IND AS 109, 32 & 107 - FINANCIAL INSTRUMENTS

Before we proceed for in depth discussion we should understand the basic knowledge of
some of the terms, which are as under:

What is Financial Instrument?

FI is any contract that gives rise to Financial Assets for One Entity and Financial Liability or
Equity for Another Entity.

There can be two types of FI:

Primary FI : such as receivables, payables, loans

Derivatives FI: such as futures, options, forwards, swaps

What is Financial Asset?

A Financial Asset is any asset i.e.

(a) cash, includes deposits of cash with banks or financial institution

(b) any equity instrument of another entity (such as investment in equity shares of another
entity)
(c) a contractual right to receive cash or another financial asset from another entity (such
as trade receivables, loan receivables, bonds receivables)
(d) a contractual right to exchange the financial assets or financial liability with another
entity under the conditions that are favorable to the entity.

ITEMS of ASSETS FA – Yes/No

Building
Receivables
Inventory
Advance Tax
Loan Given
Rent Advance
3 month rent deposit with
loandlord as security
Advance to Supplier

What is Financial Liability?

Financial liability is any liability i.e.

(a) A contractual obligation to deliver cash (such as trade payables, loan liabilities) or to
deliver another financial asset to another entity.
(b) A contractual obligation to exchange the financial asset or financial liability with
another entity under the conditions which are potentially unfavorable to the entity.

Compiled by CA. Jai Chawla - 9981489567 Page 1

 ITEMS of LIABILITIES FL – Yes/No
Loan Taken
Creditors/Payables
Salary Payable
Credit balance of debtors
Debentures Issued
Provision for Income Tax

What is Equity? (Fix Payment ki koi obligation nai hoti)

An equity instrument is any contract that evidences a residual interest in the assets of an
entity after deducting all of its liabilities. Equity Holder can-not claim on the company, if he
can claim he is not equity he is someone else.

ITEMS Equity – Yes/No

Redeemable Pref Share
Capital

100% Compulsorily
Convertible Debentures

Convertible Debentures at
the option of Holder

CLASSIFICATION OF FINANCIAL ASSETS:

Under IND-AS 109, financial assets are classified into 3 categories for the accounting
purpose:

(i) Amortised cost

(ii) Fair value through Other Comprehensive Income (FVTOCI)
(iii) Fair value through Profit & Loss(FVTPL)

The above classification will be based on entity’s “Business Model” for managing the
financial assets.

The classification will be made as under:

(i) Financial assets measured at Amortised Cost -

-If the business model is such that the objective is to earn INTEREST INCOME
on the instruments.
-And the instrument generates cash flows only from INTEREST & PRINCIPAL.
-On SPECIFIED DATES
eg. FD, LIC, Debentures redeemable in cash

If the above three conditions are satisfied then financial asset will be measured at Amortised
Cost and any initial transaction cost will be ADDED to the cost of financial asset.

Compiled by CA. Jai Chawla - 9981489567 Page 2

 (ii) Financial assets measured at Fair Value Through OCI (FVTOCI)-
-If the business model of an entity is such that the objective is to earn INTEREST
as well as OTHER INCOME (such as capital gain) from the instrument,
-And the instrument generates PRINCIPAL & INTEREST only,
-On SPECIFIED DATES.
Then the financial asset will be measured at FVTOCI
eg. Listed company’s debentures

(iii) Financial assets measured at Fair Value Through P&L (FVTPL)-

This is a residual category and the financial assets fall under this category are
generally those assets whose contractual cash flows are not fixed and they does
not generate on specified dates such as instruments in equity shares of other
companies.
eg. Equity shares (except not held for trading), derivatives.

EQUITY SHARES OF OTHER COMPANY/ DERIVATIVES:

Is it held for trading?

If Yes :- then FVTPL

If No:- there is an option to designate it to FVTOCI or FVTPL

NOTE: If the option of FVTOCI is selected then any resulting gain/loss on REVALUATION
will be transferred to OCI and NO RECYCLING to P&L is permissible and this option is
IRREVOCABLE. On sale of such option, it will also be reflected in OCI and not P&L.

