SARANSH Indian Accounting Standards

INDIAN ACCOUNTING STANDARD (IND AS) 109:

FINANCIAL INSTRUMENTS

Classification of Financial Instruments

Financial Assets Financial Liabilities

Amortized Fair Value Fair Value Amortized Fair Value

Cost through other through profit Cost through profit
comprehensive or loss or loss
income (FVTPL) (FVTPL)
(FVTOCI)

Classification of Financial Assets

Amortized Fair Value Fair Value

Cost through other through profit
comprehensive or loss
income (FVTPL)
(FVTOCI)

Business SPPI Business SPPI Held for Residual

Model Contractual Model Contractual trading category
‘Hold-to- + cash flow ‘Hold-to-col + cash flow
collect’ test lect’ and sell test

Financial Assets Measured at

Amortized Fair value through Fair value

Cost Other Comprehensive through profit
Income or loss

If below conditions are met: • FA shall be measured at FVOCI if FA are accounted at FVTPL if:
(a) FA is held with BM whose below conditions are met: (a) Any asset which is not
objective is to hold (a) FA is held with BM whose measured at amortised
financial assets in order objective is achieved both by cost and not measured at
to collect contractual collecting contractual cash flows FVOCI; or
cash flows and selling FA If on initial recognition,
(b) Contractual terms give (b) Contractual terms give rise on (b) any asset may irrevocably
rise on specified dates to specified dates to cash flows that be designated as FVTPL
cash flows that are solely are solely payments of principal if specific criteria met.
payments of principal and interest on the principal
and interest on the amount outstanding
principal amount • Any equity instruments for which the
outstanding. entity makes an irrevocable election to
carry at fair value through OCI

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Measurement of Financial Assets

Initial measurement Subsequent measurement

Fair value –
• Normally evidenced by the FA measured at FA measured at fair value
transaction price (ie, fair value Amortised cost [FVTPL/ FVOCI]
of consideration given or
received)
• Where part of consideration Fair value at initial recognition • Fair value determined
is for other than the financial periodically
• Principal repayments
instrument, then entity shall • For equity instruments – cost
• Cumulative interest using EIR*
measure fair value of the may represent fair value in
financial instrument some situations

• Interest. Dividend For FVTPL/FVOCI debt For FVOCI equity instruments

recorded in P&L instruments– • Dividend recorded in P&L
• Gains/ losses also • Interest / Dividend • Gains / losses recorded in OCI
recorded in P&L recorded in P&L
• Gains/ losses also
recorded in P&L

The decision tree for classification of financial assets can be understood with the help of following flow chart

Debt investments Derivative investments Equity investments

Contractual cash flows solely payments of principal and interest

Pass Fail Fail Fail

Business model (BM) test (at entity level) Held for trading?
Hold to BM to collect
collect contractual Neither No
1 2 Yes
contractual cash flows 1 or 2
cash flows and sell asset

Fair value option elected? FVOCI option elected?

No Yes
No Yes
No
FVOCI FVOCI
Amortised cost (with recycling) FVPL (no recycling)

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What Is Amortized Cost?

Particulars Amount
Initial Recognition (Fair value / Transaction value) XXXX
Less : Principal repayment XXXX
Less : Cumulative amortization (EIR) XXXX
Less : Impairment / un-collectability XXXX
Amortized costs XXXX

• Effective interest rate (EIR) method is used to calculate the amortized costs of a financial asset or a financial liability as well as
the allocation & recognition of interest revenue or expense in income statement.
• EIR is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset
or financial liability to the gross carrying amount of a financial asset or to the amortised cost of a financial liability.
The computation of EIR includes all cash flows between the parties in the contract e.g. Fees, transaction costs, premium or
discounts.
• Transactions costs are the incremental costs that are directly attributable to the acquisition or issue of any financial assets or
liability.

