financial instruments 03062014

CA Manish C. Iyer +919650035652 [email protected]

1

IAS 32: Financial Instrument: Presentation IAS 39: Financial Instruments: Recognition and

MeasurementIFRS 7: Financial Instruments: Disclosures

IFRS 9: Financial Instruments (effective from 01 January 2015)

A C C O U N T I N G F O R F I N A N C I A L I N S T R U M E N T S


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Copyright Recognition…

IFRS, IAS, SIC, IFRIC are copyright of International Financial Reporting Standards

Foundation (IFRS Foundation).

SLIDES IN THIS PRESENTATION CONTAIN REFERENCES FROM THE RELEVANT IFRS THAT ARE THE COPYRIGHT OF IFRS FOUNDATION

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Discussion Points

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• Scope• Definitions• Presentation of Financial Instruments• Recognition and Measurement of

Financial Instruments• Disclosures


4

Scope• All types of Financial Instruments except

– Interests in subsidiaries, joint ventures and associates accounted for under IFRS 10 or IAS 28 other than• Interest in subsidiaries, associate and joint ventures accounted

for at FVTPL or AFS in SFS• Contingent consideration in a business combination that is a

financial instrument• Forward contract between an acquirer and a selling shareholder

to buy or sell an acquiree resulting in a business combination at a future acquisition date for IAS 32 and IFRS 7 only– Forward contract term should not exceed a reasonable

period normally necessary to obtain any required approvals and to complete the transaction

• Derivatives linked to interest in subsidiaries for IAS 32 only• Potential voting rights accounted under IFRS 10 or IAS 28 for IAS

32 and IFRS 7


5

Scope (contd…)

• All types of Financial Instruments except– Rights and obligations under Leases, except• Lease receivable are subject to derecognition and

impairment provisions• Finance lease payables are subject to

derecognition provisions• Derivatives embedded in leases are subject to the

embedded derivative provisions

– Employee Benefits


6

Scope (contd…)

• All types of Financial Instruments except– Own equity instruments and FI classified as equity in

accordance with para 16A, 16B, 16C and 16D for IAS 39 and IFRS 7

– Loan commitments (Apply Ind AS 37) other than• Those that the entity designates as at FVTPL• Those that the entity has a past practice of selling the

assets resulting from its loan commitments shortly after origination

• Loan commitments that can be settled net in cash or by delivering or issuing another financial instrument

• Commitments to provide a loan at below market rate


7

Scope (contd…)

• All types of Financial Instruments except– Rights and obligations arising under Insurance

contracts other than Financial Guarantee / Credit Insurance Contracts (FGCs)• Applies to FGCs if the issuer has not explicitly asserted

application of IFRS 4 to such contracts– FGCs that contain discretionary participation feature are

excluded always

• Derivatives embedded in insurance contracts if they require separation in accordance with IAS 39– Derivatives that are themselves an insurance contract are

excluded always


8

Scope (contd…)

• All types of Financial Instruments except– Contracts to buy or sell a non-financial item except• That can be settled net in cash• Empirical evidence of settling net in cash• Delivery of the underlying and selling the underlying

within a short period for generating profit from short-term fluctuations in price or dealer’s margin• That are readily convertible into cash


9

Definitions• Financial Instrument (FI)– Contract– FA of one entity– FL or Equity of another

• Equity Instrument (EI)– Contract evidencing a residual interest

• Fair Value (FV)– Amount for which an asset could be exchanged or a liability

settled, between knowledgeable, willing parties in an arms length transaction

– Price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date


10

Definitions• Financial Asset (FA)

– Any asset that is• Cash• An equity instrument of another entity• A contractual right

– To receive cash– To receive another financial asset from another entity– To exchange financial assets or financial liabilities with

another entity under potentially favourable conditions– To receive variable no. of entity’s own equity instruments for

fixed amount of cash– To receive fixed no. of entity’s own equity instruments for

variable amount of cash


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Definitions• Financial Liability (FL)– Any liability that is a contractual obligation• To deliver cash• To deliver another financial asset to another entity• To exchange financial assets or financial liabilities under

potentially unfavourable conditions• To deliver variable no. of entity’s own equity

instruments for fixed amount of cash• To deliver fixed no. of entity’s own equity instruments

for variable amount of cash


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Definitions

• Derivative–Change in value in response to a change in

some other variable• In case of non-financial variable, it is not

specific to a party to the contract–No or little initial net investment– Settled at a future date


13

Definitions

• Insurance Contract– Contract under which one party (the insurer) accepts

significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder

• Financial Guarantee Contract– Contract that requires the issuer to make specified

payments to reimburse the holder for a loss it incurs if a specified debtor fails to make payment when due under a debt instrument’s original or modified terms


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Definitions

• Insurance risk– Any risk other than financial risk

• Financial risk– Risk of a possible future change in one or more of

a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract


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Issues

• Whether an oral contract giving right to receive cash is a Financial Instrument?

• Whether bank deposit is a Financial Instrument?• Whether trade accounts receivable and payable, loans

and bonds receivable and payable are Financial Instruments?

• Whether prepaid expense or advance from customers is a Financial Instrument?

