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Evergrande: Accounting for Embedded Derivatives

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This case explores the accounting treatment for embedded derivatives of China Evergrande Group (HKEx: 3333). It had been the second-largest property developer in China by property sales and largest by land reserves and borrowing size.

On 24 September 2020, a suspicious "letter" was widely circulated on the Internet. The stock price plunged. The “letter” was purportedly sent by Evergrande to the Chinese government, urging the approval of a “listing plan” which was crucial in the “reorganization plan” of the Group.

Back in December 2016, Evergrande used this plan to attract new “strategic investors” (SIs) to inject capital. To attract SIs, Evergrande and the SIs had agreed that if the reorganization could not be executed by 31 January 2021, the SIs could exercise either one of the two rights. One right was to demand Evergrande to repurchase their shares. Another right was to demand Evergrande to compensate 50% of their shares. Later the SIs invested RMB130,000mn in total, instantly enabling Evergrande to alleviate liquidity strains and continued to expand aggressively by leverage.

Was the RMB130,000mn properly accounted for in financial statements, despite RMB2,500mn of “financial derivative liability” throughout 2017 to 2020? Should the two “rights” be treated as “options” in accounting?

Learning Objective:

On completion of the case, students will be able to:

1. Distinguish between traditional derivatives and embedded derivatives

2. Apply the appropriate accounting treatment for embedded derivatives

3. Understand the uses of Binomial Lattice Model in the context of valuation of derivatives

4. Assess the accounting treatment of non-controlling interest (NCI) call and NCI put

5. Perform elementary forensics on financial statements pertinent to NCI call and NCI put

Year of Publication: 2022
Ref. No.: 22/731C
Discipline: Accounting & Control
Industry: Real Estate
Country: China (People's Rep. of)
Company: China Evergrande Group
Languages: English
Pages of Text: 11