Financial
Instruments:
Application
issues under
Ind AS
March 2017
KPMG.com/in
Perspectives on accounting for
financial instruments
About the publication
As we approach the end of the first financial year
since Indian Accounting Standards (Ind AS) became
applicable, Indian companies in the first phase of
convergence will soon be required to prepare their first
annual financial statements in compliance with Ind AS.
Due to the pervasiveness and distinct nature of
accounting for financial instruments, our research
demonstrates that almost all companies that have
presented their quarterly results upon transition to Ind
AS have disclosed adjustments relating to financial
instruments.
The Ind AS framework notified by the Ministry of
Corporate Affairs (MCA) in 2015 includes three
standards on financial instruments, Ind AS 109,
Financial Instruments, Ind AS 32, Financial Instruments:
Presentation, and Ind AS 107, Financial Instruments:
Disclosures. The guidance provided in these standards
is extensive and often complex in nature, requiring
significant interpretation and exercise of judgement.
The principles of Ind AS 109 are based on International
Financial Reporting Standard (IFRS) 9, Financial
Instruments, which becomes applicable internationally
from 1 January 2018 onwards. As a result Indian
companies face significant practical implementation
issues due to the absence of precedents arising from
international application.
While companies have applied the recognition and
measurement requirements of these standards over
the past three quarters, the annual financial statements
will pose new challenges due to the extensive and
onerous disclosure requirements in Ind AS 107.
Compilation of these disclosures may require access to
detailed information which may sometimes be difficult
to obtain in the absence of changes to information
systems for capturing relevant data.
This publication highlights many of the practical issues
that Indian companies may face when implementing
the guidance on financial instruments under Ind AS.
It elucidates the relevant accounting principles in a
clear and concise manner, with the help of flowcharts
and worked examples that illustrate the application of
key concepts and the related accounting impact on
the balance sheet and statement of profit and loss.
It is based on the Ind AS notified by MCA, including
amendments up to 1 March 2017.
Need for judgement
References
This publication intends to highlight some of the
practical application issues with the help of certain
facts and circumstances detailed in the examples
used. In practice, transactions or arrangements
involving financial instruments are likely to be complex.
Therefore, further interpretation and significant use
of judgement may be required in order for an entity
to apply Ind AS to its own facts, circumstances and
individual transactions. Further, some information
contained in this publication may change as practice
and implementation guidance continue to develop.
Users are advised to read this publication in
conjunction with the actual text of the standards and
implementation guidance issued, and to consult their
professional advisors before concluding on accounting
treatments for their own transactions.
References to relevant guidance and abbreviations,
when used, are defined within the text of the
publication.
Contents
Scope and definitions
•
Contracts for purchase or sale of non-financial items
•
Accounting for financial guarantee contracts
Derivatives
•
Foreign currency embedded derivatives
•
Put options written on non-controlling interests
Equity and financial liability classification
•
Classification of convertible preference shares
•
Preference shares convertible into a variable number of shares
•
Impact of contingent settlement provisions on classification of financial instruments
Recognition and derecognition
•
Accounting for long-term deposits and advances
•
Derecognition of trade receivables under a factoring arrangement
•
Derecognition of a financial liability
•
Extinguishment of a financial liability with an equity instrument
•
Accounting for low interest and interest free loans
01
09
17
29
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Classification and measurement
•
Classification of investments in preference shares
•
Classification of investments in mutual funds
•
Analysis of business model to determine classification of financial assets
•
Application of effective interest method
Impairment of financial assets
•
71
Impairment assessment for trade receivables
Hedge accounting
•
Hedging foreign currency risk on forecast transactions
•
Hedge accounting using cross currency interest rate swaps
Financial instruments: Disclosures
•
53
79
93
Frequently Asked Questions (FAQs) on disclosure of financial instruments
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Scope and definitions
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Financial Instruments: Application issues under Ind AS
2
Contracts for purchase or sale of non-financial items
Ind AS 109, Financial Instruments applies to contracts to buy or sell non-financial items that:
•
Can be settled net in cash; and
•
Are not entered into, or continue to be held, for the purpose of receipt or delivery of the non-financial item in accordance with
the entity’s expected purchase, sale or usage requirements.
Contracts that meet the criteria above are considered to be derivative instruments under Ind AS 109 and those that do not, are
considered executory contracts that are outside the scope of Ind AS 109. This case study highlights the relevant guidance and
illustrates its application to a group of contracts.
Key terms of contracts to buy/sell non-financial items
Company Z is engaged in the business of importing oil seeds for further processing as well as trading purposes. It enters into the
following types of contracts as on 1 October 2016:
Contract 1
Contract 2
Contract 3
Nature of
contract
Import of oil seeds from a foreign
supplier
Purchase of oil seeds from a
domestic producer/supplier
Contract to sell oil seeds on the
commodity exchange
Quantity and
rate
100 MT at USD400 per MT to be
delivered as on 31 March 2017
50 MT at INR30,000 per MT to
be delivered as on 31 January
2017
50 MT at USD450 per MT,
maturing as on 15 January 2017
Net settlement
clause included
in the contract
Yes
Yes
Yes
Net settlement
in practice
for similar
contracts
Yes – company Z has net settled
some of these contracts in the
past. There have also been
several instances of the oil seeds
being sold prior to or shortly after
taking delivery. These instances
of net settlement constitute
approximately 30 per cent of the
value of total import contracts.
Yes – company Z has net settled
some of the domestic purchase
contracts. However, these
instances constitute only 1
per cent of the total domestic
purchase contracts in value. The
remaining contracts are settled
by taking delivery of the oil
seeds which are used for further
processing.
Yes – these contracts are required
to be net settled with the
exchange on the maturity date.
Company Z enters into these type
of derivative contracts to hedge
the risks on its domestic oil seeds
purchase contracts.
Accounting issue
Company Z is required to determine if the contracts entered into for purchase and sale of oil seeds are derivatives within the
scope of Ind AS 109 or are executory contracts outside the scope of Ind AS 109.
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3
Financial Instruments: Application issues under Ind AS
Accounting guidance
Figure 1 illustrates the guidance in Ind AS 109 on analysis of contracts to purchase or sell non-financial items:
Figure 1: Guidance on contracts to purchase or sell non-financial items
No
Can the contract be settled net in cash/
another financial instrument/by exchanging
financial instruments, or is the non-financial
item readily convertible into cash?
Yes
Does the entity have a past practice for similar contracts
of:
• net settlement, or
• taking delivery and selling within a short period of time
No
Is the contract entered into and held in
accordance with the entity’s expected
purchase, sale or usage requirements?
Yes
No
Yes
Has the entity elected to apply the ‘fair
value option’ if FVTPL accounting would
eliminate or significantly reduce an
accounting mismatch?
FVTPL
Yes
No
Executory
contract
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition September 2016
Ind AS 109 is applicable to those
contracts that can be settled net in
cash or another financial instrument,
including if the non-financial item is
readily convertible into cash. However,
contracts that were entered into and
continue to be held for the purpose of
the receipt or delivery of a non-financial
item in accordance with an entity’s
expected purchase, sale or usage
requirements are not included in the
scope of Ind AS 109 (this is the ‘normal
sales and purchases’ or ‘own-use’
exemption).
If the entity has a past practice of net
settlement for similar contracts, such
contracts would not be considered to
meet the ‘own-use’ exemption.
Contracts that meet the ‘own-use’
exemption and are excluded from the
scope of Ind AS 109 may give rise to
accounting mismatches. For example,
an entity may enter into derivative
contracts to hedge the risks arising from
such executory contracts and may be
monitoring their net exposure on a fair
value basis. The derivatives would be
measured at fair value through profit
or loss (FVTPL) whereas the executory
contracts would not be recognised in
the financial statements, leading to
an accounting mismatch. Ind AS 109
therefore permits an entity to irrevocably
designate such contracts as FVTPL even
if they meet the ‘own-use’ exemption.
Analysis
Contract 1
The following factors indicate that this
contract does not meet the ‘own-use’
exemption:
•
The contract permits net settlement,
and
•
There is a past practice of a significant
proportion (30 per cent in this
illustration) of similar contracts being
settled on a net basis either in cash
or by sale of the oil seeds prior to
delivery/shortly after taking delivery.
Therefore, this contract would fall within
the scope of Ind AS 109 and should be
recognised as a derivative instrument as
on 1 October 2016.
