St.

Joseph’s College of Commerce (Autonomous)

Advanced Financial Reporting II

Module 3 : Financial Instruments

Definition:
A financial instrument is any contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity.

There are three reporting standards that deal with financial instruments:

●  IAS 32 Financial Instruments: Presentation

●  IFRS 7 Financial Instruments: Disclosures
●  IFRS 9 Financial Instruments

IAS 32 deals with the classification of financial instruments and their presentation in
financial statements. IFRS 9 deals with how financial instruments are measured and when
they should be recognised in financial statements. IFRS 7 deals with the disclosure of
financial instruments in financial statements.

A financial asset is any asset that is:

o  'cash'
o  'a contractual right to receive cash or another financial asset from another
entity'
o  'a contractual right to exchange financial assets or liabilities with another
entity under conditions that are potentially favourable'
o 'an equity instrument of another entity'

A financial liability is any liability that is a contractual obligation:

∙  'to deliver cash or another financial asset to another entity', or
∙  'to exchange financial assets or liabilities with another entity under conditions that
are potentially unfavourable', or
∙  'that will or may be settled in the entity’s own equity instruments.'

Initial recognition of financial liabilities

A financial liability is initially recognised at its fair value. This is usually the net proceeds of
the cash received less any costs of issuing the liability.

Subsequent measurement of financial liabilities

Financial liabilities will be carried at amortised cost, other than liabilities held for trading
and derivatives that are liabilities, both of which are unlikely to be seen within FR.

Amortised cost is calculated as:

Initial value + effective interest – interest paid

Preference shares

If irredeemable preference shares contain no obligation to make any payment, either of

capital or dividend, they are classified as equity. If preference shares are redeemable, or
have a fixed cumulative dividend they are classified as a financial liability.

Interest and dividends

The accounting treatment of interest and dividends depends upon the accounting treatment
of the underlying instrument itself:

- equity dividends declared are reported directly in equity

- dividends on instruments classified as a liability are treated as a finance cost in the
statement of profit or loss.

Compound instruments

A compound instrument is a financial instrument that has characteristics of both equity and
liabilities, such as a convertible loan.
A convertible loan has the following characteristics:
●  It is repayable, at the lender's option, in shares of the issuing company instead of
cash
●  The number of shares to be issued is fixed at the inception of the loan
●  The lender will accept a rate of interest below the market rate for non-
Convertible instruments
As the lender is allowing the company a discounted rate in return for the potential
issue of equity, these convertible instruments are accounted for using split
accounting, recognising both their equity and liability components.
●  There is a liability or debt element, as the issuer has the potential obligation to
deliver cash
●  There is also an equity element, as the investors may choose to convert the loan into
shares instead.

Initial recognition
● The liability is measured at its fair value. The fair value is the present value of the
future cash flows (interest and capital) discounted using the market rate of interest
for non-convertible debt instruments.
● The equity element is equal to the loan proceeds less the calculated liability element.
● Subsequent measurement
● The liability is measured at amortised cost:
Initial value + market-rate interest – interest paid
● The equity is not re-measured and remains at the same value on the statement of
financial position until the debt is redeemed.

Financial assets

Initial recognition of financial assets

IFRS 9 deals with recognition and measurement of financial assets. 'An entity shall recognise
a financial asset on its statement of financial position when, and only when, the entity
becomes party to the contractual provisions of the instrument'

Initial measurement of financial assets

At initial recognition, all financial assets are measured at fair value. This is likely to be the
purchase consideration paid to acquire the financial asset. Transaction costs are included
unless the asset is fair value through profit or loss.

Equity instruments
Equity instruments (purchases of shares in other entities) are measured at either:
●  fair value through profit or loss, or
●  fair value through other comprehensive income
Fair value through profit or loss
This is the default category for equity investments. Any transaction costs associated
with the purchase of these investments are expensed to profit or loss, and are not
included within the initial value of the asset. The investments are then revalued to
 fair value at each year-end, with any gain or loss being shown in the statement of
profit or loss.
Fair value through other comprehensive income
Instead of classifying equity investments as fair value through profit or loss (FVPL),
an entity may designate the investment as 'fair value through other comprehensive
income' (FVOCI). This designation must be made on acquisition and can only be
done if the investment is intended as a long- term investment. Once designated this
category cannot later be changed to FVPL.
Under FVOCI:
∙  Transaction costs are capitalised
∙  The investments are revalued to fair value each year-end, with any gain or loss being
shown in other comprehensive income and taken to an investment reserve in equity. The
investment reserve can be negative. If a FVOCI investment is sold, the investment reserve
can be transferred into retained earnings or left in equity.

