Year 3 Year 4 Year 5
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
(RTP May 2018)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 787
Answer
(i) At the time of initial recognition
`
Liability component
Present value of 5 yearly interest payments of ` 40,000, discounted at 12%
annuity (40,000 x 3.605) 1,44,200
Present value of ` 5,00,000 due at the end of 5 years, discounted at 12%,
compounded yearly (5,00,000 x 0.567) 2,83,500
4,27,700
Equity component
(` 5,00,000 – ` 4,27,700) 72,300
Total proceeds 5,00,000
Note: Since ` 105 is the conversion price of debentures into equity shares and not the
redemption price, the liability component is calculated @ ` 100 each only.
Journal Entry
` `
Bank 5,00,000
Dr.
To 8% Debentures (Liability component) 4,27,700
To 8% Debentures (Equity component) 72,300
(Being Debentures are initially recorded a fair value)
(ii) At the time of repurchase of convertible debentures
The repurchase price is allocated as follows:
Carrying Fair Value @ Difference
Value @ 12% 9%
` ` `
Liability component
Present value of 2 remaining yearly interest
payments of ` 40,000, discounted at 12%
and 9%, respectively 67,600 70,360
Present value of ` 5,00,000 due in 2 years,
discounted at 12% and 9%, compounded
yearly, respectively 3,98,500 4,21,000
Liability component 4,66,100 4,91,360 (25,260)
Equity component
(5,25,000 - 4,91,360) 72,300 33,640* 38,660
Total 5,38,400 5,25,000 13,400
*(5,25,000 – 4,91,360) = 33,640
788 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
Journal Entries
` `
8% Debentures (Liability component) Dr. 4,66,100
Profit and loss A/c (Debt settlement expense) Dr. 25,260
To Bank A/c 4,91,360
(Being the repurchase of the liability component recognised)
8% Debentures (Equity component) Dr. 72,300
To Bank A/c 33,640
To Reserves and Surplus A/c 38,660
(Being the cash paid for the equity component recognised)

  
Question 192
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 Instruments', 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 0.1118
(May 2018) (8 Marks)
Answer
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 the financial instrument, an entity shall measure the fair value of the
financial instrument.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 789
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 made by H Ltd. in its subsidiary. This can further be
substantiated by the nominal rate of dividend i.e. 0.0001 % mentioned in the terms of the
instrument issued.
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 Closing balance
@ 12%
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)
31st March, Redeemable Preference Shares Dr. 53,55,904
2018 To Interest income 53,55,904
(Being interest income on loan component
recognized)
790 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Date Particulars Amount Amount

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 193
On 1st January 2017, Expo Limited agreed to purchase USD ($) 40,000 from E&l Bank in future
on 31st December 2017 for a rate equal to `65 per USD. Expo Limited did not 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 tilt the date of actual purchases of USD.
For the purpose of accounting, use the following information representing marked 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 30th September, 2017 `24,000
Spot rate of USD on 31st December, 2017 `62 per USD
(May 2018) (8 Marks)
Answer
Assessment of the arrangement using the definition of derivative included under
lndAS109.
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 is 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.
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:
(a) the value of the contract to purchase USD at a fixed price changes in response to
changes in foreign exchange rate.
(b) the initial amount paid to enter into the 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.
(c) the contract is settled in future
The derivative is a 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.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 791
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.
(ii) 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. (`)
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 40,000 x `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 194
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 at below market rate of interest. Ind AS 109
requires that a financial asset or financial liability is 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.
792 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
What is the accounting treatment of the difference between the transaction price and the fair
value on initial recognition in the book of NAV Ltd.?
Present value factors at 12%:
Year 1 2 3 4 5
PVF 0.892 0.797 0.712 0.636 0.567
(November 2018) (4 Marks)
Answer
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
Year Future cash flow Discounting factor Present value
(in lakh) @ 12% (in lakh)
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 data 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 may also calculate the above fair value by the way of annuity on interest amount
rather than separate calculation.

