Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Accounting and Reporting of Financial Instruments – CA Final FR Study Material is designed strictly as per the latest syllabus and exam pattern.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Compound Financial Instruments (Based On Para Nos. Ag30 To Ag35 of Appendix A)

Question 1.
Vedika Ltd. issued 80,000 8% convertible debentures @ ₹ 100 each on 1st April, 2015. The debentures are due for redemption on 31st March, 2019 at a premium of 20%, convertible into equity shares to the extent of 50% and balance to be settled in cash to the debenture holders. The interest rate on equivalent debenture without conversion right was 12%. The conversion to equity qualifies as fixed for fixed. You are required to separate the debt and equity components at the time of issue and show the accounting entries in Vedika Ltd.’s books at initial recognition only. The following present values of Rupee 1 at 8% and 12% are provided for a period of 5 years. [Nov. 2020-10 Marks]

Interest rate Year 1 Year 2 Year 3 Year 4 Year 5
8% 0.923 0.853 0.789 0.731 0.677
12% 0.887 0.788 0.701 0.625 0.557

Answer:
Computation of Debt and Equity component:

Particulars Workings Amount
Proceeds 80,000 × 100 80,00,000
Less:
Liability Component Interest (80,000 × 100 × 8%)                    ‘ 6,40,000 × 3.001 [PVIFA i.e. @ 12% for 1-4 years] (19,20,640)
Principal (80,000 × 100 × 50% × 120%) 48,00,000 × 0.625 [PVIF @ 12% for 4th Year end] (30,00,000)
(49,20,640)
Equity Component Balancing figure 30,79,360

Journal entry on initial recognition:

Bank                                                                                      Dr 80,00,000
To 8% Debentures – Debt component

To 8% Debentures – Equity component

49,20,640

30,79,360

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 2.
On 1st April, 20X4, S Ltd. issued 5,000, 8% convertible debentures with a face value of ₹ 100 each maturing on 31st March, 20X9. The debentures are convertible into equity shares of S Ltd. at a conversion price of ₹ 105 per share. Interest is payable annually in cash. At the date of issue, S Ltd. could have issued non-convertible debt with a 5 year term bearing a coupon interest rate of 12%. On 1st April, 20X7, the convertible debentures have a fair value of ₹ 5,25,000. S Ltd. makes a tender offer to debenture holders to repurchase the debentures for ₹ 5,25,000, which the holders accepted. At the date of repurchase, S Ltd. could have issued non-convertible debt with a 2 year term bearing a coupon interest rate of 9%.

Show accounting entries in the books of S Ltd. for recording of equity and liability component:

  1. At the time of initial recognition and
  2. At the time of repurchase of the convertible debentures.

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

Interest Rate Year 1 Year 2 Year 3 Year 4 Year 5
8% .  0.926 0.857 0.794 0.735 0.681
9% 0.917 0.842 0.772 0.708 0.650
12% 0.893 0.797 0.712 0.636 0.567

Answer:
(i) At the time of initial recognition
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 1
Note: Since ₹ 105 is the conversion price of debentures into equity shares and not the redemption price, the liability component is calculated @ ₹ 100 each only.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Journal Entry
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 2

(ii) At the time of repurchase of convertible debentures
The repurchase price is allocated as follows:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 3
*(5,25,000 – 4,91,360) = 33,640

Journal Entries
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 4

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 3.
V Limited issues convertible bonds of ₹ 75,00,000 on 1st April, 2018. The bonds have a life of five years and a face value of ₹ 20 each, and they offer interest payable at the end of each financial year at a rate of 4.5 percent annum. The bonds are issued at their face value and each bond can be converted into one ordinary share in Veer Ltd. at any time in the next five years.

Companies of a similar risk profile have recently issued debt at 6 percent per annum with similar terms but without the option for conversion.

You are required to:
(i) Provide the appropriate accounting entries for initial recognition as per the relevant Ind AS in the books of the company.
(ii) Calculate the stream of interest expenses across the five years of the life of the bonds.
(iii) Provide the accounting entries if the holders of the bonds elect to convert the bonds to ordinary shares at the end of the fourth year.
Answer:
Present value of bonds at the market rate of debt
Present value of principal to be received in 5 years discounted at 6%
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 5

(i) Journal Entries
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 6

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

Date Payment Interest expense at 6% (e of previ­ous year × 6%) Increase in bond liability (c – b) Total bond liability (e of previous year +d)
(a) (b) (c) (d) (e)
1st April, 2018 70,24,050
31st March, 2019 3,37,500 4,21,443 83,943 71,07,993
31st March, 2020 3,37,500 4,26,480 88,980 71,96,973
31st March, 2021 3,37,500 4,31,818 94,318 72,91,291
31st March, 2022 3,37,500 4,37,477 99,977 73,91,268
31st March, 2023 3,37,500 4,46,232* 1,08,732 75,00,000

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

* Difference is due to rounding off.