• Whether a promissory note to deliver govt. bonds is a FI?• Whether Taxes payable is a financial instrument?


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Issues• Whether the following are financial instrument– Contract to purchase vegetables and fruits from

farmers. – Contract to purchase vegetable and fruits from

farmers and simultaneous contract to sell those vegetables and fruits to Mandi.

– Contract to purchase vegetable and fruits from farmers providing that on expiry the differential price will be paid by one party to the other.

– Inventory of Gold and Silver– Contract to buy gold


17

Issues• White Ltd. enters into a fixed price forward

contract to purchase one million kilograms of copper in accordance with its expected usage requirements. The contract permits White Ltd. to take physical delivery of the copper at the end of 3 months or to pay or receive a net settlement in cash, based on the change in the fair value of copper. Is the contract within the scope of FI standards?


18

Issues

• White Ltd. enters into a put option with Mr. Black that permits White Ltd. to put the manufacturing facility at Baddi to Mr. Black for `500 lac. The current value of the manufacturing facility is `750 lac. The option expires in 12 months. The option, if exercised, may be settled through physical delivery or net cash, at White Ltd.’s option. Whether the option is an FI?

• Had the contract been forward contract, whether the same will be an FI?


19

Issues

• White Ltd. having functional currency as `, sells products in US denominated in US$. White Ltd. enters into a contract with an investment bank to convert US$ into ` where White Ltd. would sell US$ based on its sales volume in US in exchange for ` on the basis of a formula based on EBITDA. Whether the contract is a derivative contract?

• If White Ltd. sells US$ based on its sales volume in US in exchange for ` at the fixed exchange rate of US$ 1.00:`49.00, whether the contract will be a derivative contract?


20

Issues• White Bank issues a guarantee contract that compensates the

holder for more than the loss incurred. Whether the contract is an FGC?

• White bank provides compensation to Black Ltd. if the machine sold by Yellow Ltd. fails to produce 1000 tonnes of output per month. Whether the contract is an FGC?

• White bank issues a credit derivative that provides for payment if the credit rating of a debtor falls below the average credit rating of that class of borrowers in the industry. Whether the contract is an FGC? If yes, why? If not, what change will make the contract an FGC?

• White Ltd. enters into a contract with Black Ltd. where White is required to make specified payments to Black Ltd., if the residual value of the lathe machine falls below a particular level at a future date. Whether the contract is a FI? If yes, why? If not, what change will make the contract, FI?


21

Issues• White Farms Ltd. enters into a contract with Black Bank

where Black bank agrees to pay a fixed sum of Rs.1 crore if White suffers loss due to poor production caused by below average rainfall during the monsoon months. White pays a premium of Rs.5 lac for the contract. Whether the contract is a financial instrument?

• If, in the above case, Black agrees to pay the sum of Rs.1 crore if the average rainfall is below a particular level irrespective of the fact that White has suffered any damage, whether the contract will be a financial instrument?


22

Issues• White enters into Rs.100 lakh notional amount

five year pay fixed, receive variable interest rate swap. The interest rate of the variable part is reset on a quarterly basis to 3 month LIBOR. The interest rate of the fixed leg of the swap is 10%. At inception of the swap, White pre-pays its fixed obligation of Rs. 50 lakh while retaining the right to receive variable interest payments. Whether the instrument is a derivative?


23

Issues• White enters into Rs.100 lakh notional amount

five year pay variable, receive fixed interest rate swap. The interest rate of the variable part is reset on a quarterly basis to 3 month LIBOR. The interest rate of the fixed leg of the swap is 10%. At inception of the swap, White pre-pays its variable obligation while retaining the right to receive fixed interest payments. Whether the instrument is a derivative?


24

Issues

• White Ltd. makes a 5 year fixed rate loan to Black Ltd., while Black Ltd. makes a 5 year variable rate loan for the same amount to White Ltd. There are no transfers of principal at inception of the two loans, since White Ltd. and Black Ltd. have a netting arrangement. White Ltd. and Black Ltd. account for the loan as loan receivable and payable. Whether the treatment is proper?


25

Issues

• White Ltd. has guaranteed obligations under pension plans, lease rentals and taxes of its subsidiary Black Ltd. The management of White Ltd. seeks your opinion on whether such guarantees should be accounted as financial instruments?


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IAS 32: FI - Presentation

• Objective– Classification of FI from the perspective of issuer

into• Financial Liability• Equity

– Classification of related interest, dividends, losses and gains

– Establishing offsetting principles


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Presentation Aspects

•Classification on Initial Recognition•Classification of components not revised due to change in the probability of option being exercised

Liability Equity

Compound Financial Instrument


28

Issues

• White Ltd. having functional currency of ` issues rights to acquire a fixed no. of its equity shares for a fixed amount of Singapore dollars to a select no. of shareholders. Whether the instrument is a liability or equity?

• If, in the above case, White Ltd. offers the rights pro rata to all its shareholders, whether the instrument will be liability or equity?


29

Issues• White ltd. issues 100 preference shares for `100

each. The preference shares are to be mandatorily redeemed by White Ltd. for `500 each after 10 years. No dividend is payable. White Ltd. has presented the preference shares as part of Share Capital and no dividend is recognised.

