as 30 31 32 - analysing impact on banks - 201109
TRANSCRIPT
8/6/2019 As 30 31 32 - Analysing Impact on Banks - 201109
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Analysing Impact of AS
30, 31, 32 on Banks
Financial Services Industry – Emerging
Trends, Challenges & Way Forward
WIRC of ICAINovember 20, 2009 Presented by :‐
Ashutosh Pednekar Partner, M P Chitale & Co.
2 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Disclaimers
These are my personal views and can not be construed to
be the views of M/s.M. P. Chitale & Co., Chartered
Accountants
ICAI has no responsibility for its contents
These views do not and shall not be considered as a
professional advice.
This presentation should not be reproduced in part or in
whole, in any manner or form, without my written
permission.
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3 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Why an AS for Financial Instruments ?
Globalisation of Indian Economy;
Increasing sophistication of financial products andmarkets;
Increased use of derivatives for risk mitigation andtrading;
No comprehensive standard until now (AS -13, AS - 11
and AS - 16 partly deal with the same);
Diverse practices made comparability of performance
difficult.
4 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
AS for financial instruments
Recognition
and
derecognition
of
financial
instruments
Measurement
of
financial
instruments
Derivatives
and
hedge
accounting
AS 30
Presentation
AS 31
Disclosure
AS 32
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5 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Key concepts
Fair valuation;
Symmetry; and
Hedge accounting
The standard focuses on substance over form in accountingfor financial instruments. The key concepts that come tofore are:
The standard is likely to have far reaching implications onaccounting of most assets and liabilities with consequent PLimplications due to fair valuation, changes in various lawsand challenging certain normally accepted principles
6 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
AS 31 – Objective and scope
Establish principles for
Presenting financial instruments as liability or equity (and relatedclassification of interest, dividends, losses and gains) by theissuer
Offsetting a financial asset and a financial liability
Presentation of transactions in own equity
Accounting for treasury stock
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7 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Financial
asset
&
Financial instruments – definition
Contract that gives rise toboth a financial asset of one
entity
Financial
liability
Equity
instrument
A financial liability and /or anequity
instrument of another entity
8 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Financial instruments – examples
Financial assets and liabilities
Trade receivables and payables
Loans receivable and payable
Deposits and advances
Perpetual debt instruments
Contractual rights arising on contingent assets – eg. Guarantees
Finance leases
Following are not financial assets and instruments
Physical assets such as property, plant and equipment
Prepaid expenses (associated with the delivery of goods and servicesand not contractual obligation to pay cash or another financial asset).
Liabilities that are not of a contractual nature (such as income taxes)
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9 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Financial instruments – examples…
Equity instruments
Equity shares
Irredeemable preference shares
Portion of preference shares having discretionary dividends afterreducing liability component
Warrants / written call options that are settled by a fixed number ofown instruments for a fixed amount of cash or another financialasset (equity option component of a convertible bond/debenture)
Derivative financial instruments
Options, futures, forwards, interest rate swaps, currency swapsetc.
IMPACT ANALYSIS
New concept for Indian GAAP
10 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Liability or Equity?
Financial instrument is an equity instrument only if both criteria aremet:
There is no obligation to deliver cash or another financial asset or toexchange financial assets or financial liability; and
The issuer will exchange fixed amount of cash or another financial assetfor a fixed number of its own equity instruments.
Does the entity have an unavoidable contractual obligation to deliver or exchange?
Yes No
Liability Equity
When there is a statutory requirement for classification as equity or liability,compliance with law = compliance with AS
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11Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Liability or Equity? Compound instrument = part equity and part debt e.g. convertible debt
Split accounting required
The liability portion is valued first and the equity portion is the residual amount
Classification of liability and equity components of a convertible instrument is
not revised as a result of a change in the likelihood that a conversion option
will be exercised.
Standard does not prescribe the specific line item in equity where a equity
component of a compound instrument should be reflected in.
No gain or loss arises from initially recognising the components of a
compound instrument separately. Once allocation of equity and liability components are made, subsequent gain
or loss is made in accordance with the accounting principles applicable to the
related component.
Subsequent changes in the terms of an instrument are recognised (by
comparing with the fair value of the new instrument) in the profit and loss
account.
