FAQs

Contract is settled through the entity’s own equity instrument

Contract is settled through the entity’s own equity instrument

When a contract is settled through the entity’s own equity instrument, can it be regarded as equity?

A contract that will be settled by the entity receiving or delivering a fixed number of its own shares for no future consideration or exchanging a fixed number of its own shares for a fixed amount of cash or another financial asset, is an equity instrument.

If such a contract can be settled by the entity by receiving or delivering a variable number of its own shares for an amount that is not yet determined (variable), then such contract should be classified as a financial liability. This is so because the entity here uses its equity instrument as a currency to settle a financial liability.

Own use exemption as per the Accounting Standard

Own use exemption as per the Accounting Standard What is meant by own use exemption as per the Accounting Standard? Contracts that are entered into for the purpose of the receipt or delivery of a non-financial item for the entity’s own use is excluded from the scope of Accounting Standards for financial …
Read More

Consequences of treating equity vs liability

Consequences of treating equity vs liability What are the consequences of treating a contract as equity and how its treatment is different if treated as liability? The consequences of treating particular contract as equity are as follows: Treatment when the financial instrument is equity: Any consideration received (such as the premium received for a …
Read More

Classification of Foreign Currency Convertible Bond (FCCB)

Classification of Foreign Currency Convertible Bond (FCCB) An entity has issued a foreign currency convertible bond (FCCB). The Bond is denominated in foreign currency and would be converted into a fixed number of equity shares. Will this be treated as equity instrument or as a financial liability? Contracts that will be settled …
Read More

Bifurcation of compound financial instruments

Bifurcation of compound financial instruments Should the entity monitor a compound financial instrument in bifurcating such instrument into liability and equity component constantly and account for the same on every reporting period? A compound financial instrument should be evaluated for the terms of the financial instrument to determine whether it contains both …
Read More

What are treasury shares and how are these presented

What are treasury shares and how are these presented What are treasury shares and how are these presented in the financial statements? If an entity acquires its own equity instruments, these instruments are known as ‘treasury shares’ and are deducted from equity. No gain or loss shall be recognised in profit …
Read More

Can a corporate entity still follow settlement date accounting?

Can a corporate entity still follow settlement date accounting?

Since cash method of accounting is not allowed for a corporate entity in India, can a corporate entity following Ind AS still follow settlement date accounting? Is there any conflict here?

As per Ind AS 109, a regular way purchase or sale of financial assets shall be recognised, as applicable, using trade date accounting or settlement date accounting.

However, the entity should apply the same method consistently for all purchases and sales of financial assets that are classified in the same way as per the accounting standard. Assets that are mandatorily measured at a fair value through profit or loss form a separate classification from assets designated as measure at fair value through profit or loss. Investments in equity instruments accounted for using the fair value option (FVO) form another separate classification.

When an entity follows settlement date accounting, accounting standard ensures that the fair value changes of such an asset is also recognised in the books of accounts with the effect that the net result of following settlement date accounting would tantamount to following accrual basis of accounting. This is because when settlement date accounting is applied an entity accounts for any change in the fair value of the asset to be received during the period between the trade date and the settlement date in the same way as it accounts for the acquired asset. In other words, the change in value is not recognised for assets measured at amortised cost; it is recognised in profit or loss for assets classified as financial assets measured at fair value through profit or loss; and it is recognised in other comprehensive income for financial assets measured at fair value through other comprehensive income.

Transaction not representing the fair value

Transaction not representing the fair value A financial asset or financial liability should be measured at fair value on initial recognition. What if the transaction does not represent the fair value of the financial asset or financial liability? If at initial recognition the transaction value is different from the fair value, then …
Read More

Treatment of transaction costs

Treatment of transaction costs How are the transaction costs treated? Transaction costs incurred while acquiring a financial asset or incurring a financial liability is treated differently depending upon the classification of such financial asset or financial liability. Transaction costs include fees and commission paid to agents (including employees acting as selling agents), advisers, …
Read More

What is the concept of effective interest method?