• White ltd. issues non-redeemable 100 preference shares for Rs.100 each. Dividends to be paid on preference shares is at the discretion of White Ltd. White Ltd. has presented the preference shares as part of Share Capital and no dividend is recognised.


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SolutionCalculation of IRR:Year Cash Flows

0 100001 02 03 04 05 06 07 08 09 0

10 -5000017%

Amortised cost calculation of preference shares:

YearOpening Balance Interest

Cash Flows

Closing Balance

0

1 10,000 1,746 - 11,746

2 11,746 2,051 - 13,797

3 13,797 2,409 - 16,207

4 16,207 2,830 - 19,037

5 19,037 3,324 - 22,361

6 22,361 3,905 - 26,265

7 26,265 4,586 - 30,852

8 30,852 5,387 - 36,239

9 36,239 6,328 - 42,567

10 42,567 7,433 50,000 -


31

Issues• The governing bye-laws of White Co-operative Bank Ltd.

allows its members to redeem shares once the loan amount is fully repaid. The bye-laws provide that redemptions are made at the sole discretion of the governing body of White Co-operative Bank Ltd. However, in its history, it has never refused to redeem member’s shares, although the governing board has the right to do so. How should White Co-operative Bank Ltd, classify the shares issued to its members?

• Continuing with the previous example, if governing bye-laws state that approval of a redemption request is automatic unless the bank is unable to make payments without violating RBI regulations regarding liquidity and reserves. How should White Co-operative Bank Ltd. classify the members’ shares?


32

Issues

• White ltd. issues debt instruments requiring it to make annual payments in perpetuity equal to a stated interest rate of 9% applied to a stated par or principal amount of Rs.1000. Whether the debt instrument is liability or equity?

• White Mutual Fund classifies the units issued in its funds to unitholders as part of Share Capital.


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Exceptions to Principle

Puttable instruments classified as

equity instruments

Pro rata share of entity’s net assets

Subordinate to all other classes of instruments

All such subordinate Financial Instrument have identical features

Does not have any obligation other than to redeem or repurchase the instrument

Cash Flows based substantially on profit or loss or change in fair value of recognised & unrecognised net

assets

No other instrument that has Cash Flows based substantially on profit or loss or change in fair value of recognised &

unrecognised net assets


34

Exceptions to Principle

Instruments that impose an obligation to deliver to

another party a pro

rata share in the net

assets of the entity only

on liquidation

Pro rata share of entity’s net assets

Subordinate to all other classes of instruments

All such subordinate Financial Instrument have identical features

No other instrument that has Cash Flows based substantially on profit or loss or change in fair value of

recognised & unrecognised net assets


35

Accounting for Reclassification

• From Equity to Liability– Measure at fair value of liability– Difference between the fair value of liability and

the amount recognised previously in equity to be recognised in equity

• From Liability to Equity– Measure at the carrying value of the liability


36

Issues• White Ltd. has entered into a contract to deliver as many

of the entity’s own equity shares as are equal in value to the 100 ounces of Gold. How should White Ltd. classify the FI?

• White Ltd. has issued equity shares with an option to the holder to require its buy back by White Ltd. for cash. How should White Ltd. classify the equity shares?

• White Ltd. purchases a call option that gives White Ltd. a right to reacquire a fixed number of its own equity instruments in exchange for delivering a fixed amount of cash. White Ltd. has recognised the call option as a financial asset?


37

Issues• White Ltd. purchases an oil-linked bond that

gives it the right to receive interest at every quarter and principal of Rs.1 lac at the end of 5 years with an option to exchange the principal amount for a fixed quantity of oil. White Ltd. treats the contract as a contract to buy a non-financial item as it intends to buy oil on maturity rather than take back the principal amount in cash. Whether the treatment is proper?


38

Issues• White Ltd. issues equity shares to Black Private Equity Pvt.

Ltd. that requires it to transfer its manufacturing facility in Baddi if it fails to make distributions of dividend at an average rate of 15% per annum over a period of 5 years. White Ltd. has classified the instrument as equity share capital. Whether the treatment is proper?

• White Ltd. takes a loan from Black Ltd., its parent entity of Rs.100 crores that requires settlement in cash or through its equity shares on the BSE sensex becoming 100 points. The number of shares will be based on the the fair value of those shares so as to equal Rs.100 crores at the time BSE Sensex touches 100. White Ltd. classifies the loan as a liability. Whether the treatment is proper?


39

Issues• Same as above except that Black Ltd. is not a group

entity and Yellow Ltd., parent entity of White Ltd. has guaranteed interest payment @5% per annum till the time BSE sensex reaches 100 points. Whether the classification as a loan is proper?

• White Ltd. issues 2000 convertible bonds as on 01/04/08 having a 10 yr. term, face value of Rs.1000/- per bond & int. @6% p.a. each bond is convertible at any time up to maturity into 250 ordinary shares. When the bonds are issued, the prevailing market interest rate for similar debt without conversion option is 9%. How should the entity recognise the instrument?


