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CA Final · Financial Reporting · Recognition and Derecognition of Financial Instruments

Narmada Chemicals Ltd. owes Rs 10 crore to a lender. The lender accepts equity shares with a fair value of Rs 4 crore in full settlement of only Rs 4 crore of the principal, and the remaining Rs 6 crore liability is retained. The consideration allocated to the remaining liability is assessed and found to result in a substantial modification of its terms. Which accounting is correct for the remaining liability?

The modification is accounted for as extinguishment of the original liability and recognition of a new liability. Where only part of a liability is settled with equity, the consideration allocated to the remainder is considered, and a substantial modification triggers extinguishment accounting.

  1. AContinue the remaining Rs 6 crore at its original carrying amount, as only the equity portion was settled
  2. BAccount for the modification as extinguishment of the original liability and recognition of a new liabilityCorrect
  3. CDefer any difference in equity until the liability is repaid
  4. DTreat the remaining liability as extinguished with no new liability recognised

Explanation

When only part of a liability is extinguished by equity, the consideration allocated to the remaining liability forms part of the assessment of substantial modification. If the remaining liability is substantially modified, the modification is accounted for as extinguishment of the original liability and recognition of a new liability. Keeping the old carrying amount ignores this requirement.

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