FAQs – Guidance Note on Derivatives

Need for the guidance note on accounting for derivatives What is the need for the guidance note on accounting for derivatives? Currently, none of the notified accounting standards prescribe the proper accounting treatment for derivative contracts. Foreign exchange forward contracts, which are speculative in nature, ie, which do not hedge the payment of monetary asset or monetary liability, are within the scope of AS 11 and, as such, are not included within the scope of this guidance note. Even derivative contracts that are regulated by certain regulations specific to a particular sector or a specified group of entities are also…

Entities that are required to follow the guidance note What are the entities that are required to follow the guidance note? Banking, non-banking finance companies (NBFCs), housing finance companies and insurance entities follow derivative accounting promulgated by the respective regulatory authorities, viz, Reserve Bank of India (RBI), National Housing Bank (NHB), Insurance Regulatory and Development Authority (IRDA), etc. If the concerned regulatory authority has not prescribed any accounting treatment, then the recommendations as per this guidance note become applicable. It should be noted that as per the press note issued by the Ministry of Corporate Affairs dated 18 January, 2016,…

Transactions within the scope of this guidance note What type of transactions are within the scope of this guidance note and which are outside the scope? All transactions covered by AS 11, accounting for embedded derivative contracts and accounting for non-derivative financial assets/liabilities designated as hedging instruments are outside the scope of the guidance note. The following derivative contracts are covered by this guidance note irrespective of whether it is used as hedging instruments or not: Foreign exchange forward contracts hedging highly probable forecast transactions and firm commitments; Other foreign currency derivative contracts that are outside the scope of AS…

Key accounting principles in the guidance note? What are the key accounting principles mentioned in this guidance note? All derivatives should be accounted for at the inception and measured at fair value too at the inception as well as at every reporting period. If hedge accounting is not applied, then the derivatives should be measured at fair value. Fair value changes should be recognised in P&L. If hedge accounting is applied, then the risk management objective and the risk that is hedged should be identified and documented. Also, the entity should satisfy how the risk management objective is being met…

Fair value hedge on discontinuation of hedge accounting What happens to a fair value hedge on discontinuation of hedge accounting? Fair value hedge accounting as per the approach mentioned in the guidance note is significantly different from the fair value hedge accounting as per Ind AS 109. The fundamental difference arises on account of the concept known as ‘effective interest rate’ which runs through the entire literature of Ind AS. The effective ‘interest rate’ concept is conspicuously missing in the present iGAAP (AS). Since this guidance note is meant for those entities not covered by Ind AS, effective interest rate…

Current standards for financial instruments as per AS? What are the current accounting standards for financial instruments as per AS? Currently there are no accounting standards that specifically address financial instruments except for certain forward foreign exchange contracts covered by AS 11. The Accounting Standards relating to financial instruments, viz, AS 30, AS 31 and AS 32 which form the Indian GAAP, did not see the light of the day as these were withdrawn by March 2011, just before the scheduled date on which these were supposed to become mandatory. This created a vacuum for accounting standards relating to financial…

Guiding principle in guidance note on accounting for derivatives? What is the main guiding principle in the guidance note on accounting for derivatives? The main accounting principle enshrined in this guidance note is that all derivative contracts should be accounted for in the books of accounts and the same should be measured at fair value irrespective of whether it is part of hedging relationship or not. If a derivative contract is not part of any hedging relationship, then such a derivative is entered into for speculative purposes and the fair value changes of such derivative should be recognised in the…