ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.

193

COMPREHENSIVE ILLUSTRATIONS
Illustration 1
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% per annum
Present value factor 0.56743
Solution
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 table summarising the computations on initial recognition:

Market rate of interest 12%

Present value factor 0.56743
Present value 56,742,686
Loan component 56,742,686
Investment in subsidiary 43,257,314

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 12.194 FINANCIAL REPORTING

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 56,742,686
1 31-Mar-20X2 56,742,686 365 6,809,122 63,551,808
2 31-Mar-20X3 63,551,808 365 76,26,217 71,178,025
3 31-Mar-20X4 71,178,025 365 85,41,363 79,719,388
4 31-Mar-20X5 79,719,388 365 95,66,327 89,285,715
5 31-Mar-20X6 89,285,715 365 10,714,285 100,000,000

Journal Entries to be done at every reporting 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. 6,809,122
To Interest income 6,809,122
Interest income - March 31, 20X3
Loan receivable Dr. 76,26,217
To Interest income 76,26,217
Interest income - March 31, 20X4
Loan receivable Dr. 85,41,363
To Interest income 85,41,363
Interest income - March 31, 20X5
Loan receivable Dr. 95,66,327
To Interest income 95,66,327
Interest income - March 31, 20X6
Loan receivable Dr. 10,714,285
To Interest income 10,714,285

© The Institute of Chartered Accountants of India

 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.195

Settlement of transaction
Bank Dr. 100,000,000
To Loan receivable 100,000,000
*****

Illustration 2
A Limited issues ` 1 crore convertible bonds on 1 July 20X1. The bonds have a life of eight
years and a face value of ` 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) Provide the appropriate accounting entries for initial recognition.
(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 bonds elect to convert the bonds to
ordinary shares at the end of the third year.
Solution
(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 ` 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 X 0.5403) = 5,403,000
Present value of interest stream discounted at 8% for 8 years
(6,00,000 X 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

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 12.196 FINANCIAL REPORTING

The accounting entries will be as follows:

Dr. Amount Cr. Amount
(`) (`)
1 July 20X1
Bank 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 Bank 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 Increase in Total bond

expense 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
*difference is due to rounding off

© The Institute of Chartered Accountants of India

 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.197

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

Dr. Amount Cr. Amount

(`) (`)
30 June 20X4
Interest expense Dr. 726,061
To Bank 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 Ordinary share capital A/c 10,350,861
(Being entry to record the conversion of bonds into
shares of A Limited)

*****
Illustration 3
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 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

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 12.198 FINANCIAL REPORTING

Solution
(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').
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 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)

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 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.199

(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:

Particulars Dr. Amount Cr. 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

(`) (`)
Bank (USD Account) @ 20,000 x 66 Dr. 13,20,000
Profit and loss A/c Dr. 52,000
To Bank @ 20,000 x 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)

*****

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 12.200 FINANCIAL REPORTING

Illustration 4
Entity A (an ` functional currency entity) enters into a USD 1,000,000 sale contract on
1 January 20X1 with Entity B (an ` functional currency entity) to sell equipment on 30 June
20X1.
Spot rate on 1 January 20X1: ` /USD 45
Spot rate on 31 March 20X1: ` /USD 57
Three-month forward rate on 31 March 20X1: ` /USD 45
Six-month forward rate on 1 January 20X1: `/USD 55
Spot rate on 30 June 20X1: ` /USD 60
Assume that this contract has an embedded derivative that is not closely related and requires
separation. Please provide detailed journal entries in the books of Entity A for accounting of
such embedded derivative until sale is actually made.
Solution
The contract should be separated using the 6 month USD/` forward exchange rate, as at the
date of the contract (`/USD = 55). The two components of the contract are therefore:
• A sale contract for ` 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 = ` 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 asset on delivery.
4. In this case the carrying value of the currency forward at 30 June 20X1 on maturity is =
` (1,000,000 x 60 – 55 x 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)
` ` ` `
1-Jan-20X1 Embedded Derivative Nil Value
31-Mar-20X1 Change in Fair Value (10,000,000) 10,000,000
of Embedded
Derivatives MTM (55-
45) x 1 Million