Debt instruments

Debt instruments (such as bonds or redeemable preference shares) are categorised in one of
three ways:
●  Fair value through profit or loss
●  Amortised cost
●  Fair value through other comprehensive income
The default category is again fair value through profit or loss (FVPL). The other two
categories depend on the instrument passing two tests:
Business model test. This considers the entity's purpose in holding the investment.
Contractual cash flow characteristics test. This looks at the cash that will be received as a
result of holding the investment, and considers what it comprises.
Amortised cost
For an instrument to be carried at amortised cost, the two tests to be passed are:
●  Business model test. The entity must intend to hold the investment to maturity.
●  Contractual cash flow characteristics test. The contractual terms of the financial
asset must give rise to cash flows that are solely of principal and interest.
If a debt instrument is held at amortised cost, the interest income (calculated using
the effective interest as for liabilities) will be taken to the statement of profit or loss,
and the year-end asset value is similarly calculated using an amortised cost table:
Opening Interest Income Payment Closing balance
balance received

Fair value though other comprehensive income (FVOCI)

For an instrument to be carried at FVOCI, the two tests to be passed are:
o ∙  Business model test. The entity must intend to hold the investment to
maturity but may sell the asset if the possibility of buying another asset with
a higher return arises.
o ∙  Contractual cash flow characteristics test. The contractual terms of the
financial asset must give rise to cash flows that are solely of principal and
interest, as for amortised cost.
If a debt instrument is held at FVOCI
▪  The asset is initially recognised at fair value plus transaction costs
▪  Interest income is calculated using the effective rate of interest, in the
same way as the amounts that would have been recognised in profit
or loss if using amortised cost.
▪  At the reporting date, the asset will be revalued to fair value with the
gain or loss recognised in other comprehensive income. This will be
reclassified to profit or loss on disposal of the asset.

Derecognition

Financial instruments should be derecognised as follows:

 ●  financial asset – 'when, and only when, the contractual rights to the cash flows from
the financial asset expire' (IFRS 9, para 3.2.3),
e.g. when an option held by the entity has expired and become worthless or when
the financial asset has been sold and the transfer qualifies for derecognition because
substantially all the risks and rewards of ownership have been transferred from the
seller to the buyer.
●  financial liability – 'when, and only when, the obligation specified in the contract is
discharged or cancelled or expires'
● On derecognition the difference between the carrying amount of the asset or liability,
and the amount received or paid for it, should be included in the profit or loss for the
period.

Factoring of receivables

Factoring of receivables is where a company transfers its receivables balances to another

organisation (a factor) for management and collection, and receives an advance on the value
of those receivables in return.

A sale of receivables with recourse means that the factor can return any unpaid debts to the
business, meaning the business retains the risk of irrecoverable debts. In this situation the
transaction is treated as a secure loan against the receivables, rather than a sale.

A sale of receivables without recourse means the factor bears the risk of irrecoverable debts.
In this case, this is usually treated as a sale and the receivables are removed from the entity’s
financial statements.

Problems:

1. Evaluate whether the following are considered as a Financial Instruments:

a. Note payable in Government Bonds
Ans: Contract – Yes. Holder of the Note – right to receive – issuer of Note –
contractual obligation to deliver the Govt bonds. It is a financial instrument.
b. Financial Leases / Operating Lease
Ans: Financial Lease is a Financial Instrument , right to receive in hands of Lessor
and obligation to pay in hands of Lessee. It is a Financial Instrument.
Operating Lease is not a Financial instrument, as the Asset is not transferred and use
of asset is on the basis of exchange of some consideration.
c. Perpetual Debt Instruments
Ans: Holder – contractual right to receive the payment of interest at fixed dates, but
no right to receive the principal. It is a financial instrument.
d. Constructive Obligations
Ans: Constructive obligations is defined under IndAS 37, under provisions,
contingent assets and liabilities. No contract in this case, so not a financial
instrument.

2. Classify the following as Financial Liability or Equity Instrument:

a. Rights, Options or Warrants used to acquire a fixed number of the Equity
Instruments for a fixed amount of any Currency.
Ans: It is an Equity Instrument, if the Entity offers the Rights, Options or
Warrants to all of its existing owners of the same class of its own Non-Derivative
Equity Instruments.
b. Convertible Bond denominated in Foreign Currency to acquire a fixed number of
the Entity Instrument
Ans: It is an Equity Instrument , if the Exercise Price is fixed in any Currency.
c. Mandatorily Redeemable Preference shares with mandatory Fixed dividends
Ans: There is a contractual obligation to deliver cash that cannot be avoided,
Mandatory fixed payment of dividend and redemption by the issuer for a fixed
amount at a fixed future date. These are Financial Liabilities.
 d. Zero Coupon Bonds
Ans: Financial Liabilities – Mandatory redemption of amount at a fixed future
date, contractual obligation to deliver cash for the redemption value.

