CA Final – Financial Reporting FINANCIAL INSTRUMENTS

IND AS 32, 109, 107 - ACCOUNTING AND

REPORTING OF FINANCIAL INSTRUMENTS

Illustration 1 - Accounting for assets at amortised cost

A Ltd has made a security deposit whose details are described below. Make necessary journal entries for
accounting of the deposit. Assume market interest rate for a deposit for similar period to be 12% per annum.

Particulars Details

Date of Security Deposit (Starting Date) 1-Apr-20X1

Date of Security Deposit (Finishing Date) 31-Mar-20X6

Description Lease

Total Lease Period 5 years

Discount rate 12.00%

Security deposit (A) 10,00,000

Present value factor at the 5th year 0.567427

Solution
The above security deposit is an interest free deposit redeemable at the end of lease term for ₹ 10,00,000.
Hence, this involves collection of contractual cash flows and shall be accounted at amortised cost.
Upon initial measurement –

Particulars Details

Security deposit (A) 10,00,000

Total Lease Period (Years) 5

Discount rate 12.00%

Present value annuity factor 0.56743

Present value of deposit at beginning (B) 5,67,427

Prepaid lease payment at beginning (A-B) 4,32,573

Journal Entries
Year – 1 beginning

Particulars Amount Amount

Security deposit A/c Dr. 5,67,427
Prepaid lease expenses (ROU ASSET) Dr. 4,32,573
To Bank A/c 10,00,000

Subsequently, every annual reporting year, interest income shall be accrued@ 12% per annum and prepaid
expenses shall be amortised on straight line basis over the lease term.
Year 1 End

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Particulars Amount Amount
Security deposit A/c (5,67,427 x 12%) Dr. 68,091
To Interest income A/c 68,091
Depreciation (4,32,573 / 5 years) Dr. 86,515
To Prepaid lease expenses (ROU Asset) 86,515

At the end of 5th year, the security deposit shall accrue ₹ 10,00,000 and prepaid lease expenses shall be
fully amortised (i.e. depreciated as per Ind AS 116, this prepaid lease rent would be shown as ROU asset).
Journal entry for realisation of security deposit -

Particulars Amount Amount

Security deposit A/c Dr. 1,07,143
To Interest income A/c 1,07,143
Depreciation (4,32,573 / 5 years) Dr. 86,515
To Prepaid lease expenses (ROU Asset) 86,515
Bank A/c Dr. 10,00,000
To Security deposit A/c 10,00,000

Illustration 2 - Issue of borrowings with fixed rate of interest

A Ltd has made a borrowing from RBC Bank for ₹10,000 at a fixed interest of 12% per annum. Loan
processing fees were additionally paid for ₹ 500 and loan is payable 4 half-yearly installments of ₹ 2,500
each. Details are as follows:

Particulars Details
Loan amount ₹ 10,000
Date of loan (Starting Date) 1-Apr-20X1
Date of repayment of principal amount (Finishing Date) 31-March-20X6
Interest rate 10.00%
Interest charge Interest to be charged and paid yearly
Upfront fees ₹ 500

How would loan be accounted in books of A Ltd?

Solution
The loan taken by A Ltd shall be measured at amortised cost as follows:
- Initial measurement – At transaction price less processing fees
= 10,000 – 500 = 9,500
- Subsequently – interest to be accrued using effective rate of interest as follows:

Year end Opening Interest @ Repayment of Closing

balance 11.42% interest & principal balance
1 9,500 1,085 1,000 9,585
2 9,585 1,095 1,000 9,679
3 9,679 1,105 1,000 9,785
4 9,785 1,117 1,000 9,902
5 9,902 1,098* 11,000 -

Computation of IRR
IRR would be the rate using which the present value of cash flow should come out to be ₹ 9,500 i.e. (₹ 10,000
less ₹ 500).

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For this, we should first compute present value of cashflows using any two rates as follows:

Year Opening Repayme Closing PVF @ Present PVF @ Present

end balance nt/Cash balance 10% Value at 13% Value at
flows 10% rate 13% rate
1 9,500 1,000 8,500 0.909 909 0.885 885
2 8,500 1,000 7,500 0.826 826 0.783 783
3 7,500 1,000 6,500 0.751 751 0.693 693
4 6,500 1,000 5,500 0.683 683 0.613 613
5 5,500 11,000 (5,500) 0.621 6,830 0.543 5,970*
10,000 8,945
*Difference is due to approximation
Taking 10% as discount rate, present value (PV) comes out to be ₹ 10,000.
If rate is increased by 3% over a base rate of 10%, PV decreases by ₹ 1,055 (i.e. ₹ 10,000 less ₹ 8945).