What is the concept of effective interest method? Explain the concept of effective interest method? Effective interest method is a new concept that is introduced through the Ind AS standards. Effective interest rate is relevant not merely for financial instruments, but as a concept running through the entire gamut of the Accounting …
Read More

Contractual cash flows & effective interest rate

Contractual cash flows & effective interest rate When contractual cash flows are modified to change in the terms of contract, does the effective interest rate change? When the contractual cash flows of a financial asset are renegotiated or otherwise modified and the renegotiation or modification does not result in the de-recognition …
Read More

Derecognition of a financial asset

Derecognition of a financial asset When should a financial asset be derecognised? An entity shall derecognise financial assets when and only when the contractual rights to the cash flows from the financial assets expire or it transfers the financial asset which eventually qualifies for derecognition as per the standard. An entity transfers a …
Read More

Consequence of not de-recognising an asset after the sale

Consequence of not de-recognising an asset after the sale What is the consequence of not de-recognising an asset even after the sale of such asset? When an entity continues to recognise an asset to the extent of its continuing involvement, the entity also recognises an associated liability. The transferred asset and the …
Read More

Impairment model for different categories of financial assets

Impairment model for different categories of financial assets

Is the impairment model different for different categories of financial assets?

No. Ind AS 109 has a single impairment model that applies to all financial instruments within its scope. As per the previous version of IFRS 9, viz, IAS 39, there were different models for assets classified as held-to-maturity, available-for-sale debt instruments and available for sale equity instruments and equity instruments measured at fair value through profit or loss. Impairment on account of loan commitments and financial guarantee contracts were accounted for under IAS 37.

However, the impairment loss now is aligned with the credit risk on loans and other financial guarantees thereby creating uniformity for accounting purposes as well. As per Ind AS 109, financial assets classified as FVOCI and financial assets classified as at amortised cost are treated in the same way for the purpose of applying the impairment model.

Investments in equity instruments that are measured either at FVTPL or FVOCI are now outside the scope of Ind AS 109. Accordingly, the equity investments are not tested for impairment any longer. The concept of recognising the impairment loss when the equity investments are subject to significant or prolonged decline in their fair value is now not relevant. This has been criticised on the ground that the test of other than temporary impairment (OTTI) is difficult to apply in practice.

New impairment methodology

New impairment methodology What is the new impairment methodology? Is this concept entirely new? Yes. The new impairment methodology is completely new and this is the one instance where the accounting bodies on both sides of the Atlantic agreed to disagree. The bone of contention as far as the US GAAP is …
Read More

What are the three stages of impairment loss

What are the three stages of impairment loss What are the three stages during which the impairment loss should be provided? At the first stage, a portion of the expected credit loss is recognised on day one for all financial assets. This is calculated as the present value of cash short falls …
Read More

Impairment for debt instruments classified as FVOCI

Impairment for debt instruments classified as FVOCI Is impairment testing necessary for debt instruments classified as fair value through other comprehensive income? Debt instruments that are classified as fair value through other comprehensive income are also subjected to impairment test. This is because while the financial asset classified as FVOCI is …
Read More

Loss allowance as per Ind AS 109

Loss allowance as per Ind AS 109 Can an entity provide a loss allowance greater than the impairment loss allowance as per Ind AS 109? Previously entities used to provide for losses on certain financial assets on an ad hoc basis that means several practices which are now prohibited expressly as per …
Read More

Impairment loss allowance on performing assets

Impairment loss allowance on performing assets Should impairment loss allowance be provided on performing assets or standard assets at the time of recognition of such assets? The expected credit loss is required to be applied on day one for all types of financing assets. The expected credit losses are the present …
Read More

Treatment of collateral value for expected credit losses

Treatment of collateral value for expected credit losses How should the value of collateral be treated while measuring expected credit losses? For the purpose of measuring expected credit losses, the estimate of expected cash shortfalls shall reflect the cash flows expected from collateral and other credit enhancements that are part of …
Read More

Recognition of interest revenue during all three stages

Recognition of interest revenue during all three stages How is interest revenue recognised for a financial asset during all the three stages? Interest revenue is always recognised based on the effective interest rate. The effective interest rate is applied on the opening carrying value of a financial asset. Impairment loss, if …
Read More

Credit adjusted effective interest rate

Credit adjusted effective interest rate What is meant by credit adjusted effective interest rate? The credit adjusted effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts through the expected life of the financial asset to the amortised cost of a financial asset that is …
Read More

Interest rate swap as a hedging instrument

Interest rate swap as a hedging instrument

An interest rate swap is usually designated as a hedging instrument in spite of the fact that the fair value of an interest rate swap oscillates between positive and negative fair values. Explain the anomaly.