3. A company issued Non-redeemable Preference Shares with mandatory Fixed

Dividends. Evaluate whether such preference shares are an Equity Instruments or a
Financial Liability to the Issuer Entity.
Ans:
When pref.shares are Non- redeemable, appropriate classification is determined by
the other rights attached to them. In such case, the Principal has Equity
characteristics, the entity has contractual obligation to pay dividends, even in case of
lack of funds, or insufficient profits. In this case, obligation to pay is a Financial
Liability.

4. Determine the Business Model:

a. ABC Ltd. holds Investments to collect their CCF. Maturity of its Fin Assets is
matched to the Funding Needs. In the past, when Fin.assets credit risk has
increased , they have been sold out. Also, infrequent sales have occurred as a
result of unanticipated funding needs. Company also monitors Fair values of
Fin.assets, among other information.
Ans: Hold to collect contractual cash flows. Although the company considers Fair
values from a liquidity perspective, its objective is to hold to collect CCF. Sales in
response to an increase in Credit Risk or in frequent sales resulting from
unanticipated funding needs would not contradict that objective, even if such
sales are significant in value.
b. XYZ Ltd. anticipates Capital Expenditure in a few years. It invests its excess Cash
in Short and Long Term Financial Assets, having Contractual Lives more than its
anticipated period. The Company will hold them to collect CCF and, when an
opportunity arises, it will sell them to re-invest the Cash.
Ans: Hold to collect contractual cash flows ( and selling) – The company invests
excess cash in short term financial assets, until the company requires the funds
for making capital expenditure. When they mature, it re-invests the Cash in new
short term assets. It maintains this strategy until the funds are needed, at which
time the company uses the proceeds to fund the capital expenditure.

5. ( Method of Accounting) On 30.03.2015, an Entity enters into an agreement to

purchase a Financial Asset for Rs.100 which is the Fair value on the date. On Balance
sheet date, the Fair value is Rs.102 and on settlement Date, i.e. 02.04.2015 the Fair
value is Rs.103. Pass Journal entries on Trade and Settlement Date, when the Asset
acquired is measured at a. Amortised Cost b. FVTPL c. FVTOCI

Ans:
1. If financial asset is accounted as Amortised Cost
Trade Date Accounting Settlement date accounting
Date Journal Entry Dr Cr Journal Entry Dr Cr
30th March Financial asset a/c Dr 100 No Entry
To Payables a/c 100
31st March No Entry No Entry
2nd April Payables a/c Dr 100 Financial Asset a/c Dr 100
To Cash a/c 100 To Cash a/c 100
(Note: Only the FV on acquisition date is considered)
2. If financial asset is accounted at FVTPL
 Trade Date Accounting Settlement date accounting
Date Journal Entry Dr Cr Journal Entry Dr Cr
30 March Financial asset a/c Dr
th
100 No Entry
To Payables a/c 100
31 March Financial Asset a/c Dr
st
2 Fair value change a/c 2
To Profit & Loss 2 To profit & loss 2
a/c
2ns April Financial Asset a/c Dr 1 Fair value change a/c 1
To Profit and Loss 1 To profit & loss 1
a/c
2nd April Payables a/c Dr 100 Financial Asset a/c Dr 103
To Cash a/c 100 To Cash a/c 100
To Fair value 3
change a/c

3. If financial asset is accounted at FVTOCI

Trade Date Accounting Settlement date accounting
Date Journal Entry Dr Cr Journal Entry Dr Cr
30 March Financial asset a/c Dr 100
th
No Entry
To Payables a/c 100
31 March Financial Asset a/c Dr 2
st
Fair value change a/c 2
To OCI a/c 2 To OCI 2
2ns April Financial Asset a/c Dr 1 Fair value change a/c 1
To OCI a/c 1 To OCI 1
2nd April Payables a/c Dr 100 Financial Asset a/c Dr 103
To Cash a/c 100 To Cash a/c 100
To Fair value 3
change a/c
(Note : In settlement accounting method, the entry is passed only on settlement
date, but the trade date value is paid)
6. An Entity is about to purchase a portfolio of Fixed Rate Assets that will be financed
by Fixed Rate debentures. Both Financial Assets and liabilities are subject to the same
Interest rate risk that gives rise to opposite changes in fair value that end to offset
each other. Comment on the appropriate method of accounting.
Ans:
Company can opt for Fair value Option, but if it is not opted for, then The asset is
classified as FVTOCI with Gains or Losses is recognized in the OCI, Fixed Rate
Debentures as Amortised cost.