  
Question 195
Veer Limited issues 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 per cent per annum with similar
terms but without the option for 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.
(November 2018) (8 Marks)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 793
Answer
(a) 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
Present value of interest stream discounted at 6% for 5 years
(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. Amount Cr. 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 entry 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 entry to record the interest expense)
(ii) The stream of interest expense is 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 expense at Increase in Total bond

6% (e of previous bond liability liability (e of
year x 6%) (c-b) previous year
+d)
(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
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.
794 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(iii) 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 entry 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 196
KK Ltd. has granted an interest free loan of `10,00,000 to its wholly owned Indian Subsidiary YK
Ltd. There is no transaction cost attached to the said loan. The Company has not finalised any
terms and conditions including the applicable interest rates on such loans. The Board of Directors
of the Company are evaluating various options and has requested your firm to provide your views
under Ind AS in following situations:
(i) The Loan given by KK Ltd. to its wholly owned subsidiary YK Ltd. is interest free and
such loan is repayable on demand.
(ii) The said Loan is interest free and will be repayable after 3 years from the date of granting
such loan. The current market rate of interest for similar loan is 10%. Considering the
same, the fair value of the loan at initial recognition is `8,10,150.
(iii) The said loan is interest free and will be repaid as and when the YK Ltd. has funds to
repay the Loan amount.
Based on the same, KK Ltd. has requested you to suggest the accounting treatment of the above
loan in the stand-alone financial statements of KK Ltd. and YK Ltd. and also in the consolidated
financial statements of the group. Consider interest for only one year for the above loan.
Further the Company is also planning to grant interest free loan from YK Ltd. to KK Ltd. in the
subsequent period. What will be the accounting treatment of the same under applicable Ind AS?
(RTP May 2019)
Answer
Scenario (i)
Since the loan is repayable on demand, it has fair value equal to cash consideration given. KK
Ltd. and YK Ltd. should recognize financial asset and liability, respectively, at the amount of loan
given (assuming that loan is repayable within a year). Upon, repayment, both the entities should
reverse the entries that were made at the origination.
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 795
Journal entries in the books of KK Ltd.
At origination
Loan to YK Ltd. A/c Dr. ` 10,00,000
To Bank A/c ` 10,00,000
On repayment
Bank A/c Dr. ` 10,00,000
To Loan to YK Ltd. A/c ` 10,00,000
Journal entries in the books of YK Ltd.
At origination
Bank A/c Dr. ` 10,00,000
To Loan from KK Ltd. A/c ` 10,00,000
On repayment
Loan from KK Ltd. A/c Dr. ` 10,00,000
To Bank A/c ` 10,00,000
In the consolidated financial statements, there will be no entry in this regard since loan receivable
and loan payable will get set off.
Scenario (ii)
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).
If 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 the financial instrument, an
entity shall measure the fair value of the financial instrument. The difference in fair value and
transaction cost will treated as investment in Subsidiary YK Ltd.
Both KK Ltd. and YK Ltd. should recognise financial asset and liability, respectively, at fair value
on initial recognition, i.e., the present value of ` 10,00,000 payable at the end of 3 years using
discounting factor of 10%. Since the question mentions fair value of the loan at initial recognition
as ` 8,10,150, the same has been considered. 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.
Journal entries in the books of KK Ltd. (for one year)
At origination
Loan to YK Ltd. A/c Dr. ` 8,10,150
Investment in YK Ltd. A/c Dr. ` 1,89,850
To Bank A/c ` 10,00,000
During periods to repayment- to recognise interest
796 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Year 1 – Charging of Interest

Loan to YK Ltd. A/c Dr. ` 81,015
To Interest income A/c ` 81,015

Transferring of interest to Profit and Loss

Interest income A/c Dr. ` 81,015
To Profit and Loss A/c ` 81,015
On repayment
Bank A/c Dr. ` 10,00,000
To Loan to YK Ltd. A/c ` 10,00,000