At the outset, it may seem rather strange that an interest rate swap which has the potential of having a fair value that oscillates between positive and negative values is permitted to be designated as a hedging instrument while a written option which has a negative fair value at all times is prohibited from being designated as a hedging instrument. The reason is that in a written option, the risk exposure is unlimited while the profit potential is pegged at the premium received on such written option. Hence, written option always shows a negative fair value which represents a liability at all times. However, at the time of expiry, if an option expires worthless, then the premium received on such option is treated as income.

An interest rate swap on the other hand is taken to convert a fixed rate instrument into a variable rate instrument or vice versa. At the risk management objective level, the purpose of interest rate swap instrument is achieved by merely converting a variable rate instrument into a fixed rate instrument or vice versa. The risk management objective is drafted so as to achieve the risk management strategy of the enterprise. The specific interest rate swap instrument taken may or may not minimise the risk as a result of which it is likely that the interest rate swap instrument may show a negative fair value at times. However, considering the risk management strategy at the enterprise level, the interest rate swap instrument in fact seeks to achieve the goals of the risk management strategy; hence, the interest rate swap is permitted to be designated as a hedging instrument.

Rebalancing to achieve hedge effectiveness

Rebalancing to achieve hedge effectiveness What do you mean by rebalancing and how does it help achieve hedge effectiveness? Rebalancing is a new concept introduced by a major amendment to IFRS 9 during November 2013. Rebalancing means adjustments made to the quantities of the hedged item or the hedging instrument of an …
Read More

Voluntary discontinuation of hedge accounting

Voluntary discontinuation of hedge accounting Can a hedge accounting be voluntarily discontinued and why? As per the new requirements, hedge accounting cannot be voluntarily discontinued. Hedge accounting can be discontinued only if the hedge effectiveness requirements are not met or that the hedging instrument is liquidated. Even when the hedge effectiveness requirements …
Read More

Cash flow hedge Vs fair value hedge

Cash flow hedge Vs fair value hedge What is a cash flow hedge and how is it different from a fair value hedge? A cash flow hedge is a hedge of the exposure to variability in cash flows attributable to a particular risk associated with a recognised asset or liability or a …
Read More

Is hedge accounting mandatory?

Is hedge accounting mandatory? Is hedge accounting mandatory or optional? Hedge accounting is not mandatory. However, considering the benefits of complying with hedge accounting, entities would want to follow hedge accounting when they are in a position to comply with the requirements for hedge accounting. The biggest benefit of hedge accounting …
Read More

Accounting for a cash flow hedge

Accounting for a cash flow hedge How would you account for a cash flow hedge? Get the lower of the cumulative fair value changes to the hedging instrument and the fair value of the hedged item, viz, the present value of expected cash flows.The amount calculated in step 1 above is taken …
Read More

Reasons for revamping hedge accounting by IASB

Reasons for revamping hedge accounting by IASB What prompted the hedge accounting standard to be revamped by IASB? The main reason for revamping the accounting standards relating to financial instruments by the IASB is the direct outcome of the shock that sent shivers through the spine of several conglomerates as a …
Read More

Rebalancing and discontinuation of cash flow hedge

Rebalancing and discontinuation of cash flow hedge Briefly explain rebalancing and discontinuation of cash flow hedge. If the hedge effectiveness requirements are not met, the entity should adjust the hedge ratio by a process known as ‘rebalancing’ so long as the hedging relationship continues to meet the risk management objective of undertaking …
Read More

Difference between hedging and speculation

Difference between hedging and speculation What is the basic difference between hedging and speculation? If an investor takes a derivative position by holding the corresponding underlying, it is called hedging. The derivative position should be in the opposite direction of the underlying position, eg, if a person holds 100 shares of …
Read More

Difference between speculation and gambling

Difference between speculation and gambling Is there any difference between speculation and gambling? Both speculation and gambling involves taking a position in the derivative segment without having any corresponding underlying. In the case of speculation, the open interest does not exceed the sum total of the underlying outstanding. However, in the …
Read More

Link between hedge accounting & risk management objective

Link between hedge accounting & risk management objective What is the link between hedge accounting and the risk management objective of an entity? The objective of hedge accounting is to manage the risk that an entity faces. In the context of hedge accounting, the entity manages effectively the risk by using the …
Read More

Risk management objective & risk management strategy

Risk management objective & risk management strategy Explain the relationship between risk management objective and risk management strategy of an entity. The risk management strategy of an entity should be distinguished from its risk management objective. The risk management strategy is established at the highest level at which an entity determines how …
Read More