7. Entity XYZ enters into a Fixed Price Forward Contract to purchase 10,000 kg 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 Standards?
Ans:
In this case , Purchase of Copper (commodity) settled at future date, is a Derivative
Instrument. But there is not settlement in delivery of copper but only by cash.
So in this case, if XYZ intends to settle the contract by taking delivery of Copper and
no history of settling in cash and selling it within short period after delivery for the
purpose of generating a profit from short term fluctuations in price margin, it is not
accounted for Derivative.

8. Bhanu Ltd has entered into a contract by which it has the option to sell its identified
PPE to Akhil Ltd for Rs.100 lakhs after 3 years whereas its current market price is
Rs.150 lakhs. Is the Put Option of Bhanu Ltd a Financial Instrument? Explain.
Ans:
 Purchase or sale of Asset (PPE) usually is accounted as derivative. But if there is
intention to sell the identified property and settle by delivery and not by settling net
in cash, then the contract should not be accounted as Financial Instrument.

Hari Ltd has entered into a contract by which it has the option to sell its specified
asset to Ram Ltd. for Rs.100 lakhs after 3 years, whereas the Current Market Price is
Rs.150 lakhs. Hari always settles account by delivery. What type of Option is this? Is
it a Financial Instrument? Explain with reference to the relevant Accounting
Standard.
Ans:

In this case, Hari intends to settle by delivery. In this case it is not a financial
instrument. (accounted as sale of PPE and Option to Sell )

9. IMPORTANT : An Entity issues 2,000 Convertible Debentures at the start of the Year
1. The debentures have a 3 year term and are issued at par with a Face value of
Rs.1,000 per Debenture, for a total proceeds of Rs.20,00,000. Interest payable annually
in arrears at a nominal annual interest rate of 6%. Each debenture is convertible at
any time up to maturity into 250 Equity shares. When the Debentures are issued, the
prevailing market Interest Rate for similar Debt without conversion options is 9%.
Explain the presentation in the Financial Statements.
(Note : Actual interest paid / received only to be taken into consideration, not the
prevailing market interest rate)
Ans :
Computation of Fair value of the Liability
Particulars year Outflow Step 1 Discount factor @ PV of outflow
9% ( 1/ 1.09)n Step 2
Interest (20 L x 1 , 2, 3 1,20,000 2.5313 3,03,756
6%) (0.917+0.841+0.772)
Principal 3 20,00,000 0.772 15,44,400
amount
F v of Liability 18,48,156 –
Step 3
Particulars year Outflow Discount factor @ PV of outflow
9% ( 1/ 1.09)n
Interest (20 L x 1 , 2, 3 1,20,000 0.917 1,10,040
6%)
1,20,000 0.841 1,00,920
1,20,000 0.772 92,640
Principal 3 20,00,000 0.772 15,44,400
amount
F v of Liability 18,48,156

Initial recognition as Compound Financial Instrument

(6% Convertible Debenture)
Fair value of the instrument = 20,00,000
(-) Fair value of liability = 18, 48,156
Equity component(B/F) = 1,51,884
 Journal entry (on date of Initial recognition)
Cash a/c Dr 20,00,000
To Debentures a/c 18,48,156 – Financial Liability
To Equity Share reserve a/c 1,51,884 – Equity Instrument
(For initial recognition of compound instrument)

Amortised cost table:

10. IMPORTANT :You are required to

a. Identify Equity and Liability Components
b. Compute Bond Liability at the end of each year and
c. Pass necessary Journal entries from the following information:
No of Convertible bonds – 5,000 bonds issued at the beginning of Year 1
Value of Bonds – Rs.500 per Bond
Period of Bonds – 3 years validity
Interest Rate on the Bond – 9% p.a. annually
Proceeds received – Rs.25 lakhs
Conversion – At the bond Holder’s discretion, conversion into 125 Ordinary
shares for each bond of Rs.500
Prevailing market rate – 11% p.a. for Bonds issued without Conversion option

Computation of Fair value of the Liability

Particulars Year Outflow Discount factor PV of outflow
@11%
Interest 1 , 2, 3 2,25,000 (0.901+0.811+0.731) 5,49,675
(25,00,000 x 2.443
9%)
Principal 3 25,00,000 0.731 18,27,500
amount
F V of Liability 23,77,175

Fair value of Compound instrument (500 x 5000) = 25,00,000

(-) fair liability component = (23,77,175)
Equity instrument 1,22,825

Computation of Bond Liability at the end of each year (Amortised Cost table)

