Financial Instruments Book Series as per Ind AS 109 (indas109)
Preface to the Book
Financial instruments are probably the most complex topic in the entire literature of accounting standards. Accounting for financial instruments in the Indian context was earlier covered by AS 30, AS 31, and AS 32 issued by the Institute of Chartered Accountants of India (ICAI) in the year 2007/2008. These standards were supposed to become mandatory from April 1, 2011, but did not see the light of the day as these were withdrawn by ICAI, mainly due to the fact that the corresponding accounting standards of International Accounting Standards Board (IASB) viz., IAS 32, IAS 39 and IFRS 7 were undergoing significant changes as a fall out of the financial crisis of the year 2008. IASB subsequently issued IFRS 9 as a replacement of IAS 39 on 24th July 2011, the mandatorily effective date being 1st January 2018 for entities adopting IFRS.
The IASB completed the financial instruments project in three phases spread over a period of around four years. The first instalment of the modifications / improvements to IAS 39 was introduced during the year 2009 covering the new classifications and measurements requirements. IASB published IFRS 9 that introduced new classification and measurement requirements in the year 2009 and 2010. The new hedge accounting model was announced in the year 2013. In July, 2014, the final version of the standard IFRS 9 was published, replacing the earlier versions of IFRS 9 and included the new impairment methodology amongst other changes.
Indas109 is the converged Indian Accounting Standard and is mandatory along with 38 other standards notified by the Ministry of Corporate Affairs, starting from the financial year 1st April 2016 in a phased manner covering listed companies and companies having certain specified net worth.
It is pertinent to note that while the rest of the world, wherever IFRS is being implemented, started to follow IFRS 9 effective 1st January 2018, India implemented the same effective 1st April, 2016.
In this series of books, Financial Instruments is covered in a series of 7 books as follows:
Book-2: Presentation (Ind AS 32)
Book-4: Recognition, Measurement & de-recognition
Book-6: Fair Value Hedge Accounting
Book-7: Cash Flow Hedge Accounting
India never had any formal accounting standards on financial instruments thus far. Since India is first amongst the several geographical locations implementing the accounting standard covering financial instruments, we never had any precedence for guidance on several of the new concepts that were introduced by IFRS 9 which are also imported verbatim into Ind AS 109 till a couple of years back. At the time of writing this series of books on Financial Instruments, we do have the precedence from the entities that have already started to follow Ind AS 109 in India as well as IFRS 9 in the rest of the world. The relevant extracts from the published financial reports are reproduced at the relevant places wherever it is found necessary and useful.
Approach: The key concept covered by the accounting standard is discussed along with ample illustrations to elucidate and amplify the topic for better understanding. Journal entries along with the trial balance, profit & loss account and balance sheet are also given to get a complete grasp of the topic covered. It should be noted that the profit & loss account and balance sheet given may not conform to the strict presentation/disclosure requirements mandated by the standard, as the limited purpose is to help understand the topic covered by such illustration. Comprehensive presentation and disclosures that are required to be provided mandatorily are given at the end of each book along with sample extracts from published accounts wherever it is relevant and useful.
Note: In an effort to make each book in this series complete and independent of each other as far as possible, certain concepts which have already been covered in another book of the same series might be repeated.
Book-1: Financial Instruments – Introduction as per Indas109
This book being the first in this series, gives an introduction about the accounting standards relevant from the perspective of accounting for financial instruments. This gives a basic overview of the three main accounting standards that are covered in this book viz., Ind AS 32, Ind AS 109 and Ind AS 107.
Ind AS 32 is the converged accounting standard of IAS 32 and deals with the financial instruments from the perspective of an issuer. It primarily addresses the presentation related issues and provides guidance as and when a financial instrument should be considered as a financial asset, a financial liability or an equity instrument. Compound instruments that should be bifurcated at the time of issuance into liability and equity components are also covered by Ind AS 32. Ind AS 109 is the converged accounting standard of IFRS 9 and deals with financial instruments from the perspective of an investor.