40

SolutionCalculation of fair value of bond and equity:

Year Cash flows Discount @9% Present Value1 120000 0.9174 1100922 120000 0.8417 1010023 120000 0.7722 926624 120000 0.7084 850115 120000 0.6499 779926 120000 0.5963 715527 120000 0.5470 656448 120000 0.5019 602249 120000 0.4604 55251

10 2120000 0.4224 895511Fair Value of a Bond 1614941Consideration received 2000000 Fair Value of Equity 385059


41

Issues

• Same as original example except that the currency is in USD.How should the entity recognise the instrument?

•Would it make any difference if the bonds are issued to shareholders


42

Presentation Aspects

• Treasury Shares• Offsetting FA and FL– Legally enforceable right– Intention to settle on a net basis• Transferred asset that does not qualify for

derecognition shall not be offset with the associated liability


QUESTIONS

43


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IAS 39: FI – Recognition and Measurement

• Recognise on becoming a party to the contractual provision of the instrument

• On recognition, classify all FA into– Fair Value through Profit or Loss (FVTPL)– Held to Maturity (HTM)

• Category removed by IFRS 9

– Loans and Receivables (LR)– Available for Sale (AFS)

• Category renamed as Far Value through Equity by IFRS 9

• On recognition, classify FL into– FVTPL– Others

• Classification governs subsequent measurement


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Classification Definitions• FVTPL– Held for Trading (HFT)– Designated as at FVTPL at inception

• Should eliminate or significantly reduce accounting mismatch• Should have documented risk management and investment

strategy on the basis of which information is provided internally to KMP

• Excludes– Investment in equity instruments that do not have a quoted mkt. px. In an

active market and whose fair value cannot be reliably measured

– All Derivative except• Financial Guarantee Contracts• Designated and effective hedging instrument• Linked to unquoted equity instruments


46

Classification Definitions• HTM

– Non-derivative FA– Fixed or determinable payments– Fixed Maturity– The entity has positive intention and ability to hold to maturity– Tainting provisions are not attracted

• Synonyms of taint: spoil, stain, contaminate, dirty, infect, foul, ruin, pollute

• Tainting Provisions for HTM– If sold in any circumstance other than below before maturity,

reclassify all HTM into AFS for two years• 3 months before maturity• Entire principal component is collected• Not within the control of the entity


47

Classification Definitions

• LR–Non-derivative FA– Fixed or determinable payments–Not quoted in an active market– Excludes• FA classified as FVTPL• FA classified as AFS


48

Classification Definitions

• AFS–Non-derivative FA–Designated as AFS–Residual category


49

Recognition – Issues • When should a purchase order raised for

purchase of raw materials be recognised?• When should a forward contract be recognised?• When should an option contract be recognised?• White Ltd. has bought perpetual debt

instrument that provide for interest payment for an indefinite period. White Ltd. has classified the FI as HTM. Comment.

• White Ltd. classified equity investments as HTM.


50

Recognition – Issues • Whether FA that is puttable having

determinable payments for a fixed period can be categorised as HTM?

• Whether deposits held in Banks are HTM or LR?

• Are deposits held in Banks and classified as HTM, Cash and Cash Equivalents?


51

Embedded Derivatives

• To be separated from host contract if– The economic characteristics and risks of the

embedded derivative are not closely related to that of the host contract

– A separate instrument with the same terms as the embedded derivative would meet the definition of a derivative

– The hybrid instrument is not measured at Fair Value• Separation of embedded derivative not required if

the entire hybrid contract is designated as at FVTPL


52

Embedded Derivatives

Is the contract carried at FVTPL?

NO

Would it be derivative if it was freestanding?

YES

Closely related to host contract?

NO

Split and account for the derivative separately

YES

Do not split the embedded derivative

NO

YES


53

Embedded Derivatives - Examples

• Embedded put option in a bond that enable the holder to require the issuer to reacquire the instrument for cash or other asset that varies on the basis of the change in equity or commodity price or index

• A call option embedded in an equity instrument that enables the issuer to reacquire the equity instrument at a specified price from the perspective of the holder.


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Embedded Derivatives - ExamplesInstrument Host

ContractEmbedded Derivatives

Convertible Bond Debt Instrument

Purchased call option on equity securities

Debt paying interest quarterly based on an equity index

Debt Instrument

Four forward contracts p.a. on equity index

A two year fixed quantity sale of denim denominated in US$ between a French seller entity and an Indian buyer entity with a predetermined rate of exchange

Purchase contract

Foreign currency forward contract.


55

Issues

• White Ltd. is a real estate entity operating in India. It owns several office buildings in Mumbai and Kolkata that are rented to Indian and foreign entities. All lease contracts are denominated in USD, but payments can be made in specified amounts of either USD or INR. However, almost all of the lease payments are settled in INR. Whether there is any embedded derivative? Can White Ltd. designate the lease contract as at FVTPL?


56

Issues

• White Gas Ltd. is engaged in distribution of natural gas for domestic and industrial purposes in India in the ratio of 20:80. It sources gas from Gas exploration companies. Its Gas purchase costs is in USD. All other costs are in INR. All its billings are in INR. However, the entity provides an option to industrial consumers to pay for Gas in USD. Whether there is any embedded derivative?