To decrease PV by ₹ 1,055, rate should be increased = 3%

To decrease PV by Re.1, rate should be increased = 3%
1,055
To decrease PV by ₹ 500, rate should be increased = 3 % X 500
1,055
= 1.42%

This would mean that the discount rate to get present value of cashflows equivalent to ₹ 9,500 should be
11.42% (i.e. 10% + 1.42%).

Illustration 3 - : Issue of borrowings with fixed rate of interest

A Ltd has made a borrowing from RBC Bank for ₹10,000 at a fixed interest of 12% per annum. Loan
processing fees were additionally paid for ₹ 500 and loan is payable 4 half-yearly installments of ₹ 2,500
each. Details are as follows:

Particulars Details
Loan amount ₹ 10,000
Date of loan (Starting Date) 1-Apr-20X1
Date of loan (Finishing Date) 31-March-20X3
Description of repayment Repayment of loan starts from 30-
Sept-20X1 (To be paid half yearly)
Installment amount ₹ 2,500
Interest rate 12.00%
Interest charge Interest to be charged quarterly
Upfront fees ₹ 500
How would loan be accounted in books of A Ltd?
Consider IRR is 16.60% p.a.
Solution
The loan taken by A Ltd shall be measured at amortised cost as follows:
- Initial measurement – At transaction price less processing fees
= 10,000 – 500 = 9,500
- Subsequently – interest to be accrued using effective rate of interest as follows:

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Date Amount of Re- Upfront Amount of Days IRR Revised Loan
Loan payment fees paid Interest Calculation Interest Balance
computed
1-Apr-20X1 10,000 - 500 - - 9,500 - -
30-Jun-20X1 - - - 300 90 (300) 389 9,589
30-Sep-20X1 - 2500 - 300 92 (2,800) 401 7,190
31-Dec-20X1 - - - 225 92 (225) 301 7,266
31-Mar 20X2 - 2500 - 225 90 (2,725) 297 4,838
30-Jun-20X2 - - - 150 91 (150) 200 4,888
30-Sep-20X2 - 2500 - 150 92 (2,650) 204 2,442
31-Dec-20X2 - - - 75 92 (75) 102 2,473
31-Mar-20X3 - 2500 - 75 91 (2,575) 102 0
IRR 16.60%

Illustration 4 – (Past Exam – May 2018)

A Ltd. issued redeemable preference shares to a Holding Company – Z Ltd. The terms of the instrument
have been summarized below. Account for this in the books of Z Ltd.

Nature Non-cumulative redeemable preference shares

Repayment: Redeemable after 5 years
Date of Allotment: 1-Apr-20X1
Date of repayment: 31-Mar-20X6
Total period: 5.00 years
Value of preference shares issued: 100,000,000
Dividend rate 0.0001%
Market rate of interest 12% per annum
Present value factor 0.56743

Solution:
Applying the guidance in Ind AS 109, a ‘financial asset’ shall be recorded at its fair value upon initial
recognition. Fair value is normally the transaction price. However, sometimes certain type of instruments may
be exchanged at off market terms (ie, different from market terms for a similar instrument if exchanged
between market participants).
For example, a long-term loan or receivable that carries no interest while similar instruments if exchanged
between market participants carry interest, then fair value for such loan receivable will be lower from its
transaction price owing to the loss of interest that the holder bears. In such cases where part of the
consideration given or received is for something other than the financial instrument, an entity shall measure
the fair value of the financial instrument.
In the above case, since A Ltd has issued preference shares to its Holding Company – Z Ltd, the relationship
between the parties indicates that the difference in transaction price and fair value is akin to investment made
by Z Ltd. in its subsidiary.
Following is the table summarising the computations on initial recognition:

Market rate of interest 12%

Present value factor 0.56743
Present value 56,742,686
Loan component 56,742,686

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Investment in subsidiary 43,257,314

Subsequently, such preference shares shall be carried at amortised cost at each reporting date. The
computation of amortised cost at each reporting date has been done as follows:

Year Date Opening Asset Days Interest @ 12% Closing balance

1-Apr-20X1 56,742,686
1 31-Mar-20X2 56,742,686 365 6,809,122 63,551,808
2 31-Mar-20X3 63,533,153 365 76,26,217 71,178,025
3 31-Mar-20X4 71,157,131 365 85,41,363 79,719,388
4 31-Mar-20X5 79,695,987 365 95,66,327 89,285,707
5 31-Mar-20X6 89,285,707 365 10,714,285 100,000,000

JOURNAL ENTRIES TO BE DONE AT EVERY REPORTING DATE

Particulars Amount Amount

Date of transaction
Investment - Equity portion Dr. 43,257,314
Loan receivable Dr. 56,742,686
To Bank 100,000,000
Interest income - March 31, 20X2
Loan receivable Dr. 6,809,122
To Interest income 6,809,122
Interest income - March 31, 20X3
Loan receivable Dr. 76,26,217
To Interest income 76,26,217
Interest income - March 31, 20X4
Loan receivable Dr. 85,41,363
To Interest income 85,41,363
Interest income - March 31, 20X5
Loan receivable Dr. 95,66,327
To Interest income 95,66,327
Interest income - March 31, 20X6
Loan receivable Dr. 10,714,285
To Interest income 10,714,285
Settlement of transaction
Bank Dr. 100,000,000
To Loan receivable 100,000,000

Illustration 5
As part of staff welfare measures, Y Co Ltd. has contracted to lend to its employees sums of money at 5%
per annum rate of interest. The amounts lent are to be repaid in five equal instalments for principle along with
the interest. The market rate of interest is 10% per annum for comparable loans. Y lent ₹1,600,000 to its
employees on 1st January 20X1.
Following the principles of recognition and measurement as laid down in Ind AS 109, you are required to
record the entries for the year ended 31 December 20X1, for the transaction and also compute the value of
loan initially to be recognised and amortised cost for all subsequent years.
For the purpose of calculation, following discount factors at interest rate of 10% per annum may be adopted
–
At the end of year –
Year Present value factor
1 .909
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2 .827
3 .751
4 .683
5 .620

Solution:
i) Calculation of initial recognition amount of loan to its employees:

Year end Cash flow Total PV factor Present

value
Principal Interest @
5%
20X1 320,000 80,000 400,000 .909 363,600
20X2 320,000 64,000 384,000 .827 317,568
20X3 320,000 48,000 368,000 .751 276,368
20X4 320,000 32,000 352,000 .683 240,416
20X5 320,000 16,000 336,000 .620 208,320
1,406,272

ii) Calculation of amortised cost of loan to employees

Year end Amortised Interest to be Repayment Amortised cost

cost (opening recognised (including interest) (closing
balance) balance)
20X1 1,406,272 140,627 400,000 1,146,899
20X2 1,146,899 114,690 384,000 877,589
20X3 877,589 87,759 368,000 597,348
20X4 597,348 59,735 352,000 305,083
20X5 305,083 30,917* 336,000 -
*305,083 * 10% = 30,508. Difference of ₹ 409 is due to approximation in computation.

iii) Journal Entries to be recorded of Y Ltd. for the year ended 31 December 20X1

Particulars Debit Credit

Staff loan A/c Dr. 16,00,000
To Bank A/c 16,00,000
(Being disbursement of loans to staff)
Prepaid staff cost A/c* Dr. [(1,600,000 – 1,406,272)] 1,93,728
To Staff loan A/c 1,93,728
(Being the excess loan balance over present value thereof in order to reflect
the loan at its present value booked as prepaid)
Staff loan A/c Dr. 1,40,627
To Interest expense A/c 1,40,627
(Being interest accrued on loans to staff)
Staff cost A/c Dr. 38,746
To Prepaid expense A/c 38,746
(Being interest accrued on loans to staff)

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* Where the difference between the amount given by the Company to its employees and its fair value
represents another asset, then such asset shall be recognised. Accordingly, such difference is recognised
as prepaid employee cost and amortised over the period of loan.