Primarily, it addresses the issues relating to the classification of financial assets and liabilities (Book 3), recognition, measurement and de-recognition of financial assets and the liabilities (Book 4). Ind AS 109 also deals with impairment of financial assets and provides guidance as to how to compute the expected credit on certain financial assets (Book 5). This standard also addresses the concepts on hedge accounting and provides guidance as to how a hedging relationship should be accounted for, be it a fair value hedge (Book 6) or a cash flow hedge or a hedge of net investment in foreign operation (Book 7).
Ind AS 107 is the converged accounting standard of IFRS 7 and enumerates the requirements relating to the disclosures about the financial instruments that would enable users of the financial statements to evaluate the significance of the financial instruments for the entity’s financial position and performance.
The concept of accounting mismatch is given with a practical illustration. Basic accounting entries for different kinds of financial assets are given with examples. The concepts of hedging speculation and gambling are also elucidated in this book. This book also gives an overview of the various types of financial instruments and their nuances including different types of derivative instruments.
Book-2: Financial Instruments – Presentation as per Ind AS 32
This book explains the nuances of financial instruments and what constitutes a financial asset and a financial liability and discusses the classification of financial liability and equity. The classification between financial liabilities and equity components is extremely important because this has a wider import regarding the way the instruments are presented in the balance sheet as well as the manner in which income and expenses arising on account of such financial instruments affect the profit and loss account. Ind AS 32 addresses the issues relating to the presentation of interest and dividends as well as offsetting of financial assets and financial liabilities under certain conditions.
Book-3: Classification & reclassification as per Ind AS 109
This book discusses the criteria for classifying financial instruments into various categories viz., amortised cost, fair value through profit or loss (FVTPL) and fair value through other comprehensive income (FVOCI). This also discusses the choice that an entity has to designate a financial asset at fair value through profit or loss and the circumstances in which such option can be exercised. The criteria for classification of financial instruments viz., the SPPI test as well as the criteria to examine the business model are all explained in this book. Meaning of principal and interest, the time value of money, the modified time value of money and regulated interest rates are discussed along with the impact of these on the classification of financial assets.
This book also discusses the classification of financial liabilities and discusses the circumstances under which financial liabilities can be designated as FVTPL on initial recognition. The disclosure requirements in respect of the classification of financial instruments and some sample disclosures from published accounts are also given in this book.
This book discusses the concept of embedded derivatives and the accounting treatment for hybrid contracts and financial hosts. Embedded derivatives in financial instruments require to be separated from the host and accounted for as derivative if certain conditions are satisfied, which is discussed in this book. This also discusses the measurement of embedded derivatives in case of non-option type of derivative as well as option based embedded derivatives. The examples of embedded derivative not closely related to the host contract and the embedded derivatives closely relate to the host contract are given here. This book discusses about re-assessment of embedded derivatives and disclosures required in respect of embedded derivatives. Sample disclosures from published accounts in respect of embedded derivatives are given.
Book-4: Recognition & Measurement as per Ind AS 109
This book discusses the circumstances under which a financial asset or a financial liability is recognised initially with examples of initial recognition in respect of regular way purchase or sale of initial assets. Trade date accounting and settlement date accounting is also considered in this book. Subsequent measurement of financial assets, amortised cost measurement of financial assets, the key concept of effective interest rate and calculation thereof are all discussed in this book. Illustration is given as to how the effective rate of interest is computed for purchased or originated credit impaired assets.
When the computed cash flows are modified, should the effective interest rate be modified? This is discussed in this book. The basic accounting entries required for various types of instruments are considered in this book. Subsequent measurement of financial liabilities and liabilities designated at fair value through profit or loss is discussed here along with the impact of credit risk on the valuation of such liabilities. The circumstances under which a financial asset is derecognised is discussed in this book as also the derecognition requirements for financial liabilities. The disclosure requirements in respect of recognition, measurement and derecognition are considered here along with sample disclosures from published accounts.