• White Ltd. owns a bond with a detachable warrant wherein White Ltd. can exercise the warrant to buy shares while keeping the bond intact. Whether there is any embedded derivative?


57

Initial Measurement

• At Fair Value• For FA / FL not at FVTPL add transaction costs

that are directly attributable to the acquisition or issue of the FA or FL

• Short-term receivables and payable with no stated interest rate at original invoice amount


58

Subsequent Measurement

• FVTPL• HTM• LR• Short-term receivables and payables with no

stated rate of interest• AFS• Unquoted equity instruments and derivative

linked to it


59

Subsequent Measurement

• Financial Guarantee Contracts and Loan Commitments– As per Ind AS 37; or– At amortised cost• Whichever is higher

• All other FL at amortised cost


60

Issues

• White Ltd. issues 1000 zero coupon bonds for `1000 each to be redeemed after five years for a total of `1500000. Show the carrying amount of bonds and the impact on SPL for five years.

• White Ltd. borrows a term loan for ten years from Black Bank Ltd. of `10 lac @ 10% p.a. Black Bank Ltd. charges 2% processing fee and the amount disbursed is 98% of the sanctioned amount. White Ltd. would pay `1 lac plus interest per annum to settle the loan. Show the carrying amount of loan and the impact on Profit and Loss till loan is settled.

61

SolutionCalculation of IRR:

Year Cash Flows -

10,00,000

1

-

2

-

3

-

4

-

5

-15,00,000

8%

Amortised Cost of Bond:

YearOpening Balance Interest

Cash Flows

Closing Balance

1

10,00,000

84,472

-

10,84,47

2

2

10,84,472

91,607

-

11,76,07

9

3

11,76,079

99,345

-

12,75,42

5

4

12,75,425

1,07,737

-

13,83,16

2

5

13,83,162

1,16,838

15,00,00

0

-


62

SolutionCalculation of IRR:

Year Cash Flows

0 9800001 -2000002 -1900003 -1800004 -1700005 -1600006 -1500007 -1400008 -1300009 -120000

10 -11000011%

Amortised cost of loan:

Year Opening Balance Interest Cash Flows

Closing Balance

1 9,80,000 1,03,168 -2,00,000 8,83,168

2 8,83,168 92,975 -1,90,000 7,86,143

3 7,86,143 82,760 -1,80,000 6,88,904

4 6,88,904 72,524 -1,70,000 5,91,427

5 5,91,427 62,262 -1,60,000 4,93,689

6 4,93,689 51,973 -1,50,000 3,95,662

7 3,95,662 41,653 -1,40,000 2,97,314

8 2,97,314 31,299 -1,30,000 1,98,614

9 1,98,614 20,909 -1,20,000 99,523

10 99,523 10,477 -1,10,000 -


63

Issues• White Ltd. has given interest free loan of `10 lac to its

employee for housing purposes to be repaid in 10 equal yearly installments. Had the employee obtained the loan from a bank / financial institution, the interest rate would be 10% on the loan. Show the amortised cost of the loan for the entire period of the loan.

• White Ltd. has borrowed `10 lac of loan from Black Ltd. The repayment terms of the loan specify 120 EMI of `10000/-. However, White Ltd. expects to repay the loan in annual instalments `100000/-. White Ltd, has sought your opinion on cash flows to be taken for calculating interest.


64

SolutionCalculation of fair value of employee loan:

Year Cash Flows Discount @10% Present Value1 100000 0.9091 909092 100000 0.8264 826453 100000 0.7513 751314 100000 0.6830 683015 100000 0.6209 620926 100000 0.5645 564477 100000 0.5132 513168 100000 0.4665 466519 100000 0.4241 42410

10 100000 0.3855 38554Fair Value of Employee Loan 614457Amount Given as loan 1000000Day 1 loss on fair valuation 385543


65

Solution (contd.)Amortised cost of Employee Loan:

YearOpening Balance Interest Cash Flows

Closing Balance

1 6,14,457 61,446 1,00,000 5,75,902 2 5,75,902 57,590 1,00,000 5,33,493 3 5,33,493 53,349 1,00,000 4,86,842 4 4,86,842 48,684 1,00,000 4,35,526 5 4,35,526 43,553 1,00,000 3,79,079 6 3,79,079 37,908 1,00,000 3,16,987 7 3,16,987 31,699 1,00,000 2,48,685 8 2,48,685 24,869 1,00,000 1,73,554 9 1,73,554 17,355 1,00,000 90,909

10 90,909 9,091 1,00,000 -

385544


66

Issues

• White Ltd. manages its loan portfolio on fair value basis. White Ltd. obtained a loan of Rs.10 lac from Black Ltd. requiring a bullet payment of Rs.12 lac after 10 years. The market rate for such a loan for an entity with a similar credit rating of White Ltd. is 8%. After 3 years, the credit risk of White Ltd. increases and hence the comparable interest rate increase to 12%. At what value would the loan be recognised in White Ltd.’s books and what would be effect of decrease in credit rating of White Ltd.