Can hedging instrument be a non-derivative

Can hedging instrument be a non-derivative A hedging instrument should necessarily be a derivative. Do you agree? Hedging instrument need not necessarily be a derivative instrument even though mostly derivative instruments are used as hedging instruments. The key feature of a derivative instrument should be that it should help minimise the risk …
Read More

Written options as a hedging instrument

Written options as a hedging instrument Why a written option cannot be used as a hedging instrument? The objective of hedging is to minimise the risk and/or to protect the unrealised profits. A hedging instrument should typically restrict the exposure to loses while at the same time provide scope for unlimited …
Read More

Hedge ratio in hedge accounting requirements

Hedge ratio in hedge accounting requirements What is meant by hedge ratio and how it is helpful in meeting the hedge accounting requirements? Hedge ratio refers to the number of units that are used as hedging instrument for the purpose of hedging a hedged item. Usually, the ratio is 1:1 for most …
Read More

Existing asset or liability as a hedged item

Existing asset or liability as a hedged item Only an existing asset or liability can be designated as a hedged item in a fair value hedge. Do you agree? This statement is not correct, as the hedged item in a fair value hedge can be in addition to the above an unrecognised …
Read More

Accounting for a fair value hedge

Accounting for a fair value hedge How do you account for a fair value hedge? A fair value hedge is accounted for as follows: The gain or loss on the hedging instrument is recognised in profit or loss. If the hedging instrument hedges an equity instrument classified as FVOCI, then it is recognised …
Read More

Time value of forward points in hedge accounting

Time value of forward points in hedge accounting How is the time value of forward points in a derivative contract treated in hedge accounting? An entity is allowed to designate only the change in the intrinsic value of an option contract in a hedging instrument. Similarly, an entity can also designate only …
Read More

Difference between AS 11 and Ind AS 21?

Difference between AS 11 and Ind AS 21?

Conceptually, is there any difference between AS 11 and Ind AS 21?

In AS 11, there is no concept of functional currency. Foreign currency is a currency other than the reporting currency. Also, there is no concept of presentation currency in AS 11. As per Ind AS 21, functional currency is the currency of the primary economic environment in which an entity operates. Foreign currency is a currency other than the functional currency. Presentation currency is the currency in which the financial statements are prepared.

AS 11 is applicable to exchange differences on all forward exchange contracts that are hedging instruments for existing assets and liabilities. Not applicable for those contracts that hedge firm commitments or highly probable forecast transactions.

Foreign currency derivatives not within the scope of AS 11 (some derivatives embedded in other contracts) are within the scope of Ind AS 21. Ind AS 21 is also applicable when an entity translates from functional currency to presentation currency.

Foreign exchange contracts: Trading or speculative in nature.

The premium or discount on the contract is ignored and at each balance sheet date the value of the contract is marked to market and the gain or loss on the contract is recognised. Accounted for as derivative and valued at fair value.

Foreign exchange contracts: Not for trading or speculative in nature.

The premium or discount on the contract is amortised as expense or income over the life of the contract. Exchange differences recognised in P&L in the reporting period in which the exchange rates change. Accounted for as derivative and valued at fair value.

Transaction are covered by Ind AS 21

Transaction are covered by Ind AS 21 What type of transaction are covered by Ind AS 21? Accounting for transactions and balances in foreign currenciesTranslating the results and financial position of foreign operations, included in the financial statements of the entity by consolidation or the equity methodTranslating an entity’s results and financial …
Read More

Transaction are outside the scope of Ind AS 21

Transaction are outside the scope of Ind AS 21 What type of transaction are outside the scope of Ind AS 21? Derivative transactions and balances that are within the scope of Ind AS 109 ‘Financial Instruments’.Ind AS 109 applies to many foreign currency derivatives and, accordingly, these are excluded from the scope …
Read More

Importance of functional currency?