Reclassification of financial assets and the circumstances which constitute changes in the business model and the circumstances which do not constitute the changes in the business model are given in this book. The effects of reclassifying assets from one category to another category and the accounting treatment to be given under those circumstances are given in this book.
Gains and losses arising on account of financial assets classified as amortised cost, FVTPL as well as FVOCI are covered, including the gains or losses for hedged items. Disclosures required in respect of reclassification and sample disclosures for the same are also provided in this book.
Book-5 – Financial Instruments – Impairment as per Ind AS 109
A new impairment methodology was introduced by the IASB when it released the final version of IFRS 9 on 24th July 2014. IASB agreed to disagree with Financial Accounting Standards Board (FASB) on certain issues relating to the impairment methodology which is quite significant from the perspective of the convergence of US GAAP with IFRS. Needless to say that Ind AS 109 imbibes the new impairment methodology from IFRS 9. As per the revised requirements, an entity should always account for the ‘expected credit losses’ without waiting for credit losses to be incurred. The revised requirement is expected to provide more timely information about the expected credit losses as opposed to the ‘incurred credit loss’ model, which was considered to be ‘too little and too late’.
This book covers extensively the basics of the expected credit losses model and the impairment requirements for the three stages viz., when the asset is acquired, when the credit risk increases significantly on the assets and when the asset becomes credit impaired. The disclosures required for impairment and sample disclosures from published accounts are also provided in this book.
Book-6 – Fair Value Hedge Accounting as per Ind AS 109
Hedge accounting has undergone significant changes in the last few years and the IASB incorporated major revisions of hedge accounting when IFRS 9 was amended in December 2013. The main reason for such a major revamp of the hedge accounting methodology was driven by the financial crisis of the year 2008. The new requirements made the requirements more principle based and enlarged the scope of hedge accounting in including the application of hedge accounting to cover non-financial risks also. This book discusses some of the basic concepts that are necessary to understand the meaning of hedge accounting e.g., the concept of open interest, hedging, speculation and gambling.
The risk-reward profile for futures and options contracts are discussed initially for equity related products and subsequently for interest rate related financial instruments. The qualifying criteria for hedge accounting, the instruments that could be designated as hedged item and hedging instruments are all discussed in this book. Rebalancing and changes to hedge ratio, which again is a novel concept that was recently introduced by IASB, is also discussed in this book. The circumstances under which hedge accounting could be discontinued and the consequences of discontinuance of hedge accounting are discussed in this book.
This book discusses as to what is meant by fair value hedge, how to identify a hedged item and what are the requirements for designating a hedging instrument in a fair value hedge. The qualifying criteria for the continuance of hedge accounting and hedge effectiveness requirements are discussed. The accounting treatment for fair value hedge for hedging both the non-financial asset as well as financial instruments is discussed with extensive numerical examples. The treatment of time value / forward points in derivatives and accounting for the time value of the options contracts and the time value in forward contracts are discussed exhaustively, giving the treatment for accounting time value for transaction related hedge item and time period related hedge item.
The concept of basis adjustment entry is discussed and the way it is different from the reclassification entry is also analysed here. Rebalancing a hedge by changing a hedge ratio is also considered in this book with exhaustive illustrations. The treatment given to the hedged item and hedging instruments on discontinuing hedge accounting is also covered.
Book-7 – Cash Flow Hedge Accounting as per Ind AS 109
This book discusses as to what is meant by a cash flow hedge and elaborates the difference between a cash flow hedge and a fair value hedge. Identification of the hedged item, hedging instrument, designation and classifying criteria for cash flow hedge and hedge effectiveness requirements are given in this book. Accounting for a cash flow hedge is given with several numerical examples. Accounting treatment on discontinuation of cash flow hedge accounting is also provided in this book.
The new requirement of hedge accounting permits hedging net position and this is also discussed. The disclosure requirements relating to hedge accounting including sample disclosures from published accounts are provided in this book relating to all types of hedges.