Particulars Year 1 Year 2 Year 3

Opening bal 1/1 23,77,175 24,13,664 24,54,167
+ Notional 2,61,489 2,65,503 2,70,833
Interest @ 11%
31/12 26,38,664 26,79,167 27,25,000
Less Actual 2,25,000 2,25,000 2,25,000
interest paid @
9%
Closing balance 24,13,664 24,54,167 25,00,000 –
of liability Principal

Journal Entries
Date Particulars Debit Credit
1/1 Cash / Bank a/c Dr 25,00,000
To Convertible Bond Liability a/c 23,77,175
To Equity Component a/c 1,22,825
(For initial recognition of Bond
liability)
31/1 Finance cost a/c Dr (@11%) 2,61,489
2 To Convertible Bond Liability a/c 36,489
 To Cash / bank a/c (@9%) 2,25,000
(For unwinding interest and int paid )
2- Finance cost a/c Dr (@11%) 2,65,503
31/1 To Convertible Bond Liability a/c 40,503
2 To Cash / bank a/c (@9%) 2,25,000
(For unwinding interest and int paid )
3- Finance cost a/c Dr (@11%) 2,70,833
To Convertible Bond Liability a/c 45,833
To Cash / bank a/c (@9%) 2,25,000
(For unwinding interest and int paid )

11. IMPORTANT: Vinayak Ltd. granted Rs.10,00,000 loan to its Employees at a

concessional interest rate of 4% p.a. Loan is to be repaid in five equal annual
instalments along with interest. Market rate of interest of such loan is 10% p.a.
Following the principles of recognition and measurement as laid down under IndAs
109, record the entries for the first year for the loan transaction and also calculate the
value of loan initially to be recognized and Amortised Cost for all subsequent years.
Ans
Computation of Initial recognition
Year Opening Future Cash inflow Total – P.V Factor Discounted
Balance Receivabl @ 10% cash inflow
e from (Market
employees interest
rate)
Principal Interest @
4% (on Op
.bal)
1 10,00,000 2,00,000 40,000 2,40,000 0.909 2,18,160
(10,00,000
x 4%)
2 8,00,000 2,00,000 32,000 2,32,000 0.826 1,91,632
(800000 x
4%)
3 6,00,000 2,00,000 24,000 2,24,000 0.751 1,68,224
(600000 x
4%)
4 4,00,000 2,00,000 16,000 2,16,000 0.683 1,47,528
(400000 x
4%)
5 2,00,000 2,00,000 8,000 2,08,000 0.621 1,29,168
Initial 8,54,712
recognition

Calculation of Amortised Cost of Loan to Employees

Year Amortised cost Interest @ 10% Repayment Amortised
(EIR) ADD B incl interest Cost (Closing
OP BAL = A (Op bal x int rate) (P+I) balance)
DEDUCT C =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

Journal Entries
Date/Year Particulars Debit Credit
 1/1/Year 1 Loan to Employees a/c Dr - 10,00,000
Financial Asset
To Cash a/c 10,00,000
(For loan given to employees)
31/12/year1 Loan to employees a/c 85,471
To Interest on loan a/c 85,471
(For int receivable on loan)
31/12 Bank a/c 2,40,000
To Loan to employees a/c 2,40,000
(For interest and principal
received)
31/12 Employee Benefit /Loan exp a/c 1,45,288
Dr (10,00,000 – 1,45,288
To Loan to Employees a/c 854712)
(For difference in loan value given
and the present value , to be
debited to P/L In the same year)
31/12 P/L a/c Dr 1,45,288 1,45,288
To Emp ben exp/Loan Exp
(For exp debited to P/L)
31/12 Interest on loan a/c Dr 85,471
To P/L a/c 85,471
(For interest credited to P/L)

12. On 1st January 2015, an entity issued a debt instrument with a coupon rate of 3.5% at
a par value of Rs.60,00,000. The directly attributable costs of issue were Rs.1,20,000.
The debt instruments repayable on 31st December 2021, at a premium of Rs.11,00,000.
What is the total amount of the finance cost associated with the debt instruments?
Ans:
Computation of total finance cost
Amount
Issue cost 1,20,000
Interest (60,00,000 x 3.5%x 7 years) 14,70,000
Premium on redemption 11,00,000
Total finance cost 26,90,000