Accounting For Transaction Costs For The Purpose Of Effective Interest Rate Method

Fees that are integral part of effective interest rate Fees that are not an integral part of effective interest rate

(a) Origination fee received by the entity relating to the (a) Fee charged for servicing a loan;
creation or acquisition of a financial asset. Such fees may
include compensation for activities such as evaluating the
borrower's financial condition, evaluating and recording
guarantees, collateral and other security arrangements,
negotiating the terms of the instrument, preparing and
processing documents and closing the transaction. These
fees are an integral part of generating an involvement with
the resulting financial instrument.

(b) Commitment fee received by the entity to originate a (b) Commitment fee to originate a loan when it is unlikely
loan where it is probable that the entity will enter into a that a specific lending arrangement will be entered
specific lending arrangement. These fees are regarded as into;
compensation for an ongoing involvement with the
acquisition of a financial instrument. If the commitment
expires without the entity making the loan, the fee is
recognised as revenue on expiry.

(c) Origination fee paid on issuing financial asset measured (c) Loan syndication fee received by an entity that arranges a
at amortised cost. These fees are an integral part of loan and retains no part of the loan package for itself (or
generating an involvement with a financial liability. An retains a part at the same effective interest rate for compa-
entity distinguishes fees and costs that are an integral part rable risk as other participants).
of the effective interest rate for the financial liability from
origination fees and transaction costs relating to the right
to provide services, such as investment management
services.

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Financial Asset (FA) Classified as Subsequently Measured at Amortised Cost

if it meets both of following criteria:

‘Hold-to-collect’ business model test + ‘SPPI’ contractual cash flow characteristics test

Objective is to hold the financial asset in Objective is to hold the financial asset in
order to collect contractual cash flows order to collect contractual cash flows

Note: Equity instrument can never be classified at amortized costs

Examples of FA classified and accounted for at amortised cost:

• Trade receivables
• Investments in government bonds (not held for trading)
• Investments in term deposits (at standard interest rates)
• Loan receivables with ‘basic’ features

Business Model Tests

• An entity’s business model refers to how an entity manages its financial assets so to generate / realise cash
flows
• In other words, business model is concerned with whether an entity will collect contractual cash flows by
holding them to maturity or sell those financial assets or both.

• An entity is not required to perform this assessment on ‘worst case’ or ‘stress case' scenarios
• Rather, it is determined on the basis of scenarios which are reasonably expected to occur
• For example, if an entity expects that it will sell a particular portfolio of financial assets only in a stress
case scenario which is not likely to occur, the entity will not consider such scenario to determine its
business model.

An entity may have one of the following models for its debt instruments :

(a) Hold to collect (b) Hold to collect contractual cash (c) Other business model –
contractual cash flows: flows and selling financial assets: Actively buying & Selling :

An entity holds • In this type of business model, the entity’s key • In this business model, an entity
financial assets to management personnel have made a decision manages its financial assets with the
collect contractual that both collecting contractual cash flows objective of realising cash flows
cash flows till and selling financial assets are integral to through the sale as against realizing
maturity. That is, the achieve the objective of the business model. contractual cash flows.
entity manages the • Consider that an entity anticipates capital • The entity makes decisions to hold /
assets held within the expenditure in a few years. The entity invests sell the investment based on an
portfolio to collect its excess cash in short and long—term asset's fair values and manages its
those particular financial assets so that it can fund the financial assets to realise their fair
contractual cash expenditure when needed. Many financial values.
flows. assets have contractual lives which exceed the • In this case, the entity’s objective
entity’s anticipated investment period. Hence, will typically result in an active
the entity will hold financial assets to collect buying and selling. This business
the contractual cash flows and, when an model results in measurement as at
opportunity arises, it will sell the financial FVTPL.
assets to reinvest cash in other financial or
non-financial assets with a higher return.

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SPPI TEST

Contractual terms give rise to cash flows that are Solely Payments of Principal and Interest on the principal amount
outstanding

Contractual cash flows consistent with a basic lending arrangement

Interest element – Consider factors like:

• Time value of money
• Credit risk
• Liquidity
• Profit margin
• Service or administrative costs.