-Derivatives are always classified at FVTPL.

-Initial transaction cost incurred on those financial assets which are categorized as FVTPL
are not added to the cost of financial asset, they are directly transferred to P&L

-However the transaction cost incurred on financial assets categorized under AMORTISED
COST or FVTOCI, shall be added to the cost of asset.

RECOGNITION OF FINANCIAL ASSET

(1) INITIAL RECOGNITION: Financial assets are initially measured at fair value.
Generally the “Traded Value” i.e. cost will be the fair value. In rare case there might be a
chance of ONE DAY GAIN where fair value and cost is different.

(2) SUBSEQUENT RECOGNITION: When we close the books of month end, quarter end
or year end in this case the subsequent measurement will be based on type of FA.

Type-1: AMORTISED COST:- FA in this category are measured at amortised cost using
effective interest rate (IRR). And any transaction cost incurred will be ADDED to FA.

Compiled by CA. Jai Chawla - 9981489567 Page 3

Example- A Co. provided loan to another company of Rs. 1,00,000 at concessional interest
rate of 5% pa payable in 4 years of equal principal amount along with interst. Suppose the
Market rate of Interest is 10%.

Type-2: FVTOCI:- At every period end the asset will be fair valued and the gain/loss will be
transferred to OCI. Any transaction cost will be ADDED to FA.

when such asset will be sold, entire fair value gain/loss accumulated in OCI will be recycled
to P&L

EXCEPTION: If equity shares are not held for trading and designated as FVTOCI then
recycling to P&L is not allowed.

For Example: We bought shares of Infosys at Rs.2100. Transaction cost is Rs.2. On quarter
end FV of shares is Rs.2250. These shares are designated as FVTOCI, not held for trading.

Answer: Day-1 Investment in shares Dr. 2102

To Bank A/c 2102

Quarter end –Investment in shares Dr. 148

To OCI 148

Now suppose if we sell these shares at Rs.2500 and transaction cost is Rs.3

Bank Dr. 2497

To investment in shares A/c 2250

To OCI A/c 247

Type-3: FVTPL:- This is a residual category and generally all equity shares and derivatives
(for trading) are covered under this category.

At each period end they are revalued and any fair value gain/loss is transferred to p&l a/c.

On sale of these assets, the realised gain/loss will be transferred to p&l a/c. Any transaction
cost will be CHARGED TO P&L A/C and not added to the cost of FA.

For example, Assume same example-1 ,now shares are held for trading.

Since they are held for trading, they are classified as FVTPL:

(1) Investment in shares Dr. 2100

Transaction cost Dr. 2
To Bank 2102
(2) At quarter end:
Investment in shares Dr. 150
To Fair value gain (p&l) 150
(3) P&L Dr. 2
To Transaction cost 2

Compiled by CA. Jai Chawla - 9981489567 Page 4

 (4) On sale :
Bank A/C Dr 2500
To Investment in shares 2250
To Realisation gain(p&l) 250
(5) Investment cost Dr. 3
To Bank 3
(6) P&l Dr. 3
To Investment cost 3

For Example: We bought a government security bond at Rs.98 for 5 years tenure. FV Rs.100,
7% coupon rate at the end of 1st year FV Rs. 99.5

Answer:

Situation-1:- Holding this under a business model where we wish to generate only into
income , categorized as amortised cost.

Initial outflow Rs.98

Following are the Cash rights

Year Cash right PV@7% PV@8%

1 7

2 7

3 7

4 7

5 107

Since 7% is contractual rate, it is not the effective so it is required to be calculated.

IRR- 7.5%

Situation-2: Holding under a business model where we wish to generate interest.

We have categorized it as FVTOCI.

Day-1: Initial recording –

7% Bonds (FA) Dr. 98

To Bank A/c 98

Year end:

Bank a/c Dr. 7

Compiled by CA. Jai Chawla - 9981489567 Page 5

 To interest received 7

Bond A/c Dr. 1.5

To FV gain 1.5

This above FV gain which is awarding in OCI will be recycled to P&L after 5 years when
bonds are matured.