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Financial Instruments: Application issues under Ind AS
The contract would be in the nature of
a forward contract to buy 100 MT of oil
seeds as on 31 March 2017 at USD400
per MT. Company Z would have to
recognise the fair value changes (based
on change in forward purchase rate) on
this contract in the statement of profit
and loss at each reporting date.
Contract 2
Contract 2 also permits net settlement
in cash. Further, there have been some
instances of similar domestic purchase
contracts being settled net in cash in
the past. However, these have been
infrequent in nature and insignificant
in proportion to the total value of
similar contracts (i.e. 1 per cent in this
illustration). Company Z is in the practice
of taking delivery of the oil seeds
purchased under similar contracts and
using them for further processing in its
plants.
This indicates that the domestic
purchase contract meets the criteria for
the ‘own-use’ exemption and should be
considered as an executory contract.
Therefore, this contract would not fall
within the scope of Ind AS 109.
Contract 3
This contract is in the nature of a
derivative contract transacted on a
commodity exchange and is required
to be net settled in cash on maturity.
Therefore, this derivative contract would
be covered by Ind AS 109 and required to
be classified and measured at FVTPL.
Fair value option
The derivative contracts (similar to
contract 3) are transacted to hedge
the risks on the domestic purchase
contracts. While the derivatives are
required to be measured at FVTPL, the
domestic purchase contracts meet the
‘own-use’ exemption and are considered
as executory contracts. These are
typically not recognised until physical
delivery of the oil seeds (depending
on the terms of purchase). This gives
rise to an accounting mismatch in the
statement of profit and loss.
4
receipt or delivery of the non-financial
item in accordance with the entity’s
expected purchase, sale or usage
requirements (i.e. meets the ‘own-use’
exemption). This option (known as the
‘fair value option’) is available only if
it eliminates or significantly reduces
an accounting mismatch that would
otherwise arise.
Consequently, company Z may opt to
irrevocably designate contract 2 (and
similar contracts) as measured at FVTPL
to eliminate the inconsistency described
above.
Ind AS 109 permits a contract to buy
or sell a non-financial item that can be
settled net in cash/another financial
instrument to be irrevocably designated
at inception as measured at FVTPL even
if it was entered into for the purpose of
Consider this….
• If company Z does not elect to apply the fair value option and measure contract 2 at
FVTPL, it may elect to apply hedge accounting to contract 3. Since contract 3 is a
derivative that was entered into to hedge the risks arising from the domestic oil seeds
purchase contracts (similar to contract 2), it may be designated in a hedging relationship
provided it meets the qualifying criteria. However, hedge accounting for hedges of risks
arising from non-financial items is often complex due to the large volumes involved and
the absence of individual correlation between the derivatives (hedging instruments) and
the hedged items when managing net exposures. Therefore, the use of the fair value
option generally involves lower cost and effort.
• The existence of a past practice of net settlement is a matter of judgement since Ind
AS 109 does not specify any bright lines or thresholds. Infrequent and unforeseeable
incidents of net settlement in the past would generally not be considered as indicative of
a past practice of net settlement for all similar contracts.
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5
Financial Instruments: Application issues under Ind AS
Accounting for financial guarantee contracts
Ind AS 109, Financial Instruments includes within its scope, an issuer’s rights and obligations arising under an insurance contract
that meets the definition of a financial guarantee contract. A scope exemption is available for such contracts only when an issuer
had previously asserted explicitly that it regards such financial guarantees as insurance contracts and has used accounting that is
applicable to insurance contracts under Ind AS 104, Insurance Contracts.
In this case study, we analyse how to identify a financial guarantee contract (as defined in Ind AS 109) and the appropriate
accounting treatment to be followed by the issuer and the holder.
Key terms of the contract
Subsidiary company S enters into a term loan arrangement with bank B on 1 April 2016 on the following terms:
Contractual features
Details
Term
5 years
Loan amount
INR100 million
Interest
11 per cent per annum, payable quarterly
Principal repayment
20 quarterly instalments
Guarantee
Parent company P (the flagship company of the group) provides a guarantee to bank B – to
make payment of the amount due if company S fails to make a payment within 30 days after
it falls due. (Any subsequent recoveries are utilised to reimburse company P for amounts
paid under the guarantee).
Guarantee fee/premium
Nil
Company P has made no assertion in its business documentation or its previous financial statements that it regards financial
guarantee contracts as insurance contracts.
Company S has estimated the fair value of the guarantee (using the principles of Ind AS 113, Fair Value Measurement) as INR5
million based on the premium/fee that it would be required to pay to a market participant (e.g., a bank) to provide a similar guarantee
at 1 April 2016.
Accounting issue
Company P
The parent company P is required to analyse whether the guarantee provided to bank B meets the definition of a financial guarantee
contract and should be recognised at its fair value under Ind AS 109.
Company S
Company S is the beneficiary of the guarantee. While Ind AS 109 does not specifically apply, company S may reflect the financial
guarantee contract appropriately in its financial statements on the same principles as those applied by company P .
Bank B
The holder of the financial guarantee is required to assess whether this guarantee is within the scope of Ind AS 109 or should be
accounted for separately.
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Financial Instruments: Application issues under Ind AS
6
Accounting guidance and analysis
Scope and definition
Ind AS 109 defines a financial guarantee contract as ‘a contract that requires the issuer to make specified payments to reimburse
the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or
modified terms of a debt instrument.’ Based on this definition, the contract between company P and bank B qualifies as a financial
guarantee contract only if it meets all the conditions illustrated in Figure 1 below.
Figure 1: Analysis for qualifying as a financial guarantee contract
Guidance
No
Analysis
Is the reference obligation a
debt instrument
Yes - the contract guarantees the term loan (a debt
instrument) provided by bank B to company S
Yes
No
Is the holder compensated
only for a loss that it incurs?
Yes - company P will compensate bank B only in
the event that company S fails to make a payment
within 30 days after it falls due
Yes
No
Is the holder not compensated
for more than the actual loss
incurred?
Yes - company P will compensate bank B only for
losses incurred (any subsequent recoveries from
company S are repaid to company P)
Yes
The contract qualifies as a financial guarantee contract
If the guarantee contract does not meet one of the three conditions,
it may be a credit derivative contract
Source: KPMG in India’s analysis, 2017 read with Ind AS 109
Based on the analysis above, the
contract between company P and bank
B meets the definition of a financial
guarantee contract and will fall within
the scope of Ind AS 109.
Recognition and measurement
Guarantor – Company P
Ind AS 109 requires the guarantor
to recognise the financial guarantee
contract initially at its fair value. Since
company P is the parent entity of the
beneficiary, company S, there will be no
impact at a consolidated level. However,
P will be required to recognise a liability
in its separate financial statements for
the fair value of the financial guarantee.
As no payment is made by S to P,
this may be considered as a deemed
capital contribution by company P to
its subsidiary, since the guarantee has
been provided by P in its capacity as a
shareholder.
Subsequently, this guarantee is to be
measured at the higher of an amount
determined based on the expected loss
method (as per guidance in Ind AS 109)
or the amount originally recognised
less, the cumulative amount recognised
as income on a straight-line basis in
accordance with Ind AS 18, Revenue.
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7
Financial Instruments: Application issues under Ind AS
The following is the accounting treatment in the separate financial statements of company P.
Date
Accounting entry
Amount in INR
1 April 2016
On initial recognition of the financial guarantee
Investment in S
Financial guarantee liability
31 March 2017
Dr
Cr
5,000,000
5,000,000
Dr
Cr
1,000,000
1,000,000
Subsequent recognition of income on a straight line basis (assuming expected loss is
less than the unamortised liability amount)
Financial guarantee liability
Guarantee income
Source: KPMG in India’s analysis, 2017
Beneficiary – Company S
Ind AS 109 does not apply to the
beneficiary of a financial guarantee
contract. In an arm’s length transaction
between unrelated parties, the
beneficiary would recognise the
guarantee fee or premium paid as an
expense. However, in the illustration
above, company S does not pay a
premium to its parent entity for providing
this financial guarantee.
Therefore, company S would be
required to develop and consistently
apply an accounting policy to recognise
the impact of this financial guarantee
contract in its separate financial
statements.
parent entity. Therefore, company S
should recognise the fair value of the
guarantee as an equity infusion by the
parent as follows.