Interest rate can be fixed or floating, zero /any other interest rate

Contractual cash flows linked to features such as changes in equity or commodity prices, would not pass the SPPI test
because they introduce exposure to risks or volatility

SPPI Test will be met if there is a prepayment penalty i.e. additional compensation for early termination or extension of
contract

Features consistent with SPPI Test Features not consistent with SPPI Test
Prepayment option Options, forward and swaps
Fixed / variable rate of interest Conversion options
Caps, floors, collars

Financial Assets Classified as Fair Value Through OCI (FVOCI)

Financial asset (FA) is measured at FVOCI

if it meets both of following criteria:

‘Hold-to-collect and sell’ business

model test + ‘SPPI’ contractual cash flow characteristics test
-characteristics test

Objective is achieved by both holding the financial Contractual terms give rise to cash flows that are
asset in order to collect contractual cash flows and Solely Payments of Principal and Interest (SPPI) on
selling the financial asset the principal amount outstanding.

Intention of the entity is to sell the instrument before the investment matures.

Examples of FA classified and accounted for at FVOCI:

• Investments in government bonds where the investment period is likely to be shorter than maturity
• Investments in corporate bonds where the investment period is likely to be shorter than maturity

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FVOCI – Debt Instruments – Accounting Requirement

For Debt instruments classified as FVOCI, accounting requirements are as follows:

S.No Nature of Item Accounting treatment

1 Interest income To be recognised in profit or loss using the effective
interest rate method
2 Other changes in the carrying amount on To be recognized in OCI
re-measurement to fair value
3 when the related financial asset is Cumulative fair value gain or loss recognised in OCI
derecognised is recycled to profit or loss.

• For debt instruments that are classified as FVOCI, entities will need to track both the amortised cost and fair value
• The amounts recorded in profit or loss will reflect amortised cost and the balance sheet will reflect the fair value of
the financial asset

FVOCI – Equity Instruments – Accounting Requirement

Default Approach –
• Ind AS 109 requires all equity investments to be measured at fair value
• All changes in fair value to be recognised in profit or loss

FVOCI category option – Equity investments (not held for trading)

• Entities can make an irrevocable election at initial recognition to classify the instruments as at FVOCI
• Such option is available instrument by instrument i.e. (item by item)
• All subsequent changes in fair value being recognised in OCI
• Dividends received on equity investments to be recognised in profit or loss

Financial Assets Classified as Fair Value Through PL (FVTPL)

Fair value through profit or loss (FVTPL) is the residual category in Ind AS 109

Financial asset (FA) classified and measured at FVTPL if FA is:

• A held-for-trading financial asset
• A debt instrument that does not qualify to be measured at amortised cost or FVOCI
• An equity investment which the entity has not elected to classify as at FVOCI

Examples of FA classified and accounted for at FVTPL are:

• Derivatives that have not been designated in a hedging relationship, e.g.:
- Interest rate swaps
- Commodity futures/option contracts
- Foreign exchange futures/option contracts
• Investments in shares that the entity has not elected to account for at FVOCI
• Contingent consideration receivable from the sale of a business

Under Ind AS 109, consideration is first given to whether a financial asset is to be measured at amortised cost and
FVOCI and, if it is not, it will be measured at FVTPL

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Classification of Financial Liabilities

Amortized Fair Value through

Cost profit or loss (FVTPL)

Default Residual
category Category

Held for Entity elects to

trading measure at FVTPL
(using fair value option)

Financial liability is classified into two categories:

Category Main use Examples
Amortised Cost • Trade payables
(Default category) All liabilities not in the below category • Bank borrowings
Fair value through • Financial liabilities that are held for • Derivatives eg. Interest rate swaps,
profit or loss trading (including derivatives). Commodity futures/option contracts
• Financial liabilities that are designated as • Contingent consideration payable
FVTPL the entity on initial recognition. arising from one or more
• Contingent consideration recognised by business combinations.
an acquirer in a business combination

Initial Recognition

An entity shall recognise a financial asset or a financial liability in its statement of financial position when, and only
when, the entity becomes party to the contractual provisions of the instrument

Initial Measurement

• On initial recognition, financial assets or financial liabilities are measured at FAIR VALUE.
• If the financial assets or financial liabilities are not recognized at fair value, transaction costs that are directly attribut-
able to the acquisition or issue of the financial asset or financial liability are adjusted against the fair value

What is Transaction Cost?

Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial
instrument.

Examples of costs that qualify as transaction costs Examples of costs that do not qualify as transaction costs
Fees and commissions paid to agents, advisers, brokers Debt premiums or discounts
and dealers
Levies by regulatory agencies and securities exchanges Financing costs
Transfer taxes and duties Internal administration costs
Credit assessment fees and registration charges

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Initial Measurement & Transaction Costs – Financial Assets & Liabilities

Financial asset Initial measurement Transaction costs

At amortized cost Fair value Capitalize
At fair value through OCI Fair value Capitalize
At fair value through profit or loss Fair value Expense

Financial liability Initial measurement Transaction costs

Amortized cost Fair value Deduct from the amount originally recognized
At fair value through profit or loss Fair value Expense

Subsequent Recognition of Financial Assets

Amortized Cost FVOCI FVTPL

• Amortized Cost • Change in FV is • Change in FV is

• Interest / Dividends recognized in OCI recognized in PL
to be recognized in • Interest / Dividends • Interest / Dividends
Profit or loss to be recognized in to be recognized in
Profit or loss Profit or loss

Subsequent Recognition of Financial Liabilities

Amortized Cost FVTPL

Amortized Cost Fair Value

• Change in the FV is
charged to PL

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The classification and measurement of financial instruments

are summarized as below:

Financial Assets Financial Liabilities

Classification Amortised FVTOCI FVTPL Amortised FVTPL

Cost Cost

Basis of Classification • BM test to • BM test to • Held for • Default • If held for

collect collect & sell trading (SPPI criterial trading
• SPPI test • SPPI test or BM test fail) • Entity elects
FVTPL
(using fair
value option)

Initial recognition • Fair Value • Fair Value • Fair Value • Fair Value • Fair Value • Fair Value

Subsequent recognition • Amortised • Fair Value • Fair Value • Amortised • Fair Value • No Re-
Cost Cost measurement

Reclassification of Financial Assets

An entity shall reclassify financial assets, only if the entity changes its business model for managing those financial
assets

Such changes are determined by the entity's senior management as a result of external or internal changes
and must be significant to the entity's operations and demonstrable to external parties

Accordingly, a change in an entity's business model will occur only when an entity either begins or ceases to
perform an activity that is significant to its operations; for example, when the entity has acquired, disposed of
or terminated a business line

Such changes are expected to be very infrequent

Examples of a change in business model include the following:

(a) An entity has a portfolio of commercial loans that it holds to sell in the short term. The entity acquires a
company that manages commercial loans and has a business model that holds the loans in order to collect
the contractual cash flows. The portfolio of commercial loans is no longer for sale, and the portfolio is now
managed together with the acquired commercial loans and all are held to collect the contractual cash flows.
(b) A financial services firm decides to shut down its retail mortgage business. That business no longer accepts
new business and the financial services firm is actively marketing its mortgage loan portfolio for sale.

Following are not changes in business model:

(a) A change in intention related to particular financial assets (even in circumstances of significant changes in
market conditions);
(b) Temporary disappearance of a particular market for financial assets;
(c) A transfer of financial assets between parts of the entity with different business models.

A change in the objective of the entity's business model must be effected before the reclassification date

If an entity reclassifies financial assets, it should apply the reclassification prospectively from the reclassification date

The entity should not restate any previously recognised gains, losses (including impairment gains or losses) or
interest

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Reclassification Of Financial Assets – Accounting

Original Revised Accounting treatment

Classification Classification
Amortised FVTPL • Fair value is measured at reclassification cost date
Cost • Difference between previous amortized cost and fair value is recognised in
P&L

FVTOCI • Fair value is measured at reclassification cost date.