(iii) If the holders of the bond elect to convert the bonds to ordinary shares at the end of the fourth year (after receiving their interest payments), the entries in the fourth year would be:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 7

Question 4.
(i) On 1st April, 2014, S Ltd. issued 5,000, 8% convertible debentures with a face value of ₹ 100 each maturing on 31 st March, 2019. The debentures are convertible into equity shares of S Ltd. at a conversion price of ₹ 105 per share. Interest is payable annually in cash. At the date of issue, S Ltd. could have issued non-convertible debentures with a 5 year term bearing a coupon interest rate of 12%. On 1st April, 2017, the convertible debentures have a fair value of ₹ 5,25,000. S Ltd. makes a tender offer to debenture holders to repurchase the debentures for ₹ 5,25,000, which the holders accepted. At the date of repurchase, S Ltd. could have issued non-convertible debt with a 2 year term bearing a coupon interest rate of 9%.

Examine the accounting treatment in the books of S Ltd., by passing appro-priate journal entries, for recording t>f equity and liability component:

  1. At the time of initial recognition and
  2. At the time of repurchase of the convertible debentures.

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

Interest Rate Year 1 Year 2 Year 3 Year 4 Year 5
8% 0.926 0.857 0.794 0.735 0.681
9% 0.917 0.842 0.772 0.708 0.650
12% 0.893 0.797 0.712 0.636 0.567

(ii) On 1 January, 2018, Entity X writes a put option for 1,00,000 of its own equity shares for which it receives a premium of ₹ 5,00,000.

Under the terms of the option, Entity X may be obliged to take delivery of 1,00,000 of its own shares in one year’s time and to pay the option exercise price of ₹ 22,000,000. The option can only be settled through physical delivery of the shares (gross physical settlement). Examine the nature of the financial instrument and how it will be accounted assuming that the present value of option exercise price is ₹ 2,00,000?
Answer:
(i) (1) At the time of initial recognition
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 8
Note: Since ₹ 105 is the conversion price of debentures into equity shares and not the redemption price, the liability component is calculated @ ₹ 100 each only.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Journal Entry
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 9

(2) At the time of repurchase of convertible debentures
The repurchase price is allocated as follows:

Carrying Value @ 12% Fair Value Differ­ence
Liability component
Present value of 2 remaining yearly inter­est payments of ₹ 40,000, discounted at 12% and 9%, respectively 67,600 70,360
Present value of ₹ 5,00,000 due in 2 years, discounted at 12% and 9%, compounded yearly, respectively 3,98,500 4,21,000
Liability component 4,66,100 4,91,360 (25,260)
Equity component (5,25,000 – 4,91,360) 72,300 33,640* 38,660
Total 5,38,400 5,25,000 13,400

*(5,25,000 – 4,91,360) = 33,640

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Journal Entries
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 10

(ii) This derivative involves Entity X taking delivery of a fixed number of equity shares for a fixed amount of cash. Even though the obligation for Entity X to purchase its own equity shares for ₹ 22,000,000 is conditional on the holder of the option exercising the option, Entity X has an obligation to deliver cash which it cannot avoid.

As per para 23 of Ind AS 32 ‘Financial Instruments: Presentation’, the accounting for financial instrument will be as below:
The financial liability is recognised initially at the present value of the redemption amount, and is reclassified from equity. This would imply that a financial liability for an amount of present value of ₹ 22,000,000, say ₹ 20,000,000 will be recognised through a debit to equity. The initial premium received (₹ 5,00,000) is credited to equity.

Subsequently, the financial liability is measured in accordance with Ind AS 109. While a subsequent paragraph will deal with measurement of financial liabilities. The financial liability of ₹ 20,000,000 will be measured at amortised cost as per Ind AS 109 and finance cost of ₹ 2,000,000 will be recognised over the exercise period.

If the contract expires without delivery, the carrying amount of the financial liability is reclassified to equity i.e. an amount of ₹ 22,000,000 will be reclassified from financial liability to equity.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 5.
(1) Q Ltd. issued 10,00,000 of 8% Long-Term bond-A Series of ₹ 1 each on 1st April, 2016. The bond tenure is 3 years. Interest is payable annually on 1st April each year. The investors expect an effective interest rate on the loan at 10%. 0 Ltd. wants you to suggest the suitable accounting entries for the issue of these bonds as per applicable Ind AS. Consider the discounting factor 3 years, 10% discounting factor is 0.751315 and 3 years cumulative discounting factor is 2.48685.
(i) What is the principal value of the bond at the initial recognition at the time of issue of bond as per applicable Ind AS?
(ii) What is the present value of the interest payment to be recognised as part of the sale price of the bond as per applicable Ind AS?
(iii) What are the proceeds of the sale of the bond to be recognized at the time of initial recognition as per applicable Ind AS?
(iv) What is the accounting entry to be passed at the time of accounting for payment of interest for the first year?

(2) Q Ltd. has also issued 10,00,000 of 8% Long Term Bond-B Series of ₹ 1 each on 1st April, 2016. The bond tenure is 3 years. Interest is payable annually on 1st April each year. However, the bond holders of this series are entitled to convert the bonds to shares of Re. 1 each on the date of maturity, instead of receiving the principal repayment. Interest rate on the similar bond without conversion option is 10%. Q Ltd. has requested you to suggest the following for this type of instrument:
(a) What is entry to be passed at the date of issuance of the bond as per applicable Ind AS?
(b) What is entry to be passed at the date of conversion of the bond as per applicable Ind AS?
Answer:
(1) (i) Option (C) : ₹ 7,51,315
(ii) Option (C) : ₹ 1,98,948
(iii) Option (B) : ₹ 9,50,263
(iv) Option (B) :
Bond Interest Expenses A/c Dr. ₹ 95,026
To Discount on Bond A/s ₹ 15,026
To Cash/Bank A/c  ₹ 80,000