Case Study 1 (Analysis of FS)

On April 1, 20X1, Pluto Ltd. has advance a loan for ₹10 lakhs to one of its employees for an interest rate at
4% per annum (market rate 10%) which is repayable in 5 equal annual installments along with interest at
each year end. Employee is not required to give any specific performance against this benefit.
The accountant of the company has recognised the staff loan in the balance sheet equivalent to the amount
disbursed i.e. ₹10 lakhs. The interest income for the period is recognised at the contracted rate in the
Statement of Profit and Loss by the company i.e. ₹ 40,000 (₹ 10 lakhs x 4%).
Analyse whether the above accounting treatment made by the accountant is in compliance with the Ind AS.
If not, advise the correct treatment alongwith working for the same.
Solution
The above treatment needs to be examined in the light of the provisions given in Ind AS 32 and Ind AS 109
on Financial Instruments’ and Ind AS 19 ‘Employee Benefits’.
Para 11 (c) (i) of Ind AS 32 ‘Financial Instruments : Presentation’ states that:
“A financial asset is any asset that is:
(c) a contractual right:
(i) to receive cash or…..”
Further, paragraph 5.1.1 of Ind AS 109 states that:
“at initial recognition, an entity shall measure a financial asset or financial lia bility at its fair value”.
Further, paragraph 5.1.1 of Appendix B to Ind AS 109 states that:
“The fair value of a financial instrument at initial recognition is normally the transaction price (i.e. the fair
value of the consideration given or received. However, if part of the consideration given or received is for
something other than the financial instrument, an entity shall measure the fair value of the financial
instrument. For example, the fair value of a long term loan or receivable that carries no interest can be
measured as the present value of all future cash receipts discounted using the prevailing market(s) of interest
rate of similar instrument with a similar credit rating. Any additional amount lent is an expense or reduction
of income unless it qualifies for recognition as some other type of asset”.
Further, paragraph 5.2.1 of Ind AS 109 states that:
“After initial recognition, an entity shall measure a financial asset at:
(a) amortised cost;
(b) fair value through other comprehensive income; or
(c) fair value through profit or loss.
Further, paragraph 5.4.1 of Ind AS 109 states that:
“Interest revenue shall be calculated by using the effective interest method. This shall be calculated by
applying the effective interest rate to the gross carrying amount of a financial asset”
Paragraph 8 of Ind AS 19 states that:
“Employee Benefits are all forms of consideration given by an entity in exchange for service rendered by
employees or for the termination of employment”.

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The Accountant of Pluto Ltd. has recognised the staff loan in the balance sheet at ₹10 lakhs being the amount
disbursed and ₹ 40,000 as interest income for the period is recognised at the contracted rate in the statement
of profit and loss which is not correct and not in accordance with Ind AS 19, Ind AS 32 and Ind AS 109.
Accordingly, the staff advance being a financial asset shall be initially measured at the fair value and
subsequently at the amortised cost. The interest income is calculated by using the effective interest method.
The difference between the amount lent and fair value is charged as Employee benefit expense in statement
of profit and loss.
a) Calculation of Fair Value of the Loan

Year Cash Inflow Discounting Factor Present

(10%) Value
1 2,40,000 0.909 2,18,160
2 2,32,000 0.826 1,91,632
3 2,24,000 0.751 1,68,224
4 2,16,000 0.683 1,47,528
5 2,08,000 0.621 1,29,168
Total 8,54,712

Staff loan should be initially recorded at ₹ 8,54,712.

b) Employee Benefit Expense
Loan Amount – Fair Value of the loan = ₹ 10,00,000 – ₹ 8,54,712 = ₹ 1,45,288
₹1,45,288 shall be charged as Employee Benefit expense in Statement of Profit and Loss for the year ended
31.03.20X2.
Amortisation table:

Year Opening Interest (10%) Repayment Closing

balance of balance of Staff
Staff Advance (c) Advance
(a) (b)= (a x 10%) (d) = a + b -c

1 8,54,712 85,471 2,40,000 7,00,183

2 7,00,183 70,018 2,32,000 5,38,201
3 5,38,201 53,820 2,24,000 3,68,021
4 3,68,021 36,802 2,16,000 1,88,823
5 1,88,823 19,177 (b.f.) 2,08,000 Nil

Balance Sheet extracts showing the presentation of staff loan as at 31st March 20X2
Ind AS compliant Division II of Sch III needs to be referred for presentation requirement in Balance Sheet on
Ind AS.

Assets
Non-Current Assets
Financial Assets
(i) Loan 5,38,201
Current Assets
Financial Assets
(i) Loans (7,00,183 - 5,38,201) 1,61,982

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