Situation-3: The instruments does not qualify under any business model,we are holding it
for trading (FVTPL)

Day-1: 7% Bond Dr. 98

To Bank A/c 98

Year-1 end: Bank A/c 7

To interest received 7

Bond (FA) Dr. 1.5

To Realisation gain (P&L) 1.5

Financial Assets (Amortised Cost) - Staff Advances

 If the entity provides Staff advances without interest or at concessional interest rates, then
such advances should be recognized by applying effective interest rate (Amortised cost
method).
 If staff advance exceeds the present value of expected cash inflows, then excess is called
‘Employee Compensation’.
 Employee Compensation should be written off over the period of expected benefits. If the
ratio of expected benefits are not identifiable then employee compensation should be written
off to the statement of profit and loss at inception.

Q1. B ltd gave one of its Employees, staff advance of Rs. 5,00,000 at 3% on 1-4-2008. Loan is
repayable in 4 installments along with Interest. Market Rate of rest is 10%. Prepare Loan to Employee
A/c.

Q2. Comforts Ltd. granted Rs.10,00,000 loan to its employees on January 1, concessional interest rate
of 4% per annum. Loan is to be repaid in five equal instaImentsalongwith interest. Market rate of
interest for such loan is 10% Following the principles of recognition and measurement as laid down
in AS-30-'Financial instruments : Recognition and measurements', record the entries for the year
ended 31st December, 2009 for the loan transaction, and also calculate the value of loan initially to be
recognized and amortised cost for all the subsequent years. The present value of Re. I receivable at the
end of each year on discount factor of 10% can be taken as:
Year end
1. 0.9090
2. 0.8263

Compiled by CA. Jai Chawla - 9981489567 Page 6

 3. 0.7512
4. 0.6829
5. 0.6208
(May 2010, 4 marks)

Compiled by CA. Jai Chawla - 9981489567 Page 7

Compiled by CA. Jai Chawla - 9981489567 Page 8
Compiled by CA. Jai Chawla - 9981489567 Page 9
Compiled by CA. Jai Chawla - 9981489567 Page 10
 CLASSIFICATION OF FINANCIAL LIABILITY
Under IND-AS 109, Financial Liabilities are classified into 2 categories i.e.

(i) Amortised cost (Default category)

(ii) FVTPL (Fair value to P&L)

TYPES OF FINANCIAL LIABILITY UNDER AMORTISED COST:

 Compound FI
 Non compound FI

COMPOUND FINANCIAL INSTRUMENT

Compound Financial Instruments are those instruments which are having features of both
equity as well as financial liability.

-Financial liability are measured at FVTPL when they are held for trading . A financial
liability is held for trading when it is acquired or incurred principally for the purpose of
selling or repurchasing it in the near term or when it is a derivative. (except a derivative of
hedging)

Accounting treatment of financial liability which can be measured at amortised cost:

 For the purpose of accounting, we need EFFECTIVE INTEREST RATE (i.e. IRR)
for the financial liability measured at amortised cost.
 The effective interest rate will be given in the question or we need to calculate interest
by interpolation technique.

Q3. B Ltd Issued 10% convertible Debentures of Rs.100 each for Rs.5,00,000 on 1-4-2008, These are
to be converted into Equity Shares on 31-3-2011
Debenture without conversions right can be issued at 13%.
Present Debenture is Balance Sheet.
(Answer: FL – 118058 and Equity – 381942)

Q4. B Itd Issued 9% Convertible Debentures of Rs.7,00,000 at 10% discount on 14-2008 convertible
on 31-3-2011. These are to be converted at 10% Premium Discount Rate on Non- Convertible
Debentures is 13%.Calculate Debt. and Equity.
(Answer: Fin. Liab.: Rs. 148743; Equity: Rs. 481257)

