Extinguishing Financial Liabilities with Equity Instruments (Ind AS 109 Appendix D)

Understand Extinguishing Financial Liabilities with Equity Instruments

Key rules to remember

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.

How to solve Extinguishing Financial Liabilities with Equity Instruments questions

1. 1Check scope. Is the debtor issuing its own equity to a creditor to settle a financial liability under renegotiated terms? Rule out creditor acting as shareholder, common-control capital transactions and settlement under original terms such as a conversion option.
2. 2Fix the extinguishment date. This is the date the equity is issued and the liability is settled. Use the fair value on this date, not the date of agreement.
3. 3Find the carrying amount of the liability extinguished. Include accrued interest and use amortised cost where the liability is so measured.
4. 4Measure the equity issued at fair value (number of shares × fair value per share). Use the liability's fair value only if the equity's fair value is not reliably measurable.
5. 5Compute the difference: carrying amount minus equity measured. Recognise it in profit or loss, as gain or loss.
6. 6Split the equity into share capital (face value) and securities premium. Pass the journal entry.
7. 7If settlement is partial, decide whether part of the consideration relates to modification of the remaining liability. Allocate it, then account for the remainder under the rules for modification.
8. 8Disclose the gain or loss separately if it is material, as the standards on presentation require.

Quickest way: Three-line swap check

Common mistakes in Extinguishing Financial Liabilities with Equity Instruments

• Crediting equity with the carrying amount of the debt and showing no gain or loss.

  Students assume the swap is a simple transfer from liability to equity.

  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.

  The question gives several dates, and the first one looks natural.

  Fix: Use the fair value on the date the liability is extinguished, which is when the equity is issued.

• Recognising the gain directly in equity or other comprehensive income.

  Students think a transaction with a lender in its capacity as investor is an equity transaction.

  Fix: Under the Appendix, the difference goes to profit or loss. Equity transactions with owners in that capacity are outside scope.

• Applying Appendix D to a conversion option exercised under the original terms.

  Both situations involve issuing shares against debt.

  Fix: Appendix D covers renegotiated settlement. Conversion under original terms follows the compound instrument rules.

• Ignoring accrued interest when finding the carrying amount.

  Only the principal is highlighted in the question.

  Fix: Include accrued interest and amortised cost adjustments in the liability's carrying amount before computing the difference.

• Treating the whole transaction as an extinguishment when only part of the debt is settled.

  Students overlook the partial settlement guidance.

  Fix: Check whether part of the consideration relates to modification of the remaining liability. Allocate the consideration and assess the remaining liability.

Worked examples