Workings:
Since the Effective interest rate on the loan is 10% while the Bond has been issued at 8%, the financial liability will be recognized affair value determined as follows:

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Calculation of initial recognition amount of 8% Long-term Loan Bond A Series

Particulars
Present value of the principal repayable after 3 years (10,00,000 × 751315) 7,51,315
Present value of Interest [(10,00,000 × 8%) × 2.48685] 9,50,263
Total Present Value of Long-term Loan Bond 1,98,948

Interest for the first year recognized in the books as per effective interest rate method
= ₹ 9,50,263 × 10% = ₹ 95,026
However, interest paid is @ 8% i.e, ₹ 10,00,000 × 8% = ₹ 80,000

(2) (a) Option (B): Cash/Bank A/c – ₹ 10,00,000
To 8% LT Bond Series B A/c – ₹ 9,50,263
To Share Option A/c – ₹ 49,737

Workings:
It is a compound instrument.

Calculation of initial recognition amount of 8% Long-term Loan Bond B Series liability and equity component
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 11

(b) 8% LT Bond Series B A/c – ₹ 10,00,000
Share Option A/c – ₹ 49,737
To Share Capital A/c – ₹ 10,00,000
To Share Premium A/c – ₹ 49,737

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 6.
On 1 April, 2018, an 8% convertible loan with a nominal value of ₹ 6,00,000 was issued at par. It is redeemable on 31 March, 2022 also at par. Alternatively, it may be converted into equity shares on the basis of 100 new shares for each ₹ 200 worth of loan.

An equivalent loan without the conversion option would have carried interest at 10%. Interest of ₹ 48,000 has already been paid and included as a finance cost.
Present value rates are as follows:

Year End @8% @ 10%
1

2

3

4

0.93

0.86

0.79

0.73

0.91

0.83

0.75

0.68

How will the Company present the above loan notes in the financial statements for the year ended 31 March, 2019?
Answer:
Step 1 : There is an ‘option’ to convert the loans into equity i.e. the loa!n 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.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Step 2 : Debt element of the financial instrument so as to recognise the liability is the present value of interest and principal.

The rate at which the same is to be discounted, is the rate of equivalent loan note without the conversion option would have carried interest at 10%, therefore this is the rate to be used for discounting.

Step 3 : Calculation of the debt element of the loan note as follows:
8% Interest discounted at a rate of 10% Present Value (6,00,000 × 8%)

S. No. Year Interest amount PVF Amount
Year 1 2019 48,000 0.91 43,680
Year 2 2020 48,000 0.83 39,840
Year 3 2021 48,000 0.75 36,063
1,19,583
Year 4 2022 648,000 0.68 4,40,640
Amount to be recognised as a liability 5,60,223

Initial proceeds – (6,00,000)
Amount to be recognised as equity – 39,777
* In year 4, the loan note is redeemed therefore ₹ 6,00,000 + ₹ 48,000 = ₹ 6,48,000.

Step 4 : The next step is to recognise the interest component equivalent to the loan that would carry if there was no option to cover. Therefore, the interest should be recognised at 10%. As on date ₹ 48,000 has been recognised in the statement of profit and loss i.e. 6,00,000 × 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.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

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 × 10%) ₹ 56,000
Already charged to the income statement (₹ 48,000)
Additional charge required ₹ 8,000

Journal Entries for recording additional finance cost for year ended 31 March, 2019
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 12

Question 7.
Blueberry Ltd entered into the following transactions during the year ended 31st March, 20X2:
(a) Entered into a speculative interest rate option costing ₹ 10,000 on 1st April, 20X0 to borrow ₹ 60,00,000 from Exon Bank commencing 30th June, 20X2 for 6 months at 4%.
The value of the option at 31st March, 20X2 was ₹ 15,250.
(b) Purchased 6% debentures in Fox Ltd on 1st April, 20X1 (their issue date) for ₹ 150,000 as an investment. Blueberry Ltd. intends to hold the debentures, until their redemption at a premium, in 5 years’ time. The effective rate of interest of the bond is 8%.
(c) Purchased 50,000 shares in Cox Ltd on 1st October, 20X2 for ₹ 3.50 each as an investment. The share price on 31st March, 20X2 was ₹ 3.75.

Show the accounting treatment and relevant extracts from the financial statements for the year ended 31st March, 20X2 of transactions related to financial instruments.

Blueberry Ltd designates financial assets at fair value through profit or loss only when this is unavoidable. [MTP-May 2020]
Answer:
Balance Sheet as at 31st March, 20X2
[Extract]

Financial Assets:
Interest rate option (Working Note -1) 15,250
6% Debentures in Fox Ltd. (Working Note – II) 1,53,000
Shares in Cox Ltd. (Working Note – III) 1,87,500

Statement of Profit and Loss [Extract]
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 13

Working Notes:

Working Note -1:
Interest Rate option:
Subsequent Measurement:
It is a derivative and therefore it must be accounted using FVTPL.
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 14
Thus,
Financial Assets (₹ 10,000 + ₹ 5,250) = ₹ 15,250 (For Balance Sheet)
Gain on interest option = ₹ 5,250 (For Statement of Profit and Loss)

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Working Note – II:
Debentures:

Subsequent Measurement:
On the basis of information provided, it can be treated as a held-to-maturity investment (Business model of holding investment for collecting Contractual cash flows); which implies to be measured at amortized cost.
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 15
Thus,
Amortized cost at 31st March, 20X2:
(₹ 150,000 + ₹ 12,000 – ₹ 9,000) = ₹ 153,000 (For Balance Sheet)
Effective interest on 6% debenture = ₹ 12,000 (For Statement of Profit and Loss)

Working Note – III:
Shares in Cox Ltd.:

Subsequent Measurement:
Equity shares are measured at FVTPL unless it is not held for trading in which case it is measured at FVTOCI (Non- recycling) or FVTPL whichever option the company chooses.