One view is that the subsidiary should
mirror the accounting treatment in the
separate financial statements of the
Date
Accounting entry
Amount in INR
1 April 2016
On initial recognition of the financial guarantee
Prepaid expense (guarantee premium)
Equity
31 March 2017
Dr
Cr
5,000,000
5,000,000
Dr
Cr
1,000,000
1,000,000
Subsequent recognition of income on a straight line basis (assuming expected loss is
less than the unamortised liability amount)
Guarantee expense
Prepaid expense (guarantee premium)
Source: KPMG in India’s analysis, 2017
On consolidation, the transactions
recognised in the separate financial
statements of the parent and subsidiary
companies will be eliminated.
An alternative view may be that the
guarantee is an integral part of the
borrowing and the subsidiary company
merely recognises the guaranteed
borrowing from the bank at its fair value,
being the nominal amount of proceeds
received. The financial guarantee from
the parent is not recognised separately.
On consolidation, the parent entity
should reverse the accounting entries
relating to the financial guarantee that
were recognised in its separate financial
statements.
Holder – Bank B
Ind AS 109 does not provide any specific
guidance on accounting by the holder
of a financial guarantee. A holder may
develop and consistently apply an
accounting policy for such contracts
under Ind AS.
from the underlying loan. The effect of
the protection offered by such guarantee
should be considered by the holder
when measuring the fair value of the
debt instrument, estimating expected
cash flows and assessing impairment of
the debt instrument.
A financial guarantee contract held by
an entity that is not an integral part of
another financial instrument is not within
the scope of Ind AS 109. If a financial
guarantee is an integral element of a
debt instrument held by the entity, it
should not be accounted for separately.
Guarantees given by parent would
generally be an integral part of the loan.
Such guarantees cannot be separated
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Financial Instruments: Application issues under Ind AS
8
Consider this….
• A guarantee contract that requires the guarantor (company P in the
illustration above) to make a payment to the holder (bank B) when
a loss has not been incurred, for example, based on changes in the
credit rating of company S, does not meet the definition of a financial
guarantee contract. Similarly, guarantee contracts that fail any one
of the three conditions in Figure 1 above are not financial guarantee
contracts as defined in Ind AS 109. Such contracts may be considered
credit derivatives and measured at fair value with changes in fair value
recognised in the statement of profit and loss (fair value through profit
or loss).
• Other features that may result in guarantee contracts being
considered credit derivatives include those that require the guarantor
to make payments in response to changes in a specified variable
(e.g., credit index, interest rates, etc.) or when the debtor fails to
make payment within a specified credit period. However, in the latter
case, if subsequent recoveries from the debtor are used to repay
the guarantor such contracts may still qualify as financial guarantee
contracts.
• In the example above, if the subsidiary company S pays the parent
company P a guarantee commission/premium, company P is required
to determine if this premium represents the fair value of the financial
guarantee contract. If the premium is equivalent to an amount that
company S would have paid to obtain a similar guarantee in a standalone arm’s length transaction, then the fair value of the financial
guarantee contract at inception is likely to equal the premium
received. Company P should recognise a liability for the amount of
premium received and subsequently measure the financial guarantee
contract at the higher of the amount of loss allowance determined in
accordance with Ind AS 109 and the amount initially recognised, less
cumulative amount of income recognised (based on amortisation of
the premium) in accordance with Ind AS 18.
• A parent company may provide a letter of comfort or support to its
subsidiary, stating that a further equity investment would be made
in the subsidiary, as required, to enable the subsidiary to discharge
its financial liabilities. However, this may not entail an obligation to
compensate a lender when the subsidiary fails to make payments
when due. Companies should carefully evaluate the terms of such
arrangements to determine whether they meet the definition of a
financial guarantee contract.
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Derivatives
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Financial Instruments: Application issues under Ind AS
10
Foreign currency embedded derivatives
Ind AS 109, Financial Instruments provides guidance on accounting for derivatives and embedded derivatives. A derivative is
defined as ‘a financial instrument or other contract within the scope of this standard with all three of the following characteristics:
•
Its value changes in response to the change in 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,
•
It requires no initial net investment or an initial net investment that is smaller than would be required for other types of
contracts that would be expected to have a similar response to changes in market factors, and
•
It is settled at a future date.’
Companies may also enter into contracts that are not derivatives in themselves but include a derivative feature. This is known as
an ‘embedded derivative’. An embedded derivative is a component of a hybrid (non-derivative, financial or non-financial) contract
and results in some or all of the cash flows varying in a manner similar to a stand-alone derivative. Embedded derivatives in
financial assets are not separately recognised, however those in financial liabilities or in non-financial contracts are separated and
accounted for as a derivative if they meet the following conditions:
•
Their economic characteristics and risks are not closely related to the economic characteristics of the host contract,
•
A separate instrument with the same terms as the embedded derivative meets the definition of a derivative, and
•
The hybrid contract is not classified and measured at Fair Value Through Profit or Loss (FVTPL).
In this case study we describe the guidance in Ind AS 109 relating to identifying and separating foreign currency embedded
derivatives present in non-financial host contracts with the help of an illustrative example.
Illustration - Key terms of the non-financial contract
Company A, an Indian company whose functional currency is INR, enters into a contract to purchase machinery from an unrelated
local supplier, company B. The functional currency of company B is also INR. However, the contract is denominated in USD, since
the machinery is sourced by company B from a US based supplier. Payment is due to company B on delivery of the machinery.
Table 1 specifies the key terms of the contract:
Table 1: Key terms of the contract
Contractual features
Details
Contract/order date
9 September 2016
Delivery/payment date
31 December 2016
Purchase price
USD1,000,000
USD/INR Forward rate on 9 September 2016 for 31
December 2016 maturity
67.8
USD/INR Spot rate on 9 September 2016
66.4
USD/INR Forward rates for 31 December, on:
30 September
31 December (spot rate)
67.5
67
Accounting issue
Company A is required to analyse if the contract for purchase of machinery (a capital asset) from company B contains an
embedded derivative and whether this should be separately accounted for on the basis of the guidance in Ind AS 109.
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11
Financial Instruments: Application issues under Ind AS
Accounting guidance
Figure 1 illustrates the guidance in Ind AS 109 on determining whether an embedded foreign currency feature should be
separated and recognised as a derivative.
Figure 1: Guidance for separation of foreign currency embedded derivative
Is the hybrid contract a financial asset
within the scope of Ind AS 109
Classify entire contract as FVPTL/FVOCI/
Amortised cost as per guidance in Ind AS 109
Yes
No
Yes
Is the embedded derivative ‘closely related’ to
the host, i.e., either
Is the hybrid contract measured at
FVTPL?
• Denominated in the functional currency of a
substantial party,
No
• Routinely denominated in that currency in
global transactions, or
Does the embedded derivative meet the
definition of a stand-alone derivative
Yes
No
• Denominated in a currency that is commonly
used in that economy
No
Yes
Embedded derivative is not bifurcated
Embedded derivative is bifurcated and
separately recognised as a derivative
Source: KPMG in India’s analysis, 2017 read with Ind AS 109
Analysis
large majority of similar commercial
transactions around the world. For
example, transactions in crude oil
are generally considered routinely
denominated in USD. A transaction
for acquiring machinery in this
illustration would generally not qualify
for this exemption.
Based on the guidance above, the USD
contract for purchase of machinery
entered into by company A includes an
embedded foreign currency derivative
due to the following reasons:
•
The host contract is a purchase
contract (non-financial in nature) that
is not classified as, or measured at
FVTPL.
•
The embedded foreign currency
feature (requirement to settle the
contract by payment of USD at a
future date) meets the definition of a
stand-alone derivative – it is akin to a
USD-INR forward contract maturing
on 31 December 2016.
•
USD is not the functional currency of
either of the substantial parties to the
contract (i.e., neither company A nor
company B).
•
Machinery is not routinely
denominated in USD in commercial
transactions around the world. In
this context, an item or a commodity
may be considered ‘routinely
denominated’ in a particular currency
only if such currency was used in a
•
USD is not a commonly used
currency for domestic commercial
transactions in the economic
environment in which either company
A or B operate. This exemption
generally applies when the business
practice in a particular economic
environment is to use a more stable
or liquid foreign currency (such
as the USD), rather than the local
currency, for a majority of internal or
cross-border transactions, or both.
In the illustration above, companies
A and B are companies operating in
India and the purchase contract is an
internal/domestic transaction. USD
is not a commonly used currency for
internal trade within this economic
environment and therefore the
contract would not qualify for this
exemption.
Accordingly, company A is required
to bifurcate the embedded foreign
currency derivative from the host
purchase contract and recognise it
separately as a derivative.