12 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Liability or Equity?
Does the issuer potentially have
an obligation to settle gross incash or in a variable number
of own shares?
Will settlement be the exchangeof fixed number of shares
for fixed amount?
Liability
Equity
Derivative
No
No
Yes
Yes
A contract is not an equity instrument solely because it will result in the delivery of the entity’s own equity instruments
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13 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Contingent settlement provisions
An instrument with a contingent settlement provision wouldbe a financial liability for the issuer unless:
The contingent settlement provision that could require settlement incash or another financial asset is not genuine; or
The issuer can be required to settle the obligation in cash or anotherfinancial asset only in the event of liquidation of the issuer.
IMPACT ANALYSIS
Recognition on BS the financial liability arising out of suchprovisions
14 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Buyback of shares
If an entity re-acquires (buys-back) its own shares, nominalvalue of those shares should be deducted from share capital
No gain or loss should be recognized in the profit and loss account;
Difference between the consideration paid and the nominal value ofshares should be recognized in an appropriate equity account.
IMPACT ANALYSIS
In an era of capital raising by banks this has not beenexperienced yet
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15 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Interest, dividends, losses and gains
Income statement classification of interest, dividends, losses and gainsfollows directly from the balance sheet classification as liability or equity.
Any income statement effect on a financial liability will be recognized as anexpense irrespective of the nomenclature of the item eg. dividends,distributions etc.
Distributions to holders of an equity instrument should be recognized in anappropriate equity account
Transaction costs, net of any income tax benefit, of an equity transactionshould be recognized in an appropriate equity account
Discount accretion / redemption premiums form part of the recognizedinterest expense for a period on an effective interest rate basis.
Dividends classified as an expense are presented in the statement of profit
and loss as a separate item.
16 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Offsetting a financial asset and afinancial liability
currently has a legally enforceable right to set off
and an intention to settle net
or to realise the asset and settle the liability simultaneously
Practical situations will cause implementation challenges
Master netting agreements
Several instruments used to emulate a single instrument (synthetic instrument)
Items with the same risk, but different counterparties
Financial assets pledged as collateral for non-recourse liabilities
Financial assets that did not qualify for de-recognition under AS 30
but
In practice, netting will be difficult to achieve other than in very limitedsituations….because neither pure intention nor pure legal right is sufficient
IMPACT ANALYSIS
New concept for Indian GAAP
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17 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
AS 30 Coverage
Definition
Recognition & Measurement
Reclassification
Impairment & Derecognition
Derivatives & Embedded Derivatives
Hedging
Transitional Provisions
18 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Scope of AS 30 – applies to all Financialinstruments except:
Interest in Subsidiaries, Associates and Joint Ventures covered by AS 21,
23 & 27 except as mentioned in those standard;
Lease transaction covered by AS 19. However lease receivables, payables
& derivatives embedded in lease will be covered by this standard;
Insurance Contracts. However financial guarantee contracts and derivativesembedded in insurance contract covered by this standard ;
Contingent consideration for the acquirer or business combinations to buyor sell at a future date;
Loan commitments, other than specific inclusions;
Share based payments (incl ESOPs) and Employers rights and obligationsunder AS 15;
Own use commodity contracts other than those which are generally settlednet in cash;
Items are scoped out of the standard if another standard is more prescriptivein dealing with such items.
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19 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Present Classification of financial
instruments by Banks
Presented by way of a note and as Contingent LiabilitiesDerivatives
Category Particulars
Loans Bills Purchased & Discounted
CC, ODs and Loans Repayable on Demand
Term Loans
Further detailed presentation – popularly called 9 –wayclassification
Investments 6 line items to be presented
3 way categorisation HTM, AFS & HFT
Liabilities No specific categorization other than the line itemsspecified in the BR Act format
20 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
AS’ classification of financialinstruments
Category Definition
Financial assetsand financialliabilities at fairvalue through profit
and loss
Classified as held for trading (intended to be activelytraded)
All derivatives are classified as held for trading (exceptthose used as hedging instruments on financial guarantee)
Financial asset or financial liability designated as such atinception (subject to certain conditions)
Held-to-maturityinvestments
Financial assets with fixed or determinable payments andfixed maturity that an entity has the positive intention andability to hold to maturity
Loans andreceivables
Non-derivatives financial assets with fixed or determinablepayments, whether originated or acquired, quoted in anactive market. (Does not need to have a fixed maturity)
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21Ashutosh Pednekar, Partner, M. P. Chitale & Co.