These are assumed to be measured at FVTOCI (Non-Recycling).
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 16
Thus,
Shares in Cox Ltd. (₹ 1,75,000 + ₹ 12,500) = ₹ 1,87,500 (For Balance Sheet)
Gain on Equity Shares = ₹ 12,500 (For Statement of Profit and Loss)

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Special Issues On Initial Measurement of Financial Assets-Processing Fee; Transaction Value Vs Fair Value; Prepayment (Modification) [Based On Para No. 5.4.3 Of Ind As 109]

Question 8.
K Ltd. has granted an interest free loan of ₹ 10,00,000 to its wholly owned Indian Subsidiary Y Ltd. There is no transaction cost attached to the said loan. The Company has not finalised any terms and conditions including the applicable interest rates on such loans. The Board of Directors of the Company are evaluating various options and has requested your firm to provide your views under Ind AS in following situations:

(i) The Loan given by K Ltd. to its wholly owned subsidiary Y Ltd. is interest free and such loan is repayable on demand.
(ii) The said Loan is interest free and will be repayable after 3 years from the date of granting such loan. The current market rate of interest for similar loan is 10%. Considering the same, the fair value of the loan at initial recognition is ₹ 8,10,150.
(iii) The said loan is interest free and will be repaid as and when the YK Ltd. has funds to repay the Loan amount.

Based on the same, K Ltd. has requested you to suggest the accounting treatment of the above loan in the standalone financial statements of K Ltd. and Y Ltd. and also in the consolidated financial statements of the group. Consider interest for only one year for the above loan.

Further the Company is also planning to grant interest free loan from Y Ltd. to K Ltd. in the subsequent period. What will be the accounting treatment of the same under applicable Ind AS?
Answer:
Scenario (i)
Since the loan is repayable on demand, it has fair value equal to cash consideration given. K Ltd. and Y Ltd. should recognize financial asset and liability, respectively, at the amount of loan given (assuming that loan is repayable within a year). Upon, repayment, both the entities should reverse the entries that were made at the origination.

Journal entries in the books of K Ltd.
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 17

Journal entries in the books of Y Ltd.
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 18
In the consolidated financial statements, there will be no entry in this regard since loan receivable and loan payable will get set off.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Scenario (ii)
Applying the guidance in Ind AS 109, a ‘financial asset’ shall be recorded at its fair value upon initial recognition. Fair value is normally the transaction price. However, sometimes certain type of instruments may be exchanged at off market terms (i.e., different from market terms for a similar instrument if exchanged between market participants).

If a long-term loan or receivable that carries no interest while similar instruments if exchanged between market participants carry interest, then fair value for such loan receivable will be lower from its transaction price owing to the loss of interest that the holder bears. In such cases where part of the consideration given or received is for something other than the financial instrument, an entity shall measure the fair value of the financial instrument. The difference in fair value and transaction cost will treated as investment in Subsidiary Y Ltd.

Both K Ltd. and Y Ltd. should recognise financial asset and liability, respectively, at fair value on initial recognition, i.e., the present value of ₹ 10,00,000 payable at the end of 3 years using discounting factor of 10%. Since the question mentions fair value of the loan at initial recognition as ₹ 8,10,150, the same has been considered. The difference between the loan amount and its fair value is treated as an equity contribution to the subsidiary. This represents a further investment by the parent in the subsidiary.

Journal entries in the books of K Ltd. (for one year)
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 19
Note- Interest needs to be recognised in statement of profit and loss. The same cannot be adjusted against capital contribution recognised at origination.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Journal entries in the books of YLtd. (for one year)
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 20
In the consolidated financial statements, there will be no entry in this regard since loan and interest income/expense will get set off.

Scenario (iii)
Generally, a loan which is repayable when funds are available, cannot be stated as loan repayable on demand. Rather the entity needs to estimate the repayment date and determine its measurement accordingly by applying the concept prescribed in Scenario (ii).

In the consolidated financial statements, there will be no entry in this regard since loan and interest income/expense will get set off.

In case the subsidiary Y Ltd. is planning to grant interest free loan to K Ltd., then the difference between the fair value of the loan on initial recognition and its nominal value should be treated as dividend distribution by Y Ltd. and dividend income by the parent K Ltd.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 9.
S Limited issued redeemable preference shares to its Holding Company H Limited. The terms of the instrument have been summarized below. Analyse the given situation, applying the guidance in Ind AS 109 ‘Financial Instruments’, and account for this in the books of H Limited.

Nature Non-cumulative redeemable preference shares
Repayment Redeemable after 3 years
Date of Allotment 1st April, 2015
Date of Repayment 31st March, 2018
Total Period 3 Years
Value of Preference Shares issued 5,00,00,000
Dividend Rate 0.0001% Per Annum
Market rate of interest 12% Per Annum
Present value factor 0.1118

Answer:
1. Analysis of the financial instrument issued by S Ltd. to its holding company H Ltd.