Importance of functional currency? What is the importance of functional currency? The determination of functional currency is extremely important as incorrectly determining the same will affect the financial statements in a big way, causing the transactions in the functional currency to be treated as, though they were foreign currency transactions. Exchange differences will …
Read More

Financial statements presented in any currency

Financial statements presented in any currency Can an entity present its financial statements in any currency of its choice? Yes, an entity can present its financial statements in any currency of its choice which is known as presentation currency. Needless to say that these statements would be in addition to the …
Read More

Difference between monetary and non-monetary items

Difference between monetary and non-monetary items What is the difference between monetary and non-monetary items? Monetary items are those assets and liabilities that are cash or readily convertible into cash. However, the essential feature is the existence of a right to receive or obligation to deliver a fixed or determinable number …
Read More

Difference between FX translation and FX revaluation

Difference between FX translation and FX revaluation What is the difference between FX translation and FX revaluation? Foreign currency translations are first recorded initially in the units of the foreign currency. Foreign currency is a currency other than the functional currency of the entity. Each and every foreign currency translation is revalued …
Read More

Carrying amount of a monetary item

Carrying amount of a monetary item How is the carrying amount of a monetary item determined on a valuation date for a foreign currency transaction? The carrying amount of an item is determined in conjunction with other relevant Standards. For example, property, plant and equipment may be measured in terms of fair …
Read More

Carrying amount of a non-monetary item

Carrying amount of a non-monetary item How is the carrying amount of a non-monetary item determined on a valuation date for a foreign currency transaction? The carrying amount is determined by comparing the cost or carrying amount, as appropriate, translated at the exchange rate at the date when that amount was …
Read More

Exchange differences on monetary items

Exchange differences on monetary items How are the exchange differences on monetary items dealt with?  Exchange differences arise from: the settlement of monetary items at a subsequent date to initial recognition;remeasuring an entity’s monetary items at rates different from those at which they were initially recorded (either during the reporting period or at …
Read More

Exchange differences from non-monetary items

Exchange differences from non-monetary items How are the exchange differences arising from non-monetary items dealt with? Non-monetary items When a gain or loss on a non-monetary item is recognised in profit or loss, any exchange component of that gain or loss is also recognised in profit or loss.When a gain or loss on …
Read More

Exchange differences from the presentation currency

Exchange differences from the presentation currency How are the exchange differences arising from the presentation currency dealt with? Exchange differences are recognised in other comprehensive income.These exchange differences are not recognised as income or expenses for the period because the changes in exchange rates have little or no direct effect on the …
Read More

Transactions within the scope of this guidance note

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 11;
  • Equity index futures, traded equity index options, traded stock futures and option contracts;
  • Commodity derivative contracts.

Current standards for financial instruments as per AS?

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, …
Read More

Need for the guidance note on accounting for 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 …
Read More

Entities that are required to follow the guidance note

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 …
Read More

Key accounting principles in the guidance note?

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 …
Read More

Fair value hedge on discontinuation of hedge accounting

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 …
Read More

Consequences of treating equity vs liability

Consequences of treating equity vs liability

What are the consequences of treating a contract as equity and how its treatment is different if treated as liability?

The consequences of treating particular contract as equity are as follows:

Treatment when the financial instrument is equity:

  1. Any consideration received (such as the premium received for a written option or warrant on the entity’s own shares) is added directly to equity.
  2. Any consideration paid (such as the premium paid for a purchased option) is deducted directly from equity.
  3. Changes in the fair value of an equity instrument are not recognised in the financial statements.
  4. Income and expenses on instruments classified as equity instrument are taken directly to equity.
  5. Gains and losses on redemptions, refinancing, etc, of financial instruments classified as equity are shown as movements in equity.

Treatment when the financial instrument is a liability:

  1. Income and expenses on instruments classified as liabilities are reported in the statement of comprehensive income.
  2. Gains and losses on redemptions, refinancing, etc, of such instruments are also reported in comprehensive income.
  3. Example: Dividends on preference shares classified as liability are shown as expense like interest on bonds.

Own use exemption as per the Accounting Standard

Own use exemption as per the Accounting Standard What is meant by own use exemption as per the Accounting Standard? Contracts that are entered into for the purpose of the receipt or delivery of a non-financial item for the entity’s own use is excluded from the scope of Accounting Standards for financial …
Read More

Classification of Foreign Currency Convertible Bond (FCCB)

Classification of Foreign Currency Convertible Bond (FCCB) An entity has issued a foreign currency convertible bond (FCCB). The Bond is denominated in foreign currency and would be converted into a fixed number of equity shares. Will this be treated as equity instrument or as a financial liability? Contracts that will be settled …
Read More

Bifurcation of compound financial instruments

Bifurcation of compound financial instruments Should the entity monitor a compound financial instrument in bifurcating such instrument into liability and equity component constantly and account for the same on every reporting period? A compound financial instrument should be evaluated for the terms of the financial instrument to determine whether it contains both …
Read More

What are treasury shares and how are these presented

What are treasury shares and how are these presented What are treasury shares and how are these presented in the financial statements? If an entity acquires its own equity instruments, these instruments are known as ‘treasury shares’ and are deducted from equity. No gain or loss shall be recognised in profit …
Read More

Transaction not representing the fair value

Transaction not representing the fair value

A financial asset or financial liability should be measured at fair value on initial recognition. What if the transaction does not represent the fair value of the financial asset or financial liability?