Q5. A Ltd. issued 9% Convertible Debentures. at 10% discount for Rs. 7 00 000 on 1.4.09. They are
to be converted on 31-3-2012 at 5% premium. A Ltd will pay cash bonus of Rs. 50,000 on 31-3-2011.
Debenture holders are required to pay Rs. 20,000 for credit appraisal of Debentures on 31.03.2010.
Similar Debentures without conversion rights carry rate of Interest of 18%. Prepare necessary
accounts.
(Answer: Financial Liab.:Rs. 155922 and Equity: Rs. 474078)

Q6. Mega Ltd. issued Rs. 100,00,000 worth of 8% Debentures of face value Rs100/- each on par
value basis on 1st Jan, 2011. These debentures are redeemable at 12% premium at the end of 2014 or
exchangeable for Ordinary shares of Mega Ltd. on 1 : 1 basis. The interest rate for similar debentures

Compiled by CA. Jai Chawla - 9981489567 Page 11

that do not carry conversion entitlement is 12%. You are required to calculate the value of the debt
position of the above compound financial instrument. The Present value of the rupee at the end of
years 1 to 4 at 8% and 12% are supplied to you as:
8% 12%
End of year 1 0.926 0.893
End of year 2 0.857 0.797
End of year 3 0.794 0.712
End of year 4 0.735 0.636
(Answer: Financial Liability: Rs. 9553600; Equity: Rs. 446400) (November 2011, 4 marks)

Q7. On 1st April, 2008 Sigma Ltd. issued 6% Convertible debentures of face value of Rs.100 per
debenture at par. The debentures are redeemable at a premium of 10% on 31-03-2012 or these may be
converted into ordinary shares at the option of the holder, the interest rate for equivalent debentures
without conversion rights would have been 10%, Being a compound financial instrument you are
required to separate equity and debt portion (Debenture amount). The present value is Rs.1,85,400 for
equity portion. Find out the debt portion (Debenture amount). The present value of Rs. 1 receivable at
the end of each year based on discount rates of 6% and 10% can be taken as:
End of year 6% 10%
1 0.94 0.91
2 0.89 0.83
3 0.84 0.75
4 0.79 0.68
(November 2010 New Course; 8 Marks)
(Answer: FL – 2814600; No. of Debentures = 3,00,000)

Q8. You are required to:

(a) Identify Equity and Liability Components,

(b) Compute bond liability at the end of each year, and
(c) Pass necessary journal entries from the following information:
No. of Convertible Bonds 5000 bonds issued at the beginning of year 1
Value of Bonds Rs. 500 per bond
Period of Bonds 3 years validity
Interest rate on bonds 9% pa payable annually
Proceeds Received Rs. 25 Lacs
Conversion At the bond holders’ discretion, conversion into 125 ordinary
shares for each bond of Rs. 500
Prevailing Market Rate 11% pa. for bonds issued without conversion option
Present value factor for 11% 0.900; 0.812; 0.731
(Answer: 2377175 and 122825) (Nov. 2015- 8 Marks)

Q9. B ltd issued on 1-4-2008 9% Debentures whose face value is Rs. 20,00,000 at discount of 5%
Company is to redeem 50% Debentures on 31-3-2011 at 7% premium and balance will be redeemed
on 31-3-2013 at 10% premium. On 31-3- 2012 Rs. 20,000 will be distributed on cash bonus to
debenture holders. Prepare Debentures. A/c Ans. 12.66%

Q10. B ltd gave advance to C Ltd. for Rs.10,00,000 on 1-4-2008 at Interest rate of 10%. B ltd
received Rs.15,000 as processing charges. B Itd gave at 31-3-2009 loyalty bonus Rs. 5,000 and as per

Compiled by CA. Jai Chawla - 9981489567 Page 12

contract B Ltd. is to receive Rs. 10,000 on 31-3-2011 for reverification of credit fee. Loan is to be
repaid by C ltd on 31-3-2012. Prepare Loan A/c. (Answer: 10.59% IRR)