Applying the guidance in Ind AS 109, a ‘financial asset’ shall be recorded at its fair value upon initial recognition. Fair value is normally the transaction price. However, sometimes certain type of instruments may be exchanged at off market terms (ie., different from market terms for a similar instrument if exchanged between market participants).

For example, a long-term loan or receivable that carries no interest while similar instruments if exchanged between market participants carry interest, then fair value for such loan receivable will be lower from its transaction price owing to the loss of interest that the holder bears. In such cases where part of the consideration given or received is for something other than the financial instrument, an entity shall measure the fair value of the financial instrument.

In the above case, since S Ltd. has issued preference shares to its Holding Company- H Ltd., the relationship between the parties indicates that the difference in transaction price and fair value is akin to investment made by H Ltd. in its subsidiary. This can further be substantiated by the nominal rate of dividend i.e. 0.0001% mentioned in the terms of the instrument issued.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Computations on initial recognition:

Transaction value of the Redeemable preference shares 5,00,00,000
Less: Present value of loan component @ 12% (5,00,00,000 × .7118) (3,55,90,000)
Investment in subsidiary 1,44,10,000

Subsequently, such preference shares shall be carried at amortised cost at each reporting date as follows:

Year Date Opening Balance Interest @ 12% Closing balance
1st April, 2015 3,55,90,000 3,55,90,000
1 31st March, 2016 3,55,90,000 42,70,800 3,98,60,800
2 31st March, 2017 3,98,60,800 47,83,296 4,46,44,096
3 31st March, 2018 4,46,44,096 53,55,904* 5,00,00,000

* ₹ 4,46,44,096 × 12% = ₹ 53,57,292. The difference of ₹ 1,388 53,57,292 – ₹ 53,55,904) is due to approximation in present value factor.

2. In the books of HLtd.
Journal Entries to be done at every reporting date
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 21

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

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

Discounting Factor @ 15%

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

You are required to compute Liability and Equity Component and Pass Journal Entries for entire term of arrangement i.e. from the issue of Preference Shares till their conversion into Equity Shares. Keeping in view the provisions of relevant Ind AS. [May 2019 – 12 Marks]
Answer:
This is a compound financial instrument with two components – liability representing present value of future cash outflows and balance represents equity component.

(a) Computation of Liability & Equity Component:

Date Particulars Cash Flow Discount Factor Present Value
01-Apr-2017 0 1 0
31-Mar-2018 Dividend 9,00,000 0.8696 7,82,640
31-Mar-2019 Dividend 9,00,000 0.7561 6,80,490
31-Mar-2020 Dividend 9,00,000 0.6575 5,91,750
31-Mar-2021 Dividend 9,00,000 0.5718 5,14,620
31-Mar-2022 Dividend 9,00,000 0.4971 4,47,390
Total Liability Component 30,16,890
Total Proceeds 9,00,00,000
Total Equity Component (Bal. fig.) 59,83,110

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

(b) Allocation of transaction costs

Particulars Amount Allocation Net Amount
Liability Component Equity Component 30,16,890 59,83,1 10 60,338
1,19,662
29,56,552
58,63,448
Total Proceeds 90,00,000 1,80,000 88,20,000

(c) Accounting for liability at amortised cost: –
– Initial accounting = Present value of cash outflows less transaction costs
– Subsequent accounting = At amortised cost, Le., initial fair value adjusted for interest and repayments of the liability.
Effective interest rate is given at 15.86%

Opening Financial Liability A Interest B Cash Flow C Closing Financial Liability A+B-C
29,56,552 29,56,552
29,56,552 4,68,909 9,00,000 25,25,461
25,25,461 4,00,538 9,00,000 20,25,999
20,25,999 3,21,323 9,00,000 14,47,322
14,47,322 2,29,545 9,00,000 7,76,867
7,76,867 1,23,133 (b/f) 9,00,000

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

(d) Journal Entries to be recorded for entire term of arrangement are as follows:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 22
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 23
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 24

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 11.
N Limited granted a loan of ₹ 120 lakh to O Limited for 5 years @ 10% p.a. which is Treasury bond yield of equivalent maturity. But the incremental borrowing rate of O Limited is 12%. In this case, the loan is granted to O Limited at below market rate of interest. Ind AS 109 requires that a financial asset or financial liability is to be measured at fair value at the initial recognition. Should the transaction price be treated as fair value? If not, find out the fair value. What is the accounting treatment of the difference between the transaction price and the fair value on initial recognition in the book of N Ltd.?

Present value factors at 12%:

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

Answer:
Since the loan is granted to 0 Ltd. at 10% Le. below market rate of 12%. It will be considered as loan given at off market terms. Hence the Fair value of the transaction will be lower from its transaction price & not the transaction price.

Calculation of fair value
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 25
The fair value of the transaction be ₹ 111.288 lakh.

