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Overview of Indian Accounting Standard (Ind AS) 109

Overview of Ind AS 109 Financial Instruments

The objective of Ind AS 109 is to establish principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amounts, timing and uncertainty of an entity’s future cash flows.

Scope

This Standard should be applied by all entities to all types of financial instruments except:

(a) interests in subsidiaries, associates and joint ventures other than those that are accounted for as per this standard in accordance with the permission given by Ind AS 110, Ind AS 27 or Ind AS 28.

(b) rights and obligations under leases to which Ind AS 116 Leases applies. However, lease receivables are subject to the derecognition and impairment requirements of Ind AS 109, lease liabilities are subject to the derecognition requirements of Ind AS 109 and derivatives that are embedded in leases are subject to the embedded derivatives requirements of Ind AS 109.

(c) employers’ rights and obligations under employee benefit plans, to which Ind AS 19, Employee Benefits applies.

(d) financial instruments issued by the entity that meet the definition of an equity instrument.

(e) rights and obligations arising under (i) an insurance contract or (ii) a contract that is within the scope of Ind AS 104 contains a discretionary participation feature.

(f) any forward contract to buy or sell an acquiree that will result in a business combination within the scope of Ind AS 103.

(g) loan commitments other than those which entity designates as financial liabilities at fair value through profit or loss, loan commitments that can be settled net in cash or by delivering or issuing another financial instrument and commitments to provide a loan at a below-market interest rate.

(h) financial instruments, contracts and obligations under share-based payment transactions to which Ind AS 102, Share-based Payment applies except contract to buy/sell non-financial assets which are within the scope of this standard.

(i) rights to payments to reimburse the entity for expenditure that it is required to make to settle a liability that it recognises as a provision in accordance with Ind AS 37.

(j) rights and obligations within the scope of Ind AS 115, Revenue from Contracts with Customers, that are financial instruments, except for those that Ind AS 115 specifies are accounted for in accordance with this Standard.

(k) Contracts to buy or sell a non-financial item which cannot be settled net in cash or another financial instrument, or by exchanging financial instruments.

Recognition

An entity shall recognise a financial asset or a financial liability in its balance sheet when, and only when, the entity becomes party to the contractual provisions of the instrument.

Derecognition: Financial Assets

A financial asset shall be derecognised when and only when:

(a) the contractual rights to the cash flows from the financial asset expire, or

(b) it transfers the financial asset and the transfer qualifies for derecognition.

On derecognition of a financial asset in its entirety, the difference between the carrying amount (measured at the date of derecognition) and the consideration received (including any new asset obtained less any new liability assumed) shall be recognised in profit or loss.

In case of partial derecognition of a financial asset, the previous carrying amount of the whole asset shall be allocated between the part that continues to be recognised and the part that is derecognised, on the basis of the relative fair values of those parts on the date of the transfer.

Derecognition: Financial Liabilities

A financial liability (or a part of a financial liability) shall be derecognised when, and only when, it is extinguished (obligation specified in the contract is discharged or cancelled or expires).

An entity shall account for a substantial modification of the terms of contracts as an extinguishment of the original financial liability and the recognition of a new financial liability. Any difference between the carrying amount of a financial liability extinguished or transferred and the consideration paid should be recognised in profit or loss.

Classification: Financial Assets

A financial asset shall be classified and measured at amortised cost, fair value through other comprehensive income or fair value through profit or loss on the basis of both:

(a) the entity’s business model for managing the financial assets and

(b) the contractual cash flow characteristics of the financial asset.

A financial asset shall be measured at amortised cost if both of the following conditions are met:

(a) business model objective is to hold financial assets in order to collect contractual cash flows and

(b) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

A financial asset shall be measured at fair value through other comprehensive income (FVTOCI) if both of the following conditions are met:

(a) business model objective is achieved by both collecting contractual cash flows and selling financial assets and

(b) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

Financial assets other than those measured at FVTOCI and at amortised cost shall be measured at fair value through profit or loss (FVTPL). However, an entity may, at initial recognition, irrevocably designate a financial asset as measured at FVTPL, if doing so eliminates or significantly reduces ‘accounting mismatch’. An entity may also make an irrevocable election at initial recognition for particular investments in equity instruments that would otherwise be measured at fair value through profit or loss to present subsequent changes in fair value in other comprehensive income.

