IND AS 109 Financial Instruments

IND AS 109 Financial Instruments deals with classification, recognition, de-recognition and measurement requirements for all the financial assets and liabilities. This standard provides guidelines for accounting and reporting of the Financial Instruments (FI) which will enable the stakeholders to assess the timing and uncertainty of a business future cash flow.

Classification of financial assets

An entity shall classify its financial assets based on its business model for managing the financial assets or the contractual cash flow pattern of financial asset subsequently measured at:

*Amortised cost is the cost of asset or liability adjusted to achieve a constant effective rate of interest over the life of asset or liability. Amortized Cost method generally involves calculation of present value of all future cash flows expected throughout the life of the FI at the market prevailing rate of interest.

Classification of financial liabilities

All financial liabilities are measured at amortized cost, except: (a) At FVTPL shall be subsequently measured at fair value (b) Transfers that do not qualify for derecognition (continuing involvement approach) (c) Financial guarantee contracts (d) Commitments to provide a loan at a below-market interest rate (e) Contingent consideration shall be measured at fair value with changes recognized in profit or loss

Measurement under IND AS 109 Financial Instruments

Initial recognition is at fair value (transaction value) otherwise, the direct transaction cost of the FI is considered. Effective Interest Rate (EIR) method explained below:

Recognition of Financial Instruments

An entity shall recognize a financial asset or a financial liability in its balance sheet only when the entity executes the Contractual agreement involving the Instrument. A regular way purchase or sale of financial assets can be recognized and de-recognized using either the trade date accounting or the settlement date accounting.

De-recognition of financial assets

This concept is applied at a consolidated level and hence, an entity first consolidates all subsidiaries in accordance with IND AS 110. De-recognition shall be applied to a part of a financial asset or to its entirety or group subject to certain conditions. An entity shall de-recognize a financial asset only when the contractual rights to the cash flows from the financial asset expire, or it transfers the financial asset and the transfer qualifies for de-recognition. When an entity transfers a financial asset, it shall evaluate the extent to which it retains the risks and rewards of ownership of the financial asset.

De-recognition of financial liabilities

An entity shall remove a financial liability (or a part of a financial liability) only when it is extinguished (Contract obligation is discharged or canceled or expires).

Let’s see the various situation of the accounting process:

Embedded derivatives

 An embedded derivative is a component of a hybrid contract that also includes a non-derivative host contract. Some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative. A derivative that is attached to an FI but is contractually transferable independently of that instrument, or has a different counter party, is not an embedded derivative, but a separate FI.

Hybrid contracts with financial asset hosts

A hybrid contract contains both derivative and non- derivative which is not possible to transfer independent of host contract. If a hybrid contract contains a host that is not an asset, an embedded derivative shall be separated from the host and accounted for as a derivative only if:

• The economic characteristics and risks of the embedded derivative are not closely related to the host
• A separate instrument with the same terms as the embedded derivative meets the definition of a derivative
• The hybrid contract is not measured at fair value with changes in fair value recognized in profit or loss If unable to separate and measure embedded derivative from its host either, then designate the entire hybrid contract as at FVTPL. If unable to reliably measure the fair value then the difference between the fair value of the hybrid contract and the host is considered as its fair value otherwise it’s designated as at FVTPL.

Reclassification

When an entity changes its business model for managing financial assets then reclassify all affected financial assets. An entity cannot reclassify any financial liability. Classification is done based on certain principles, hence reclassification to be done if principles changes. Measurement has to be done on the date of reclassification.

Write-off

Gross Carrying Amount of a financial asset is directly reduced when no reasonable expectations of recovering a financial asset in its entirety or a portion thereof.

Impairment – Expected Credit Loss (ECL)

Impairment obligations/ recognition is based on Expected Credit Loss (ECL) model. The ECL method is required to be applied to: 1. FI measured at amortised cost 2. FI measured at FVOCI 3. lease receivables, and trade receivables or contract assets 4. financial guarantee contracts to which Ind AS 109 applies and not accounted for at FVTPL 5. all loan commitments not measured at FVTPL  

Hedging Instruments (HI)

A hedged item can be a recognized asset or liability, an unrecognized firm commitment, a forecast transaction or a net investment in a foreign operation. The hedged item can be a single item or a group of items which are reliably measurable or probable. A hedging relationship qualifies for hedge accounting only if all of the following criteria are met:

• It consists only of eligible HI and eligible hedged item
• There are formal designation and documentation and the entity’s risk management objective 
• Meets all of the following hedge effectiveness requirements:
  • Economic relationship between the hedged item and HI
  • The effect of credit risk does not dominate the value changes and
  • The hedge ratio of the hedging relationship is the same as that the entity actually hedges and the quantity of the HI that the entity actually uses to hedge that quantity of hedged item

Accounting treatment for the three types of hedging relationships:

A. Fair value hedge:

• The gain or loss on the HI recognized in profit or loss 
• Hedging gain or loss on the hedged item is adjusted to the GCA. Gain or loss of financial asset measured at FVTCI is recognized in profit or loss
• Hedged item is an equity instrument adopting changes in FVOCI shall remain in OCI
• Hedged item is an unrecognized firm commitment, the cumulative change in the fair value is recognized as an asset or a liability with a corresponding gain or loss recognized in P&L

B. Cash flow hedge:

• Cash flow hedge reserve is adjusted to the lower of the following:        
  • the cumulative gain or loss on the HI from its inception        
  • the cumulative change in fair value of the HI 
• The portion of the gain or loss on the HI that is determined to be an effective hedge is recognized in OCI.
• Any remaining gain or loss on the HI is hedge ineffectiveness is recognized in P&L

C. A hedge of a net investment in a foreign operation: 1

• Portion of the gain or loss on the HI that is determined to be an effective hedge is recognized in OCI
• Ineffective portion is recognized in P&L.