AS’ classification of financialinstruments…
Category Definition
Available-for-sale financialassets(AFS)
Non-derivative financial assets designated as AFSor that are not:
Loans or receivables
Held-to-maturity investments
Financial assets at fair value through profitand loss
Other financialliabilities
Financial liabilities that are not classified as “fairvalue through PL”, e.g. Warrants, obligations todeliver cash/cash equivalents/financial assets
22 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Held-to-Maturity Investments
Positive intent and ability to hold to maturity ?
Was any held-to-maturity instrument sold orreclassified in the current or two preceding years?
Yes
Classify as held-to-maturity andmeasure at amortised cost
Near maturity
Isolated event beyond an entity’s control
Collected substantially all principal OR
Insignificant amount in relation to the held-to-maturity portfolio
NoYes
Yes
Reclassify all HTM instruments asavailable-for-sale
No
IMPACT ANALYSIS
RBI permits sale ofHTM portfolio – willthis fail the test ofintention to hold?
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23 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Available-for-sale financial assets
All available for sale assets are marked to market through a separatecomponent of equity (Investment revaluation reserve account)
Gains and losses on AFS assets are recognised in the profit and lossaccount on disposal or impairment of the asset. However, there are anumber of other complications with available for sale gains and losses
Gain or loss on available-for-sale asset
Effective interest
rate
Other changes in
fair value
Change in valuedue to spot FXchange
Change in valuedue to embeddedderivative
EquityProfit and Loss Account
Recycled to the profit andloss account on disposal orimpairment of the asset
24 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Classification determines subsequentmeasurement of financial assets
Available-for-sale
At fair valuethrough P&L
No
Yes
Classified as held fortrading or designated
as at fair valuethrough P&L at
inception
Non-derivativefinancial assets,fixed/determinable
payments, not quotedin active market
Intent and ability tohold to maturityand meets other
criteria
Yes
Yes
No
No
Loans andreceivables
Held-to-maturity
F a i r v a l u e
( A m or t i s e d ) c o s t
… similarly applies to financial liabilities
IMPACT ANALYSIS
All valuation has to beon gross basis unlessoff setting applies
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25 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Initial Recognition
Initial Recognition of a FA or FL to be done by an entitywhen, and only when it becomes a party to thecontractual provisions of the instrument
All contractual rights & obligations under derivatives are tobe recognized on balance sheet as asset or liability except:-
If a transfer does not qualify for dercognition then
Transferor does not recognize derivatives of the FA / FL separately
Transferee does not recognize transferred FA / FL as its FA / FL
26 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Initial Recognition…
Recognize assets to be acquired or liabilities to be incurred as
a result of firm commitment to purchase or sell goods or
services only when
At least one of the parties has performed under the agreement or
It is a firm commitment applicable under the Standard But in case of an unrecognized firm commitment that is designated as
“hedged item” in a fair value hedge, any change in net fair value attributable
to hedged risk is recognized as asset or liability after inception of hedge
Don’t recognize FA/FL arising out of planned future transactions no
matter how likely, as entity is not party to the contract
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27 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Fair Value = the amount for which an asset could be exchanged, or aliability settled, between knowledgeable, willing parties in an arm’s
length transaction
At fair value + / - directlyattributable transaction cost
Other FA / FL
At fair value ondate ofacquisition orissue
FA / FL @ FVTPL
Original invoice amountif effect of discounting isimmaterial
Short-term receivables / payables with no stated interest
rate
If settlement date accounting is used for an asset that is subsequentlymeasured at cost or amortized cost, then it is initially recognized at FV on
the trade date
