FAQs

What is SPPI test?

What is SPPI Test?

SPPI test means Solely Payment of Principal and Interest.

The SPPI test is performed at the instrument level. So, if the test passes for one, it means the test passes for everyone in respect of that instrument. SPPI test should be passed for an instrument to be eligible to be classified as “Amortised Cost” instrument. If the test fails then no other test is applied on that instrument and the instrument would be classified as FVTPL only.

If the contractual terms of the financial asset give rise to cash flows that are solely payments of principal and interest on the principal amounts outstanding viz., cash flows that are consistent with a basic lending arrangement. As mentioned above this assessment must be carried out on an instrument by instrument basis.

Principal is defined as the fair value of the financial asset at initial recognition. Interest is defined as the compensation for time value of money. It also includes a compensation for credit risk and other lending risks such as liquidity, administrative costs and a profit margin.

What are Ind AS accounting standards?

What are Ind AS accounting standards? The Ministry of Corporate Affairs (MCA) on 16th February 2015 notified the Companies (Indian Accounting Standards) Rules, 2015 containing 39 Indian Accounting Standards (Ind ASs). Ind ASs are based on International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB). The roadmap for applicability of Ind AS mentions that Ind AS will be applicable in a phased manner depending upon the listing status as well as the net worth of the company. The roadmap is applicable to non-financial companies, i.e., companies other than banking, insurance and NBFCs. During these phases, the…

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Roadmap for implementing Ind AS

Roadmap for implementing Ind AS The roadmap for implementing Ind AS in a phased manner is given below. All non-financial companies For companies other than banks, NBFC and Insurance companies: Voluntary Phase 1st April 2015 or thereafter: Voluntary Basis for all companies (with comparatives) Phase I 1st April 2016: Mandatory Basis All listed on Stock Exchange in India or outside having net worth equal to or more than Rs 500 croreUnlisted companies having net worth equal to more than Rs 500 croreParent, Subsidiary, Associate and Joint Venture of above Companies can voluntarily apply Ind AS for accounting periods beginning on…

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Ind ASs relating to financial instruments

Ind ASs relating to financial instruments What are the Ind ASs relating to financial instruments? Financial instruments are primarily governed by three standards as per Ind AS, viz, Ind AS 32, Ind AS 109 and Ind AS 107. Ind AS 32 defines financial instruments, financial assets, financial liabilities and equity instruments. Ind AS 32 deals with financial instruments from the perspective of an issuer. It primarily addresses the presentation-related issues and provides guidance whether a financial instrument should be considered as a financial asset, a financial liability or an equity instrument. Ind AS 32 also addresses compound instruments that contain…

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What is the significance of Ind AS 32?

What is the significance of Ind AS 32 Ind AS 32 is the converged Accounting Standard of IAS 32 Ind AS 32 deals with financial instruments from the perspective of an issuer and provides guidance as to how an entity should present a financial instrument either as a financial asset or financial liability or as equity instrument. Ind AS 32 also provides guidance about the bifurcation of compound instruments into liability and equity components. The classification is extremely important because this has a wider import regarding the way the instruments are presented in the balance sheet as well as the…

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Ind AS for financial instruments replica of IFRS?

Ind AS for financial instruments replica of IFRS? Are the Ind AS relating to financial instruments an exact replica of its counterpart, viz, IFRS? Ind AS 32 is the converged standard of IAS 32. Ind AS 109 is the converged Ind AS of IFRS 9. Ind AS 107 is the converged Ind AS of IFRS 7. As on date, it may be correct to state that the Ind ASs relating to financial instruments are more or less a replica of its IFRS counterpart, even though there is one major carve out in Ind AS 32 and one major exception provided…

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Scopes of the three standards for financial instruments

Scopes of the three standards for financial instruments Are the scopes of all the three standards viz., Ind AS 32, Ind AS 109 and Ind AS 107 similar? Ind AS 32 is the converged standard of IAS 32. Ind AS 109 is the converged Ind AS of IFRS 9. Ind AS 107 is the converged Ind AS of IFRS 7. While the scope of all the three standards is more or less similar, it should be noted that these are not identical as each one of these standards are subject to different exclusions. The entity, therefore, should be cautious to…

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Contract to deal in non-financial item

Contract to deal in non-financial item Is a contract to buy or sell a non-financial item, a financial instrument? A contract to deal with a non-financial item is not a financial instrument. However, there are certain contracts to buy or sell a non-financial item that may be required to be accounted for as a derivative as per the financial accounting standards, eg, where the contacts to buy or sell a non-financial item that can be settled net in cash or another financial instruments or by exchanging financial instruments, as if the contracts were financial instruments. In other words, even though…

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Contract meant for own use

Contract meant for own use Can a written option that results in the delivery of a non-financial item be treated as a financial instrument, as the non-financial item is meant for own use? If the derivative contract is a purchased call option or a future contract to buy a non-financial item, this may be covered under the own use exemption, as a result of which such contracts may be outside the scope of the financial instruments standards. Some written options like written put option may also result in the physical delivery of a non-financial item. For example, a written put…

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Difference between forward contract & futures contract