• Difference between previous amortised cost and fair value is recognised in
OCI
• No change in EIR due to reclassification.
FVTPL Amortised • Fair value at reclassification date becomes its new gross carrying amount
Cost • EIR is calculated based on the new gross carrying amount

FVTOCI • Fair value at reclassification date becomes its new carrying amount
• No other adjustment is required

FVTOCI Amortised • Fair value at reclassification date becomes its new amortised cost
Cost carrying amount
• However, cumulative gain or loss in OCI is adjusted against fair value.
Consequently, the asset is measured as if it had always been measured at
amortised cost

FVTPL • Assets continue to be measured at fair value

• Cumulative gain or loss previously recognized in OCI is reclassified to
P&L at the reclassification date

Reclassification of financial liability is not allowed

Accounting for Instruments Exchanged at Off Market Terms

Initial measurement

Instrument at market terms Instrument at off-market terms

Transaction price Determine fair value of financial instrument

If FV based on Level 1 input or valuation technique Any other basis

that uses only data from observable markets

Difference between Difference between FV & transaction price recognized as

FV and transaction price (i) asset (if it qualifies to be);
recognized in P&L (ii) otherwise amortised to P&L

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Impairment- Financial Instruments

General Approach Simplified Approach

• In General Approach, impairment loss is recognized • This approach does not require an entity to track the
based on either 12 month ECL or lifetime ECL. changes in credit risks.
• Impairment loss will be lower in 12 month ECL as it • Each entity recognizes the impairment loss based on
focusses only on the probability of default within lifetime ECL at each reporting date right from its
next 12 months as compared to lifetime ECL as it initial recognition.
focusses on probability of default over life the life of • This approach is mandatory for Trade receivables
an instrument. that do not contain a significant financing
• This method depends whether there has been a component.
significant increase in credit risk.
• One needs to track the change in credit rating /
quality.

Scope and variation of the expected credit loss model

General Simplified
Scope of ECL requirements
approach approach
1. Ind AS 109 Financial Instruments
• Trade receivables that do not contain a significant financing component
• Trade receivables that contain a significant financing component Policy election at entity level
• Other debt financial assets measured at AC or at FVOCI
• Loan commitments and financial guarantee contracts not accounted for at FVPL

2. Ind AS 115 Revenue iron Contracts with Customers

• Contract assets that do not contain a significant financing component
• Contract assets that contain a significant financing component Policy election at entity level
3. Ind AS 116
• Lease receivables Policy election at entity level

What is a credit loss allowance?

Discounted value of
Amount of Contractual cash
Credit loss = flows that are due - cash flows that the
entity expects to
to an entity
receive

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General Approach

Stage 1 Stage 2 Stage 3

12-month ECL Lifetime ECL

Loss allowance Credit losses that result from

updated at each default events that are
reporting date possible within the next 12
months

Credit risk has increased significantly

since initial recognition
Lifetime ECL whether on an collective basis
criterion
+
Credit-impaired

Interest Effective Interest Rate EIR on gross carrying EIR on amortised cost
revenue (EIR) on gross amount
(gross carrying amount
recognised carrying amount less loss allowance)

Credit Risk has Credit Risk has Financial asset

not increased increased is credit
Significantly Significantly impaired

Change in credit risk since initial recognition

Improvement Deterioration

Three Stage Model for Impairment

Stage 1 Stage 2 Stage 3

Particular
Initial Significant increase Credit
Recognition in credit risk Impaired

Credit Risk Low Moderate to High Significant

ECL Model 12 Month ECL Life-time ECL Life-time ECL

Interest recognition Interest on gross Interest on gross Interest on net

recognition recognition carrying amount

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What is a ‘significant’ increase in credit risk?