Q11. FEE Ltd. borrows a sum of Rs. 20 crore from COFEE Ltd. repayable as a single bullet payment
at the end of 5 years. The interest thereon @ 5% p.a. is payable at yearly rests. Since the market rate is
8% FEE Ltd. paid an origination fee of Rs.2.40 Crores to COFEE Ltd. to compensate COFEE Ltd. for
the lower reate of interest. Apart from the above, there are no other transactions between the two
parties. You are required to show the value at which COFEE Ltd. would recognize the loan and the
annual interest thereon. (November 2011, 4 marks)

Compiled by CA. Jai Chawla - 9981489567 Page 13

 DERIVATIVES
Koi bhi cheez jiski price koi dusri cheez (underlying) se derive ho) (ek party k
liye favorable position create hoti hai aur dusri party k liye unfavorable
position banti hai i.e. FA for one party and FL/Equity for another)
It should have the following characteristics;

a. Its value changes in response to change in a underlying. (Underlying can be equity

share, stock index, commodity index, commodity price i.e gold, or any other variable
item that has some value)
b. It requires no investment or very less initial investment.
c. It is settled at a future date
d. It is settled on net to net basis (i.e in cash without any delivery)

KEY POINTS:

Basic Principle: All derivative contracts should be recognised on balance sheet at Fair
Value whether there is a favorable position or unfavorable position.

Fair value means “EXIT PRICE” i.e the price that would be paid to transfer a liability or
the price that would be received when transferring an asset to a knowledgeable willing
counterparty.

EXAMPLE-1: A Ltd. holds an option to purchase the equity shares of a listed company B
Ltd. at Rs.100 per share at the end of 90 days period.

Here A is option holder and B is option writer, Evaluate the contract whether it is a financial
asset/ liability?

ANSWER: The above contract is a call option (right to purchase) for entity A and here there
is a contractual right to exchange cash of Rs.100 for an equity share and it will be exercised
,if the market value of the share will be such that the entity A will gain .

Since A Ltd. stands to gain , if the call option is exercised therefore the exchange is
potentially favourable to A Ltd. and hence it is a FINANCIAL ASSET for A Ltd.

EXAMPLE-2: What if in above example when A Ltd. has written the option?

ANSWER: In the given case the counter party can force A Ltd. to sale the equity shares for
Rs.100 per share at anytime in the next 90 days. In the situation A Ltd. has the contractual
obligation to exchange its equity shares to another party for cash of Rs.100 per share on
potentially unfavourable terms i.e. on amount of the market price being above Rs.100 per
share. Therefore A stands to loose if the option is exercised and thus it is FINANCIAL
LIABILITY for A Ltd.

Compiled by CA. Jai Chawla - 9981489567 Page 14

Example:3 (November 2011, 4 marks)
BEE Ltd. has entered into a contract by which it has the option to sell its identified property,
plant and equipment (PPE) to AXE Ltd. for Rs. 100 lakhs after 3 years whereas its current
market price is Rs.150 lakhs. Is the put option of BEE Ltd. a financial instrument? Explain.
Hint: If settlement will be on net to net then this contract (put option) is Financial Instrument
If settlement by way of physical delivery then this is not a financial instrument.

Example:4 (November 2015, 4 marks)

Company owns an office building. Company enters into a put option with an investor that
permits the company to put the building to the investor for Rs. 150 million. The current value
of the building is Rs. 175 million. The option expires in 5 years. The option if exercised may
be settled through physical delivery or net cash, at company’s option. How do the company
and the investor account for the option?
Hint: If settlement will be on net to net then this contract (put option) is Financial Instrument
If settlement by way of physical delivery then this is not a financial instrument.

Example:5 (November 2015, 4 marks)

A Company enters into fixed price forward contract to purchase one million kilograms of
copper in accordance with its expected usage requirements. The contract permits the
company to take physical delivery of the copper at the end of 12 months or to pay or receive
a net settlement in cash, based on change in fair value of copper. Is the contract accounted for
as a derivative ? Explain.

Compiled by CA. Jai Chawla - 9981489567 Page 15

 ACCOUNTING FOR VARIOUS DERIVATIVES
Eg. of Derivatives: Futures, Options, Hedging, Forwards, Swaps

FUTURES: Entered into with the help of Exchange. It has Defined Underlying,
Defined Tenor, Defined Size.

