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

A positive result is a gain in profit or loss. A negative result is a loss in profit or loss.

Measurement of equity issued

Equity at fair value on the date of extinguishment

If equity fair value is not reliably measurable, use the fair value of the liability extinguished.

Journal entry (full settlement)

Dr Financial liability (carrying amount); Cr Share capital (face value); Cr Securities premium (fair value − face value); Cr/Dr Profit or loss (balancing figure)

Carrying amount is the amortised cost at the settlement date, including accrued interest if it is part of the liability.

Partial settlement

Allocate consideration between the part extinguished and the part that remains

If part of the consideration relates to modification of the remaining liability, allocate it and apply the modification rules to the remaining part.

Scope exclusions

Not applicable if: creditor is also a direct or indirect shareholder acting as shareholder; common control before and after with capital contribution substance; or equity issued per original terms

In these cases Appendix D does not apply, so check scope before computing.

How to solve Extinguishing Financial Liabilities with Equity Instruments questions

1. 1Check scope. Confirm the creditor acts as a creditor and the shares are not issued under the original conversion terms or as a capital contribution by a shareholder or common-control party.
2. 2Find the carrying amount of the liability at the settlement date. Use amortised cost and include accrued interest that is being settled.
3. 3Find the fair value of the equity instruments issued on the extinguishment date. Number of shares × fair value per share.
4. 4If equity fair value is not reliably measurable, use the fair value of the liability extinguished.
5. 5Compute gain or loss: carrying amount − fair value of equity issued. Take it to profit or loss.
6. 6Split the credit to equity: face value to share capital and the balance of fair value to securities premium.
7. 7If only part of the liability is settled, allocate the consideration and apply the modification rules to the remaining liability.
8. 8Write the journal entry and check that debits equal credits.

Quickest way: Three-number shortcut

Common mistakes in Extinguishing Financial Liabilities with Equity Instruments

• Crediting equity at the carrying amount of the debt instead of fair value.

  Students think the shares simply replace the debt rupee for rupee, as in older conversion accounting.

  Fix: Equity is the consideration paid and is measured at fair value. The difference goes to profit or loss.

• Taking the gain or loss to equity or reserves.

  Since shares are issued, students assume the whole transaction sits in equity.

  Fix: Ind AS 109 requires the difference between carrying amount and consideration paid to be recognised in profit or loss.

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

  The date of negotiation looks like the date of the deal.

  Fix: Measure at the date the liability is extinguished, which is when the shares are issued and the debt settled, unless the question gives one date only.

• Applying Appendix D to a convertible bond converted under its original terms.

  Both involve debt turning into shares.

  Fix: Conversion per original terms is outside this Appendix. Use the compound instrument rules in Ind AS 32.

• Using face value of the liability instead of amortised cost as the carrying amount.

  Students ignore unamortised transaction costs, discount or accrued interest.

  Fix: Take the carrying amount at settlement date from the amortised cost schedule.

• Putting the whole fair value in share capital.

  Students forget the Companies Act split into face value and premium.

  Fix: Credit face value to share capital and the excess of fair value over face value to securities premium.

Worked examples