If at initial recognition the transaction value is different from the fair value, then the difference between the fair value at initial recognition and the transaction price is recognised as gain or loss immediately. This is so in the case where the transaction occurs in an active market for an identical asset or liability or based on valuation technique derived from observable market data.

In all other cases, at the fair value adjusted to defer the difference between the fair value on initial recognition and the transaction price. Such deferred difference is recognised as a gain or loss to the extent that it arises from a change in a factor that market participants usually take into account while pricing the asset or liability. For an asset that is subsequently measured at amortised cost, the asset is recognised initially at this fair value on the traded date when an entity uses settlement date accounting for such assets.

Treatment of transaction costs

Treatment of transaction costs How are the transaction costs treated? Transaction costs incurred while acquiring a financial asset or incurring a financial liability is treated differently depending upon the classification of such financial asset or financial liability. Transaction costs include fees and commission paid to agents (including employees acting as selling agents), advisers, …
Read More

What is the concept of effective interest method?

What is the concept of effective interest method? Explain the concept of effective interest method? Effective interest method is a new concept that is introduced through the Ind AS standards. Effective interest rate is relevant not merely for financial instruments, but as a concept running through the entire gamut of the Accounting …
Read More

Contractual cash flows & effective interest rate

Contractual cash flows & effective interest rate When contractual cash flows are modified to change in the terms of contract, does the effective interest rate change? When the contractual cash flows of a financial asset are renegotiated or otherwise modified and the renegotiation or modification does not result in the de-recognition …
Read More

Derecognition of a financial asset

Derecognition of a financial asset When should a financial asset be derecognised? An entity shall derecognise financial assets when and only when the contractual rights to the cash flows from the financial assets expire or it transfers the financial asset which eventually qualifies for derecognition as per the standard. An entity transfers a …
Read More

Consequence of not de-recognising an asset after the sale

Consequence of not de-recognising an asset after the sale What is the consequence of not de-recognising an asset even after the sale of such asset? When an entity continues to recognise an asset to the extent of its continuing involvement, the entity also recognises an associated liability. The transferred asset and the …
Read More

Impairment for debt instruments classified as FVOCI

Impairment for debt instruments classified as FVOCI

Is impairment testing necessary for debt instruments classified as fair value through other comprehensive income?

Debt instruments that are classified as fair value through other comprehensive income are also subjected to impairment test. This is because while the financial asset classified as FVOCI is shown in the balance sheet at fair value, the changes in the fair value of such instruments are taken to the other comprehensive income. Fair valuing a debt instrument does not consider the impairment of the instrument. Fair value of a debt instrument is arrived at by discounting of the contractual cash flows at the current interest rate and recognising the differences in fair value in other comprehensive income. However, impairment loss allowance is required to be calculated based on the present value of the cash short falls expected to occur over the entire life of the instrument based on the profitability of default occurring over the next 12 months which essentially is a forward looking model. The loss allowance is taken to the profit and loss account and may even be a write back of the loss allowance depending upon the changes in the expected cash short falls. It should be noted that the impairment loss allowance is not considered while computing fair value of the instrument and hence debt instruments that are classified and measured at fair value through other comprehensive income are subjected to impairment testing.

