CA Final · Financial Reporting

Financial Instruments: Equity and Financial Liabilities: formula sheet

Full chapter guide

Key formulas

Basic classification rule: Contractual obligation to deliver cash or another financial asset (or exchange on potentially unfavourable terms) → Financial liability; no such obligation → Equity; The obligation must be contractual and unavoidable. Judge it by substance, not legal form.
Fixed-for-fixed test: Fixed amount of cash (in functional currency) ⇄ Fixed number of own equity instruments → Equity; otherwise → Liability or derivative; Applies to contracts settled in the issuer's own shares. Variable shares or variable cash fails the test.
Settlement options: Settlement choice with the issuer or holder → Financial liability, unless all settlement alternatives would result in equity; A net cash or net share settlement choice makes a derivative a liability unless every alternative is equity.
Puttable instruments: Puttable instrument → Liability, unless it has all the specified features and qualifies for the exception to be equity; The exception needs the instrument to be in the most subordinate class, with identical features and no other obligations.
Contingent settlement: Cash settlement depends on an uncertain event beyond the control of both parties → Liability, unless the feature is not genuine, or settlement is required only on the issuer's liquidation (or the instrument is a puttable instrument qualifying for equity); A feature is not genuine only if it has no real possibility of occurring. Ignore the feature only in that case, or where settlement arises only on liquidation. Otherwise classify the instrument as a liability.
Liability component: Liability = Σ [Cash flow(t) ÷ (1 + r)^t], where r = market rate for similar debt without conversion option; Include annual interest and the redemption amount, including any redemption premium. Use the rate for non-convertible debt, not the coupon.
Equity component: Equity = Proceeds received − Liability component; Residual method. Do not value the option separately and do not remeasure it later.
Transaction costs allocation: Cost to component = Total transaction cost × (Component amount ÷ Total proceeds); Costs on the liability part go into its initial carrying amount. Costs on the equity part are deducted from equity.
Finance cost (effective interest): Finance cost for the year = Opening liability × effective rate; Closing liability = Opening liability + Finance cost − Cash interest paid.
Fixed-for-fixed test: Fixed number of own shares for a fixed amount of cash in functional currency = equity; If the test fails, the conversion option is a derivative liability at fair value through profit or loss.
Measurement of equity issued: Equity issued = fair value of equity instruments on the date the liability is extinguished; Primary measurement. Use the fair value of the liability extinguished only if the equity's fair value cannot be reliably measured.
Gain or loss on extinguishment: Gain/(loss) = carrying amount of liability extinguished – fair value of equity issued; Positive means gain in profit or loss. Negative means loss in profit or loss. The amount is not taken to equity.
Journal entry (full settlement): Dr Financial liability (carrying amount); Cr Equity (fair value of shares issued); Cr/Dr Profit or loss (balancing figure); Credit share capital for face value and securities premium for the rest, as per the Companies Act.
Partial settlement: Consideration paid is allocated between the part of the liability extinguished and the part that is retained; If part of the consideration relates to a modification of the remaining liability, allocate it and assess that modification separately.
Scope exclusion: No Appendix D where the creditor acts as an existing shareholder, or where the transaction is a capital transaction between parties under common control, or where the settlement is under the original contract terms; State the exclusions with their conditions. Do not say that shareholder-creditors are always excluded.
Measurement of equity issued: Equity credited = Fair value of equity instruments issued (if not reliably measurable: fair value of liability extinguished); Measure at the date the liability is extinguished, which is the date the shares are issued.
Gain or loss on extinguishment: Gain / (Loss) = Carrying amount of liability extinguished − Fair value of equity issued; Positive means gain, negative means loss. Recognise in profit or loss and disclose as a separate line.
Partial settlement: Consideration allocated to part extinguished + Consideration allocated to remaining liability = Total equity issued at fair value; Allocate only if part of the consideration relates to modification of the remaining liability. Otherwise all of it relates to the part extinguished.
Journal entry: Dr Financial liability (carrying amount); Cr Share capital (face value); Cr Securities premium (balance of fair value); Cr / Dr Profit or loss (gain / loss); Carrying amount is the amortised cost on the settlement date, including accrued interest.
Derecognition condition: Derecognise when the obligation is discharged, cancelled or expires (para 3.3.1); Also applies to a substantial modification or an exchange with substantially different terms (para 3.3.2).
10% test: Difference % = (PV of new cash flows incl. net fees − PV of remaining original cash flows) ÷ PV of remaining original cash flows × 100; Discount both at the original EIR. Fees paid are added and fees received are deducted. Substantial if the absolute difference is ≥ 10%.
Gain or loss on extinguishment: Gain or loss = Carrying amount of liability extinguished − Consideration paid (cash + non-cash assets transferred + liabilities assumed, including the new liability at fair value); Recognised in profit or loss (para 3.3.3). Costs and fees go into this gain or loss.
Non-substantial modification: New carrying amount = PV of modified contractual cash flows at original EIR; The difference from the old carrying amount is a gain or loss in profit or loss (para B5.4.6). Costs or fees adjust the carrying amount and are amortised over the remaining term.

