AS30-Financial Instruments

Accounting Standard : 30
Financial Instruments –
Recognition and Measurement
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Not to published, presented or used
in any form whatsoever without the prior
permission in written from ARC or the Author
Coverage
• Scope
• Initial Recognition and Classification
• Embedded Derivatives
• Derecognition
• Subsequent Measurement, Fair
Values and Impairment
• Hedge Accounting
Scope
• Applies to:
1. Debt & Equity investments (other than
investments in subsidiaries, associates and
JVs);
2. Loans and receivables;
3. Own Debt (except own equity, taxes, employee
benefits)
4. Cash & cash equivalents
5. Derivatives including embedded derivatives;
6. Loan Commitments
7. Financial Guarantees (except insurance
contracts, weather derivatives)
Initial Recognition and Classification
• Overview:
1. Financial assets and liabilities are initially measured at
FV;
2. An entity may designate a financial instrument
irrevocably on initial recognition as held at fair value
through profit & loss, provided certain criteria are met;
3. Loans purchased by the entity that would otherwise meet
the definition of loans and receivables are classified as
such;
4. Failure to comply with the rules for held to maturity
assets taints the whole category;
5. Transfers into and out of held for trading category after
initial recognition are prohibited
Embedded Derivatives
1. Embedded derivatives should be
accounted for separately if their
economies are not closely related
to those of the host contract
Derecognition – Removal of an Asset
or Liability from the Balance Sheet
• A financial asset (or a part of a financial asset) is
derecognised when:
1. The rights to the CFs from the asset expire;
2. The rights to the CFs from the asset and substantially all
the risks and rewards of the ownership of the asset are
transferred;
3. An obligation to transfer the CFs from the asset is
assumed and substantially all the risks and rewards are
transferred;
4. Substantially all the risks and rewards are neither
transferred nor retained but control of the asset is
transferred
Derecognition – Removal of an Asset or
Liability from the Balance Sheet…contd.
• If the entity retains control of the asset but
does not transfer substantially all the risks
and rewards, the asset is recognised to
the extent of the entity’s continuing
involvement;
• A financial liability is removed from the
B/S only when it is extinguished – i.e.
when the obligation specified in the
contract is discharged or cancelled or
expires
Subsequent Measurement, Fair Values
and Impairment
• Subsequent measurement of financial assets and
liabilities depends upon classification:
1. Trading assets and liabilities and available-for-sale
assets are carried at FV;
2. Loans and advances and held-to-maturity investments
are carried at amortised costs;
• The best evidence of FV is quoted market price in an
active market;
• If quoted market prices are not available, valuation
techniques are used;
• Impairment loss should also be considered while valuing
Financial Assets
Hedge Accounting
• In order to apply hedge accounting, strict criteria,
including, the existence of formal documentation
and the achievement of effectiveness test, must be
met;
• Hedge accounting can be applied to three types of
hedging relationships viz. fair value hedges, cash
flow hedges and hedges of net investment in a
foreign operation;
• Hedge accounting must be discontinued
prospectively if the hedging relationship comes to
an end, or one of the hedging accounting criteria is
not met or hedging relationship is revoked
Illustration – Cash Flow Hedges
ABC Co. is reviewing its maize purchases for the coming
season. They anticipate purchasing 1,000 tons of maize
after 2 months. Currently, the 2 month maize futures are
selling at a price of $600 per ton and they will be satisfied
with purchasing their maize inventory at this price by the
end of May.
As renewed drought is staring the farmers in the face, they
are afraid that the maize price might increase. They
therefore hedge their anticipated purchase against this
possible increase in the maize price by going long (i.e.
buying) on 2-months maize futures at $600 per ton for 1,000
tons. The transaction requires the ABC Co. to pay an initial
margin of $30,000 into its margin account. Margin accounts
are updated twice every month
Illustration – Cash Flow Hedges
The following market prices are applicable:
Date Future Price per ton
April 1 $600
April 15 $590
April 30 $585
May 15 $605
May 31 $620
The maize price in fact did undergo an increase because of
drought and the ABC Co. purchases the projected 1,000 tons
of maize at the market price of $620 per ton on May 31
Illustration – Cash Flow Hedges
Working Notes:
Calculation of variation margins:
April 15: (600-590) x 1,000 tons = $10,000 (payable loss);
April 30: (590-585) x 1,000 tons = $5,000 (payable loss);
May 15: (585-605) x 1,000 tons = $20,000 (receivable profit)
May 31: (605-620) x 1,000 tons = $15,000 (receivable profit)
Illustration – Cash Flow Hedges
Inventory A/c 6,20,000
To Cash 6,20,000
May 31
Cash Receivable 15,000
To Hedging Reserve 15,000
May 31
Cash Receivable 20,000
To Hedging Reserve 20,000
May 15
Hedging Reserve 5,000
To Cash Payable 5,000
April 30
Hedging Reserve 10,000
To Cash Payable 10,000
April 15
Initial Margin A/c (B/S) 30,000
To Cash 30,000
April 1
Illustration – Cash Flow Hedges
1. The gain or loss on the cash flow hedge should be
removed from equity and the value of the
underlying asset recognised should be adjusted;
2. If the futures contract did not expire or was not
closed on May 31st, the gains of losses calculated
on the futures contract thereafter would be
accounted for in the income statement, because the
cash flow hedge relationship no longer exists
Notes:
Hedging Reserve 20,000
To Inventory 20,000
May 31
Cash A/c 30,000
To Initial Margin A/c 30,000
May 31
Thank You