13. On 1/1/2014, T & Co Ltd issued redeemable preference shares worth Rs.4,00,000.
The transaction costs directly attributable to the issue are Rs.20,000. The rate of
interest is 6% payable annually and the shares will be redeemed on 31.12.2017 for
Rs.4,85,000. The effective interest rate is 12%.
Required : a. Are the redeemable preference shares, debt or equity as per IndAs 32.
B . At what value the preference shares will be recognized initially as per IndAS 109.
C. Calculate the carrying amount of the preference shares at the end of each year up
to its redemption at amortised cost.
Ans:
i. Redeemable preference shares are debt and will be shown as financial
liability
ii. Initially recognized at proceeds ( –) transaction cost ( For a Financial Liability
which is not FVTPL, transaction cost to be deducted )
iii. Computation of initial recognition
Amount
Proceeds received 4,00,000
(-) Transaction cost (20,000)
Initial recognition 3,80,000
Computation of total amount payable
 Amount
Interest ( 400000 x 6%) x 4 yrs 96,000
Premium on Redemption (485000 – 400000) 85,000
Total amount payable ( other than capital) 1,81,000
Computation of amortised cost
Year Amortised cost at the Amount Amount Amortised
beginning of year payable at actually paid cost at the
EIR @ 12% (400000x6%) end
2014 3,80,000 45,600 (24,000) 4,01,600
2015 4,01,600 48,192 (24,000) 4,25,792
2016 4,25,792 51,095 (24,000) 4,52,887
2017 4,52,887 56,113(B/F) 485000
+24000

14. During the reporting period ended 31/3/2014, AK Ltd sold various financial assets:
a. AK Ltd sells a financial asset for Rs.10,000. There are no strings attached to the
sale, and no other rights or obligations are retained by AK Ltd.
Ans:
Derecognise the financial asset, all risk and reward of ownership is transferred
b. AK Ltd sells an investment in shares for Rs.10,000 but retains a call option to
repurchase the shares at any time at a price equal to their current fair value on
the repurchase date.
Ans: AK should derecognize the asset because it transferred all risks and
rewards. Even if the call option is retained , the exercise price is at current fair
value on repurchase date. The value of call option should be close to Zero.

c. AK Ltd sells a portfolio of short-term account receivable for Rs.1,00,000 and

promises to pay up to Rs.3,000 to compensate the buyer if and when any defaults
occur. Expected credit losses are significantly less than Rs.3,000, and there are no
other significant risks.
Ans:
Continue to recognize the asset, retained substantially all risks and rewards , it
has all expected credit risk and there are no substantive risks.
d. Ak Ltd sells a portfolio receivables for Rs.10,000 but retains the right to service
the receivables for a fixed fee. ( i.e. to collect payment on the receivables and pass
them on to the buyer of the receivables) The servicing arrangement meets the
pass through conditions.
Ans:
Derecognize the asset. But to recognize the servicing asset or servicing liability
for the servicing right.
e. AK Ltd sells an investment in shares for Rs.10,000 and simultaneously enters into
a total return swap with the buyer under which the buyer will return any
increase in value to AK Ltd. and AK Ltd will pay the buyer interest plus
compensation for any decreases in the value of the investment.
Ans: Should continue to recognize the sold investment, the total return swap
results in AK Ltd. still being exposed to all increases and decreases in the value of
the investment.
Required : Help AK Ltd by evaluating the extent to which de-recognition is
appropriate in each of the above case.

15. A bank has loaned Rs.250 lakhs to a property investment company X Ltd that
invested funds in residential properties consisting mainly of high quality apartments.
However, as a result of a fall in occupancy rates, the X Ltd. is unable to meet its debt
obligations. X Ltd successfully negotiated with the bank whereby the bank agreed to
accept a property with a fair market value of Rs.200 lakhs in full and final settlement
of he Rs.250 lakhs obligation. The property’s carrying value was Rs.210 lakhs. Pass
the entries for de-recognition of liability as per IndAS 109.
 Ans:
Computation of Loss and profit in asset sale and repayment of loan
Rs. In lakhs
Carrying amount of liability- loan 250
Fair value of non- cash settlement 200 - fair value of property
Gain on extinguishment of debt 50
Carrying amount of property 210
Fair value of property transferred 200
Loss in disposal (10)

Journal entry
Loan liability a/c Dr 250
Loss on disposal of asset a/c Dr 10
To Property a/c 210
To Gain on extinguishment 50
(Gain to be recognized in SOPL as Income, loss will be charge on operating profits)

16. (De-recognition) Identify whether to be de-recognized or not?

a. Entity A transfers its portfolio of receivables to Entity B under Factoring
arrangement. Debtors will pay amount due to Entity B directly. Entity A has no
additional obligations to repay any sums and has no rights to any additional
sums.
b. Same as above, but (a) Entity A has not transferred its rights to receive the Cash
flows, or (b) Any Credit Default Guarantee is given by Entity A
Ans:
a. Since Entity A has no recourse to Entity A for late payment/ Credit Risk,
Entity A has transferred substantially all the risks and rewards of ownership
of the portfolio. Hence, entity A should de-recognise entire Portfolio.
Difference between the carrying value and cash received is recognized
immediately as a Financing Cost in P/L a/c
Cash / Bank a/c Dr 95,000
P/L ( Loss in derecognition) a/c 5000
To Receivable a/c Dr 100000
b. There is no complete transfer of risk and rewards. In such case, Entity A
should not de recognize the Portfolio.