Note- Interest needs to be recognised in statement of profit and loss. The same cannot be
adjusted against capital contribution recognised at origination.
Journal entries in the books of YK Ltd. (for one year)
At origination
Bank A/c Dr. ` 10,00,000
To Loan from KK Ltd. A/c ` 8,10,150
To Equity Contribution in KK Ltd. A/c ` 1,89,850
During periods to repayment- to recognise interest
Year 1
Interest expense A/c Dr. ` 81,015
To Loan from KK Ltd. A/c ` 81,015
On repayment
Loan from KK Ltd. A/c Dr. ` 10,00,000
To Bank A/c ` 10,00,000
In the consolidated financial statements, there will be no entry in this regard since loan and
interest income/expense will get set off.
Scenario (iii)
Generally, a loan which is repayable when funds are available, cannot be stated as loan
repayable on demand. Rather the entity needs to estimate the repayment date and determine its
measurement accordingly by applying the concept prescribed in Scenario (ii).
In the consolidated financial statements, there will be no entry in this regard since loan and
interest income/expense will get set off.
In case the subsidiary YK Ltd. is planning to grant interest free loan to KK Ltd., then the difference
between the fair value of the loan on initial recognition and its nominal value should be treated as
dividend distribution by YK Ltd. and dividend income by the parent KK Ltd.

  
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 797
Question 197
On 1st April, 2014, Shelter Ltd. issued 5,000, 8% convertible debentures with a face value of Rs.
100 each maturing on 31st March, 2019. The debentures are convertible into equity shares of
Shelter Ltd. at a conversion price of Rs. 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, the convertible debentures have a fair value of
Rs. 5,25,000. Shelter Ltd. makes a tender offer to debenture holders to repurchase the
debentures for Rs. 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.
The following present values of Rs. 1 at 8%, 9% & 12% are supplied to you:
Interest Rate Year 1 Year 2 Year 3 Year 4 Year 5
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) (12 Marks)
Answer:
(i) At the time of initial recognition
Rs.
Liability component
Present value of 5 yearly interest payments of Rs. 40,000, discounted
at 12% annuity (40,000 x 3.605) 1,44,200
Present value of Rs. 5,00,000 due at the end of 5 years , discounted at
12%, compounded yearly (5,00,000 x 0.567) 2,83,500
4,27,700
Equity component
(Rs. 5,00,000 – Rs. 4,27,700) 72,300
Total proceeds 5,00,000

Note: Since Rs. 105 is the conversion price of debentures into equity shares and
not the redemption price, the liability component is calculated @ Rs. 100 each only.
Journal Entry
Rs. Rs.
Bank Dr. 5,00,000
To 8% Debentures (Liability component) 4,27,700
T o 8% Debentures (Equity component) 72,300
(Being Debentures are initially recorded a fair value)
798 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments
(ii) At the time of repurchase of convertible debentures
The repurchase price is allocated as follows:
Carrying Fair Value Difference
Value @ @ 9%
12%
Rs. Rs. Rs.
Liability component
Present value of 2 remaining yearly
interest payments of Rs. 40,000,
discounted at 12% and 9%, respectively 67,600 70,360
Present value of Rs. 5,00,000 due in 2
years, discounted at 12% and 9%,
compounded yearly, respectively 3,98,500 4,21,000
Liability component 4,66,100 4,91,360 (25,260)
Equity component (5,25,000 -4,91,360) 72,300 33,640* 38,660
Total 5,38,400 5,25,000 13,400
*(5,25,000 – 4,91,360) = 33,640
Journal Entries
Rs. Rs.
8% Debentures (Liability component) Dr. 4,66,100
Profit and loss A/c (Debt settlement expense) Dr. 25,260
To Bank A/c 4,91,360
(Being the repurchase of the liability component
recognised)
8% Debentures (Equity component) Dr. 72,300
To Bank A/c 33,640
To Reserves and Surplus A/c 38,660
(Being the c ash paid for the equity component recognised)