Long Position: Price will go up

Short Position: Price will go down
 On the date of contract: No Accounting (except for margin payment), only a
proper disclosure can be given.
 At each reporting dates: Derivative Future Asset or Liability shall be recognized
through Profit and Loss a/c (FVTPL)
 On settlement Date: Gain or Loss transfer to Profit and Loss A/c

Accounting Entries:
1. For Initial Margin:
Initial Margin (Futures) A/c Dr.
To Bank A/c
2. For Mark to Market Margin:
Bank A/c Dr. MTMDM A/c Dr.
To MTMDM A/c To Bank A/c
(in some cases this margin may not required to be paid every time)
3. Recognition on BS Date: (Ind AS application) – at Fair Value
Futures A/c (Asset) Dr. P&L A/c Dr.
To P&L A/c To Futures A/c
(Liability)
4. Settlement of Future Contract (if margin is received/paid earlier)
MTMDM A/c Dr. Futures (Liability) A/c Dr.
To Futures (Assets) A/c To MTMDM A/c
5. Settlement of Future Contract (if no margin is received/paid
earlier)
Bank A/c Dr. Futures (Liability) A/c Dr.
To Futures (Assets) A/c To Bank A/c

Compiled by CA. Jai Chawla - 9981489567 Page 16

Q12. Mr. A purchases the following units of Equity Stock Futures (ESF):

Date of Purchase ESF (Name of Expiry Date/ Contract price Contract

Company) Series per Unit Multiplier (No.
of Units)
28th March, 03 XYZ Ltd. May 03 1420 200
th
29 March, 03 PQR Ltd. June, 03 4280 50
29th March, 03 XYZ Ltd. May 03 1416 200
The contracts are settled through physical delivery of shares on the Settlement Date, i.e., May 29,
2003 and June 26, 2003 respectively.

Net Mark-to-Market Margin received in respect of the contracts for shares of XYZ Limited (May
2003 Series) till the Settlement Date is Rs. 4000. Net Mark-to-Margin paid in respect of the contract
for shares of PQR Limited (June 2003 series) till the Settlement Date is Rs.3500. Journalise settlement
entry.

FORWARDS:
 Same as Futures but without Exchange.
 Customized contract btw two parties.
 Any Underlying, any size, any tenor.

Q13.Mr, A bought a forward contract for three months of US$ 1,00,000 on Ist December at 1 US$ =
Rs.47.1 0 when exchange rate was US$ 1 = Rs.47.02. On 31 st December when he closed his books,
exchange rate was US$ 1 = Rs.47.15. On 31 st January, he decided to sell the contract at Rs.47.18 per
dollar. Show how the profits from contract will be recognized in the books. (May 2010, 5 marks)

OPTIONS: Entered into with the help of Exchange. Defined Underlying, Defined
Tenor, Defined Size.

Buyer of Options Seller of Option

Long Call position (Right to Buy) Short Call position (Obligation to Sell)
Long Put Position (Right to Sell) Short Put Position (Obligation to Buy)
(In both cases he has to pay premium) (In both cases he gets premium)

When to Exercise the Option?

Call Option – When market price is higher
Put Option – When market price is lower

(A) Buyer: To get Call/Put option I need to pay option premium. This premium is non
refundable. Amount of premium will be booked as Financial Asset until the expiry of
Contract.
Suppose, I bought NIFTY 1 month call option on 1000 lots at strike price of Rs. 8215
at the premium of Rs. 10 per unit.

Compiled by CA. Jai Chawla - 9981489567 Page 17

 Day 1 Accounting –

After 1 Month – Nifty is as follows:

Cases NIFTY Index Exercise/Not Accounting Entry
Exercise
1 8100

2 8200

3 8225

4 8250

5 8300

Now Suppose, before the end of 1 month, there is a BS date and NIFTY on that date becomes
8229. What should I do?