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 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.201

30-Jun-20X1 Change in Fair Value 15,000,000 (15,000,000)

of Embedded
Derivatives (60-45) x 1
Million
30-Jun-20X1 Recording sales at (55,000,000) 55,000,000
forward rate
30-Jun-20X1 Embedded derivative- 5,000,000 (5,000,000)
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)

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)

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 12.202 FINANCIAL REPORTING

e. 30 June 20X1 –

Particulars Dr. Amount Cr. 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)
*****
Illustration 5
On 1st January 20X1, SamCo. 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. SamCo. Ltd. did not receive 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 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
Solution
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').
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.

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 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.203

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.
d) 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 USD 20,000 on inception.
e) 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 31 st 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)

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 12.204 FINANCIAL REPORTING

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. Amount Cr. 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 31 st 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
(`) (`)
Bank (USD Account) @ 20,000 x 66 Dr. 13,20,000
Profit and loss A/c Dr. 40,000
To Bank @ 20,000 x 68 13,60,000
(being loss on settlement of put option contract
booked on actual purchase of USD)
*****
Illustration 6
ABC Company issued 10,000 compulsory cumulative convertible preference shares (CCCPS) as
on 1 April 20X1 @ ` 150 each. The rate of dividend is 10% payable every year. The preference
shares are convertible into 5,000 equity shares of the company at the end of 5 th 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%

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 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.205

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
Effective interest rate 15.86%
You are required to compute the 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 in view the provisions of relevant Ind AS.
Solution
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 Discount Net present
Flow 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
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 997,176.75
fig)
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.

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 12.206 FINANCIAL REPORTING

Opening Interest Cash Flow Closing Financial

Financial Liability Liability
A B C 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 977,233
A/c
(Being compulsorily convertible preference
shares issued. The same are divided into equity
component and liability component as per the
calculation)
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)

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 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.207

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-20X4 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)
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)

*****

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 12.208 FINANCIAL REPORTING

TEST YOUR KNOWLEDGE

Questions
1. 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 in five equal
instalments for principle along with the interest. The market rate of interest is 10% per
annum for comparable loans. Y lent ` 1,600,000 to its employees on 1 st 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
2. Wheel Co. Limited has a policy of providing subsidized loans to its employees for the
purpose of buying or building houses. Mr. X, who’s executive assistant to the CEO of
Wheel Co. Limited, took a loan from the Company on the following terms:
• Principal amount: 1,000,000
• Interest rate: 4% for the first 400,000 and 7% for the next 600,000
• Start date: 1 January 20X1
• Tenure: 5 years
• Pre-payment: Full or partial pre-payment at the option of the employee
• The principal amount of loan shall be recovered in 5 equal annual instalments and will
be first applied to 7% interest bearing principal
• The accrued interest shall be paid on an annual basis
• Mr. X must remain in service till the term of the loan ends
The market rate of a comparable loan available to Mr. X, is 12% per annum.

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 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.209

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 7% income 4% outstanding
1-Jan-20X1 (1,000,000) 1,000,000
31-Dec-20X1 200,000 42,000 16,000 800,000
31-Dec-20X2 200,000 28,000 16,000 600,000
31-Dec-20X3 200,000 14,000 16,000 400,000
31-Dec-20X4 200,000 - 16,000 200,000
31-Dec-20X5 200,000 - 8,000 -

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

that date to ` 400,000.
Following table shows the actual cash flows from the loan given to Mr. X, considering the
pre-payment event on 31 December 20X2: (amount in `)
Inflows
Date Outflows Principal Interest Interest Principal
income 7% income 4% outstanding
1-Jan-20X1 (1,000,000) 1,000,000
31-Dec-20X1 200,000 42,000 16,000 800,000
31-Dec-20X2 400,000 28,000 16,000 400,000
31-Dec-20X3 200,000 - 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.
3. 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%

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 12.210 FINANCIAL REPORTING

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
4. 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

5. 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

Explain how will the Company account for the above loan notes in the financial statements
for the year ended 31 March 20X2?

