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treatment of embedded instrument in AS31

Jacky Gupta (Employed) (61 Points)

19 June 2010

while bifarcating embedded instrument into two,

equity

and financial liability ,

whether under cashflows repayment of debt by way of issue of convertible shares is considered or not.

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9 Replies

shakuntala chhangani (FCA Course co-ordinator WIRC coaching centre) (2525 Points)
Replied 19 June 2010

My dear, Where is the flow of cash in the above example ? It is conversion and not payment.

Regards, CA Shakuntala Chhangani

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Jacky Gupta (Employed) (61 Points)
Replied 20 June 2010

exactly Maam,i m agreeing with u . But in examples framed by the Institute in Acconting std 31,

in case of convertible debentures they are taking repayment in the form of shares as there outflow while bifarcating equity and financial liability .

shakuntala chhangani (FCA Course co-ordinator WIRC coaching centre) (2525 Points)
Replied 20 June 2010

If it is at the time of bifurcation then there will be inflow of cash not the outflow. Can u please exactly tell me where have u seen the example with pg. no., if possible. Hope u will use "M'aam" in ur future communication.

Regards, CA Shakuntala Chhangani

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Jacky Gupta (Employed) (61 Points)
Replied 20 June 2010

Please mam refer Pg 33, EX 03 AS 31 at ICAI .ORG

if u give me ur mailing address i will sent it on ur adress.

Thanx maam ,for giving ur so much precious time to me...

Jacky Gupta (Employed) (61 Points)
Replied 20 June 2010

i knew mam i m asking for more , can u please explain me why we are considering the present value of Rs 2000000 in example.

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shakuntala chhangani (FCA Course co-ordinator WIRC coaching centre) (2525 Points)
Replied 20 June 2010

Just consider the situation that the entity has issued debentures without conversion option. In that case it would have issued the debentures at 9% per annum interest. It is because of conversion option the the debentureholders agree to take 6% interest. It means debt instrument covers value of equity also. In that case its pv would have been as under :

Step I

Year end interest/principal repayment Disc value @ 9% PV

1 1,20,000 0.9174 110092

2 1,20,000 0.8417 101002

3 1,20,000 0.7722 92662

20,00,000 0.7722 1544367

Fair value of debentures 1848123

It means had there been no option of conversion, the debentureholders would have given Rs. 18,48,123 to get the same benefits mentioned above.

Bal as on beginning of year Interest @ 9% total payable interest paid o/s at year end

1^st year 1848123 166331 2014454 120000 1894454

2^nd year 1894454 170501 2064955 120000 1944955

3^rd year 1944955 175046 2120000 120000 2000000

Bal repayment 2000000 nil

Step II :Ascertaining equity component :

Amonut received Rs. 20,00,000

(-) Fair value of debt Rs. 18,48,123

Fair value of equity component Rs. 1,51,877

This calculation clearly shows that debentureholders have given only Rs. 18,48,123 for debentures and bal has been paid for equity.

Step III :

That is why the entity is required to split the amount received into equity component and debt component by passing the following entry :

Bank A/c Dr. 20,00,000

To Equity - Reserve 1,51,877

To debentures A/c 18,48,123

As I said in my previous answer, cash flow will get affected at the time of receipt and not at the time of conversion. If u have any further doubt, revert back to me.

Regards, CA Shakuntala Chhangani

CA Manish K Dhoot (CA, B. Com, NCFM, CPCM) (5015 Points)
Replied 20 June 2010

As the debentures are convertible in shares at the year end so there is no outflow of cash at year end. so why we are calculating PV of Rs. 2000000 at the year end.

shakuntala chhangani (FCA Course co-ordinator WIRC coaching centre) (2525 Points)
Replied 20 June 2010

In my above example, nowhere i hv mentioned cash outflow.Again i m repeating that there will be cash inflow at the time of issue of debentures. Bifurcation is done for the purpose of initial recognition at the time of issue of debentures. debentures will remain a financial liability for a period of three years. then after conversion it will become part of equity. Till now we were recognising equity only at the time of conversion but after AS 30,31 n 32 become mandatory, we need to recognise equity component at the time of issue of financial liability.