Quick revision

A financial liability exists when the issuer has a contractual obligation to deliver cash or another financial asset, or to exchange on potentially unfavourable terms.
Classify by substance and contractual terms, not by legal form or the name of the instrument.
An instrument that gives the holder a right to demand redemption is generally a liability for the issuer, subject to the specific exceptions in Ind AS 32.
A contract settled by issuing a fixed number of own shares for a fixed amount of cash is equity (the fixed-for-fixed test).
If the number of shares varies, the contract is generally a financial liability.
A compound instrument has a liability part and an equity part, recognised separately at initial recognition.
Liability component = present value of contractual cash flows at the market rate for similar debt without the conversion option.
Equity component = total proceeds minus the liability component, and it is not remeasured later.
Debt-for-equity settlement is dealt with in Ind AS 109 and its Appendix D, not Ind AS 32: equity issued is measured at its fair value; if that cannot be reliably measured, use the fair value of the liability extinguished. Appendix D does not apply when the creditor is a direct or indirect shareholder acting as such, or when the creditor and the entity are controlled by the same party before and after the transaction and the substance is a capital contribution or distribution.
Gain or loss on settlement = carrying amount of the liability minus the value of equity issued, taken to profit or loss.
Derecognise a financial liability only when it is extinguished: discharged, cancelled or expired.
A modification is substantial if the discounted present value of the new cash flows differs by at least 10% from that of the remaining cash flows of the old liability, using the original effective interest rate and including any fees paid net of any fees received. A substantial modification is accounted for as extinguishment of the original liability and recognition of a new liability at fair value, with the difference taken to profit or loss.

Common mistakes

Classifying a preference share as equity because it is legally a share. Fix: Read the terms. Mandatory redemption or a compulsory dividend makes it a liability.
Treating a discretionary dividend history as an obligation. Fix: Only contractual terms count. If the issuer can avoid the dividend, there is no obligation on that term.
Discounting at the coupon rate Fix: When redemption is at par, discounting at the coupon rate gives a liability equal to par, leaving no equity. Use the market rate for similar non-convertible debt.
Valuing the conversion option first and treating the liability as the balance Fix: Ind AS 32 requires the liability to be measured first. Equity is the residual.
Crediting equity with the carrying amount of the debt and showing no gain or loss. Fix: Measure equity at fair value and take the difference to profit or loss. Equity issued is consideration paid.
Using the fair value of shares on the date of the agreement. Fix: Use the fair value on the date the liability is extinguished, which is when the equity is issued.
Measuring the shares at face value or at the liability amount. Fix: Always start with the fair value of the shares on the settlement date. Use the liability's fair value only when share fair value cannot be measured reliably.
Taking the difference directly to equity or retained earnings. Fix: The difference between the carrying amount and the fair value of equity issued goes to profit or loss under Appendix D. Say so clearly in the answer.
Discounting the new cash flows at the new interest rate in the 10% test. Fix: For the test, always use the original effective interest rate.
Ignoring fees paid to the lender in the 10% test. Fix: Add fees paid and deduct fees received in the test. A fee can push a case from just under 10% to over 10%.

Exam tips

Write the classification test first, then the facts, then the conclusion. Examiners reward this order.
In a case MCQ, scan the terms for redemption, put rights, share-settlement and currency before choosing.
Always check the functional currency of the strike price. It is a common hidden trap.
When an instrument shows both features, name it a compound instrument and link to the split accounting.
State the effect on presentation: liability at amortised cost, dividends as finance cost, versus equity with no remeasurement.
Write the fixed-for-fixed test in one line before you compute. Examiners often give a case where it fails and expect a derivative liability.
Show the cash flow timeline and the discount factors. Marks are given for method even if arithmetic slips.
Read which rate is for non-convertible debt. If the question gives several rates, the coupon and the conversion yield are distractors.