Hi, I would like to ask the following questions.

I have seen this:

An entity has granted the counterparty the right to choose whether a share-based payment transaction is settled in cash or by issuing equity instruments.

For transactions with parties other than employees, the entities shall measure the equity component of the compound financial instrument as the difference between the fair value of the goods or services received and the fair value of the debt component, at the date when the goods or services are received.

My question is:

I know how to do the accounting entries, but I don't know why the values of equity and debt are determined in this way. What is the logic behind it?

Thanks.

Because if an entity has granted the counter party the right to choose whether a share based payment transaction is setteled in cash or by issuing equity instruments the entity has granted a compound financial instrument(which is accounted for under the regime if IAS-39), which includes a Debt Component (i.e. The counterparty's right to demand payment in cash) and an Equity Component(The counterparty's right to demad settlement in equity instrument rather than in cash). If the transaction is with parties other than employees, in which the fair value of goods or services recieved is measured directly, the entity shall measure the equity component as the difference between the fair value of goods or services received and the fair value of the debt component, at the date goods or services are received. Mind it, the above treatment is only valid if the fair value of goods or services received is measured directly and hence the entity can also measure the fair value of debt component. The sole reason behind this treatment is the uncertainty in trasaction(i.e. Cash or Equity) and hence it will be misleading to present the liability as equity. For example, you have issued a compound instrument(worth $1,000) and your past experience shows that this compound instrument is have a 90% probablity to be setteled in cash then it will be misleading for the users to disclose this liability(of $900) as equity.

so, the respective entry would be,

==>DR:Expense=======>$1,000
======>CR:Equity========>$100
======>CR:Liability=======>$900

I hope that helps you in understanding the underlaying concept.

Regards,

Muhammad Amir.

Thank you very much, but I still have a further question and hope that you can help me with it.

Why do we use the fair value of asset to measure as the value of debt.

For Example,
Fair value of asset = 4m
Value of shares =4.4 m. The following should be as follows:
(it was found from questions of ACCA P2)

Dr Assets 4.4m
Cr Liabilities 4 m
Cr Equity 0.4 m

However, I do not understand why we measure the value of liabilities (debt part) with the fair value of asset.
On the other hand, why not do the entries as follows:

Dr Assets 4.4m
Cr Liabilities 0.4 m
Cr Equity 4 m


Thank you very much for your time.

Let I start with your example,



First of all i want to clarify the definition if liability(i.e. Debt)."The Present Obligation of an entity arising from past events, the settlement of which is expected to result in the outflow of resources embodying economic benefits"

Now, keep in mind the above definition and see the explanation of your example.

As per your example fair value of Asset/Services(i.e. Expense) is $4m(i.e. this amount has to be paid to supplier in any condition this mean that supplier can claim this $4m in any situation irrespective of the price of shares for example if the price of share options is 3.6m then he will ofcourse not exercise share options and subsequently making a loss of $0.4m instead he will be keen in having a cash payment of $4m) so, this 4 million is the liability because it is the present obligation of the entity arising from past event and if the supplier demands for payment the entity has to pay him cash of $4m(thus it fulfils the definition of Debt Component). As per your example the share options having a fair value of $4.4m this means that this amount can be broke-up in to 2 elements($4m[for fair value of asset which has to be paid irrespective of cucumstancial events] and $0.4m[this amount is the excess over the amount of asset that is offered to the supplier so it is an equity component]).

Simple is that the fair value of asset is $4m and this amount has to be paid irrspective of any condition so it fulfils the definition of debt because a supplier can claim this $4m in case of the devaluation of the equity options granted(for example they became $3.6m) however, any excess over the fair value of the asset/expense will be treated as equity because entity has no present obligation to pay this amount arises as a result of past event.

Further explanation in gaining full understanding is that for example you have bought a building for $4m from a supplier 'A' and you have given him a chioce whether to settel this transaction in Cash or in Equity and you have granted him Equity share whose fair value is expected to be $4.4m at the time of settelement.

Now if at the time of setellement the fair value of equity shares granted was became worse then expected and it is now $3.6m then ofcourse supplier will not go for exercising share options instead he will came to your office and will ask for a $4m cash because you have given him an option at the time of transaction to settle it in cash or in equity in this way this will be misleading for the users to disclose whole 4.4m as equity even after the known fact that he can come to you and ask to settel this transaction in cash.

I hope this explanation will help you in understanding this concept.

Regards,

Muhammad Amir.

wow, your explanation is very clear and logical. Now I totally understand why it is.

Really thank you very much.