© The Institute of Chartered Accountants of India

 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.211

6. On 1 April 20X1, Sun Limited guarantees a ` 10,00,000 loan of Subsidiary – Moon Limited,
which Bank STDK has provided to Moon Limited for three years at 8%.
Interest payments are made at the end of each year and the principal is repaid at the end
of the loan term.
If Sun Limited had not issued a guarantee, Bank STDK would have charged Moon Limited
an interest rate of 11%. Sun Limited does not charge Moon Limited for providing the
guarantee.
On 31 March 20X2, there is 1% probability that Moon Limited may default on the loan in the
next 12 months. If Moon Limited defaults on the loan, Sun Limited does not expect to
recover any amount from Moon Limited.
On 31 March 20X3, there is 3% probability that Moon Limited may default on the loan in the
next 12 months. If Moon Limited defaults on the loan, Sun Limited does not expect to
recover any amount from Moon Limited.
Provide the accounting treatment of financial guarantee as per Ind AS 109 in the books of
Sun Ltd., on initial recognition and in subsequent periods till 31 March 20X3.
Answers
1. (i) Calculation of initial recognition amount of loan to its employees:
Year Cash flow Total PV factor Present
end 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
(ii) Calculation of amortised cost of loan to employees
Year Amortised cost Interest to be Repayment Amortised
end (opening balance) recognised (including cost (closing
interest) 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 -

© The Institute of Chartered Accountants of India

 12.212 FINANCIAL REPORTING

*305,083 x 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
Date Particulars Debit Credit
1 Jan 20X1 Staff loan A/c Dr. 14,06,272
Prepaid staff cost A/c* Dr. 1,93,728
[(1,600,000 – 1,406,272), Refer part (ii)]
To Bank A/c 16,00,000
(Being disbursement of loans to staff and
excess loan balance over present value
thereof in order to reflect the loan at its
present value booked as prepaid staff cost)
31 Dec 20X1 Staff loan A/c Dr. 1,40,627
To Interest expense A/c 1,40,627
(Being interest accrued on loans to staff)
31 Dec 20X1 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.
2. 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:
Inflows
Date Principal Interest Interest Discount PV
income 7% income 4% factor @12%
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 Institute of Chartered Accountants of India

 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.213

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 (principal Interest @

repayment + interest 12%
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*

* Difference is due to approximation.

Journal Entries to be recorded at every period end:
a. 1 January 20X1 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Loan to employee A/c Dr. 843,879
Pre-paid employee cost A/c Dr 156,121
To Bank A/c 1,000,000
(Being loan asset recorded at initial fair value)

b. 31 December 20X1 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Bank 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%)
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)

© The Institute of Chartered Accountants of India

 12.214 FINANCIAL REPORTING

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
(`) (`)
Bank 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%)
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)
Computation of new carrying value of loan to employee:
Inflows
Date Principal Interest Interest Discount PV
income 7% income 4% factor @12%
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.

© The Institute of Chartered Accountants of India

 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.215

d. 31 December 20X2 prepayment–

Particulars Dr. Amount Cr. Amount

(`) (`)
Bank 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 Total cash inflows (principal Interest

outstanding repayment + interest @ 12%
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
e. 31 December 20X3 –
Particulars Dr. Amount Cr. Amount
(`) (`)
Bank 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)

© The Institute of Chartered Accountants of India

 12.216 FINANCIAL REPORTING

f. 31 December 20X4 –
Particulars Dr. Cr.
Amount Amount
(`) (`)
Bank 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%)
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)

3. 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 @
(principal) (interest and (opening + EIR
fee) interest – cash (11.50%)
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

(`) (`)
Bank 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)

© The Institute of Chartered Accountants of India

 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.217

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 Bank 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 Bank 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:
Date Cash flows Interest outflow Discount PV of cash
(principal) @15% factor 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