67

Solution

Calculation of Fair Value of Loan:Year Cash Flows Discount @8% Present Value

1 - 0.9259 - 2 - 0.8573 - 3 - 0.7938 - 4 - 0.7350 - 5 - 0.6806 - 6 - 0.6302 - 7 - 0.5835 - 8 - 0.5403 - 9 - 0.5002 -

10 12,00,000 0.4632 5,55,832 Fair Value of Bullet Payment Loan 5,55,832


68

Solution (contd.)

Calculation of Amortised Cost of Loan:

YearOpening Balance Interest Cash Flows

Closing Balance

1 5,55,832 44,467

-

6,00,299

2 6,00,299 48,024

-

6,48,323

3 6,48,323 51,866

-

7,00,188

4 7,00,188 56,015

-

7,56,204

5 7,56,204 60,496

-

8,16,700

6 8,16,700 65,336

-

8,82,036

7 8,82,036 70,563

-

9,52,599

8 9,52,599 76,208

- 10,28,807

9 10,28,807 82,305 - 11,11,111

10 11,11,111 88,889 12,00,000 -


69

Solution (contd.)

Calculation of Fair Value of Loan on increase in Credit Risk:

Year Cash FlowsDiscount @

12% Present Value1 - 0.8929 - 2 - 0.7972 - 3 - 0.7118 - 4 - 0.6355 - 5 - 0.5674 - 6 - 0.5066 - 7 12,00,000 0.4523 5,42,819

Amortised Cost at the end of 3rd year 7,00,188 Gain due to increase in credit risk 1,57,369


70

Reclassifications• FVTPL to other and other to FVTPL– No reclassification

• AFS to other and other to AFS– HTM on attracting Tainting to be reclassified to

AFS– AFS to LR in rare circumstance when a reliable

measure of fair value is no longer available– AFS to HTM change in intention or ability and two

years have passed


71

Hedging - Definitions• Hedging Instrument–Designated derivative–Designated non-derivative financial asset or

financial liability• For hedge of risk of changes in foreign exchange rates

– The FV or cash flows of which are expected to offset changes in the FV or cash flows of a designated hedged item


72

Hedging - Definitions• Hedged Item– Asset– Liability– Firm commitment– Highly probable forecast transaction– Net investment in a foreign operation

• The item to be designated should expose the entity to risk of changes in FV or cash flows

• Hedge Effectiveness– Degree to which changes in FV or cash flows of the

hedged item that are attributable to a hedged risk are offset by changes in FV or cash flows of the hedging instrument


73

Hedging - Relationships

• Cash Flow Hedge– Changes in fair value taken to CFHR

• Fair Value Hedge– Changes in fair value taken to SPL in the line item

affected• Net Investment Hedge– Changes in fair value taken to NIHR


74

Hedging – Conditions

• The hedging relationship must be documented in detail• The hedge should be expected to be highly effective in

the ratio of 80% - 125%• For cash flow hedges, the forecasted transaction must

be highly probable• The effectiveness of the hedge is measureable reliably• The effectiveness of the hedging relationship is

assessed on an ongoing basis, and the relationship must be deemed to be highly effective in the ratio of 80% - 125% throughout the life of the hedging relationship.


75

Effects in Profit and Loss Account

• Effective Portion: This is shown in the same line item as the hedged item

• Ineffective Portion: Recorded in Other Income and Expenses

• Excluded Portion (E.g. Time Value of Option): Recorded in Other Income or Expenses


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Hedging - Termination

• The Hedging Instrument expires or is sold, terminated or exercised;

• The hedge no longer meets the criteria for hedge accounting; or

• The entity revokes the designation• The forecast transaction is no longer probable• The highly probable forecast transactions

occurs


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Hedging - Issues• Whether a non-derivative can be designated as a

hedging instrument?• Whether an instrument can be designated for a

portion of its time period?• Whether a proportion of an instrument can be

designated as hedging instrument?• A Ltd. has entered into a zero cost tunnel where the

notional of the purchase option is lower than the notional of written option. A Ltd. designates the entire instrument as hedging instrument. Comment.


78

Hedging - Issues

• A Ltd. designates HTM as hedged item with respect to interest rate risk. Comment.

• A Ltd. has a forward contract of USD 10 lac. It has foreign currency assets of USD 40 lac and foreign currency liabilities of USD 30 lac. It designates net foreign currrency receivables of USD 10 lac as hedged item. Comment.


79

Hedging - Issues• White Ltd. has designated an option contract as hedge

instrument only for its intrinsic value. Whether the hedge relationship is proper?

• White Ltd. designates a forward contract as hedging instrument on spot basis. Whether the hedge relationship is proper?

• White Ltd., has given a variable interest loan to its subsidiary Black Ltd. The functional currency of both the entities is `. To hedge the cash flows, White Ltd. enters into an interest rate swap. White Ltd. has designated the interest rate swap as hedging instrument and the loan as the hedge item. Whether designation is proper?


80

Hedging - Issues

• White Ltd. is anticipating export orders from its US subsidiary Black Inc. To hedge the cash flows, White Ltd. has entered into forward contract with Pink Bank. White Ltd. has designated the forward contract as hedging instrument and the highly probable forecast exports as hedge item. Whether the designation is proper?


