Financial Instruments

Jul 13, 2024

Lecture: Financial Instruments - Ind AS 109, 32, and 107

Instructor: CA J. Chava

Introduction

  • Topics covered: Ind AS 32, 107, 109
  • Language of lecture: Simple English
  • Total lecture duration: 12 hours
  • Focus: Comprehensive coverage of financial instruments, including recognition, derecognition, and impairment.

Overview of Indian Accounting Standards (Ind AS) Relevant to Financial Instruments

Ind AS 32: Financial Instruments - Presentation

  • Definition
  • Presentation of financial assets, liabilities, and equity in the balance sheet

Ind AS 109: Financial Instruments

  • Recognition and measurement of financial assets and liabilities
  • Detailed accounting treatments

Ind AS 107: Financial Instruments - Disclosures

  • Disclosure requirements related to financial instruments

Importance and Scope

  • Financial instruments significantly cover at least 50% of the balance sheet.
  • Essential for both exam purposes and practical financial statement preparation.

Key Definitions

Financial Instruments

  • Definition: A contract creating a financial asset for one entity and a financial liability or equity instrument for another entity.
  • Examples: Loans, equity shares, bonds, and derivatives.

Financial Asset

  • Definition: Cash or any contractual right to receive cash or another financial asset from another entity.
  • Examples: Trade receivables, loans, equity shares of another entity.

Financial Liability

  • Definition: Any contractual obligation to deliver cash or another financial asset to another entity.

Equity Instrument

  • Definition: Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Classification and Measurement of Financial Assets (Ind AS 109)

Categories of Financial Assets

  1. Amortized Cost (AMC)

    • Conditions: Hold to collect business model and solely payments of principal and interest (SPPI)
    • Measurement: Recognized at the present value of contractual cash flows
  2. Fair Value Through Other Comprehensive Income (FVOCI)

    • Conditions: Business model to hold to collect and sell, SPPI test
    • Measurement: Fair value with changes recognized in OCI
  3. Fair Value Through Profit or Loss (FVTPL)

    • Residual category where neither AMC nor FVOCI criteria are met
    • Measurement: Fair value with changes recognized in P&L

Initial Recognition and Measurement

  • AMC: Present value of CCF at effective interest rate plus/minus transaction cost
  • FVOCI: Fair value plus/minus transaction cost
  • FVTPL: Fair value with transaction costs to P&L

Subsequent Measurement

  • AMC: Regular income to P&L, re-measurement at present value of remaining CCF
  • FVOCI: Regular income to P&L; re-measure changes to OCI, reclassification adjustments on derecognition
  • FVTPL: Regular income and fair value changes to P&L

Impairment of Financial Assets (Ind AS 109)

Expected Credit Loss (ECL) Model

  • General Approach: Applied to financial assets not measured at FVTPL
  • ECL Calculation: Probability of default (PD) × Loss given default (LGD) × Exposure at default (EAD)

Classification of Credit Risk

  • 12-Month ECL: Losses expected over the next 12 months
  • Lifetime ECL: Losses expected over the entire life of the asset

Journal Entries for Impairment

  • Recognition of Loss: Impairment loss account debit to Loss Allowance
  • Derecognition upon Credit-Impairment: Loss Allowance to Financial Asset

Derecognition of Financial Assets (Ind AS 109)

Conditions for Derecognition

  1. Transfer of contractual rights to receive cash flows
  2. Transfer involves transferring substantially all risks and rewards
  3. Expiry of contractual rights

Partial Derecognition

  • Current carrying amount of the financial asset is split
  • Journal Entry: Financial Asset (Retained) debit, Financial Asset (Transferred) debit to Entire Financial Asset, Bank (Proceeds), and Gain/Loss on Derecognition

Embedded Derivatives

  • Derivatives embedded in host contracts must be separated if they are not closely related to the host contract.
  • Example: Foreign currency contracts embedded in non-financial contracts.

Hedge Accounting (Ind AS 109)

Types of Hedges

  1. Cash Flow Hedge: Hedging variability in cash flows
  2. Fair Value Hedge: Hedging changes in the fair value of recognized assets or liabilities
  3. Hedge of Net Investment in a Foreign Operation: Protecting the value of net investments in foreign operations

Hedge Effectiveness

  • Measurement: Regularly assess whether the hedge is effective in offsetting changes in fair value or cash flows.
  • Accounting: Record the gain or loss on the hedging instrument in OCI for cash flow hedges and in P&L for fair value hedges.

Conclusion

  • Financial instruments chapter is comprehensive, covering a variety of accounting aspects including recognition, measurement, impairment, and hedging.
  • Essential for the preparation and analysis of financial statements.

Homework

  • Practice questions and examples from the lecture material.
  • Review modifications, impairments, derecognition, and hedge accounting.
  • Focus on understanding the practical applications of the standards discussed.