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 12.218 FINANCIAL REPORTING

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 Bank 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)

© The Institute of Chartered Accountants of India

 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.219

4. 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 x 50% x 1.10 x 0.68 (10% discount factor) 1,870,000
(B) Present value of interest [300,000 x 3.17] (4 years cumulative 10% 951,000
discount factor)
Total present value of debt component (A) + (B) 2,821,000
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)

5. 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

© The Institute of Chartered Accountants of India

 12.220 FINANCIAL REPORTING

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)

© The Institute of Chartered Accountants of India

 ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS 12.221

6. 1 April 20X1
A financial guarantee contract is initially recognised at fair value. The fair value of the
guarantee will be the present value of the difference between the net contractual cash
flows required under the loan, and the net contractual cash flows that would have been
required without the guarantee.
Particulars Year 1 Year 2 Year 3 Total
(`) (`) (`) (`)
Cash flows based on interest rate of 11% (A) 1,10,000 1,10,000 1,10,000 3,30,000
Cash flows based on interest rate of 8% (B) 80,000 80,000 80,000 2,40,000
Interest rate differential (A-B) 30,000 30,000 30,000 90,000
Discount factor @ 11% 0.901 0.812 0.731
Interest rate differential discounted at 11% 27,030 24,360 21,930 73,320
Fair value of financial guarantee contract
(at inception) 73,320
Journal Entry
Particulars Debit (`) Credit (`)
Investment in subsidiary Dr. 73,320
To Financial guarantee (liability) 73,320
(Being financial guarantee initially recorded)
31 March 20X2
Subsequently at the end of the reporting period, financial guarantee is measured at the
higher of:
- the amount of loss allowance; and
- the amount initially recognised less cumulative amortization, where appropriate.
At 31 March 20X2, there is 1% probability that Moon Limited may default on the loan in the
next 12 months. If Moon Limited defaults on the loan, Sun Limited does not expect to
recover any amount from Moon Limited. The 12-month expected credit losses are
therefore Rs.10,000 (Rs.10,00,000 x 1%).
The initial amount recognised less amortisation is ` 51,385 (` 73,320 + ` 8,065 (interest
accrued based on EIR)) – ` 30,000 (benefit of the guarantee in year 1) Refer table below.
The unwound amount is recognised as income in the books of Sun Limited, being the
benefit derived by Moon Limited not defaulting on the loan during the period.
Year Opening balance EIR @ 11% Benefits provided Closing balance
` ` `
1 73,320 8,065 (30,000) 51,385

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 12.222 FINANCIAL REPORTING

2 51,385 5,652 (30,000) 27,037

3 27,037 2,963* (30,000) -
* Difference is due to approximation
The carrying amount of the financial guarantee liability after amortisation is therefore
` 51,385, which is higher than the 12-month expected credit losses of ` 10,000. The
liability is therefore adjusted to ` 51,385 (the higher of the two amounts) as follows:
Particulars Debit (`) Credit (`)
Financial guarantee (liability) Dr. 21,935
To Profit or loss 21,935
(Being financial guarantee subsequently adjusted)
31 March 20X3
At 31 March 20X3, there is 3% probability that Moon Limited will default on the loan in the
next 12 months. If Moon Limited defaults on the loan, Sun Limited does not expect to
recover any amount from Moon Limited. The 12-month expected credit losses are
therefore ` 30.000 (` 10,00,000 x 3%).
The initial amount recognised less accumulated amortisation is ` 27,037, which is lower
than the 12-month expected credit losses (` 30,000). The liability is therefore adjusted to
` 30,000 (the higher of the two amounts) as follows:
Particulars Debit (`) Credit (`)
Financial guarantee (liability) Dr. 21,385*
To Profit or loss (Note) 21,385
(Being financial guarantee subsequently adjusted)
* The carrying amount at the end of 31 March 20X2 = ` 51,385 less 12-month expected
credit losses of ` 30,000.

© The Institute of Chartered Accountants of India