81

Hedging - Issues

• White Ltd. manages its foreign currency risks through forward contracts and PCFC contracts. Against Rs.100 crores of exports, it has Rs.30 crores of imports. Hence, it manages the remaining Rs.70 crores through a combination of forward contracts and PCFC contracts where in some cases forward contracts are cancelled for PCFC contracts. White Ltd. has designated all its forward and PCFC contracts including those that are taken after cancelling forward contracts as hedging instruments. Whether the designation is proper?


82

Impairment• Assessment at each reporting date • There has to be an objective evidence of impairment (Incurred

Loss Approach)– IFRS 9 advocates Expected Loss Approach

• Objective evidence of impairment include observable data about the following loss events– Significant financial difficulty of the issuer– Breach of contract– Lender granting to the borrower a concession that the lender would not

otherwise consider– Probability of bankruptcy of borrower– Observable data indicating a measureable decrease in the estimated

future cash flows from a group of financial assets, although the decrease cannot be identified with the individual financial assets in the group

– Significant or prolonged decline in FV of investment in equity instrument below its cost


83

Impairment – Measurement• Impairment of HTM or LR– IL = CA – PV of EFCF– Discounting at Original EIR– IL to be recognised in profit or loss– Reversal not greater than the asset’s amortised cost

without impairment• Impairment of Unquoted Equity Instrument carried at

cost and derivative linked to such Equity Instrument– IL = CA - PV of EFCF– Discounting at current market rate of return– No reversal


84

Impairment – Measurement• Impairment of AFS– Cumulative loss recognised in OCI to be

reclassified to Profit or Loss– Cumulative loss to be reclassified =• Acquisition cost (net of any principal repayment and

amortisation) minus• Current Fair Value minus• Previously recognised IL

– IL recognised for investment in an equity instrument classified as AFS shall not be reversed


85

Derecognition - FA

• Consolidate all subsidiaries as per IFRS 10• Determine whether the derecognition principles are to be

applied to a part or all of an asset (or a group of similar assets)

• Derecognition principles are applied to a part of a FA (or a group of similar FA) if, and only if,– The part comprises only specifically identified cash flows from an

FA– The part comprises only a fully proportionate (pro rata) share of

the cash flows of the FA– The part comprises only a fully proportionate (pro rata) share of

specifically identified cash flows from an FA


86

Derecognition – FA - Conditions

• Contractual rights to the cash flows from the FA expires; or

• The entity transfers FA that qualifies for derecognition– Transfer of a financial asset• Transfer of all risks and rewards of ownership; or• Transfer of the contractual right to receive cash

flows of the FA; or• Pass through arrangement–Must not retain any obligation or ability to invest

or pledge


87

Derecognition – FA - Conditions

• Assessment of transfer of risks and rewards– Substantially all risks and rewards of ownership

transferred, derecognise the asset– All risks and rewards of ownership not transferred• If control is transferred, derecognise the asset and

recognise separately as assets or liabilities any rights and obligations created or retained in the transfer• If control is not transferred, continue to recognise

the asset to the extent of continuing involvement


88

Derecognition – FL

• To be derecognised only when the obligation specified in the contract is– Discharged– Cancelled– Expires

• Exchange between existing borrower and lender with substantially different terms or substantial modification of terms of FL– Original FL to be derecognised and new FL to be

recognised


89

Derecognition – FA Examples• An unconditional sale of a White Ltd.’s shares• Sale of White Ltd.’s shares with an option to repurchase the

financial asset at its fair value at the time of repurchase• Sale of White Ltd.’s shares giving an option to the buyer to put

back the White Ltd.’s shares at below its face value• Sale and repurchase of White Ltd.’s shares at a fixed price which

is a listed entity with its shares being actively traded• Sale and repurchase of X Pvt. Ltd.’s shares where the repurchase

price is a fixed price• Securities lending agreement• Sale of White Ltd.’s shares giving an option to the buyer to put

back White Ltd.’s shares at Rs.20000/- per share.• Transfer of receivables where the transferor guarantees

transferee for credit losses that are likely to occur


QUESTIONS

90


91

Financial Instruments: Disclosures

• Carrying amounts of each of the following categories– Financial Assets

• FVTPL– HFT– Designated by management

• HTM• LR• AFS

– Financial Liabilities• FVTPL

– HFT– Designated by management

• At amortised cost


92

Financial Risks• Credit Risk– Risk that another party can cause a financial loss

• Liquidity Risk– Risk that obligations may not be settled within due

dates• Market Risk– Currency Risk– Interest rate risk– Other price risk


93

Disclosures of Credit Risk

• LR and Financial Liabilities designated at FVTPL – Max. exposure to credit risk– Description of collateral held as security and other credit

enhancements– Amt. that mitigates the max. exposure to credit risk– Amt. of change in fair value related to change in credit

risk– Amt. of change in FV of related credit derivatives

• During the period• Cumulatively from date of designation

– Method adopted for the above


94


– Max. exposure to credit risk without taking account of any collateral held

– Description of collateral held as security and other credit enhancements for the above