New impairment methodology

New impairment methodology What is the new impairment methodology? Is this concept entirely new? Yes. The new impairment methodology is completely new and this is the one instance where the accounting bodies on both sides of the Atlantic agreed to disagree. The bone of contention as far as the US GAAP is …
Read More

What are the three stages of impairment loss

What are the three stages of impairment loss What are the three stages during which the impairment loss should be provided? At the first stage, a portion of the expected credit loss is recognised on day one for all financial assets. This is calculated as the present value of cash short falls …
Read More

Impairment model for different categories of financial assets

Impairment model for different categories of financial assets Is the impairment model different for different categories of financial assets? No. Ind AS 109 has a single impairment model that applies to all financial instruments within its scope. As per the previous version of IFRS 9, viz, IAS 39, there were different models …
Read More

Loss allowance as per Ind AS 109

Loss allowance as per Ind AS 109 Can an entity provide a loss allowance greater than the impairment loss allowance as per Ind AS 109? Previously entities used to provide for losses on certain financial assets on an ad hoc basis that means several practices which are now prohibited expressly as per …
Read More

Impairment loss allowance on performing assets

Impairment loss allowance on performing assets Should impairment loss allowance be provided on performing assets or standard assets at the time of recognition of such assets? The expected credit loss is required to be applied on day one for all types of financing assets. The expected credit losses are the present …
Read More

Treatment of collateral value for expected credit losses

Treatment of collateral value for expected credit losses How should the value of collateral be treated while measuring expected credit losses? For the purpose of measuring expected credit losses, the estimate of expected cash shortfalls shall reflect the cash flows expected from collateral and other credit enhancements that are part of …
Read More

Recognition of interest revenue during all three stages

Recognition of interest revenue during all three stages How is interest revenue recognised for a financial asset during all the three stages? Interest revenue is always recognised based on the effective interest rate. The effective interest rate is applied on the opening carrying value of a financial asset. Impairment loss, if …
Read More

Credit adjusted effective interest rate

Credit adjusted effective interest rate What is meant by credit adjusted effective interest rate? The credit adjusted effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts through the expected life of the financial asset to the amortised cost of a financial asset that is …
Read More

Hedge ratio in hedge accounting requirements

Hedge ratio in hedge accounting requirements

What is meant by hedge ratio and how it is helpful in meeting the hedge accounting requirements?

Hedge ratio refers to the number of units that are used as hedging instrument for the purpose of hedging a hedged item. Usually, the ratio is 1:1 for most of the financial instruments. For example, if the entity wants to hedge a fixed rate debt instrument of say Rs 10 crore, then if the hedging instrument happens to be an interest rate swap, then the notional amount of the interest rate swap would also be Rs 10 crore. This means that the hedge ratio is 1:1.

In accordance with the hedge effectiveness requirements, the hedge ratio of the hedging relationship must be the same as that resulting from the quantity of the hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged item.

If an entity hedges 85% of the exposure on a hedged item, then the entity should use the same hedge ratio of 85% while designating a hedging relationship using the same hedge ratio. For example, if an entity hedges only 60% of the fixed rate debt exposure as per its risk management strategy, then while designating the hedging relationship the entity should designate only 60% of the value of debt security as the hedging instrument. The entity is not allowed to increase or decrease the hedge ratio that is in accordance with the actual hedge that the entity undertakes as per its risk management strategy.

The designation of the hedging relationship using the same hedge ratio that the entity actually uses in its risk management strategy should not create an imbalance between ratings of the hedged item and the hedging instrument that is used by the entity for hedging purposes.

As per the previous version of hedge accounting, viz, IAS 39, once the hedge ratio is determined, it was not permitted to be changed during the life of the hedging relationship. This caused enormous hardship for the entities and many times the hedge accounting had to be discontinued because of a change in the hedge ratio that is warranted as per the real life scenario. Considering the need for addressing this issue, IFRS 9 and Ind AS 109 now permits the hedge ratio to be modified even during the course of hedging relationship without the entity having to discontinue hedge accounting. The hedge ratio is modified by either increasing or decreasing the hedged item or the hedging instrument so as to achieve the desired relationship. The accounting treatment when such hedge ratio is modified is very elaborately given in this Standard.

Rebalancing to achieve hedge effectiveness

Rebalancing to achieve hedge effectiveness What do you mean by rebalancing and how does it help achieve hedge effectiveness? Rebalancing is a new concept introduced by a major amendment to IFRS 9 during November 2013. Rebalancing means adjustments made to the quantities of the hedged item or the hedging instrument of an …
Read More

Voluntary discontinuation of hedge accounting

Voluntary discontinuation of hedge accounting Can a hedge accounting be voluntarily discontinued and why? As per the new requirements, hedge accounting cannot be voluntarily discontinued. Hedge accounting can be discontinued only if the hedge effectiveness requirements are not met or that the hedging instrument is liquidated. Even when the hedge effectiveness requirements …
Read More

Cash flow hedge Vs fair value hedge

Cash flow hedge Vs fair value hedge What is a cash flow hedge and how is it different from a fair value hedge? A cash flow hedge is a hedge of the exposure to variability in cash flows attributable to a particular risk associated with a recognised asset or liability or a …
Read More

Is hedge accounting mandatory?