Initial Measurement
28 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Fair value (FV)
Presumption of FV
Entity is a going concern, without
the intention or need to liquidate or
curtail materially the scale of operations or
to undertake a transaction on adverse terms
FV is not the amount that would be received or paid in
a forced transaction,
involuntary liquidation or
distress sale
FV reflects credit quality of financial instrument
E.g. Amount lent at below market rate and up-front received as
compensation; discount accreted to the PL A/c using effective
interest rate method
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29 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Transaction Costs (TC)
TC = Incremental cost directly attributable to acquisition, issue or disposal
of FA or FL
Increment cost = cost that would not have been incurred if the entity had not acquired,
issued or disposed off the financial instrument
For FA TC are added to amount originally recognized
For FL TC are deducted from amount of debt originally recognized
Present RBI requirement is to charge off TC
TC expected to be incurred on transfer or disposal of a FI are not included in its
measurementTC not considered in fair value measurement at initial recognition
FI @ FV through PL
Short term receivables & payables
TC included in calculation of amortized cost using effective interest rate method andthus amortized through P & L over life of instrument
30 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Subsequent Measurement of FA
Test forimpairment to beperformed
Test for impairmentto be performed
Test forimpairment to beperformed
No test forimpairment to beperformed
Amortized Cost
using effectiveinterest method
HTM Investments
FV without
deductingtransactions coststhat may beincurred on sale ordisposal
FA @ FVTPL
Amortized Cost usingeffective interestmethod except forshort-termreceivables that arecarried at original
invoice amount
Loans &Receivables
FV withoutdeductingtransactions coststhat maybe incurredon sale or disposal
Available for Sale
Equity instruments without quoted value & whose fair value cannot be reliably measured and
derivatives linked to such equity instruments measured at cost
For FA measured at FV and the FV is negative, then it is a FL
Hedged FA items to follow hedge accounting requirements
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31Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Subsequent Measurement of FL
At amortized cost using effective interest method except
FL at FVTPL unless
Derivative liability linked to an unquoted equity instrument whose
FV cannot be determined measured at cost
FL arising out of transfer of FA not qualifying for derecognition
Recognize obligations retained by the entity
Short-term payables at original invoice amount
Financial Guarantee Contract & Commitments to provide Loans
below Market Interest Rate, higher of
Amount determined as per AS 29 and
Amount initially recognized
Hedged FL items to follow hedge accounting requirements
32 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Regular Way Purchase or Sale of a Financial Asset
Trade Date Accounting : The trade date is the date that an entitycommits itself to purchase or sell an asset.
Settlement Date Accounting : The settlement date is the date on
which an asset is delivered to or by an entity.
There is no bar in applying Trade Date Accounting forcertain category of Financial Asset and Settlement DateAccounting for another category
Trade date/Settlement Date
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33 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
ReclassificationsAt fair value through profit or loss category
No reclassification of a financial instrument either into or out of this
category is permissible
HTM Investments to AFS category
Reclassify the investment as ‘available for sale’
Remeasure it at fair value
Recognise the difference between its carrying amount and the fair value in theappropriate equity account (Investment Revaluation Reserve Account).
From AFS to HTM category
the fair value carrying amount on that date becomes its new cost.
Any previous gain or loss recognised directly in the appropriate equityaccount:
Is amortised over the remaining life of the investment using the effectiveinterest rate method.
IMPACT ANALYSIS
RBI permits reclassification – will this be construed asagainst AS 30?