Accounting treatment
The separated embedded derivative
is a forward contract entered into on
9 September 2016, to exchange USD
1,000,000 for INR at the USD/INR
forward rate of 67.8 on 31 December
2016. Since the forward exchange rate
has been deemed to be the market
rate on the date of the contract, the
embedded forward contract has a fair
value of zero on initial recognition.
Subsequently, company A is required
to measure this forward contract
at its fair value, with changes in fair
value recognised in the statement of
profit and loss. The following is the
accounting treatment at quarter-end
and on settlement, based on the terms
specified in Table 1. (These accounting
entries are illustrative in nature and
exclude the impact of discounting as
well as the deferred tax adjustments for
simplicity).
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Financial Instruments: Application issues under Ind AS
12
Date
Accounting entry
9 September 2016
On initial recognition of the forward contract
(No accounting entry recognised since initial fair value of the forward contract is
considered to be nil)
30 September 2016
Fair value change in forward contract
Forward contract asset (company B) ((67.8-67.5)*1,000,000)
Profit or loss
Dr
Cr
300,000
300,000
Fair value change in forward contract
Forward contract asset (company B) ((67.8-67)*1,000,000-300,000)
Profit or loss
Dr
Cr
500,000
500,000
Recognition of machinery acquired
Property, plant and equipment (at forward rate)
Forward contract asset (company B)
Creditor (company B)
Dr 67,800,000
Cr
800,000
Cr 67,000,000
Settlement – payment to company B
Creditor (company B)
Bank
Dr 67,000,000
Cr 67,000,000
31 December 2016
31 December 2016
31 December 2016
Amount in INR
Source: KPMG in India’s analysis, 2017
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13
Financial Instruments: Application issues under Ind AS
Consider this….
• While the payment made by company A to company B for purchase of the
machinery is INR67 million, based on the spot exchange rate on the date of
delivery, the amount capitalised to property, plant and equipment is INR67.8 million.
Therefore, the cost of purchase of the machinery in INR (being the host contract)
is ultimately measured at the forward rate on the date of the contract and the
additional INR0.8 million is recognised in the statement of profit and loss as the fair
value change in the separated embedded derivative (USD-INR forward exchange
contract).
• Although company B sourced the machinery from a US based supplier and hence,
the cost of the machinery supplied to company A may be based on its USD price,
this does not preclude separation of the embedded derivative from the host
contract.
• However, if the US based supplier is a related party of company B and the
contract could not have been fulfilled by company B (considering the requisite
resources or technology to fulfil the contract) independently, further analysis may
be required to determine if the supplier is also a ‘substantial party’ to the contract.
If so determined, then the embedded foreign currency derivative may not require
separation since USD is the functional currency of the supplier, being a substantial
party to the contract.
• An extension in the contract term due to delay in delivery of the machinery by
company B would also result in an extension in the term of the embedded foreign
currency derivative. This would be similar to a roll-over of the derivative at a forward
exchange rate that is determined on the basis of the market forward exchange rate
for the new date of delivery.
• Companies may enter into purchase or sale contracts that are denominated in a
foreign currency in order to manage the currency risk on another exposure. For
example, an Indian company that has sales denominated in EUR may enter into a
EUR denominated contract to purchase machinery from an entity that has a JPY
functional currency. This may act as a ‘natural hedge’ enabling the company to use
its EUR inflows to make a payment to the supplier. However, such ‘third currency’
contracts would have to be assessed to determine if they contain a foreign currency
embedded derivative.
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Financial Instruments: Application issues under Ind AS
14
Put options written on non-controlling interests
An entity may enter into business
arrangements with other businesses
or investors for various purposes
including joint development of real
estate, financing construction of
infrastructure, obtaining technical
know-how or market access, etc.
These arrangements may involve one
entity acquiring a controlling interest
in an existing business or each party
acquiring equity interests in an entity or
venture that is being established. Some
of these arrangements may require an
entity (generally, the controlling entity)
to provide minority investors with a
mechanism to exit their investment after
a certain period of time, by writing a put
option to the investors in relation to their
equity interest.
In this case study we will analyse
the classification and measurement
requirements for put options written by
an entity in favour of the non-controlling
interest (NCI) holders of its subsidiary.
Key terms of financial
instruments
On 1 April 2016, company P (the
company or the entity), a listed real
estate developer entered into an
agreement with company S, to develop
100 acres of land belonging to company
S into a residential real estate project.
Both companies would acquire equity
interests in a newly established
company, PS. The new company (PS)
would have a total share capital of
INR1,000 million, with company P
holding 65 per cent of the shares and
company S holding the remaining 35 per
cent. Company P controls company PS,
which is therefore considered to be its
subsidiary.
As part of the shareholders’ agreement,
company P has written a put option
in favour of company S. This provides
company S with a right to sell its shares
in company PS at any time after a period
of five years at a fixed exercise price
being equal to the amount invested by
company S plus a return of 12.5 per cent
per annum. The exercise price would
be adjusted for any dividends paid to
company S prior to the exercise date,
such that the overall return received
by company S would be 12.5 per cent
per annum. On exercise of this option,
company P would be liable to acquire
the entire shareholding of company S
either for cash or for a variable number
of ordinary shares of company P.
Company P and company S are entitled
to a dividend (whenever declared by
company PS) in the proportion of their
shareholding until the time that the put
option is exercised.
The option will remain exercisable until
such time that company P controls
company PS. If company P decides
to exit its investment in company PS
while the option remains unexercised,
it may do so only if the acquiring entity
provides a similar right to company S.
Accounting issue
Company P needs to determine the
classification and measurement
requirements that apply to the put
option in its stand-alone as well as
consolidated financial statements.
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15
Financial Instruments: Application issues under Ind AS
Accounting guidance
Figure 1 below illustrates the accounting treatment for the written put option in the consolidated financial statements of the
issuer.
Figure 1: Accounting for written put options on NCI
Put option allows settlement in cash or shares
of parent
(select one of two approaches)
Put option requires payment in cash
Does NCI have present access to returns
Yes
Present access
method
Dr Other equity
Cr Option liability
No
Anticipated
acquisition method
Approach 1
(select one of two
accounting policies)
Approach 2
Derivative liability at
FVTPL
Classify shares of
subsidiary together with
put option as financial
liability
Dr Non-controlling interest
Cr Option liability
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition, September 2016
Analysis
Consolidated financial statements of the
issuer
Ind AS 110, Consolidated Financial
Statements requires company P to
consolidate company PS since it controls
this entity. In the consolidated financial
statements, the put option written by
the company represents the group’s
obligation to acquire one class of its
own non-derivative equity instruments
(shares in company PS) by delivering
either cash, or a variable number of
a different class of its own equity
instruments (shares in company P).
In the absence of direct guidance
in Ind AS 32, Financial Instruments:
Presentation or Ind AS 109, Financial
Instruments, the company P may elect
an accounting policy based on either of
the following approaches.
Approach 1 – Put option recognised
separately as a derivative liability
The shares issued by the subsidiary to
NCI holders are considered as equity
instruments, being ownership interests
in the consolidated group and the put
option is recognised separately. The
company may elect to apply one of the
following two accounting policies for
measurement of the put option liability:
Recognise a financial liability for the
present value of the exercise price
of the put option: In accordance with
Ind AS 32, the put option represents a
contractual obligation for the company to
purchase its own equity instruments for
cash/another financial asset. Therefore,
the company should recognise the
present value of the amount payable
on exercise of the option as a financial
liability.
The IFRS Interpretations Committee has
considered the issue of recognition of
change in the carrying amount of such
a put liability and indicated that under
IFRS, companies could elect to present
such changes either in profit or loss or in
equity. If the same interpretation were
applied under Ind AS, then the company
could elect and consistently adopt an
accounting policy for recognising the
change in the present value of the
amount payable on exercise of the put
option, on each reporting date, either in
profit or loss or equity.
In accordance with the principles of
Ind AS 110, the other impact of this
transaction may be recognised on the
basis of the NCI’s present access to the
returns associated with the underlying
shares (participation in fair value
changes and rights to receive dividends).
In the illustration above, the NCI holders
would continue to receive dividends on
the shares held in company PS until the
exercise of the put option. However,
the option is exercisable at a fixed
price that is adjusted for any dividends
previously paid and the NCI holders
cannot participate in the subsequent
fair value changes in their shares. This
indicates that the NCI does not have
present access to all returns associated
with an ownership interest in the shares.
Therefore, the other impact of the put
option transaction should be recognised
as a debit to NCI (anticipated acquisition
method) in the consolidated financial
statements.
