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:
Sl.No | Business Model | Measurement |
1 | The financial asset is held to collect contractual cash flows and the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. | Amortised cost* |
2 | Financial asset is held by both collecting contractual cash flows & selling financial assets The financial asset gives rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. | Fair Value Through Other Comprehensive Income (FVTOCI) |
3 | If it does not meet the criteria for the above two methods – residual | Fair Value Through Profit & Loss (FVTPL) |
*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 underIND 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:
Sl.No | Nature of Financial Asset | Interest Revenue calculation |
1 | Normal | EIR to Gross Carrying Amount (GCA) |
2 | Purchased Credit-impaired | Use credit adjusted EIR |
3 | Becomes Credit-impaired | Use EIR in subsequent period |
4 | Contractual cash flow Modified | Recalculate GCA and modify gain or loss in P&L |
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 assetor 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 whichit retains the risks and rewards of ownership of the financial asset.
Sl.No | All Risk and Rewards of ownership | Result |
1 | Transfers substantially | De-recognise the financial asset and recognize separately the obligations created or retained in the transfer |
2 | Retains substantially | Continue to recognize the financial asset |
3 | Neither transfers nor retains substantially | Determine if entity has retained control ofthe 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:
Sl.No | Event | Accounting Process |
1 | Exchange between existing borrower and lender with substantial modification | Extinguishment of the original financial liability and the recognition of a new financial liability |
2 | On extinguishment or transferred to another party (entirely or part) | Difference between the carrying amount and the consideration paid (including any non-cash assets) to be recognized in profit or loss |
3 | Repurchase a part of a financial liability | Allocate the previous carrying amount between the part that continues to be recognized and the part that is de-recognized based on the fair values as on the date of the repurchase |
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, anembedded 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.
Measurement of Reclassification | ||
---|---|---|
Initial | Revised | Accounting |
Amortised Cost | FVTPl | FV on reclassification date and difference in PL |
Amortised Cost | FVOCI | FV on reclassification date and difference in OCI |
FVOCI | Amortised Cost | FV on reclassification date is carrying value. Cumulative gain/loss in OCI adjusted to FV |
FVOCI | FVTPL | Asset considered at FV. Cumulative gain/loss in OCI adjusted in PL |
FVTPL | FVOCI | Asset considered at FV |
FVTPL | Amortised Cost | FV on reclassification date is carrying value. New EIR computed |
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
Sl.No | Name | Explanation |
1 | General Approach | If there is no considerable increase in credit risk since initial recognition then 12 month ECL is used. If credit risk has increased significantly, life-time ECL is used. In future, if credit quality improves to the extent there is a no longer significant increase in credit risk, an impairment loss is based on 12 month ECL. |
2 | Simplified Approach | Tracking changes in credit risk are not required an impairment loss is recognized based on lifetime ECLs at each reporting date. This is mandatory for trade receivables or contact receivables per IND AS 115 if is no significant finance component. Provision is done based on the past overdue. |
Hedging Instruments (HI)
A hedged item can be a recognized asset or liability, an unrecognized firm commitment, a forecasttransaction 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 isrecognized 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.
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I am an expert in financial instruments, particularly well-versed in the International Financial Reporting Standards (IFRS). My deep understanding and practical experience in the field allow me to provide comprehensive insights into topics such as IND AS 109 Financial Instruments.
Let's break down the key concepts discussed in the article:
IND AS 109 Financial Instruments:
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Objective:
- Classification, recognition, de-recognition, and measurement requirements for financial assets and liabilities.
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Financial Asset Classification:
- Based on business model or contractual cash flow pattern.
- Categories:
- Held to collect contractual cash flows (Amortised cost).
- Held for both collecting cash flows and selling (Fair Value Through Other Comprehensive Income - FVTOCI).
- Residual category (Fair Value Through Profit & Loss - FVTPL).
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Financial Liability Classification:
- Generally measured at amortized cost, except for specific cases like fair value through profit and loss.
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Measurement under IND AS 109:
- Initial recognition at fair value.
- Effective Interest Rate (EIR) method for subsequent measurement.
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Recognition of Financial Instruments:
- Recognized in the balance sheet upon execution of contractual agreements.
- Regular way purchase/sale can use trade date or settlement date accounting.
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De-recognition of Financial Assets:
- Applies at a consolidated level.
- Based on transfer of risks and rewards of ownership.
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De-recognition of Financial Liabilities:
- Removed when extinguished (contract obligation discharged, canceled, or expires).
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Embedded Derivatives:
- Component of hybrid contracts.
- Separated if economic characteristics and risks are not closely related to the host.
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Reclassification:
- Change in business model may lead to reclassification of affected financial assets.
- Classification and measurement adjusted on the date of reclassification.
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Impairment - Expected Credit Loss (ECL):
- General Approach: 12-month ECL if no significant credit risk increase since initial recognition.
- Simplified Approach: Lifetime ECLs, tracking changes in credit risk not required for certain receivables.
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Hedging Instruments:
- Criteria for hedge accounting: Eligible hedging items, formal designation/documentation, economic relationship, no dominance of credit risk, and matching hedge ratio.
- Types of hedging relationships: Fair value hedge, cash flow hedge, and a hedge of a net investment in a foreign operation.
This overview covers the fundamental aspects of IND AS 109 Financial Instruments, providing a solid foundation for understanding its principles and applications.