34 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Gains & Losses on changes in FV
FA / FL @ FVTPL
Recognized in P & L
AFS – FA
Appropriate Equity Account (Investment Revaluation Reserve) except
Impairment losses & Foreign Exchange Gains & Losses to P & L
When FA is derecognized, balance in this equity account is transferred
to P & L
FA / FL @ Amortized Cost
Recognized in P & L
Hedged items to follow Hedge Accounting requirements
In case of settlement date accounting
Change in FV between trade date & settlement date is not recognized ifthe FA / FL is carried at cost
Otherwise it is taken to P & L or the Appropriate Equity Account
IMPACT ANALYSIS
AFS presently net negative in PLand net positive is ignored
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35 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Objective evidence of impairment
Evidence of impairment
Significant financial difficulty of the issuer
Default or breach of contract
Granting of a concession by the lender due to the borrower’s financial position
Bankruptcy or financial reorganisation of the borrower
Disappearance of an active market for the assets concerned because of financialdifficulties
Significant or prolonged decline in market price in the case of an equity security
Observable data that there is a measurable decrease in the estimated future cash flowsfor a group of financial assets
Adverse changes in the payment status of borrowers in the group
National or local economic conditions that correlate with defaults on assets in the group
At each balance sheet date, the entity should assesswhether there is objective evidence of impairment for anasset or group of financial assets
36 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Assessment of objective evidence for Impairmentof financial assets measured at amortised cost
Individually significantfinancial assets
yes no
Individually
significant impaired
Asses separately Collectively
Not included incollective
assessment
yes no
Included incollective
assessment
results
continue
IMPACT ANALYSISWill all this change the IRACnorms?Focus is on cash flows not onsecurity value as at present
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39 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Main concepts of derecognition principles
Continued
recognition
Assets remain onthe balance sheet of
the transferorDerecognise
Assets qualifyfor
de-recognitionand removal
from the
balance sheet
Analysis of
risks andrewards
of ownership of
financial assets
Yes
Yes
Has the entity transferred its rights toreceive the cash flows from the asset?
Has the entity assumed an obligation topay the cash flows from the asset thatmeets the conditions in paragraph 18?
Has the entity retained substantially allrisks & rewards?
Yes
Continue to recognise the asset to the extent of the entity’s continuing involvement
Analysis of
control offinancial assets
Yes
No
Have the rights to the cash flows fromthe asset expired?
Has the entity retained control of theassets?
No
Has the entity transferred substantiallyall risks and rewards?
No
No
No
No
Yes
If the entity retains the right to service the FA for a fee it should recognise a serviceasset or liability for that service contract
Yes
E.g. Repo, securitization, PTC Etc.
IMPACT ANALYSIS Securitisation guidelines willneed to be reviewed
40 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Freestanding derivatives – definition
Fair value changes inresponse to the change inunderlying
Interest rate
Financial instrument price
Commodity price
Foreign exchange rate
Credit rating/index
Index of prices or rates
Other variables (in the caseof a non-financial variable -it is not specific to a partyto the contract)
Three characteristics
No initialnet investment or an initial netinvestment that is smaller than
would be required for othertypes of contracts that wouldbe expected to have a similar
response to changes inmarket factors
Settledat a future date
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41Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Derivatives excluded from AS 30
derivative accounting rules
All derivatives are always marked-to-market (MTM) withchanges in fair value recognised in the P&L (unless usedas hedging instruments in cash flow hedge when fair valuechanges are in reserves) except for:
Regular way purchase or sale of afinancial asset
Delivery within a time frameestablished by regulation orconvention in the market
Apply trade date or settlement dateaccounting
Contracts for ‘normal’ purchasesand sales of non-financial items
Intended to meet purchase, sale orusage requirements
Designated for that purpose
Will be settled by delivery
42 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Embedded derivatives
How to identify?
An implicit or explicit term in a contractthat makes it behave like a derivative
Instruments with conversion features
Instruments with option to extend the termof debt
Index linked payments
Purchase or sale of contracts in foreign / third currency (other than currency ofmajor party, or currency in which thecontract is normally denominated)
When to separate?
The embedded derivative is notclosely related to economic
characteristics and risks of the host
(e.g. leverage, optionality feature);
Embedded derivative would be a
derivative if it was freestanding; and
The host contract is not carried at fair
value through profit or loss
An embedded derivative is a component of a hybrid (combined)instrument that also includes a non-derivative host contract,where some of the cash flows of the combined instrument vary ina way similar to a stand-alone derivative.
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43 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Embedded derivatives – decision tree
YesNo separation
No
Yes
No
No separation
No separation
Entire contract is treated
as held for trading andmeasured at fair value
Separately account for: derivative under AS 30 host contract under AS 30 or other relevant AS
No
Yes
No
Yes
Does embedded derivative meet the definitionof a derivative under AS 30?
Characteristics or risks which are closely relatedto the host contract?
Can fair value of the derivative componentseparately be reliably measured?
Host held for trading with changes to fair valuerecorded in the income statement?