Recognise put options as derivative
liabilities at FVTPL: If the company
elects to apply this accounting policy,
it is required to account for put options
separately as derivative liabilities
measured at their fair value through
profit or loss (FVTPL) in the consolidated
financial statements. On initial
recognition of the derivative liability,
the company should also evaluate an
appropriate accounting treatment for the
corresponding impact.
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Financial Instruments: Application issues under Ind AS
For example, one alternative could be
to debit equity since this represents a
cost of its investment in company PS.
The equity shares held by NCI (company
S) would continue to be classified
and presented as equity instruments.
Subsequent changes in the fair value
of the derivative liability should be
recognised in profit or loss.
Approach 2 – Classify shares held by NCI
together with the put option as financial
liabilities
Under this approach, the company
may apply the guidance in Ind AS 32 by
considering all the contractual terms
and conditions between the group and
the NCI holders. This would require
analysing the shares in company PS held
by company S together with the put
option written by company P in favour
of company S. On a combined analysis
of these instruments, the substance of
the contractual terms states that there
is a contractual obligation for the parent
entity (company P) to deliver cash or a
variable number of shares to the NCI
holder at a future date, in exchange
for the shares held in the subsidiary.
Therefore, the shares held by NCI,
together with the put option, effectively
meet the definition of a financial
liability and are recognised as such in
the consolidated financial statements.
(Refer pages 18 to 28 for case studies on
equity and liability classification.)
Stand-alone financial statements of the
issuer
In the example above, the put option
written by company P in favour of
company S to acquire the latter’s
shareholding in company PS, will be
settled by payment of a fixed amount of
cash or a variable number of shares of
company P (based on the cash amount
payable and the fair market value of
shares of company P).
At an entity-level, the option is a
derivative instrument that obliges the
company to acquire a financial asset
(being shares of company PS) at a fixed
price on a future exercise date. The
option may be settled in cash or in a
variable number of the company’s own
equity instruments, indicating that it
does not meet the criteria for equity
16
classification in Ind AS 32. (Refer page
22 for a case study on classification of a
financial instrument as equity or financial
liability.)
In accordance with Ind AS 109, the
company should therefore recognise
the option as a derivative liability
measured at FVTPL in its standalone
financial statements. The fair value of
the option may be computed using a
valuation technique such as an option
pricing model and the company may
consider involving a valuation expert
for this purpose. The company should
also assess an appropriate accounting
treatment for the corresponding impact
on initial recognition of the derivative
liability. For example, in this scenario,
this impact could be recognised as an
adjustment to the cost of the investment
in company PS, since the option has
been written by the company in relation
to this investment. Subsequent changes
in the fair value of the derivative liability
should be recognised in profit or loss.
Consider this….
• The accounting treatment for put options written in favour of NCI can be complex and
should be based on a careful analysis of facts and circumstances, including the specific
contractual terms related to the transaction. In addition, companies should clearly
disclose the related accounting policy choices in their financial statements.
• An entity may write a put option in favour of NCI holders in an existing subsidiary which
is exercisable only on the occurrence of uncertain future events that are outside the
control of both parties to the contract. In this case, the entity should account for the put
option only if the terms affecting the exercisability of the option are genuine.
• If an entity chooses an accounting policy to recognise changes in the carrying amount
of an NCI put option in equity, then the entity should include all changes in the
carrying amount of the liability, including the accretion of interest in equity. Further, in
accordance with the interpretation considered by the IFRS Interpretations Committee,
the accounting policy choice to recognise changes in the present value of the exercise
price in equity would not be available if a parent entity has entered into a forward
agreement with the NCI holder to sell the shares held in a subsidiary to the parent at a
future date.
• If company PS was a joint venture between company P and company S, the written put
option on company S would have to be recognised as a freestanding derivative even
in the consolidated financial statements. This would be recognised and measured at
FVTPL, where the fair value would be generally determined on the basis of an option
pricing model. Subsequent changes in fair value would be recognised in the statement
of profit and loss. This is because a joint venture is an equity accounted investee (not
considered to be part of the group in the consolidated financial statements) and the put
options written by the entity would not represent a contractual obligation to acquire a
class of its own equity instruments (in contrast, equity instruments in a subsidiary are
considered to be part of the group’s own equity).
© 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Equity and financial liability
classification
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Financial Instruments: Application issues under Ind AS
18
Classification of convertible preference shares
Ind AS 32, Financial Instruments: Presentation establishes principles for the classification of financial instruments, from the
perspective of the issuer, into financial assets, financial liabilities and equity instruments.
Ind AS 32 requires the issuer of a financial instrument to classify the instrument, or its component parts, on initial recognition in
accordance with the substance of the contractual arrangement and the definitions provided in the standard.
In this case study, we analyse the key terms of an Optionally Convertible Preference Share (OCPS) to determine its classification
and accounting treatment.
Key terms of the financial instrument
Company X issues 2,000 OCPS on 1 April 2016 with the following key features:
Contractual
features
Details
Term
5 years
Face value
INR1,000 each, issued at par
Redemption
Redeemable at the end of the term on 31 March 2021
Dividend
Discretionary, non-cumulative dividend of 6 per cent per annum
Conversion option
Optionally convertible by the holder into ordinary shares at any time until maturity (American-style
option)
Conversion ratio
Each preference share is convertible into 5 ordinary shares
Company X has determined that the
market interest rate for instruments of
comparable credit status and providing
substantially the same cash flows, on
the same terms, but with mandatory
distributions and without the conversion
option, as 9 per cent.
Accounting issue
The OCPS are financial instruments that
are required to be classified by company
X in accordance with the guidance in
Ind AS 32. The subsequent accounting
treatment for the OCPS is based on
such classification.
The OCPS is redeemable at the end
of its five year term, indicating that it
contains a liability component. However,
the dividend payable on the OCPS is
discretionary and non-cumulative in
nature. Further, the holder may also
convert the OCPS into a pre-determined
number of ordinary shares at any time
until maturity. This indicates that the
OCPS may also contain an equity
component and is in the nature of
a ‘compound’ financial instrument.
Company X should therefore analyse
each of these components separately to
determine their classification.
Ind AS 32 requires an issuer of a
financial instrument to evaluate its terms
to determine whether it contains both a
liability and an equity component. Such
components are analysed and classified
separately as either a financial liability,
financial asset or an equity instrument.
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19
Financial Instruments: Application issues under Ind AS
Accounting guidance and analysis
Classification of the OCPS
The following is an illustration of the relevant guidance in Ind AS 32 for classification of the OCPS and our analysis.
Figure 1: Analysis to classify the OCPS based on relevant guidance
Guidance
Yes
Analysis of the OCPS
Identify the components of
the OCPS
Redeemable principal
amount
Discretionary, noncumulative distribution
Holder’s option to
convert into ordinary
shares
Is there a contractual
obligation to deliver cash/
another financial asset?
Yes
No
No
No
Yes
No
Can the component be settled
in the issuer’s own equity
instruments?
No
Yes
No Is the component a derivative
that meets the ‘fixed for fixed’
criterion?
Yes
Yes
Do all settlement alternatives
result in equity classification?
Yes
No
Financial
liability
Yes
Equity
Financial liability
Equity
Equity
Source: KPMG in India’s analysis, 2017, read with Ind AS 32
As illustrated above, each component
is analysed separately to determine its
classification. The analysis, based on the
guidance in Ind AS 32, indicates that:
•
The redeemable principal amount
of the OCPS is in the nature of
a financial liability component
as company X has a contractual
obligation to redeem this amount to
the holders at the end of the five year
term,
•
The discretionary, non-cumulative
dividend component is an equity
component since the company has
no contractual obligation to pay this
dividend to the holders, and
•
The conversion option into a fixed
number of ordinary shares is also in
the nature of an equity component,
since the company could be required
to settle this component by issuing
a fixed number of its own equity
instruments.
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Financial Instruments: Application issues under Ind AS
20
Initial recognition amounts
Ind AS 32 requires the issuer to first determine the carrying amount of the liability (redeemable principal component) by
measuring the fair value of a similar liability (including any embedded non-equity derivative features) that does not have an
associated equity component.
The carrying amount of the equity instrument represented by the discretionary dividend stream and the option to convert the
OCPS into ordinary shares should be determined by deducting the fair value of the financial liability from the fair value of the
compound financial instrument as a whole.
Figure 2 illustrates the process for allocation of the initial carrying amount of the OCPS into its liability and equity components.