Difference between forward contract & futures contract What is the difference between a forward contract and a futures contract? A forward contract is a derivative instrument between two parties to buy or to sell an asset at a specified future time at a price agreed upon today. A forward contract is non-standardised. The party agreeing to buy the underlying asset in the future at the delivery price assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. On the other hand, a futures contract is a derivative contract which is a…

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Difference between futures contract & options contract

Difference between futures contract & options contract What is the basic difference between a futures contract and an options contract? Both futures contract and options contract are known as derivative contracts. In a futures contract, there is an underlying, the notional amount and an expiry date. In the case of an options contract, apart from the above, there is also a strike price. The fair value of a futures contract is determined by the cost of carry and corporate actions of the underlying, if any. However, the fair value of an options contract is determined based on the implied volatility…

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Definition of derivative instruments

Definition of derivative instruments Are derivative instruments specifically defined in the standards and if so, where? A derivative instrument is a subset of financial instrument with mainly three characteristics, viz, its value changes in response to a change in the underlying variable, it requires no or low initial net investment and its settled on a future date. In the definition of financial asset, derivative instrument is covered under (c) (ii), viz, to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity. Purchased call options and put options and derivatives having a…

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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…

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Criteria for classifying as either financial liability or equity

Criteria for classifying as either financial liability or equity What is the core criteria while classifying a financial instrument as either financial liability or equity? The core criteria while classifying a financial instrument is to examine whether there exists a future obligation on the part of the entity to part…

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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…

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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…

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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…

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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…

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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.

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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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Presentation of impairment loss for debt instruments at FVOCI

Presentation of impairment loss for debt instruments at FVOCI How is impairment loss presented in the balance sheet and profit and loss account in respect of debt instruments measured at FVOCI? For financial assets that are debt instruments measured at FVOCI, both the amortised cost and the fair value of…

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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…

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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,…

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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…

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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.

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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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Foreign currency risk in a firm commitment as a fair value hedge

Foreign currency risk in a firm commitment as a fair value hedge Foreign currency risk associated with a firm commitment can be designated as a fair value hedge only. Explain. No. A hedge of the foreign currency risk associated with such firm commitments may be designated as a cash flow…

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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…

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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…

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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…

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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…

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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 currencies
  • Translating the results and financial position of foreign operations, included in the financial statements of the entity by consolidation or the equity method
  • Translating an entity’s results and financial position into a presentation currency
  • Applies to the presentation of an entity’s financial statements in a foreign currency and sets out requirements for the resulting financial statements to be described as complying with Indian Accounting Standards (Ind ASs).
  • For translations of financial information into a foreign currency that do not meet these requirements, this Standard specifies information to be disclosed.

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…

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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…

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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….

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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…

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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?

  1. 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.
  2. If hedge accounting is not applied, then the derivatives should be measured at fair value. Fair value changes should be recognised in P&L.
  3. 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 by the respective derivative contract. This should be done at the inception of the hedging relationship as well as on an on-going basis.
  4. An entity may apply hedge account for certain contracts and for certain other contracts it may not apply hedge accounting. In other words, hedge accounting for the derivative contracts is purely optional and not mandatory. However, if hedge accounting is not applied then the derivative contract should be measured at fair value and accounted for at the inception as well as at every reporting period as mentioned in (1) above.
  5. An entity should make appropriate disclosures in its financial statements, including its accounting policies, risk management objectives and the hedging activities that the entity has undertaken.

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,…

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Guiding principle in guidance note on accounting for derivatives?

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…

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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…

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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…

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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…

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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…

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What are Ind AS accounting standards?

What are Ind AS accounting standards?

The Ministry of Corporate Affairs (MCA) on 16th February 2015 notified the Companies (Indian Accounting Standards) Rules, 2015 containing 39 Indian Accounting Standards (Ind ASs). Ind ASs are based on International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB).

The roadmap for applicability of Ind AS mentions that Ind AS will be applicable in a phased manner depending upon the listing status as well as the net worth of the company. The roadmap is applicable to non-financial companies, i.e., companies other than banking, insurance and NBFCs. During these phases, the financial companies, i.e., banking, insurance and NBFCs, will not be required to apply Ind AS for preparation of their financial statements either voluntarily or mandatorily.

Net worth is the aggregate value of the paid-up share capital and all reserves created out of the profits and securities premium amounts after deducting the aggregate value of the accumulated losses, deferred expenditure and miscellaneous expenditure not written off as per the audited balance sheet. This does not include reserves created out of the revaluation of assets, write-back of depreciation and amalgamation. Net worth is calculated as per the standalone financial statements of the company as on 31st March 2014 or the first audited balance sheet for accounting period which ends after that date for the purpose of first-time adoption Ind AS.

What is SPPI test?