IMPACT ANALYSIS No guidelines atpresent for embeddedderivatives
44 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Hedging Relationships
Net investment
in a foreign
entity
Cash flow
Fair
Value
Exposure
Hedged items Hedginginstruments
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45 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Criteria for hedge accounting
Risk management objective and strategy for the hedge
Identification of the hedging instrument
The related hedged item or transaction
The nature of the risk being hedged
How hedging instrument’s effectiveness will be assessed
1. Hedge relationship must be documented at inception
2(a) Hedge relationship must be expected to be highly effective at inception andsubsequent periods
2(b) Hedge effectiveness can be reliably measured
3. In the case of hedging future cash flows, there must be a high probability
of that cash flow occurring
2(c) Actual hedge effectiveness must be measured
46 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Hedged Items
Recognized FA / FL
Unrecognized Firm Commitment
Highly Probable Forecasttransaction
Single or grouped
Qualifying Items
For its entire fair value or for oneor more risk exposure
For a portion or a group of similarassets / liabilities
Designated FI
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47 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Hedged Items…
Foreign Currency Risk
In entirety for all risks
Designated NonFinancial Items
Can be hedged only for currencyrisk and credit risk
HTM
Changes in the fair value throughStatement of Profit & Loss
Unrecognized FirmCommitment
48 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Hedging Instruments
Derivatives can be used as hedging instruments
Proportion of the instrument can be designated
Time value can be excluded
Interest element & spot price of a forward contract can beseparated
Non-derivative FA / FL can be hedging instrument onlyfor foreign currency risk
Hedge accounting permitted only when instrumentsinvolve an external party
Between group entities, transactions are eliminated and hencedo not qualify for hedge accounting in CFS
But in SFS hedge accounting is permitted
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49 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Hedging Instruments…
Single instrument can hedge more than one risk
Two or more derivatives or proportions of them can hedge
one risk
Not permitted for net written options
But purchased options are permitted
In India a corporate can write options only for zero coststructures which can be designated as Hedging
Instrument
Purchased options are permitted
Recent draft guidelines on writing options by corporates
50 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Qualifying hedging instruments –General rules
Natural hedges of FX risk permitted in limited circumstances
All of the derivative must be used in the hedge relationship
Derivative cannot hedge another derivative
More than one derivative can be used in a hedging relationship
Permitted strategies include:
partial term
5 year swap used to hedge part of 10 year debt as part of cash flow hedge
proportional hedging
Profit related hedges not permitted
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51Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Hedge effectiveness
The effectiveness test itself must be stated upfront in the hedgedocumentation. This means that it must be designed and tested toensure that it provides a suitable solution before the hedge commences
There are two components to an effectiveness test:
the prospective test
the retrospective test
Following criteria to be fulfilled at inception & during the life of the hedge
Hedge is expected to achieve offsetting changes in fair value / cash flows
attributable to the hedged risk
Comparing past changes in fair value / cash flows
High statistical correlation between hedged item and hedging instrument
Actual results of hedge are within a range of 80%-125%
52 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Hedge effectiveness…
Hedging instrument - 120
Hedged item + 100
computed effectiveness is within a range of 80% -125% (83% /
120% in this case)
the hedge relationship is highly effective
nevertheless a loss of 20 has to be recorded in profit and loss
due to ineffectiveness
the fact that the hedge relationship is highly effective does not
lead to ignore the loss incurred due to ineffectiveness
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53 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Transitional Provisions
Designation and Measurement of existing Financial Assetand Financial Liability.
Change the designation and measurement as per the standard.
Adjust resultant gain or loss
To the extent of P&L impact, from the opening Revenue Reserve.
To the extent of ‘equity’ impact to recognize in equity account.
Derecognition of Financial Assets and Financial LiabilitiesRequirements of the Standard to be applied prospectively.
Can be applied retrospectively provided the information needed wasobtained at the time of initially accounting for these transactions.
If chosen to apply retrospectively, it should be done for all FA & FL.
54 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Hedge Accounting :
Measure all derivatives at fair value.
Eliminate all deferred losses and gains if any, arising onderivatives which under the previous accounting policy of theentity were reported as assets or liabilities.
Adjust any resulting gains or losses (as adjusted by any relatedtax expense / benefit) against opening balance of revenuereserves and surpluses.
Embedded Derivatives
an entity to assess whether an embedded derivative is to beseparated from the host contract and accounted for as derivative.