Figure 2: Allocation of initial carrying amount of OCPS
Fair value of the entire OCPS (INR1,000)
Fair value of liability component (INR650)
(INR1,000 discounted at 9 per cent over 5 years)
Residual equity component (INR350)
(INR1,000 - INR650)
Source: KPMG in India’s analysis, 2017
Accounting treatment
The following are the illustrative accounting entries on initial recognition and for subsequent measurement of the OCPS,
assuming conversion occurs at the end of the first year.
Date
Accounting entry
1 April 2017
On initial recognition of the OCPS
Bank (2,000*1,000 per share)
OCPS liability (2,000*650)
Equity (2,000*350)
31 March 2017
Dr 2,000,000
Cr 1,300,000
Cr
700,000
Accrual of interest for year 1
Interest expense (1,300,000*9%)
OCPS liability
31 March 2017
Amount in INR
Dr
117,000
Cr
117,000
Dr
Cr
1,417,000
1,417,000
Assuming that the OCPS is converted into equity at the end of year 1
OCPS liability
Equity (To be split between equity and securities premium)
Source: KPMG in India’s analysis, 2017
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21
Financial Instruments: Application issues under Ind AS
Consider this….
• An instrument that is redeemable in cash may also include an equity
component based on its other terms. In the illustration above, a holder’s
option to convert the OCPS into a fixed number of ordinary shares is
classified as an equity component. The amount attributable to this equity
component on initial recognition shall remain in equity and will not be
reclassified even if the OCPS are ultimately redeemed in cash by the issuer.
• The OCPS include a discretionary dividend component, which is also
classified as equity. If the issuer declares and pays a distribution on the
OCPS, this is considered to be an equity distribution/dividend payment and
not an interest expense.
• The interest expense recognised by the issuer on the liability component
represents the unwinding of the discount applied in determining the fair
value of this financial liability at the time of initial recognition.
© 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Financial Instruments: Application issues under Ind AS
22
Preference shares convertible into a variable number
of shares
In determining whether to classify a
financial instrument (or its components)
on initial recognition as a financial
liability or as equity, Ind AS 32, Financial
Instruments: Presentation requires
an entity to assess the substance of a
contractual arrangement rather than
its legal form. Accordingly, an entity
needs to consider all of the terms and
conditions of the financial instrument.
Therefore, it is possible for an instrument
that qualifies as equity for legal or
regulatory purposes, to be classified as a
financial liability under Ind AS.
Given the complexity of some of the
arrangements which companies enter
into for raising funds from investors,
a thorough analysis may be required
before the classification of the
arrangement can be determined.
In this case study we consider a
common area of application of
debt equity classification involving
instruments where an issuer company
is obliged to convert an instrument into
a variable number of its own ordinary
shares. Such arrangements are common
in situations where companies have
sought funding from private equity
investors. Funding arrangements with
an assured rate of return could result in
a liability classification even if the legal
form of the instrument may be equity.
Similarly, while an instrument that is
compulsorily convertible into fixed
number of shares may be classified as
equity, any feature linked to subsequent
issue of shares at a value below the
conversion price may result in increased
complexities. We consider some of
these issues with the help of an example
below.
Illustrative example
Z Private Limited (the company), is in the process of expanding its business and has received an investment from ABC Holdings, a
private equity investor, to which it has issued compulsorily convertible preference shares (CCPS) on 1 October 2016. Following are
the key terms of the preference shares:
Particulars
Key terms of preference shares
Description
1,000,000, cumulative preference shares of INR100 each, issued at par (INR100,000,000)
Dividend
No mandatory distributions are payable to the CCPS holders
Optional conversion
Convertible into 1 equity share each at the option of the holder at any time prior to maturity
Conversion price
INR100 per CCPS
Adjustments to
conversion ratio for
optional conversion
If the company subsequently issues additional equity instruments at a market price (effective
price) that is below the conversion price per preference share, then the conversion price shall be
reduced to the effective price and the conversion ratio shall be adjusted accordingly.
Conversion at
maturity if not
optionally converted
by the holder
Convertible into a variable number of shares at maturity (30 September 2021) based on a formula
as follows:
No of shares issued on conversion = Amount invested + 14% per annum
Equity share price (fair value)
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23
Financial Instruments: Application issues under Ind AS
Accounting issue
The company is required to classify the compulsorily convertible preference share, or its components as a financial liability or an
equity instrument.
Accounting guidance
The following is an illustration of the relevant guidance in Ind AS 32 for classification of financial instruments as equity or a financial
liability:
Figure 1: Classification of issued financial instruments in accordance with Ind AS 32
Does the instrument contain an obligation to deliver cash or
another financial asset?
Yes
No
Financial liability
Yes
Is the instrument a non-derivative that will be settled in the entity’s
own equity instruments?
No
Yes
Is the instrument a derivative that will be
settled other than by an entity exchanging
fixed amount of cash or another financial
asset for fixed number of its own equity
instruments (fixed for fixed)?
No
Does the entity have an obligation to deliver variable number of its
own equity instruments?
No
Equity
Yes
Financial liability
Source: KPMG in India’s analysis, 2017 read with Ind AS 32
Analysis
The CCPS has three components:
•
•
•
the holder’s option to convert
the CCPS into a fixed number of
shares prior to maturity subject to
adjustments in the conversion ratio
if additional shares are issued at a
market price below the conversion
price (down round protection)
the principal amount that is
convertible into a variable number of
ordinary shares of the issuer (Z Private
Limited) on maturity, and
the guaranteed return of 14 per cent
per annum that forms part of the
amount converted into a variable
number of shares at maturity
conversion option.
The components of the CCPS are
analysed for classification as follows.
Holder’s option to convert into a fixed
number of shares
The CCPS are convertible at the option
of the holder into a fixed number of
equity shares of the company prior to
maturity. This conversion option is a
derivative instrument that is analysed
for classification as an equity or financial
liability on initial recognition of the
CCPS. The option requires the company
to deliver a fixed number of its own
shares for a fixed amount of another
financial asset (1 ordinary share for every
CCPS held) indicating that it may meet
the ‘fixed for fixed’ criterion for equity
classification under Ind AS 32.
‘Down round’ protection feature
However, it is also important to consider
the anti-dilution clause for adjustments
to the conversion ratio. Adjustments
that alter the conversion ratio only to
prevent dilution of the interest held
by the preference shareholders (due
to dividends paid on ordinary shares,
bonus issues, stock splits, etc.) do not
violate the fixed-for-fixed requirement.
Therefore, such anti-dilutive terms
do not result in the instrument being
classified as a financial liability. ‘Antidilutive’ clauses are those that adjust the
conversion ratio to compensate holders
for changes in the number of equity
instruments outstanding that relate to
share issuances or redemptions not
made at fair value. These do not include
any other form of compensation to the
preference share holder for fair value
losses - e.g. when the conversion ratio is
adjusted if the share price falls below a
predetermined level, or if new shares are
issued at a then-current market price that
is below the conversion price.
In the illustration above, the conversion
ratio is subject to change if additional
shares are issued at a market price that
is lower than the conversion price for the
CCPS. This indicates that the variation in
conversion ratio is intended to preserve
the value of the interest held by the
preference shareholders and is not in the
nature of an anti-dilutive clause. This is
also known as a ‘down round’ protection
feature. In summary, the conversion
option is a derivative feature that would
not meet the ‘fixed for fixed’ criterion
and would be classified as an embedded
derivative liability.
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Financial Instruments: Application issues under Ind AS
Conversion into variable number of
shares
The principal amount or the amount
invested by CCPS holders along with an
assured return computed at 14 per cent
per annum, is convertible into a variable
number of shares on maturity of the
CCPS, i.e. on 30 September 2021. The
conversion ratio or number of shares
to be delivered by the company will
be determined based on an equity fair
valuation as on the date of conversion,
using the formula below:
No of shares issued on conversion =
(Amount invested + 14% per annum)/
Equity share price (fair value)
For example, the amount invested
(INR100 per CCPS) along with a
compounded return of 14 per cent per
annum would amount to approximately
INR192 per CCPS at 30 September 2021,
i.e. INR192 million in aggregate. If the fair
value of one ordinary share of Z Private
Limited is INR120 as on 30 September
2021, the company would be required
to issue 1.6 million ordinary shares (192
million/120) on conversion of the CCPS
at maturity. Conversely, if the fair value
of one ordinary share of the company is
INR240, the company would be required
to issue 0.8 million ordinary shares (192
million/240) to the CCPS holders at
maturity.