Interpretation of ‘significant’

Original credit risk at initial recognition Expected life or term structure

• Change in absolute probability of default (PD) • Risk of a default occurring increases with the
occurring is more significant for financial expected life of the financial instrument
instruments with lower initial credit risk as • PD will decrease less quickly over time for
compared to financial instrument with higher initial instrument with significant payments obligations
risk of default occurring close to maturity

Factors or Indicators of Change in the Risk of a Default Occurring

Credit spread (e.g., Operating results Business, financial or

credit default swap) economic conditions

Credit rating (internal Regulatory, economic

or external) or technological
Factors or indicators of
change in the risk of a environment
Rates or terms (e.g., default occurring
covenants, collateral)
Collateral, guarantee
or financial support, if
Credit risk management Payment status this impacts the risk of
approach and behaviour a default occurring

Simplified Approach: Provision Matrix

According to the simplified approach, for trade receivables and contract assets that do not contain a significant
financing component, an entity shall always measure loss allowance at an amount equal to lifetime expected
credit losses

A provision matrix could be used to estimate ECL for these financial instruments

For example, an entity may set up the following provision matrix based on its historical observed default
rates, which is adjusted for forward-looking estimates:
• non-past due: 0.3% of carrying value
• 30 days past due: 1.6% of carrying value
• 31-60 days past due: 3.6% of carrying value
• 61-90 days past due: 6.6% of carrying value
• more than 90 days past due: 10.6% of carrying value

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Probability of Default

Expected credit loss (ECL) = EAD * PD * LGD

Exposure at default (EAD) will be the gross amount of debt financial asset or borrowing

Probability of default (PD) is the likelihood that a loan will not be repaid and will fall into default. It must be
calculated for each borrower. The credit history of the borrower and the nature of the investment must be
taken into consideration when calculating PD

Loss given default (LGD) is the fractional loss due to default

LGD = 1 – Recovery Rate (RR)

Recovery Rate (RR) is defined as the proportion of a bad debt that can be recovered

Derecognition of Financial Assets

Derecognition refers to the timing of removing a financial asset from the balance sheet

Process

Determine whether the de-recognition principles below are

applied to a part or all of an asset (or group of similar assets)

Yes
Have the rights to the cash flows from the asset expired Derecognise the asset
No

Yes Has the entity transferred its contractual rights to receive the
cash flows from the asset?
No
Has the entity assumed an obligation to pay the cash flows from No Continue to recognise
the asset under pass-through arrangement the asset
Yes
Yes
Has the entity transferred substantially all risks and rewards? Derecognise the asset
No
Yes Continue to recognise
Has the entity retained substantially all risks and rewards?
the asset
No
No
Has the entity retained control of the asset? Derecognise the asset
Yes
Continue to recognise the asset to the extent of the entity's
continuing involvement

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Derecognition of Financial Liabilities

An entity shall remove a financial liability (or a part of a financial liability) from its statement of financial
position when, and only when, it is extinguished - ie when the obligation specified in the contract is discharged
or cancelled or expires

A financial liability (or part of it) is extinguished when the debtor either:
(a) Discharges the liability (or part of it) by paying the creditor, normally with cash, other financial assets, goods
or services; or
(b) Is legally released from primary responsibility for the liability (or part of it) either by process of law or by the
creditor.

Legal release by creditor

A debtor can derecognise a liability can only if the creditor legally releases the debtor from the liability

Accounting for an Extinguishment of Financial Liability

1. The difference between the carrying amount of a financial liability (or part of a financial liability)
extinguished or transferred to another party and the consideration paid, including any non-cash assets
transferred or liabilities assumed, shall be recognised in profit or loss
2. Any costs or fees incurred on extinguishment shall be charged to profit & loss

Exchange or Modification of Financial Liability

Debt Restructuring
An exchange between an existing borrower and lender of debt instruments with substantially different terms
shall be accounted for as:
(a) A extinguishment of the original financial liability, and
(b) Recognition of a new financial liability.