Since fair value is based on level 1 input or valuation technique that uses only data from observable markets, difference between fair value and transaction price will be recognized in Profit and Loss as fair value loss i.e. ₹ 120 lakh – ₹ 111.288 lakh = ₹ 8.712 lakh.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 12.
Make necessary journal entries for accounting of the security deposit made by Admire Ltd., whose details are described below. Assume market interest rate for a deposit for similar period to be 12% per annum. [Nov. 2019 – 4 Marks]

Particulars Details
Date of Security Deposit (Starting Date) 1-Apr-2014
Date of Security Deposit (Finishing Date) 31-Mar-2019
Description Lease
Total Lease Period 5 years
Discount rate 12.00%
Security deposit (A) 20,00,000
Present value factor at the 5th year 0.567427

Answer:
Fair Value of security deposit = 20,00,000 × 0.567427 = 11,13,854 (Assuming no interest is paid during 5 years)
Journal Entry:

Security Deposit Dr 11,13,854
ROV Asset Dr 8,86,146
To Bank 20,00,000

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 13.
An Indian entity, whose functional currency is rupees, purchases USD dominated bond at its fair value of USD 1,000. The bond carries stated interest @ 4.7% p.a. on its face value. The said interest is received at the year end. The bond has maturity period of 5 years and is redeemable at its face value of USD 1,250.

The fair value of the bond at the end of year 1 is USD 1,060. The exchange rate on the date of transaction and at the end of year 1 are USD 1 = ₹ 40 and USD 1 = ₹ 45, respectively. The weighted average exchange rate for the year is 1 USD = ₹ 42.

The entity has determined that it is holding the bond as part of an investment portfolio whose objective is met both by holding the asset to collect contractual cash flows and selling the asset. The purchased USD bond is to be classified under the FVTOCI category.

The bond results in effective interest rate (EIR) of 10% p.a.

Calculate gain or loss to be recognized in Profit & Loss and Other Comprehensive Income for year 1.
Also pass journal entry. [RTP November 2020]
Answer:
Computation of amounts to be recognized in the P&L and OCI:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 26

Journal Entry to recognize gain/loss:
[Figures have been rounded off to the nearest rupees]
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 27

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Impairment (Based On Chapter 5.5 of Ind As 109)

Question 14.
On 1st April, 2017, A Ltd. lent ₹ 2 crores to a supplier in order to assist them with their expansion plans. The arrangement of the loan cost the company ₹ 10 lakhs. The company has agreed not to charge interest on this loan to help the supplier’s short-term cash flow but expected the supplier to repay ₹ 2.40 crores on 31st March, 2019. As calculated by the finance team of the company, the effective annual rate of interest on this loan is 6.9% On 28th February, 2018, the company received the information that poor economic climate has caused the supplier significant problems and in order to help them, the company agreed to reduce the amount repayable by them on 31st March, 2019 to ₹ 2.20 crores. Suggest the accounting entries as per applicable Ind AS.
Answer:
The loan to the supplier would be regarded as a financial asset. The relevant accounting standard Ind AS 109 provides that financial assets are normally measured at fair value.

If the financial asset in which the only expected future cash inflows are the receipts of principal and interest and the investor intends to collect these inflows rather than dispose of the asset to a third party, then Ind AS 109 allows the asset to be measured at amortised cost using the effective interest method.

If this method is adopted, the costs of issuing the loan are included in its initial carrying value rather than being taken to profit or loss as an immediate expense. This makes the initial carrying value ₹ 2,10,00,000.

Under the effective interest method, part of the finance income is recognised in the current period rather than all in the following period when repayment is due. The income recognised in the current period is ₹ 14,49,000 (₹ 2,10,00,000 × 6.9%)

In the absence of information regarding the financial difficulties of the sup-plier the financial asset at 31st March, 2018 would have been measured at ₹ 2,24,49,000 (₹ 2,10,00,000 + 14,49,000). The information regarding financial difficulty of the supplier is objective evidence that the financial asset suffered impairment at 31st March, 2018.

The asset is re-measured at the present value of the revised estimated future cash inflows, using the original effective interest rate. Under the revised estimates the closing carrying amount of the asset would be ₹ 2,05,79,981 (₹ 2,20,00,000/1.069). The reduction in carrying value of ₹ 18,69,019 (₹ 2,24,49,000 – 2,05,79,981) would be charged to profit or loss in the current period as an impairment of a financial asset.

Therefore, the net charge to profit or loss in respect of the current period would be ₹ 4,20,019 (18,69,019 – 14,49,000).

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Derecognition Of Financial Liabilities (Based On Chapter 3.3 Of Ind As 109 And Including Appendix D Of Ind As 109)

Question 15.
On 1 January 20X0, P Ltd. issues 10 year bonds for ₹ 10,00,000, bearing interest at 10% (payable annually on 31st December each year). The bonds are redeemable on 31 December 20X9 for ₹ 10,00,000. No costs or fees are incurred. The effective interest rate is 10%. On 1 January 20X5 (i.e. after 5 years) Preet Ltd. and the bondholders agree to a modification in accordance with which:

  • the term is extended to 31 December 20Y1;
  • interest payments are reduced to 5% p.a.;
  • the bonds are redeemable on 31 December 20Y1 for ₹ 15,00,000; and
  • legal and other fees of ₹ 1,00,000 are incurred.

P Ltd. determines that the market interest rate on 1 January 20X5 for borrowings on similar terms is 11%.

