Module 3 : Financial Instruments

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
th
30 March Financial asset a/c Dr 100 No Entry
To Payables a/c 100
st
31 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

2. If financial asset is accounted at FVTPL

Trade Date Accounting Settlement date accounting
Date Journal Entry Dr Cr Journal Entry Dr Cr
th
30 March Financial asset a/c Dr 100 No Entry
To Payables a/c 100
31st March Financial Asset a/c Dr 2 Fair value change a/c 2
To Profit & Loss a/c 2 To profit & loss 2
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
th
30 March Financial asset a/c Dr 100 No Entry
To Payables a/c 100
st
31 March Financial Asset a/c Dr 2 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

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. 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 Discount factor @ PV of outflow
9% ( 1/ 1.09)n
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
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 capital a/c 1,51,884 – Equity Instrument
(For initial recognition of compound instrument)
10. 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 )
9%) 2.443
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

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 of 24,13,664 24,54,167 25,00,000 –
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. 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 @ 10% cash inflow
Principal Interest @
4% (on Op
.bal)
1 10,00,000 2,00,000 40,000 2,40,000 0.909 2,18,160
2 8,00,000 2,00,000 32,000 2,32,000 0.826 1,91,632
3 6,00,000 2,00,000 24,000 2,24,000 0.751 1,68,224
4 4,00,000 2,00,000 16,000 2,16,000 0.683 1,47,528
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
incl interest Cost (Closing
balance)
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 10,00,00
To Cash a/c
(For loan given to employees) 10,00,000
31/12/year Loan to employees a/c 85,471
1 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 Dr 1,45,288
To Loan to Employees a/c 1,45,288
(For difference in loan 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. Hari Ltd. has lent a sum of Rs.10 lakhs @ 18% pa. for 10 years. The Loan had a fair
value of Rs.12,23,960 at the effective interest rate of 13%. To mitigate repayment
risk but at the same time retaining control over the loan, Hari 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% of Interest that carried Fair value of
Rs.29,000 and Rs.1,84,620 respectively. The consideration for the transaction was
Rs.9,90,000.
The interest component retained included a 2% fees towards collection of Principal
and Interest that has a fair value of Rs.65,160. Defaults if any are deductible to a
maximum extent of the Company’s claim on the Principal Portion. You are required
to how the Journal entries to record the de-recognition of the Loan.

Computation of Fair value of Portion of Loan transferred ( Principal & Interest)

Particulars Fair value Proportionate
carrying amount Rs.
Fair value of Loan Asset 12,23,960 10,00,000
Less: Fair value of principal (29,000) (23,694)
retained
Less Fair value of Collection of (65,160) (53,237)
asset
Less Fair value of Interest (1,19,460) (97,601)
retained (1,84,620 – 65160)
Fair value of Portion 10,10,340 8,25,468- value of
transferred loan transferred

Proportion : (10,00,000 / 1223960) x 29000 = Rs.23694

Journal Entries
Loan Receivable a/c Dr 10,00,000
To bank a/c 10,00,000

Bank a/c Dr 9,90,000

To Loan receivable a/c 8,25,468 ( Transferred portion of principal and interest)
To Gain in transfer 1,64,532 – SOPL (B/F)
(For transfer of loan to a third party at a gain )

Loan receivable / Financial Asset a/c Dr 1,00,000 (10% of 10,00,000)

To Financial Liability a/c 1,00,000
(For any default, maximum amount to be borne by the entity, maximum principal
claim)

Principal Strip a/c Dr 23,694

Interest Strip a/c Dr 97,601
Servicing asset a/c Dr 53,237
To Loan receivable a/c (10,00,000 – 8,25,468) 1,74,532
( For
13. 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 31 st 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) 147,00,000
Premium on redemption 11,00,000
Total finance cost 26,90,000

14. 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% end
201 3,80,000 45,600 (24,000) 4,01,600
4
201 4,01,600 48,192 (24,000) 4,25,792
5
201 4,25,792 51,095 (24,000) 4,52,887
6
201 4,52,887 56,113(B/F) 485000
7 +24000

15. 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
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
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
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.
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
f. AK Ltd sells a portfolio of receivables 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 significantly exceed Rs.3,000
Required : Help AK Ltd by evaluating the extent to which de-recognition is
appropriate in each of the above case.

16. 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 250
Fair value of non- cash settlement 200
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)

17. (De-recognition) Identify whether to be 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
b. There is no complete transfer of risk and rewards. In such case, Entity A
should not recognize the Portfolio.

18. A company invested in equity Shares of another entity on 15 th 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
th
15 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 10,200
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

19. 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 7th 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.