The substantially different terms are as below:

(A) (B)
Present value of:
Is greater
• cash flows under the new LESS Discounted present value of
than or equal
terms, the remaining cash flows of
to 10% of (B)
• any fees paid the original financial liability
• net of any fees received

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Accounting treatment –
Costs of fees incurred on extinguishment or Modification

Scenario Accounting

Where exchange of debt instruments or modification Any costs or fees incurred are recognised as part of the
is accounted for as an extinguishment gain or loss in PL on the Extinguishment

Where exchange of debt instruments or modification Any costs or fees incurred shall be adjusted in the
is not accounted for as an extinguishment carrying amount of the liability and are amortised over
the remaining term of the modified liability

Exchange or Modification of Financial Liability – Accounting Treatment

If the 10% test is passed, principle of “extinguishment accounting” are applied, that is:

1. De-recognition of the existing liability.

2. Recognition of the new or modified liability at its FAIR VALUE (net of any fees incurred directly related to
the new liability). Fair value of the new or modified liability is estimated based on the expected future cash flows
of the modified liability, discounted using the interest rate at which the entity could raise debt with similar
terms and conditions in the market.

3. Gain or loss on extinguishment : Charge to PL.

4. Recognising any incremental costs or fees incurred for modification (and not for the new liability), and any
consideration paid or received, in profit or loss.

5. EIR Accounting for New Loan : Calculating a new effective interest rate for the modified liability, which is then
used in future periods.

Modification of Financial Liability – Accounting Treatment

Two alternate approaches are possible: Approach 1 and Approach 2

Approach 1: Recognition of gain or loss on date of modification

1. Under this approach, the difference between:
(a) discounted present value of the remaining cash flows of the original financial liability, and
(b) discounted present value of the remaining cash flows of the new financial liability both computed using
original effective interest rate, is recognized in profit or loss.
2. In addition, any fees or costs incurred will also be recognized in profit or loss.

Approach 2: Amortisation of gain or loss on date of modification

Under this approach,
1. Fees or costs incurred are netted against the existing liability;
2. the effective interest rate is recalculated. This is the rate which discounts the future cash flows as per modified
contractual terms to the adjusted carrying amount mentioned above
3. the adjusted effective interest rate is used to determine the amortised cost and interest expense in future periods

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Derivatives and Embedded Derivatives

DERIVATIVE DEFINITION

Three characteristics

Fair value changes in No or little initial net Settled at a future date

response to changes investment
in one or more
underlying variables

• Measured at Fair Value

• Any change in Fair value needs to be recognised in PL (except for hedge accounting)

Examples of derivatives and underlying

Type of contract Main variable

Interest rate swap Interest rate

FX forward Foreign exchange rate

Commodity option Commodity price

Credit default swap Credit risk

Purchased or written stock call or put option Equity price

Accounting Treatment of Derivative

All derivatives are measured at fair value with changes in fair value being recognized in profit or loss for the
period, except derivatives that qualify as hedging instruments

Particulars DR / CR Amount
Derivative Assets (BS) Dr XXXX
To income on account of derivative (PL) Cr XXXX
(Derivative assets is recorded in case of MTM gain)

Expense on account of derivative (PL) Dr XXXX

Derivative Liability (BS) Cr XXXX
(Derivative liability is recorded in case of MTM loss)

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Embedded Derivatives

Hybrid Instrument

Embedded
Derivative

Host Contract

Host Contract may be Debt , Equity, Executory Contract, Lease, Insurance

Embedded derivative may be Interest rate index, Commodity Index, Equity index

An embedded derivative is:

• a component of a hybrid contract
• that also includes a non-derivative host
• with the effect that some of the cash flows of the combined instrument vary in a way similar
• to a stand-alone derivative.

An embedded derivative causes:

• Some or all of the cash flows that otherwise would be required by the contract
• to be modified according to a specified interest rate, financial instrument price, commodity price, foreign
exchange rate, index of prices or rates, credit rating or credit index, or other variable,
• provided in the case of a non-financial variable that the variable is not specific to a party to the contract.