The CCPS is therefore in the nature
of a non-derivative contract that will
be settled in a variable number of the
issuer’s own equity instruments (refer
Figure 1 above). This is because the
company is in effect using its own shares
as currency and the holder would not
be exposed to any gain or loss arising
from movements in the fair value of
equity instruments. This indicates that
the CCPS principal amount and the
assured return of 14 per cent per annum
are financial liabilities of the company in
accordance with Ind AS 32.
24
Accounting treatment for the
components of the CCPS
As discussed above, the CCPS is
considered a ‘hybrid’ financial liability,
i.e. comprising the following two
components:
•
A host non-derivative liability
component for the interest and
principal amount, and
•
A separable derivative component
(i.e. the holder’s option to convert into
shares).
Ind AS 109 requires the separable
embedded derivative to be measured
at fair value on initial recognition, with
subsequent changes in fair value
recognised in profit or loss. The CCPS
is therefore split into its components on
initial recognition as illustrated in figure
2 below.
Figure 2: Bifurcation of CCPS into embedded derivative and host financial liability
CCPS
(Hybrid financial instrument)
Embedded derivative (measured at
fair value on initial recognition)
Host financial liability (fair value
of combined CCPS less fair value of
embedded derivative)
Source: KPMG in India’s analysis, 2017
On initial bifurcation of the derivative
component, no gain or loss should be
recognised by the company. The initial
recognition amount for the non-derivative
liability component is determined as the
difference between the fair value of the
combined CCPS instrument (usually the
transaction price) and the fair value of the
embedded derivative.
The liability component is subsequently
measured at amortised cost using the
effective interest rate (EIR) method.
The EIR is computed as the rate that
discounts the future contractual cash
flows (the principal amount and the
assured return of 14 per cent per
annum) to the carrying amount initially
recognised by the company.
Alternatively, the company may
designate the entire hybrid contract
as a financial liability measured at fair
value through profit or loss on initial
recognition. The entire CCPS would then
be measured at fair value with changes
in fair value recognised in profit or loss.
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25
Financial Instruments: Application issues under Ind AS
Consider this….
• Companies should consider the impact of any clauses that alter the conversion
ratio for instruments (or components) that are settled by delivery of an entity’s own
equity instruments. This can pose a challenge due to the increasing complexity
in the terms of structured instruments. For example, careful analysis would
be required for a change in the conversion ratio to compensate a preference
shareholder as a result of a rights issue, where the issuance of shares is not at
fair value. While such adjustments may not vitiate the ‘fixed for fixed’ criterion for
equity classification, this should be determined based on a detailed analysis of the
contractual terms of the instruments.
• Preference shares that include an element of guaranteed/assured returns are
often a feature of investments in structured instruments made by private equity or
venture capital investors. These features are designed to provide the investor with a
minimum return on exit. The assured minimum return may be in the form of a cash
obligation of the issuer or the requirement to issue additional shares to compensate
for a lower fair value on conversion. Such arrangements should be carefully analysed
to determine the classification of the structured instruments by investee companies.
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Financial Instruments: Application issues under Ind AS
26
Impact of contingent settlement provisions on
classification of financial instruments
Companies may issue financial
instruments to investors that require
redemption on the occurrence of
future events that are uncertain. Such
arrangements are designed to provide
an exit mechanism for the investor in
adverse circumstances, for example,
the issuer’s failure to list its equity
instruments or a change in control of the
issuer.
Ind AS 32, Financial Instruments:
Presentation provides guidance on
classifying a financial instrument that
may require an entity to deliver cash
or another financial asset, or settle it in
such a way that it would be classified as
a financial liability, only on the occurrence
or non-occurrence of uncertain future
events. Such events may be beyond the
control of both the issuer and the holder
of the instrument. These arrangements
are referred to as ‘contingent settlement
provisions’.
In this case study we illustrate how the
inclusion of a contingent settlement
provision in convertible preference
shares issued by an entity may impact
the classification of the preference
shares.
Key terms of the financial
instrument
ABC Private Limited (the company or
the entity) is an operating e-commerce
company that has entered into a
shareholding agreement with a private
equity investor. On 1 October 2016, the
company issued 2,000,000 convertible
preference shares of INR100 each to the
investor. The investor intends to exit its
investment in the company when the
company makes an initial public offer
(IPO) for its ordinary shares, which is
expected to occur in three years. The
preference shares therefore provide
for automatic conversion into 15 equity
shares of INR10 each for each INR100
preference share when the IPO takes
place, provided the IPO takes place
within three years. If the company does
not complete an IPO within three years,
the issuer is obliged to redeem the
preference shares in cash for an amount
equal to the amount invested plus a
return of 15 per cent per annum.
Accounting issue
ABC Private Limited needs to assess
the impact of the requirement to
redeem the preference shares in cash
on the non-occurrence of an IPO, on
the classification of the preference
shares as a financial liability or an equity
instrument.
Accounting guidance and
analysis
Figure 1 below outlines the relevant
guidance in Ind AS 32 for classification
of a financial instrument containing a
contingent settlement provision and
includes our analysis.
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27
Financial Instruments: Application issues under Ind AS
Figure 1: Classification of a financial instrument as equity or financial liability
Guidance
Yes
Analysis of financial instrument
Identify the components of
the preference shares
Redemption on nonoccurence of IPO
Conversion into fixed
number of ordinary
shares on IPO
Is there a contractual
obligation to deliver cash/
another financial asset
Yes
No
No
May the component be
settled in the issuers’ own
equity instruments?
No
Yes
Yes
No
Is the component a
derivative that meets the
fixed for fixed criterion?
Yes
Yes
Do all settlement
alternatives for the
derivative component result
in equity classification?
Yes
Yes
No
Does the issuer of the
financial instrument have
an unconditional right to
avoid making payments?
Yes
No
No
Is the contingent
settlement feature
considered to be nongenuine?
Yes
No
No
Financial liability
Equity
Financial liability
Equity
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition, September 2016
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Financial Instruments: Application issues under Ind AS
Redemption on nonoccurrence of an IPO
Ind AS 32 states that the issuer of a
financial instrument does not have an
unconditional right to avoid payment,
when the issuer is required to deliver
cash (or another financial asset), on the
occurrence or non-occurrence of an
uncertain future event that is beyond the
control of both the issuer and the holder
of the instrument.
In the illustration above, the issuer may
be required to redeem the preference
shares on the non-occurrence of an
IPO. While the decision to initiate an
IPO process is within the control of the
issuer, its successful completion would
be dependent on market conditions
at that time as well as the receipt of
regulatory approvals. These factors are
not within the control of the issuer or the
preference share holder. Accordingly, the
company cannot unconditionally avoid
the contractual obligation to redeem the
preference shares.
Ind AS 32 also requires consideration
of whether the contingent settlement
provision is non-genuine in nature.
Generally, a contingent settlement
feature would be regarded as genuine,
except in rare circumstances when it
has no economic substance and may be
removed by either parties to the contract
without any compensation. For example,
a contingent settlement feature involving
a change in tax law that results in a loss
of specific tax benefits for the issuer
or the holder would be considered
genuine even if the possibility of such
an event occurring is remote. In this
case study, the contingent feature has
economic substance since it is intended
to provide an exit with a defined return
to the investor in a scenario where the
investor is unable to exit the investment
in an IPO. Therefore, the preference
shares contain a financial liability, being
the contractual obligation to redeem on
non-occurrence of a contingent event,
regardless of the likelihood of cash
settlement.
28
Conversion into fixed number
of shares
The preference shares are convertible
into a fixed number of ordinary shares
of the company on occurrence of the
contingent event, i.e. an IPO. This
conversion feature is a derivative that
would be settled by the delivery of a
fixed number of shares on occurrence
of the IPO. This indicates that this
feature meets the criteria for equity
classification.
Therefore, the preference shares are
compound instruments with a liability
and equity component. Ind AS 32
requires the company to first determine
the initial recognition amount of the
liability (redeemable component) by
measuring the fair value of a similar
liability that does not have an associated
equity component. The difference
between the fair value (generally,
transaction price) of the combined
instrument and the fair value of the
liability component is recognised as the
equity component.
Consider this….
Other examples of contingent settlement features include scenarios where an issuer
has a contractual obligation to deliver cash on payment of dividend on ordinary shares,
or on the occurrence of a change in control (takeover) of the issuer, that requires
approval by shareholders. The exercise of judgement, based on a careful analysis of
specific facts and circumstances, is required in these situations to determine whether
the shareholders of an entity are acting as a body under the entity’s governing charter
- i.e. as issuer (part of the entity), or as individual investors (not as part of the entity).