17. A company invested in equity Shares of another entity on 15th March for Rs.10,000.
Transaction Cost = Rs.200 ( not included in Rs.10,000) Fair value on Balance sheet
date = Rs.12,000. Pass entries when asset acquired is measured at FVTPL, FVTOCI.
Ans:
Journal Entries
a. FVTPL
15th March Investment a/c Dr 10,000
Transaction Cost a/c Dr 200
To payables a/c 10,200
31 March Investment a/c Dr 2,000
To Fair value Gain 2,000
31 March P/L a/c Dr 200
To Transaction cost 200
31 March Fair value gain a/c Dr 2,000
To P/L 2,000
b.FVTOCI
15th march Investment a/c Dr 10,200
To Bank a/c PL – 10,200
transaction cost will be
added to asset value)
31 March Investment a/c Dr 1,800
To Fair value Gain 1,800
 31 March Fair value gain a/c Dr 1,800
To OCI 1,800
31 March OCI a/c Dr 1,800
To Fair value reserve a/c 1,800

18. A company borrowed Rs.50 lakhs @ 12% p.a. Tenure of the loan is 10 years. Interest
is payable every year and the Principal is repayable at the end of 10 th year. The
company defaulted in payment of interest for the Year 4,5,6. A loan reschedule
agreement took place at the end of 7 th year. As per the agreement, the company is
required to pay Rs.90 lakhs at the end of 8 th year. Calculate the additional amount to
be paid on account of rescheduling and also the Book value of Loan at the end of 8 th
year when the Reschedule Agreement took place.
Ans:
Assumption in this case , Interest is compounded in case of default ( P(1+r)n)

Particulars Computation Rs.

Loan amount 50,00,000
Period of default 4 to 8 years 5 years
Book value at the end of 8th year ( from 50,00,000 x (1.12)power 88,11,708
year 4 to year 8 compounding) of 5
Rescheduled amount to be paid at the 90,00,000
end of 8th year
Additional amount to be paid on 1,88,291
rescheduling

Revision Problems:

19. A company issues 5% loan notes at their nominal value of $20,000 with an effective
rate of 5%. The loan notes are repayable at par after 4 years.
What amount will be recorded as a financial liability when the loan notes are issued?
What amounts will be shown in the statement of profit or loss and statement of
financial position for years 1–4?

Ans;
JE
Bank a/c Dr 20000
To Loan Notes a/c 20,000

SOPL
Finance Cost ( 20000 x 5%) 1000
( Loan taken x Effective rate of interest)
SOFP
Non-Current liabilities
Year 1: 20,000
Year 2 : 20,000
Current liabilities
Year 3 : 20,000
Year 4 : NIL

Amortised Cost Computation:

Year Opening Finance Cost Cash paid Closing

balance (@5%) (@5%) balance
1 20,000 1,000 1,000 20,000
2 20,000 1,000 1,000 20,000
3 20,000 1,000 1,000 20,000
 4 20,000 1,000 1,000 NIL

20. A company issues 0% loan notes at their nominal value of $40,000. The loan notes are
repayable at a premium of $11,800 after 3 years. The effective rate of interest is 9%.
What amount will be recorded as a financial liability when the loan notes are issued?
What amounts will be shown in the statement of profit or loss and statement of
financial position for years 1–3?

Ans:

JE
Bank a/c Dr 40000
To Loan Notes a/c 40,000

SOPL
Year 1 = Finance Cost ( 40,000 x 9%) 3,600
Year 2 = 3924
Year 3= 4276
SOFP
Non-Current liabilities
Year 1: 43,600
Current liabilities
Year 2 : 47,524
Year 3: NIL

Amortised Cost Computation:

Year Opening Finance Cost Cash paid Closing

balance (@9%) (@0%) balance
1 40,000 3,600 - 43,600
2 43,600 3,924 - 47,524
3 47,524 4,276 51,800 NIL

21. A company issues 4% loan notes with a nominal value of $20,000.

The loan notes are issued at a discount of 2.5% and $534 of issue costs are incurred.
The loan notes will be repayable at a premium of 10% after 5 years. The effective rate
of interest is 7%. What amount will be recorded as a financial liability when the loan
notes are issued? What amounts will be shown in the statement of profit or loss and
statement of financial position for year 1?