Host Embedded
Particulars
Contract Derivative
1 Company A holds a bond which is convertible into the ordinary shares Bond Asset Conversion option
of Company B of Bond into shares

2 Company A enters into a lease contract with an inflation factor such Lease contract Adjustment to RPI
that each year, rentals are adjusted for changes in Risk Price Index (RPI)

3 Company A sells PPE to Company B of USD 1 lac. Both the Companies Sale Contract INR / USD foreign
are located in India. Exchange

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Separation of Embedded Derivatives from Host Contract

Does the hybrid contract contain a host that is an asset within the scope of Ind AS 109?

No – separate embedded Yes – don’t separate

derivatives that fulfil certain embedded derivatives (Refer
conditions as below note 1 below)

Economic characteristics and Entire hybrid instrument is

risks of the embedded Yes measured at fair value
derivative are closely related through profit or loss
to those of the host? (Refer note 2 below)

No

A separate instrument with

the same terms as the No
embedded derivative would
meet the definition of a
derivative?

Yes

Is the hybrid contract Yes

measured at fair value
through profit or loss?

No

Embedded derivative is
separated and accounted for
separately (refer section
below)

Note 1:
This implies that embedded derivatives are permitted to be separated from only such hybrid contracts that contain a
host which is either a (a) financial instrument classified as financial liability or equity or compound; or (b) contract
for purchase or sale of a non-financial item.

Note 2:
If both the host and embedded derivative have economic characteristics of an equity instrument, the hybrid
instrument is not carried at fair value through profit or loss. In other words, this measurement category is applicable
only for host contracts which are financial liabilities.

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Accounting For Embedded Derivatives

Is the hybrid contract designated at fair value through profit

or loss in its entirety (paragraph 4.3.5 of Ind AS 109)?

No Yes

Can the fair value of Yes Measure embedded Don’t separate

embedded derivative be derivative and allocate embedded
measured reliably? residual to host derivatives

No

Is the entity able to Yes Is the entity able to Entire hybrid

measure the fair value of measure the fair value of instrument is measured
the hybrid contract? the host contract? at fair value through
profit or loss
No Yes

Fair value of embedded

derivative = Fair value of
hybrid contract minus
fair value of host
contract

Regular Way Purchase or Sale of Financial Assets

Ind AS 109 defines a regular way purchase or sale as,

• a purchase or sale of a financial asset
• under a contract
• whose terms require delivery of the asset
• within the time frame
• established generally by regulation or convention in the marketplace concerned

Regular way purchase or sale of financial assets

Trade date accounting Settlement date accounting

Trade date = date that an entity commits Settlement date = date that an asset is
itself to purchase or sell an asset delivered to or by an entity

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Regular Way Purchase or Sale of Financial Assets – Examples

• For instance, on the Bombay Stock Exchange in India, all transactions in all groups of securities in the Equity
segment, Fixed Income securities and Government securities are settled on “T+2” basis.

• In this case, “T” is the trade date and “T+2” is the settlement date i.e. exchange of monies and securities between
the buyers and sellers respectively takes place on second business day (excluding Saturdays, Sundays, bank and
Exchange trading holidays) after the trade date.

• It follows that if a contract is entered into with a broker for purchase or sale of securities which is normally
traded on the Bombay Stock Exchange, with a settlement period that differs from the norms mentioned above,
it would not be regarded as a regular way purchase or sale.

Trade Date & Settlement Date Accounting

Books Trade Date Settlement Date

In the books Initial Recognition : • Account for any change in the fair value
of buyer • Recognises : Financial asset and of the asset to be received during the
Financial liability on the trade date period between the trade date and the
itself. settlement date.

Subsequent Recognition : Classification wise accounting:

• Subsequently measures the financial • Amortized costs: change in value is not
asset in accordance with its recognised;
classification category. • FVTOCI : FV changes to be recognized
in OCI .
• PVTPL : FV changes to be recognized
in PL.

In the books • Seller derecognises the financial asset. • Derecognises financial asset at the
of seller settlement date.
• Recognises any gain or loss on sale on • Does not recognise any fair value
the trade date. changes between the trade date and
settlement date.

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