Is hedge accounting mandatory? Is hedge accounting mandatory or optional? Hedge accounting is not mandatory. However, considering the benefits of complying with hedge accounting, entities would want to follow hedge accounting when they are in a position to comply with the requirements for hedge accounting. The biggest benefit of hedge accounting …
Read More

Accounting for a cash flow hedge

Accounting for a cash flow hedge How would you account for a cash flow hedge? Get the lower of the cumulative fair value changes to the hedging instrument and the fair value of the hedged item, viz, the present value of expected cash flows.The amount calculated in step 1 above is taken …
Read More

Reasons for revamping hedge accounting by IASB

Reasons for revamping hedge accounting by IASB What prompted the hedge accounting standard to be revamped by IASB? The main reason for revamping the accounting standards relating to financial instruments by the IASB is the direct outcome of the shock that sent shivers through the spine of several conglomerates as a …
Read More

Rebalancing and discontinuation of cash flow hedge

Rebalancing and discontinuation of cash flow hedge Briefly explain rebalancing and discontinuation of cash flow hedge. If the hedge effectiveness requirements are not met, the entity should adjust the hedge ratio by a process known as ‘rebalancing’ so long as the hedging relationship continues to meet the risk management objective of undertaking …
Read More

Difference between hedging and speculation

Difference between hedging and speculation What is the basic difference between hedging and speculation? If an investor takes a derivative position by holding the corresponding underlying, it is called hedging. The derivative position should be in the opposite direction of the underlying position, eg, if a person holds 100 shares of …
Read More

Difference between speculation and gambling

Difference between speculation and gambling Is there any difference between speculation and gambling? Both speculation and gambling involves taking a position in the derivative segment without having any corresponding underlying. In the case of speculation, the open interest does not exceed the sum total of the underlying outstanding. However, in the …
Read More

Link between hedge accounting & risk management objective

Link between hedge accounting & risk management objective What is the link between hedge accounting and the risk management objective of an entity? The objective of hedge accounting is to manage the risk that an entity faces. In the context of hedge accounting, the entity manages effectively the risk by using the …
Read More

Risk management objective & risk management strategy

Risk management objective & risk management strategy Explain the relationship between risk management objective and risk management strategy of an entity. The risk management strategy of an entity should be distinguished from its risk management objective. The risk management strategy is established at the highest level at which an entity determines how …
Read More

Can hedging instrument be a non-derivative

Can hedging instrument be a non-derivative A hedging instrument should necessarily be a derivative. Do you agree? Hedging instrument need not necessarily be a derivative instrument even though mostly derivative instruments are used as hedging instruments. The key feature of a derivative instrument should be that it should help minimise the risk …
Read More

Written options as a hedging instrument

Written options as a hedging instrument Why a written option cannot be used as a hedging instrument? The objective of hedging is to minimise the risk and/or to protect the unrealised profits. A hedging instrument should typically restrict the exposure to loses while at the same time provide scope for unlimited …
Read More

Interest rate swap as a hedging instrument

Interest rate swap as a hedging instrument An interest rate swap is usually designated as a hedging instrument in spite of the fact that the fair value of an interest rate swap oscillates between positive and negative fair values. Explain the anomaly. At the outset, it may seem rather strange that an …
Read More

Existing asset or liability as a hedged item

Existing asset or liability as a hedged item Only an existing asset or liability can be designated as a hedged item in a fair value hedge. Do you agree? This statement is not correct, as the hedged item in a fair value hedge can be in addition to the above an unrecognised …
Read More

Accounting for a fair value hedge

Accounting for a fair value hedge How do you account for a fair value hedge? A fair value hedge is accounted for as follows: The gain or loss on the hedging instrument is recognised in profit or loss. If the hedging instrument hedges an equity instrument classified as FVOCI, then it is recognised …
Read More

Time value of forward points in hedge accounting

Time value of forward points in hedge accounting How is the time value of forward points in a derivative contract treated in hedge accounting? An entity is allowed to designate only the change in the intrinsic value of an option contract in a hedging instrument. Similarly, an entity can also designate only …
Read More

Subscribe to our News Letter

I hope you enjoy reading this blog

Scroll to Top