Ans:

JE
Bank a/c Dr 18,966
To Loan Notes a/c 18,966
(20000 – discount 500 – transaction cost 534 = 18,966)

SOPL
Year 1 = Finance Cost 1328
SOFP
Non-Current liabilities
Year 1: 19,494
Amortised Cost Computation:
 Year Opening Finance Cost Cash paid Closing
balance (@7%) (@4%) balance
1 18,966 1,328 (800) 19,494

22. On 1 April 20X7, a company issued 40,000 $1 redeemable preference shares with a
coupon rate of 8% at par. They are redeemable at a large premium which gives them
an effective finance cost of 12% per annum. How would these redeemable preference
shares appear in the financial statements for the years ending 31 March 20X8 and
20X9?
Ans:
Redeemable Preference Share are treated as “Financial Liability “ – Obligation
towards the payment of Interest and Final payment
SOPL
Year 2018 = Finance Cost = 4,800
Year 2019 = 4,992
SOFP
Non-Current liabilities
Year 2018: 41,600
Year 2019 : 43,392
Amortised Cost Computation:

Year Opening Finance Cost Cash paid Closing

balance (@12%) (@8%) balance
1 40,000 4,800 (3200) 41,600
2 41,600 4992 (3200) 43,392
23. An entity issues 2% convertible bonds at their nominal value of $36,000. Interest is
payable annually in arrears. The bonds are convertible at any time up to maturity
into 40 ordinary shares for each $100 of bond. Alternatively the bonds will be
redeemed at par after 3 years. Similar non-convertible bonds would carry an interest
rate of 9.1%. The present value of $1 payable at the end of year, based on rates of 2%
and 9.1% are as follows: What amounts will be shown as a financial liability and as
equity when the convertible bonds are issued? What amounts will be shown in the
statement of profit or loss and statement of financial position for years 1–3?

Ans:
Bank a/c Dr 36,000
To Financial Liability a/c 29,542
To Equity a/c 6,458 ( 36000 – 29542)

Year Cashflow Discount @9.1% Present value

1 720 0.92 662
2 720 0.84 605
3 36,720 0.77 28,275
Total Liability 29,542

SOPL

Year 1 : 2688

Year 2: 2867

Year 3: 3062

SOFP
 Year 1 Year 2 Year 3
Equity 6458 6458 6458
Non-Current 31,510 33,658
liabilities
Current liabilities 36,000

Amortisation Cost computation

Year Opening Finance Cost Cash paid Closing

balance (@9.1%) (@2%) balance
1 29,542 2,688 (720) 31,510
2 31,510 2,867 (720) 33,658
3 33,658 3,062 (720) 36,000

24. A company invests $5,000 in 10% loan notes. The loan notes are repayable at a
premium after 3 years. The effective rate of interest is 12%. The company intends to
collect the contractual cash flows which consist solely of repayments of interest and
capital and have therefore chosen to record the financial asset at amortised cost.
What amounts will be shown in the statement of profit or loss and statement of
financial position for the financial asset for years 1–3?
Ans:
Financial Asset , classified as Amortised cost

Year 1 Year 2 Year 3

SOPL – Investment 600 612 625
Income
SOFP - Non-Current 5,100
Assets
Current assets 5,212 NIL

Year Opening Investment Cash received Closing

balance Income (@10%) balance
(@12%)
1 5,000 600 (500) 5,100
2 5,100 612 (500) 5,212
3 5,212 625 (500) NIL
(5,337)

25. A company invested in 10,000 shares of a listed company in November 20X7 at a cost
of $4.20 per share. At 31 December 20X7 the shares have a market value of $4.90.
Prepare extracts from the statement of profit or loss for the year ended 31 December
20X7 and a statement of financial position as at that date.

Ans:

The investment should be measured at fair value through profit or loss.

Statement of profit or loss

 Investment Income (10,000 × (4.90 – 4.20)) = $7,000

Statement of financial position

Current assets

Investments (10,000 × 4.90) = $49,000

26.  A company invested in 20,000 shares of a listed company in October 20X7 at a cost
of $3.80 per share. At 31 December 20X7 the shares have a market value of $3.40. The
company is not planning on selling these shares in the short term and elects to hold
them as fair value through other comprehensive income. Prepare extracts from the
statement of profit or loss and other comprehensive income for the year ended 31
December 20X7 and a statement of financial position as at that date.

Ans:

The investment in these shares is considered to be a financial asset at fair value

through other comprehensive income.
Statement of profit or loss and other comprehensive income Other comprehensive
income
Loss on investment - $8000
Statement of financial position
Non-current asset investments (20,000 × $3.40) = $68,000
FVOCI reserve = (8,000)