IND AS 109 requires that the derivative instruments needs to be fair valued through P&L.
Since this is a call option, Strike price is increased there is a favorable position (Gain of Rs.
4000)

Accounting at BS date:

Suppose on settlement date the Nifty becomes 8221 –

Accounting on settlement date:

Q14. Mr. Investor buys a stock option of ABC Co. Ltd. in July, 2003 with a strike price on 30.7.2003
Rs.250 to be expired on 30.8.03. The premium is Rs.20 per unit and the market lot is 100. The margin
to be paid is Rs.120 per unit.
Show the accounting treatment in the books of Buyer when:
(i) The option is settled by delivery of the asset, and
(ii) The option is settled in cash and the index price is Rs. 260 per unit.

Compiled by CA. Jai Chawla - 9981489567 Page 18

Ans.: Rs.1,000 (November 2004, Marks 12)

Q15. Accounting for Equity Index Options

Mr. A buys the following equity index options and the seller/writer of these options is Mr. B.

Date of Type of Expiry Date Premium Per Contract Strike Price

Purchase Options Unit Multiplier
(No. of Units)
29 March, 03 S&P CNX May 31, 2003 15 200 880
Nifty Call
29 March, 03 S&P CNX May 31, 2003 20 200 885
Nifty Put
Mr. A and Mr. B follow the calendar year as the accounting year. Prepare Journal Entries. Assume
price of S&P CNX NIFTY on 31st May 2003 Rs.882.

Q16. Continuing with above, except the following facts:

(a) Mr. A and Mr. B follow the financial year as the accounting year.
(b) On 31st March, 2003: For Call Option May 2003 Strike Price Rs.880, closing rate of premium
Rs.6 per unit. For put Option May 2003 Strike Price Rs. 885, closing rate of premium Rs.28 per unit.

Q17. A buyer buys a stock option of New Light Company Limited on 30th August, 2006 with a strike
price of Rs.150 per unit to be expired on September 30, 2006. The premium is Rs.10 per unit and the
market lot is of 100. The margin to be paid is Rs. 60 per unit.
Show, how the transactions will appear in the books of the seller, when: (1) The option is settled by
delivery of the Asset, and
(ii) The option is settled in cash and the Index price is Rs. 160 per unit.
Assume market price Rs.160 in both cases (May 2007; Marks 8)

Compiled by CA. Jai Chawla - 9981489567 Page 19

HEDGE ACCOUNTING
Meaning:

 Making an investment
 or acquiring some derivative or non-derivative instruments
 in order to offset potential losses (or gains) that may be incurred on some
items as a result of particular risk.

Some Important Terms:

(a) Hedged risk: Eg. foreign currency risk.

(b) Hedged item is a receivable/payable in foreign currency (Asset or

Liability).

(c) Hedging instrument is a foreign currency forward contract to sell EUR for a
fixed rate at a fixed date.

(d) Firm Commitment: A firm commitment is a binding agreement for the

exchange of specified quantity of resources at specified future date or dates.

(e) Forecast Transaction: A forecast transaction is an uncommitted but

anticipated future transaction.

There must be a formal document of hedging in order to be eligible to apply hedge accounting

Types of Hedging

Fair Value Hedge Cash Flow Hedge Net Investment Hedging

Fair Value Hedge Cash Flow Hedge Net Investment Hedging

Recognized Risky Risky Forecast Here Underlying is
Assets/Liab. Transaction Investment in Foreign
(Eg. Receivables, Invst in (Eg. Plan to Purchase of operation (Eg. Foreign
Equity instrument) Forg. Currency in future) Subsi)
Fair Value Hedged Item Fair Value Hedged Instrument Hedging through
(A/L) through P&L through OCI Derivative instrument
Fair Value Hedged Amt. in OCI to be FV the Investment as well
Instrument through P&L transferred to P&L when as Hedged Instrument
such transaction Occur. through OCI
(recycling)
Net effect will be in P&L On Sale of FO, recycled to
a/c only P&L

Compiled by CA. Jai Chawla - 9981489567 Page 20

PRESENTATION OF DERIVATIVES IN THE FINANCIAL STATEMENTS:

1. Derivatives that are intended for trading or speculative purposes should be reflected as
current assets and liabilities.
2. Derivatives that are hedges of recognised assets and liabilities (fair value hedge)
should be classified as Current or Non current based on classification of the hedged
item.
3. Derivatives that are hedges of forecasted transactions (Cash flow hedge) should be
classified as current or non current based on settlement date/maturity date.