Analyse whether the extinguishment accounting will apply or not as per Ind AS. If yes, determine the fair value of the modified liability and compute the gain or loss on modification.
Answer:
The repayment schedule for the original debt till the date of renegotiation is as below:

Date/year ended Opening balance Interest ac­crual Cash flows Closing balance
1 January 20X0 10,00,000 10,00,000
31 December 20X0 10,00,000 1,00,000 (1,00,000) 10,00,000
31 December 20X1 10,00,000 1,00,000 (1,00,000) 10,00,000
31 December 20X2 10,00,000 1,00,000 (1,00,000) 10,00,000
31 December 20X3 10,00,000 1,00,000 (1,00,000) 10,00,000
31 December 20X4 10,00,000 1,00,000 (1,00,000) 10,00,000

On 1 January 20X5, the discounted present value of the remaining cash flows of the original financial liability is ₹ 10,00,000.
On this date, Preet Ltd. will compute the present value of:

  • cash flows under the new terms -i.e. ₹ 15,00,000 payable on 31 December 20Y1 and ₹ 50,000 payable for each of the 7 years ending 31 December 20Y1.
  • any fee paid (net of any fee received) – i.e. ₹ 1,00,000 using the original effective interest rate of 10%.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

The total of these amounts to ₹ 11,13,158 (Refer Working Note). This differs from the discounted present value of the remaining cash flows of the original financial liability by 11.32% ie. by more than 10%. Hence, extinguishment accounting applies.

The next step is to estimate the fair value of the modified liability. This is determined as the present value of the future cash flows (interest and principal), using an interest rate of 11% (the market rate at which Preet Ltd. could issue new bonds with similar terms). The estimated fair value on this basis is ₹ 958,097 (Refer Working Note). A gain or loss on modification is then determined as:

Gain (loss) = carrying value of existing liability – fair value of modified liability – fees and costs incurred i.e. ₹ 10,00,000 – ₹ 9,58,097 – ₹ 1,00,000 = Loss of t 58,097
Working Note:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 28
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 29

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 16.
H Limited borrowed ₹ 500,000,000 from a bank on 1 January, 2017. The original terms of the loan were as follows:

  • Interest rate: 11%
  • Repayment of principal in 5 equal instalments
  • Payment of interest annually on accrual basis
  • Upfront processing fee: ₹ 5,870,096 Effective interest rate on loan: 11.50%

On 31 December, 20X2, H Limited approached the bank citing liquidity issues in meeting the cash flows required for immediate instalments and re-negotiated the terms of the loan with banks as follows:

  • Interest rate 15%
  • Repayment of outstanding principal in 10 equal instalments starting 31st December, 2018.
  • Payment of interest on an annual basis

Record journal entries in the books of H Limited till 31 st December, 2018, after giving effect of the changes in the terms of the loan on 31st December, 2017.
Answer:
On the date of initial recognition, the effective interest rate of the loan shall be computed keeping in view the contractual cash flows and upfront processing fee paid. The following table shows the amortisation of loan based on effective interest rate:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 30

(a) 1 January, 2016
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 31

(b) 31 December, 2016
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 32

(c) 31 December, 2017 – Before H Limited approached the bank –
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 33
Upon receiving the new terms of the loan, H 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:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 35
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:

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

(d) 31 December, 2017 – accounting for extinguishment
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 36

(e) 31 December, 2018
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 37

Embedded Derivatives (Based On Chapter 4.3 of Ind As 109)

Question 17.
On 1st January, 2017, E Limited agreed to purchase USD (S) 40,000 from E Bank in future on 31st December, 2017 for a rate equal to ₹ 65 per USD. E Limited did not pay any amount upon entering into the contract. E Limited is a listed company in India and prepares its financial statements on a quarterly basis.

Using the definition of derivative included in Ind AS 109 and following the principles of recognition and measurement as laid down in Ind AS 109, you are required to record the entries for each quarter ended tilt the date of actual purchases of USD.

For the purpose of accounting, use the following information representing marked to market fair value of forward contracts at each reporting date:

As at 31st March, 2017 ₹ (50,000)
As at 30th June, 2017 ₹ (30,000)
As at 30th September, 2017 ₹ 24,000
Spot rate of USD on 31st December, 2017 ₹ 62 per USD

Answer:
Assessment of the arrangement using the definition of derivative included under Ind AS 109.

Derivative is a financial instrument or other contract within the scope of this Standard with all three of the following characteristics:
(a) its value changes in response to the change in foreign exchange rate (emphasis laid)
(b) it requires no initial net investment or an initial net investment is smaller than would be required for other types of contracts with similar response to changes in market factors.
(c) it is settled at a future date.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Upon evaluation of contract in question, on the basis of the definition of derivative, it is noted that the contract meets the definition of a derivative as follows:
(a) the value of the contract to purchase USD at a fixed price changes in response to changes in foreign exchange rate.
(b) the initial amount paid to enter into the contract is zero. A contract which would give the holder a similar response to foreign exchange rate changes would have required an investment of USD 40,000 on inception.
(c) the contract is settled in future

The derivative is a forward exchange contract.
As per Ind AS 109, derivatives are measured at fair value upon initial recognition and are subsequently measured at fair value through profit and loss.

Accounting in each Quarter
(i) Accounting on 1st January, 2017
As there was no consideration paid and without evidence to the contrary the fair value of the contract on the date of inception is considered to be zero. Accordingly, no accounting entries shall be recorded on the date of entering into the contract.

