IFRIC 19, “Extinguishing Financial Liabilities with Equity Instruments,” provides guidance on how to account for the extinguishment of financial liabilities with equity instruments, including shares or other equity instruments of the entity. In this article, we will provide definitions, explanations, examples, and case studies to help entities understand the application of IFRIC 19.
Definitions:
Financial Liabilities:
Financial obligations arising from contractual arrangements that require the entity to deliver cash or other financial assets to another party.
Equity Instruments:
Instruments that represent residual interest in the assets of an entity after deducting liabilities.
Explanations:
Under certain circumstances, an entity may extinguish a financial liability by issuing equity instruments to the creditor. IFRIC 19 provides guidance on how to account for such extinguishments in the entity’s financial statements. The key principle is that the fair value of the equity instruments issued should be measured at the date of extinguishment and used to derecognize the financial liability. Any difference between the carrying amount of the financial liability and the fair value of the equity instruments issued should be recognized in profit or loss.
Examples:
ABC Corporation has a financial liability of $1 million in the form of a loan payable to XYZ Bank. ABC Corporation decides to extinguish the financial liability by issuing 100,000 shares of its common stock, which has a fair value of $12 per share, to XYZ Bank. The fair value of the equity instruments issued is $1.2 million (100,000 shares x $12 per share). The carrying amount of the financial liability is $1 million. As per IFRIC 19, ABC Corporation would derecognize the financial liability of $1 million and recognize the difference of $0.2 million ($1.2 million – $1 million) in profit or loss.
DEF Limited has a financial liability of $500,000 in the form of a bond payable to GHI Investments. DEF Limited decides to extinguish the financial liability by issuing 50,000 preferred shares, which have a fair value of $12 per share, to GHI Investments. The fair value of the equity instruments issued is $600,000 (50,000 shares x $12 per share). The carrying amount of the financial liability is $500,000. As per IFRIC 19, DEF Limited would derecognize the financial liability of $500,000 and recognize the difference of $100,000 ($600,000 – $500,000) in profit or loss.
Case Studies:
Let’s look at two case studies to further illustrate the application of IFRIC 19:
Case Study 1:
Conversion of Debt into Equity
ABC Corporation has a financial liability of $2 million in the form of a convertible bond that is due for repayment. The bond allows the bondholders to convert the debt into equity at their option. Some of the bondholders decide to exercise their option and convert the bond into equity shares of ABC Corporation. The fair value of the equity shares issued is $2.5 million, while the carrying amount of the financial liability is $2 million.
In this case, ABC Corporation would derecognize the financial liability of $2 million and recognize the difference of $0.5 million ($2.5 million – $2 million) in profit or loss as per IFRIC 19.
Case Study 2:
Settlement of Debt with Equity Instruments
DEF Limited has a financial liability of $1.5 million in the form of a loan payable to GHI Bank. DEF Limited is facing financial difficulties and proposes to settle the debt by issuing equity shares to GHI Bank. The fair value of the equity shares issued is $1 million, while the carrying amount of the financial liability is $1.5 million.
In this case, DEF Limited would derecognize the financial liability of $1.5 million and recognize the difference of $0.5 million ($1 million – $1.5 million) in profit or loss as per IFRIC 19.
Conclusion:
IFRIC 19 provides guidance on how to account for the extinguishment of financial liabilities with equity instruments. Entities should measure the fair value of the equity instruments issued at the date of extinguishment and use it to derecognize the financial liability. Any difference between the carrying amount of the financial liability and the fair value of the equity instruments issued should be recognized in profit or loss. Examples and case studies can help entities understand the application of IFRIC 19 in practice and ensure appropriate accounting treatment for extinguishing financial liabilities with equity instruments in their financial statements.
In summary, IFRIC 19 provides clear guidance on the accounting treatment for extinguishing financial liabilities with equity instruments. It is important for entities to carefully assess and apply the requirements of IFRIC 19 to ensure accurate and consistent financial reporting. Seeking professional advice and staying updated with the latest developments in accounting standards can further assist entities in complying with IFRIC 19 and other relevant accounting standards.