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

Understand Extinguishing Financial Liabilities with Equity Instruments

Key rules to remember

Gain or loss on extinguishment

Gain / (Loss) = Carrying amount of liability extinguished − Fair value of equity instruments issued

Recognise in profit or loss. Positive means gain, negative means loss.

Measurement of equity issued

Equity issued = Fair value of equity instruments on the date of extinguishment

Use the fair value of the liability extinguished only if the fair value of equity cannot be measured reliably.

Equity split

Share capital = Number of shares × Face value; Securities premium = Fair value of equity − Share capital

Assumes shares are issued at a fair value above face value.

Partly settled liability

Consideration = Part for liability extinguished + Part for modification of remaining liability

If part of the equity relates to the remaining liability, allocate the consideration and assess modification of that remaining liability.

Scope exclusions

Not covered: creditor acting as shareholder; common control with equity distribution or contribution in substance; settlement under original terms

Check these before applying Appendix D.

How to solve Extinguishing Financial Liabilities with Equity Instruments questions

1. 1Check the scope. Is the creditor acting as a shareholder? Are the parties under common control with an equity distribution or contribution in substance? Was the equity issued under the original terms, such as a conversion option? If yes, Appendix D does not apply.
2. 2Identify the carrying amount of the liability being extinguished. Include accrued interest and unamortised costs if the question says so, because the carrying amount is at amortised cost.
3. 3Find the fair value of the equity issued on the date of extinguishment: number of shares × fair value per share. Use the fair value of the liability only if the equity fair value is not reliably measurable.
4. 4Decide if the whole liability or only a part is extinguished. If only part, check whether some consideration relates to a modification of the remaining liability and allocate accordingly.
5. 5Compute the gain or loss: carrying amount extinguished − fair value of equity issued. Recognise it in profit or loss.
6. 6Pass the journal entry: debit the liability (and any loss), credit share capital at face value, credit securities premium for the balance, and credit any gain to profit or loss.
7. 7State the disclosure: show the gain or loss as a separate line item or in the notes, and write a one-line conclusion.

Quickest way: Three-number shortcut

Common mistakes in Extinguishing Financial Liabilities with Equity Instruments

• Measuring the equity at its face value or at the carrying amount of the liability.

  Students treat the swap like a normal share issue at par, or assume that the liability value is the price of the shares.

  Fix: Use the fair value of the shares on the date of extinguishment. Use the liability's fair value only if the equity cannot be measured reliably.

• Applying Appendix D when the creditor is acting as an existing shareholder.

  The question says 'debt settled by shares' and students jump to the calculation without reading the facts.

  Fix: Read the facts for the creditor's capacity. If the creditor acts as a shareholder, or the parties are under common control with an equity contribution in substance, Appendix D is excluded.

• Reversing the sign of the gain or loss.

  Students forget which side is the consideration and which is the liability.

  Fix: Think of it as paying consideration. If you pay less (fair value of shares) than you owe (carrying amount), it is a gain. If you pay more, it is a loss.

• Crediting the difference to equity or to securities premium instead of profit or loss.

  Students confuse the difference with a premium on shares.

  Fix: The gain or loss on extinguishment goes to profit or loss. The premium is only the fair value of the shares minus their face value.

• Ignoring the fact that the liability is only partly settled.

  Students apply the full carrying amount without reading how much was extinguished.

  Fix: Use the carrying amount of only the part extinguished. Assess whether the remaining liability is substantially modified and whether part of the consideration relates to it.

• Using the fair value of shares on the date of the agreement rather than the date of issue.

  Students pick the first date mentioned in the question.

  Fix: Use the fair value on the date the equity instruments are issued and the liability is extinguished, unless the question clearly gives a different date for extinguishment.

Worked examples