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

Tungabhadra Steel Ltd settles part of a financial liability by issuing equity instruments to the creditor. The consideration is allocated between the part extinguished and the remaining liability. Which statement is correct about the remaining liability?

The consideration allocated to the remaining liability forms part of the test for substantial modification. If the remaining liability is substantially modified, the original liability is treated as extinguished and a new liability recognised. Part settlement does not automatically derecognise the whole liability, nor ignore the remainder.

  1. AThe consideration allocated to the remaining liability is ignored and the remaining liability continues unchanged
  2. BThe consideration allocated to the remaining liability forms part of assessing whether its terms are substantially modified, and if so the original liability is treated as extinguished and a new liability recognisedCorrect
  3. CThe remaining liability must always be derecognised in full once any part is settled with equity
  4. DThe remaining liability is reclassified as equity if the creditor is a shareholder

Explanation

Where only part of the liability is extinguished, the consideration is allocated between the extinguished part and the remainder. The amount allocated to the remainder is part of the test of whether the remaining liability's terms are substantially modified. If they are, the modification is accounted for as extinguishment of the original liability and recognition of a new one, so full derecognition is not automatic.

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