Q18. On 24 January, 2006 Chinnaswamy of Chennai sold goods to Watson of Washington, USA for
an invoice price of $40,000 when the spot market rate was Rs.44.20 per U.S.$, Payment was to be
received after three months on 24th April, 2006 To mitigate the risk of loss from decline in the
exchange rate on the date of receipt of payment, Chinnaswamy immediately acquired a forward
contract to sell on 24th April, 2006 US$ 40,000 @ Rs.43.70. Chinnaswamy closed his books of
account on 31st march, 2006 when the spot rate was Rs.43.20 per US $. On 24th April, 2006 the date
of receipt of money by Chinnaswamy, the spot rate was Rs.42.70 per US$.

Pass Journal entries in the books of Chinnaswamy to record the effect of all the above mentioned
events.

Compiled by CA. Jai Chawla - 9981489567 Page 21

DEBT SECURITISATION:-
Meaning:

1. It means transfer of recievables of a bank to SPECIAL PURPOSE VEHICLE with

full or partial rights along with risk. These are transferred against specified
consideration.
2. To provide the funding for the purpose purchaser of loan from bank SPV issues
certificates and securities in India.
eg. ARCIL
3. For accounting purpose following points are important to be discussed:
(a) We need to calculate the INTRINSIC VALUE of strips sold and strips unsold
based on Discounting rate { strip sold : position of loan which is transferred and
vice versa for strip unsold}
eg. Apportion BV of loan in the ratio of above intrinsic values.

JOURNAL ENTRIES IN THE BOOKS OF ORIGINATOR (WHO TRANSFERRED

LOAN):

1. Sold stripes a/c Dr.

Unsold stripes a/c Dr.
To loan a/c
2. Bank a/c Dr.
To sold stripes a/c
To P&L (any difference)
3. As far as the unsold stripes are concerned, we need to calculate effective rate
of interest i.e. IRR because they are categorized under “AMORTISED
COST”.

For example: Loan Rs. 10,00,000 @ 10%, cost of collection Rs.5000 p.a.

Period- 3 years, repayment schedule is as under:-

50% in year-1

20% in year-2

30% in year-3

This loan is transferred to SPV to the extent of 60% right on both principal and interest.
Collection cost will continue to be incurred. Discounting rate of SPV @ 14%.Consideration
for transfer is agreed at Rs. 5 lakhs. Show accounting treatment in the books of originator.

Q19.Parikshit Ltd. holds Rs.1,00,000 of loans yielding 18 per cent interest per annum for their
estimated lives of 9 years. The fair value of these loans, after considering the interest yield, is
estimated at Rs, 1, 10,000.

The company securities the principal component of the loan plus the right to receive interest at 14% to
Susovana Corporation, a special purpose vehicle, for Rs. 1,00,000.

Compiled by CA. Jai Chawla - 9981489567 Page 22

Out of the balance interest of 4 percent, it is stipulated that half of such balance interest, namely 2 per
cent, will be due to Pankshit Ltd. as fees for continuing to service the loans. The fair value of the
servicing asset so created is estimated at Rs. 3,500. The remaining half of the interest is due to
Parikshit Ltd. as an interest strip receivable, the fair value of which is estimated at Rs. 6,500.

Give the accounting treatment of the above transactions in the form of journal entries in the books of
originator. (June-09, old 16 Marks)

Compiled by CA. Jai Chawla - 9981489567 Page 23

Important Notes:

Compiled by CA. Jai Chawla - 9981489567 Page 24

Important Notes:

Compiled by CA. Jai Chawla - 9981489567 Page 25

Important Notes:

Compiled by CA. Jai Chawla - 9981489567 Page 26