What is SPPI Test? SPPI test means Solely Payment of Principal and Interest. The SPPI test is performed at the instrument level. So, if the test passes for one, it means the test passes for everyone in respect of that instrument. SPPI test should be passed for an instrument to…

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Roadmap for implementing Ind AS

Roadmap for implementing Ind AS The roadmap for implementing Ind AS in a phased manner is given below. All non-financial companies For companies other than banks, NBFC and Insurance companies: Voluntary Phase 1st April 2015 or thereafter: Voluntary Basis for all companies (with comparatives) Phase I 1st April 2016: Mandatory…

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Ind ASs relating to financial instruments

Ind ASs relating to financial instruments What are the Ind ASs relating to financial instruments? Financial instruments are primarily governed by three standards as per Ind AS, viz, Ind AS 32, Ind AS 109 and Ind AS 107. Ind AS 32 defines financial instruments, financial assets, financial liabilities and equity…

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What is the significance of Ind AS 32?

What is the significance of Ind AS 32 Ind AS 32 is the converged Accounting Standard of IAS 32 Ind AS 32 deals with financial instruments from the perspective of an issuer and provides guidance as to how an entity should present a financial instrument either as a financial asset…

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Ind AS for financial instruments replica of IFRS?

Ind AS for financial instruments replica of IFRS? Are the Ind AS relating to financial instruments an exact replica of its counterpart, viz, IFRS? Ind AS 32 is the converged standard of IAS 32. Ind AS 109 is the converged Ind AS of IFRS 9. Ind AS 107 is the…

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Scopes of the three standards for financial instruments

Scopes of the three standards for financial instruments Are the scopes of all the three standards viz., Ind AS 32, Ind AS 109 and Ind AS 107 similar? Ind AS 32 is the converged standard of IAS 32. Ind AS 109 is the converged Ind AS of IFRS 9. Ind…

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Contract to deal in non-financial item

Contract to deal in non-financial item Is a contract to buy or sell a non-financial item, a financial instrument? A contract to deal with a non-financial item is not a financial instrument. However, there are certain contracts to buy or sell a non-financial item that may be required to be…

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Contract meant for own use

Contract meant for own use Can a written option that results in the delivery of a non-financial item be treated as a financial instrument, as the non-financial item is meant for own use? If the derivative contract is a purchased call option or a future contract to buy a non-financial…

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Difference between forward contract & futures contract

Difference between forward contract & futures contract What is the difference between a forward contract and a futures contract? A forward contract is a derivative instrument between two parties to buy or to sell an asset at a specified future time at a price agreed upon today. A forward contract…

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Difference between futures contract & options contract

Difference between futures contract & options contract What is the basic difference between a futures contract and an options contract? Both futures contract and options contract are known as derivative contracts. In a futures contract, there is an underlying, the notional amount and an expiry date. In the case of…

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Definition of derivative instruments

Definition of derivative instruments Are derivative instruments specifically defined in the standards and if so, where? A derivative instrument is a subset of financial instrument with mainly three characteristics, viz, its value changes in response to a change in the underlying variable, it requires no or low initial net investment…

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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 by an entity delivering a fixed number of its own equity instruments in exchange for a fixed amount of foreign currency are treated as a liability as per IFRS 9. Accordingly, contracts which include a conversion option in a foreign currency denominated convertible bond are liabilities. A derivative contract which involves an entity delivering a fixed number of its own equity instruments in exchange for a fixed amount of foreign currency fails the ‘fixed for fixed test’ and be classified as liability. However, as per the carveout mentioned in Ind AS 32, an exception is provided to the definition of ‘financial liability’. Accordingly, equity conversion option embedded in a convertible bond denominated in foreign currency to acquire a fixed number of entity’s own equity instruments is considered as equity instrument if the exercise price is fixed in any currency. A convertible bond denominated in foreign currency to acquire a fixed number of entity’s own equity instruments may result in issuing a variable number of its own equity instrument depending upon the exchange rate at the time of conversion. In spite of this, such FCCB would be considered as equity instrument pursuant to the carveout provided as mentioned above. The liability and equity component will be split accordingly.

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…

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Criteria for classifying as either financial liability or equity

Criteria for classifying as either financial liability or equity What is the core criteria while classifying a financial instrument as either financial liability or equity? The core criteria while classifying a financial instrument is to examine whether there exists a future obligation on the part of the entity to part…

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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…

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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…

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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…

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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…

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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, brokers and dealers, levies by regulatory agencies and security exchanges, and transfer taxes and duties. Transaction costs do not include debt premiums or discounts, financing costs or internal administrative or holding costs.

For financial assets not measured at fair value through profit or loss, transaction costs are added to the fair value at initial recognition. For financial liabilities, transaction costs are deducted from the fair value at initial recognition. For financial instruments that are measured at amortised cost, transaction costs are subsequently included in the calculation of amortised cost using the effective interest method and, in effect, amortised through profit or loss over the life of the instrument.

For financial instruments that are measured at fair value through other comprehensive income transaction costs are recognised in other comprehensive income as part of a change in fair value at the next re-measurement. If the financial asset is measured, those transaction costs are amortised to profit or loss using the effective interest method and, in effect, amortised through profit or loss over the life of the instrument.

What is SPPI test?

What is SPPI Test? SPPI test means Solely Payment of Principal and Interest. The SPPI test is performed at the instrument level. So, if the test passes for one, it means the test passes for everyone in respect of that instrument. SPPI test should be passed for an instrument to…

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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…

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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…

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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…

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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…

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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…

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