(ii) Accounting on 31st March, 2017
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 38

(iii) Accounting on 30th June, 2017
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 39

(iv) Accounting on 30th September, 2017
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 40

(v) Accounting on 31st December, 2017
The settlement of the derivative forward contract by actual purchase of USD 40,000
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 41

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Question 18.
On 1st April, 2017, X Ltd., a company incorporated in India enters into a contract to buy solar panels from Good Associates, a firm domiciled in UAE, for which delivery is due after 6 months i.e. on 30th September, 2017. The purchase price for solar panels is US$ 50 million.

The functional currency of XYZ is Indian Rupees (INR) and of Good Asso-ciates is Dirhams.

The obligation to settle the contract in US Dollars has been evaluated to be an embedded derivative which is not closely related to the host purchase contract.
Exchange rates:
1. Spot rate on 1st April, 2017: USD 1 = ₹ 60
2. Six-month forward rate on 1st April, 2017: USD 1 = ₹ 65
3. Spot rate on 30th September, 2017: USD 1 = ₹ 66
Analyse the contract and pass the necessary journal entries.
Answer:
Host contract:
Host contract to purchase solar panels.
Embedded derivative:
Forward contract to pay US Dollars.

For accounting of embedded derivative, we need to split the transaction as under:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 42
# A notional payment in INR at 6-month forward rate – ₹ 32,500 lacs. (USD 500 lacs X INR 65 per USD)
## A notional receipt in INR; i.e. a forward contract to sell US Dollars at INR 65 per US Dollar.

Note:
A notional INR payment in respect of host contract and the notional INR receipt in respect of embedded derivative would create an offsetting position.

The host contract is not accounted for until delivery. The embedded derivative is recorded at FVTPL.
On delivery A Ltd. will record the solar panels at the amount of the host contract(₹ 32,500 lacs). The derivative asset or liability (i.e. the cumulative gain or loss) is settled by becoming part of the financial liability that arises on delivery.
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 43
# The effect is that the financial liability at the date of delivery is ₹ 33,000 lacs (32,500 + 500) which is equal to USD 500 lacs × 66 (i.e. spot rate on 30th September, 2017.)

Subsequently, the financial liability (creditors) is a financial instrument de-nominated in USD. It will be retranslated at the dollar spot rate in the normal way, until it is settled.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Impairment of Ind As 109 (Based On Chapter 5.5)

Question 19.
An entity purchases a debt instrument with a fair value of ₹ 1,000 on 15th March, 20X1 and measures the debt instrument at fair value through other comprehensive income. The instrument has an interest rate of 5% over the contractual term of 10 years, and has a 5% effective interest rate. At initial recognition, the entity determines that the asset is not a purchased or original credit-impaired asset.

On 31st March 20X1 (the reporting date), the fair value of the debt instrument has decreased to ? 950 as a result of changes in market interest rates. The entity determines that there has not been a significant increase in credit risk since initial recognition and that ECL should be measured at an amount equal to 12 month ECL, which amounts to ₹ 30.

On 1st April 20X1, the entity decides to sell the debt instrument for ₹ 950, which is its fair value at that date.

Pass journal entries for recognition, impairment and sale of debt instruments as per Ind AS 109. Entries relating to Interest income are not to be provided. [RTP-November 2019]
Answer:
On Initial recognition:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 44
The cumulative loss in other comprehensive income at the reporting date was ₹ 20. That amount consists of the total fair value change of ₹ 50 (that is, ₹ 1,000 – ₹ 950) offset by the change in the accumulated impairment amount representing 12 month ECL, that was recognized (₹ 30).

On Sale of debt instrument:
Accounting and Reporting of Financial Instruments – CA Final FR Study Material 45

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Hedge Accounting (Based On Chapter 6 Of Ind As 109)

Question 20.
Discuss the heed of hedge accounting and types of various hedges?
Answer:
Hedge accounting may be required due to accounting mismatches in:
Measurement – some financial instruments (non-derivative) are not measured at fair value with changes being recognised in the statement of profit and loss whereas all derivatives, which commonly are used as hedging instruments, are measured at fair value

Recognition – unsettled or forecast transactions that may be hedged are not recognised on the balance sheet or are included in the statement of profit and loss only in a future accounting period, whereas all derivatives are recognised at inception.

Recognition mismatches include the hedge of a contracted or expected but not yet recognised sale, purchase or financing transaction in a foreign currency and future committed variable interest payments.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

Types of hedge accounting
1. Fair value hedge accounting model
A fair value hedge seeks to offset the risk of changes in the fair value of an existing asset or liability or an unrecognised firm commitment that may give rise to a gain or loss being recognised in the statement of profit and loss.

A fair value hedge is a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect the statement of profit and loss.

2. Cash flow hedge accounting model
A cash flow hedge seeks to offset certain risks of the variability . of cash flows in respect of an existing asset or liability or a highly
probable forecast transaction that may be reflected in the state-ment of profit and loss in a future period.

A cash flow hedge is a hedge of the exposure to variability in cash flows that (i) is attributable to a particular risk associated with a recognised asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable forecast transaction or a firm commitment in respect of foreign currency and (ii) could affect the statement of profit and loss.

Accounting and Reporting of Financial Instruments – CA Final FR Study Material

3. Net investment hedging
An investor in a non-integral operation is exposed to changes in the carrying amount of the net assets of the foreign operation (the net investment) arising from the translation of those assets into the reporting currency of the investor.

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