– Info about the credit quality of FA that are neither past due nor impaired

– CA of FA that would otherwise be past due or impaired whose terms have been renegotiated


95


• FA that are past due or impaired– Ageing analysis– Analysis of FA individually determined to be

impaired at the end of the reporting period– Factors considered for impairment– Description of collateral held by the entity as

security and other credit enhancements and, unless impracticable, an estimate of their fair value


96


• Collateral & other credit enhancements obtained that meet the recognition criteria in other standards– Nature & carrying amt. of the assets obtained– If the assets are not readily convertible into cash,

its policies for disposing off such assets or for using them in its operations


97

Disclosures on Derecognition

• For assets transferred that do not qualify for derecognition– Nature of the assets– Nature of risks and rewards to which the entity remains

exposed– CA of the assets and the associated liabilities

• If the entity continues to recognise all of the assets

– Total CA of the orig. assets, amt. of assets that the entity continues to recognise and CA of the associated liabilities• If the entity continues to recognise the assets to the extent of

its continuing involvement


98

Disclosures of Collateral

• For entities that have pledged collateral– CA of Financial Assets pledged as collateral for liabilities or

contingent liabilities– Terms and conditions relating to pledge

• Entities that hold collateral and is permitted to sell or repledge the collateral in absence of default by the owner– FV of collateral held– FV of collateral sold or repledged

• Explanation of entity’s obligation to return the collateral

– Terms and conditions associated with its use of the collateral


99

Disclosures of Defaults & Breaches• Details of any defaults during the period of

principal, interest, sinking fund, or redemption terms

• CA of loans payable in default at the end of the reporting period

• Rectification of the default before the FS were authorised for issue

• Renegotiation of the default before the FS were authorised for issue


100

Other Disclosures for Statement of Financial Position

• Reconciliation of changes in Allowance account for each class of financial assets

• Existence of multiple embedded derivatives in a compound financial instrument


101

Disclosures for SOCI

• Net gains or losses on – FA / FL at FVTPL showing separately HFT and

Designated by Mgmt.– AFS showing separately that recognised in OCI amt.

reclassified from OCI to Profit or loss– HTM investment– LR– Financial Liabilities measured at amortised cost

• Total interest income and interest expense for FA and FL that are not at FVTPL


102

Disclosures for SOCI

• Fee income and expense (other than amt. included in EIR) arising from– FA / FL not at FVTPL– Trust and fiduciary activities that result in the

holding or investing of assets on behalf of individuals, trusts, retirement benefit plans, and other institutions

– Amt. of impairment loss for each class of FA


103

Disclosures for Hedging

• Description of each type of hedge• Description of FI designated as hedging

instruments and their FV at the end of the reporting period

• Nature of risks being hedged


104

Disclosures for Cash Flow Hedges• Periods when cash flows are expected to occur and when

they are expected to affect profit or loss• Description of any forecast transaction for which hedge

accounting had previously been used, but which is no longer expected to occur

• Amt. recognised in OCI during the period• Amt reclassified from equity to profit or loss for the period,

showing the amt. included in each line item in Statement of Comprehensive Income

• Amt. included in initial cost or other CA of a non-financial asset or non-financial liability


105

Further Disclosures - Hedging

• In FV Hedges, gains or losses– On hedging instrument– On hedged item attributable to the hedged risk

• Ineffectiveness recognised in profit or loss– Arising from cash flow hedges– Arising from net investment hedges


106

Fair Value Disclosures

• For each class of FA & FL• Methods, valuation techniques and

assumptions used for each class of FA & FL• Sensitivity analysis of fair value changes to

changes in assumptions• Total amt. of change in FV estimated using a

valuation technique recognised in profit or loss for the period


107


• If transaction price is not fair value– Accounting policy for recognising the difference in

profit or loss– The aggregate difference yet to be recognised in

profit or loss at the beginning and end of the period

– Reconciliation of changes in the balance of this difference


108


• Fair Value Disclosures not required–When CA is reasonable approximation of FV– Investments in equity instruments that do

not have a quoted market price in an active market–Contract having discretionary participation

feature if the FV of the feature cannot be reliably measured


109


• Where Fair Value disclosures not made– The fact that FV info has not been disclosed for these

instruments because their FV cannot be measured reliably– Description of instruments, their CA and an explanation why FV

cannot be measured reliably– Info about the mkt of those instrument– Info about whether and how the entity intends to dispose of

the instruments– If such instruments are derecognised

• The fact• CA at the time of derecognition• Amt of gain / loss recognised


110

Risk Management Disclosures

• For each type of risk– The exposure to risk and how they arise– Objectives, policies and processes for managing

the risk and the methods used to manage those risks

– Any changes in the above from the previous period


111

Quantitative Disclosures

• Summary quantitative data about its exposure to risk at the end of the reporting period

• Concentration of risk


112

Disclosures of Liquidity Risk

• Maturity analysis of remaining FL that shows the remaining contractual maturity

• Mgmt. of liquidity risk


113

Disclosures of Market Risk

• Sensitivity analysis of each type of market risk• Methods and assumptions used• Changes in methods and assumptions used

with reasons


QUESTIONS

114


THANK YOU

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financial instruments 03062014

Education