  
Question 198
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
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 799
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 into Equity
Shares. Keeping of view the provisions of relevant Ind AS.
(May 2019) (12 Marks)
Answer:
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 Discount Net present
Flow 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
(c) 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.
800 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Opening Interest @ 15.86% Cash Flow Closing

Financial (Dividend Financial
Liability payment) Liability
A C A+B-C
B
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-2017 Bank A/c Dr. 88,20,000
To Preference Shares A/c 29,56,552
To Equity Component of Preference shares 58,63,448
A/c
(Being compulsorily convertible preference
shares issued. The same are divided into
equity component and liability component
as per the calculation)
31-Mar-2018 Preference shares A/c Dr. 9,00,000
To Bank A/c 9,00,000
(Being dividend at the coupon rate of 10%
paid to the shareholders)
31-Mar-2018 Finance cost A/c Dr. 4,68,909
To Preference Shares A/c 4,68,909
(Being interest as per EIR method
recorded)
31-Mar-2019 Preference shares A/c Dr. 9,00,000
To Bank A/c 9,00,000
(Being dividend at the coupon rate of 10%
paid to the shareholders)
Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments 801

Date Particulars Debit Credit

31-Mar-2019 Finance cost A/c Dr. 4,00,538
To Preference Shares A/c 4,00,538
(Being interest as per EIR method
recorded)
31-Mar-2020 Preference shares A/c Dr. 9,00,000
To Bank A/c 9,00,000
(Being dividend at the coupon rate of 10%
paid to the shareholders)
31-Mar-2020 Finance cost A/c Dr. 3,21,323
To Preference Shares A/c 3,21,323
(Being interest as per EIR method
recorded)
31-Mar-2021 Preference shares A/c Dr. 9,00,000
To Bank A/c 9,00,000
(Being dividend at the coupon rate of 10%
paid to the shareholders)
31-Mar-2021 Finance cost A/c Dr. 2,29,545
To Preference Shares A/c 2,29,545
(Being interest as per EIR method
recorded)
31-Mar-2022 Preference shares A/c Dr. 9,00,000
To Bank A/c 9,00,000
(Being dividend at the coupon rate of 10%
paid to the shareholders)
31-Mar-2022 Finance cost A/c Dr. 1,23,133
To Preference Shares A/c 1,23,133
(Being interest as per EIR method
recorded)
31-Mar-2022 Equity Component of Preference shares 58,63,448
A/c Dr.
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)

  
802 Chap. 12  Indian Accounting Standard (Ind AS) 109, 32, 107: Financial Instruments

Carve-Outs
Ind AS-32
1. Foreign Currency Convertible Bonds
As per IFRS: As per accounting treatment prescribed under IAS 32, equity conversion option
in case of foreign currency denominated convertible bonds is considered a derivative liability
which is embedded in the bond. Gains or losses arising on account of change in fair value of the
derivative need to be recognised in the statement of profit and loss as per IAS 32.
Carve out: In Ind AS 32, an exception has been included to the definition of ‘financial liability’
in paragraph 11(b)(ii), whereby conversion option in a convertible bond denominated in foreign
currency to acquire a fixed number of entity’s own equity instruments is classified as an equity
instrument if the exercise price is fixed in any currency.
Reasons: This treatment as per IAS 32 is not appropriate in instruments, such as, FCCBs
since the number of shares convertible on the exercise of the option remains fixed and the
amount at which the option is to be exercised in terms of foreign currency is also fixed; merely the
difference in the currency should not affect the nature of derivative, i.e., the option. Further, the
fair value of the option is based on the fair value of the share prices of the company. If there is
decrease in the share price, the fair value of derivative liability would also decrease which would
result in recognition of gain in the statement of profit and loss. This would bring unintended
volatility in the statement of profit and loss due to volatility in share prices. This will also not give a
true and fair view of the liability as in this situation, when the share prices fall, the option will not
be exercised. However, it has been considered that if such option is classified as equity, fair value
changes would not be required to be recognised.
Accordingly, the exception has been made in definition of financial liability in Ind AS 32.