Classification: Financial Liabilities

An entity shall classify all financial liabilities as subsequently measured at amortised cost, except for:

(a) financial liabilities at fair value through profit or loss.

(b) financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies.

(c) financial guarantee contracts.

(d) commitments to provide a loan at a below-market interest rate.

(e) contingent consideration recognised by an acquirer in a business combination to which Ind AS 103 applies.

An entity may, at initial recognition, irrevocably designate a financial liability as measured at fair value through profit or loss.

Embedded derivatives

An embedded derivative is a component of a hybrid contract that also includes a non-derivative host with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative.

Reclassification

When, and only when, an entity changes its business model for managing financial assets, it shall reclassify all affected financial assets.

Measurement

At initial recognition, an entity shall measure a financial asset or financial liability at its fair value plus or minus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability.

After initial recognition, an entity shall measure a financial asset and financial liabilities in accordance with its classification.

An entity shall recognise a loss allowance for expected credit losses on a financial asset that is measured at FVTOCI and at amortised cost, a lease receivable, a loan commitment and a financial guarantee contract to which the impairment requirements of this standard applies.

An entity shall measure expected credit losses of a financial instrument in a way that reflects an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes; the time value of money; and reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions.

A gain or loss on a financial asset or financial liability that is measured at fair value shall be recognised in profit or loss unless it is part of a hedging relationship or it is an investment in an equity instrument for which option to present gains and losses in other comprehensive income has been opted or it is a financial liability designated as at fair value through profit or loss or it is a financial asset measured at fair value through other comprehensive income.

Hedge accounting

The objective of hedge accounting is to represent, in the financial statements, the effect of an entity’s risk management activities that use financial instruments to manage exposures arising from particular risks that could affect profit or loss (or other comprehensive income, in the case of investments in equity instruments for which an entity has elected to present changes in fair value in other comprehensive income).

(a) Hedging instruments: A derivative measured at fair value through profit or loss may be designated as a hedging instrument.

A non-derivative financial asset or a non-derivative financial liability measured at fair value through profit or loss may be designated as a hedging instrument unless it is a financial liability designated as at fair value through profit or loss for which the amount of its change in fair value that is attributable to changes in the credit risk of that liability is presented in other comprehensive income.

Only contracts entered into by the entity with party external to the reporting entity can be designated as hedging instruments.

(b) Hedged items: A hedged item can be a recognised asset or liability, an unrecognised firm commitment, a forecast transaction or a net investment in a foreign operation. The hedged item can be a single item or a group of items. A hedge item should be reliably measurable.

Types of Hedging Relationship- There are three types of hedging relationships:

(a) fair value hedge: a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or a component of any such item, that is attributable to a particular risk and could affect profit or loss.

(b) cash flow hedge: a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with all, or a component of, a recognised asset or liability or a highly probable forecast transaction, and could affect profit or loss.

(c) hedge of a net investment in a foreign operation as defined in Ind AS 21.

Qualifying criteria for hedge accounting

A hedging relationship qualifies for hedge accounting, only if, all of the following criteria are met:

(a) the hedging relationship consists only of eligible hedging instruments and eligible hedged items.

(b) at the inception of the hedging relationship there is formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge.

(c) the hedging relationship meets all of the following hedge effectiveness requirements:

(i) there is an economic relationship between the hedged item and the hedging instrument;

(ii) the effect of credit risk does not dominate the value changes that result from that economic relationship; and

(iii) the hedge ratio of the hedging relationship is the same as that resulting from the quantity of the hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged item.

In case a hedging relationship ceases to meet the hedge effectiveness requirement relating to the hedge ratio but the risk management objective for that designated hedging relationship remains the same, an entity shall adjust the hedge ratio of the hedging relationship so that it meets the qualifying criteria again called as ‘rebalancing’.

An entity shall discontinue hedge accounting prospectively only when the hedging relationship (or a part of a hedging relationship) ceases to meet the qualifying criteria (after taking into account any rebalancing of the hedging relationship, if applicable).

Ind AS 109 prescribes principles for hedge accounting and also requires detailed disclosures. These disclosures explain both the effect that hedge accounting has had on the financial statements and an entity’s risk management strategy, as well as providing details about derivatives that have been entered into and their effect on the entity’s future cash flows.

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