Transitional Provisions…
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55 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
AS 32’s Genesis of Disclosure
Requires disclosures in the financial statements that enable
users to evaluate
the significance of financial instruments for the entity’s
financial position and performance; and
the nature and extent of risks arising from financial
instruments to which the entity is exposed during the
period and at the reporting date, and how the entity manages those risks.
56 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Some Disclosures: Balance Sheet
Loans or Receivables designated at FV through P & L
Maximum exposure to credit risks
Any products which mitigates the aforesaid credit risks
Changes in FV due to credit risk & methods used to evaluate it
Changes in the fair value of the products mitigating the credit risks
Financial liability at FV through P & L
Changes in fair value due to credit risk and the methods used to evaluate credit risk.
Differences between the carrying amount and the amount that would be contractually required to pay.
Detailed reasons if changes in fair value due to credit risk and methods used to evaluate itare not disclosed for
Loans or receivables.
Financial liabilities at FV through P & L.
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57 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Some Disclosures: Balance Sheet
Reclassification of a financial asset from cost or amortizedcost to fair value and vice versa
Derecognition of assets transferred
Nature of the assets
Nature of retained risk and benefits (rewards) of suchassets
Details of collateral – as borrower and as lender
Reconciliation of changes in allowances for credit lossescreated.
Features of compound financial instruments containingmultiple embedded derivatives
Defaults and breaches for loans payable
58 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Some Disclosures: P & L
Net gains or losses
Financial assets or liabilities presented on fair value basis.
Available for sale financial assets
Held to maturity investments
Loans & receivablesFinancial liabilities at amortized cost
Interest income and expense excluding assets and liabilitiesdesignated at fair value through P and L
Fee income and expense excluding assets and liabilities designated atfair value through P and L
Interest Income on impaired financial assets
Impairment losses for each class of financial assets
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59 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Some Disclosure: Hedges
Disclosure of types and details of hedges
Fair value hedge
Cash flow hedge
Hedge of net investments in foreign operations
Description of each type of hedge
Description of the financial instruments used for hedging and their Fair value
Nature of risk being hedged
Ineffectiveness recognized in profit and loss account from cash flow hedges and net
investment in foreign operations hedges
60 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Some Disclosures: Valuation
Methods and valuation techniques
Assumptions applied
Basis of determining fair value
Market price
Initial transaction price
Price quotations
Valuation techniques based on market data
Valuation techniques based on assumptions
Fair value of class of assets and liabilities should be disclosed in a way that
facilitates comparison with its carrying amount
Changes in fair value estimates
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61Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Some Disclosures: Risk
Qualitative disclosures for risk of each class of financial
instruments
The exposures to risks and how they arise
Risk management procedures and methods
Changes in the above from the previous years.
Quantitative disclosures for risk of each class of financial
instruments
Summary quantitative data provided internally to the key
management
Concentration of risks
62 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Some Disclosures: Risk…
Credit Risk
Failure of a party to discharge its obligation in an contract
Liquidity Risk
Failure of a party in meeting obligations associated with financial
liabilities
Market Risk
The risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market prices.
Types of market risk: currency risk, interest rate risk and other
price risk
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63 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Impact Analysis Volatility in earnings
Impact on financial statements
MIS comparability over pre AS 30 and post AS 30 era
Performance indicators and ratios
IT systems
Contractual obligations (debt covenant, compensation)
Taxes & Distributable Profits
Managing market, investors and analysts
Greater level of documentation spelling out intentions
Management awareness
Use of experts critical
All this applies for bankers reading their clients’ financial statements
64 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
What now?
RBI has set a group to assess impact and draw up a road map for AS30 implementation in banks
Preparedness to be tested – do a dry run and one more dry run
Get ready for the volatility in the standard
Arising out of the economic crises IASB is in process of revamping IAS
39. Drafts / discussion papers issued on:- IFRS 9
Classification & Measurement lesser number of categories ofFIs
Amortized Cost & Impairment
Hedging
Fair Value Measurement new definition of FV
Credit Risk in Liability Measurement
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65 Ashutosh Pednekar, Partner, M. P. Chitale & Co.
Thank You