Such analysis would be required to establish if the contingent feature is outside the
control of the issuer and the holder, resulting in a liability classification.
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Recognition and
derecognition
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Financial Instruments: Application issues under Ind AS
30
Accounting for long-term deposits and advances
Ind AS 32, Financial Instruments: Presentation defines a financial instrument as a contract that gives rise to both a financial asset
of one entity and a financial liability or equity instrument of another entity.
Some common examples of financial instruments that give rise to financial assets for the holder and corresponding financial
liabilities for the issuer are trade receivables/payables, loan receivables/payables, etc. Certain assets, on the other hand, give the
holder a contractual right to receive goods or services, rather than the right to receive cash or another financial asset, for example
a non-cancellable prepaid insurance contract. These are not financial assets.
In this case study, we analyse various types of deposits placed and advances given to external parties to determine if these meet
the definition of financial instruments. We also illustrate the principles to be considered for recognition and measurement of these
instruments in the financial statements of an entity, when classifying them as financial assets.
Key terms of the financial instruments
Company A (the entity or the company) had the following assets in its financial statements as on 31 March 2017:
Particulars
Maturity
Amount in INR
On 1 October 2016, the company
placed an interest-free, refundable
security deposit for the operating lease
of the company’s corporate office, as
per the operating lease agreement.
The security deposit will be repaid to the company at the
end of the lease term, which is on 30 September 2021,
unless the company and the landlord reduce the lease term
by issuing notice as specified in the lease agreement.
Interest-free deposit placed with the
VAT authorities
The Value Added Tax (VAT) law requires the company to
place a security deposit with the VAT authorities. This
deposit may be utilised by the authorities if the company
fails to make payments to the authorities.
500,000
Non-refundable capital advances made
for import of machinery
As per the terms of the agreement, the machinery will
be shipped only after payment of the advance. In case of
damages on shipping, the machine/machine parts will be
replaced free of cost.
10,000,000
Prepaid rent for the corporate office for
the next 6 months
Amount will get adjusted against the monthly contractual
charge.
600,000
Advance income tax paid for AY 201617
The advance tax will be adjusted with the provision for tax
assessed by the assessing income-tax officer, any excess
amount would be refunded to the company.
5,000,000
15,000,000
The market rate of interest on risk-free investments is 7.5 per cent per annum.
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31
Financial Instruments: Application issues under Ind AS
Accounting issue
Company A is required to determine whether the assets in its financial statements meet the definition of financial assets, and
determine the appropriate accounting treatment under Ind AS 109, Financial Instruments for these assets.
Accounting guidance
Figure 1 below provides an illustration of the relevant guidance in Ind AS 32 for determining whether an asset is a financial
instrument:
Yes
Is the asset ‘Cash’?
No
Is the asset an equity instrument of another entity?
Yes
No
Is the asset a contractual right to receive cash or another financial
asset?
Yes
Asset is a
financial asset
No
Is the asset a contractual right to exchange financial assets or
financial liabilities under potentially favourable conditions?
Yes
No
Asset is not a financial asset
Source: KPMG in India’s analysis, 2017 read with Ind AS 32
Analysis – definition of
financial assets
The assets of the company are analysed
on the basis of the guidance given above:
Security deposits for operating lease
Rental/lease deposits are refundable
on completion of the lease term.
Accordingly, these represent a right to
receive cash from the holder, arising
from the contract. Hence, these meet
the definition of financial assets under
Ind AS 32.
Capital advances and prepaid expenses
In respect of capital advances, the
company will receive machines against
the advances made. Similarly, for prepaid
rent, the company will be able to utilise
the space and facilities of the corporate
office for the next six months. Since
the company adjusts/settles these
advances/prepayments against the
receipt of goods or services, rather than
by receiving cash or another financial
asset, these would not meet the
definition of financial assets.
Advance tax and deposit with VAT
authorities
The company makes payment of
advance tax in compliance with the
income tax regulations. Since there is
no contractual provision for making such
payment, it is not a financial instrument.
Similarly, the security deposit placed
with the VAT authorities is in accordance
with the taxation regulations. There is no
contractual agreement for placing such
a deposit. Hence the security deposit is
not a financial asset. The following table
summarises the analysis for the various
types of deposits and advances held by
the company.
Type of assets
Characteristics
Financial
asset
Security deposits for operating lease
Represent a contractual right to receive cash from the issuer.
Yes
Capital advances and prepaid
expenses
The future economic benefit is the receipt of goods or
services, rather than the right to receive cash or another
financial asset
No
Advance income tax and deposit with
VAT authorities
It is not based on a contract between the entity and the tax
authority, but arising through statute.
No
Source: KPMG in India’s analysis, 2017
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Financial Instruments: Application issues under Ind AS
Classification and
measurement
Classification
Ind AS 109 requires the classification
of the financial assets as subsequently
measured at amortised cost or at fair
value on the basis of an entity’s business
model for managing the financial assets
and the characteristics of the contractual
cash flows for which the financial assets
are held.
A financial asset would be measured at
amortised cost only if it meets both the
following conditions:
•
the asset is held within a business
model whose objective is to hold
the asset to collect contractual cash
flows; and
•
the contractual terms of the financial
assets give rise on specified dates to
cash flows that are solely payments of
principal and interest on the principal
amount outstanding (SPPI criterion)
As per Ind AS 109, financial instruments
are measured initially at fair value plus
transaction costs on initial recognition
and subsequently measured at
amortised cost (if they are so classified).
Ind AS 113, Fair Value Measurement,
defines fair value as 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. Accordingly, the
fair value of the financial instrument
is generally considered to be the
transaction price.
•
the fair value of the deposit- this
would be computed using the
present value technique with inputs
that include (a) future cash flows
and (b) discount rates that reflect
assumptions that market participants
would apply in pricing the financial
instrument, which is 7.5 per cent in
the illustration.
•
The difference between the fair value
of the deposits and the transaction
price on initial recognition of the
deposit needs to be accounted for
If a financial asset does not meet both
these conditions, then it is measured at
fair value.
As the security deposits would be held
for collecting the contractual cash flows
(i.e. original amount of deposit), which
is the principal amount outstanding (the
interest being nil), it meets the criteria for
measurement at amortised cost using
the effective interest method.
separately. The accounting treatment
for these will depend upon the
nature of the element included in
the deposits. Had the entity not
placed the deposits with the lessor,
the monthly rentals would have
been higher. This indicates that the
nature of the interest-free element in
these deposits represents a prepaid
expense. Hence, this difference will
be recognised as ‘prepaid expenses’,
which will be amortised to the
statement of profit and loss over the
life of the deposit on a straight line
basis.
Measurement
However, in this illustration, the deposits
are interest-free, long-term deposits- i.e.
the interest is not charged at market
rates and hence the transaction price
does not represent the fair value. The
company should, hence bifurcate the
transaction price into:
32
•
The deposits would subsequently be
measured at amortised cost, which
is computed using the effective
interest rate. The entity should, over
the period of the lease/contract,
recognise and accrue in the amortised
cost of deposits an interest income
calculated at the effective interest
rate for such deposits.
Particulars
Rental deposit
Classification
Amortised cost
Initial measurement
INR3,482,793
Difference between the deposit amount and the amortised
cost
INR1,517,207
Treatment of the difference
Recognised as prepaid lease expenses on initial recognition
and amortised over the life of the deposit.
Interest accrued over the estimated life of the deposit on
the amount recognised.
Source: KPMG in India’s analysis, 2017
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Consider this….
• The accrual of interest income will result in an altered representation of lease
expenses in the statement of profit and loss over the term of the lease. Additionally,
companies also need to assess the tax consequence on such notional interest
income.
• Other significant practical issues that companies should consider include:
–– Discounting of long-term deposits where there is no pre-defined contractual
period. For example, in the infrastructure sector, it is an industry practice to
place earnest money deposits (EMDs) for executing large turnkey/infrastructure
projects. These EMDs are refunded to the vendor once the tender is closed
irrespective of whether the contract is awarded or not. In situations like these,
companies would have to estimate the period after which such EMDs are
expected to be recovered based on historical trends and practices in the industry.
This could pose some practical difficulties in estimating the period over which
such EMDs should be discounted.
–– Long-term revenue contracts, where revenue is recognised but will be received
only after the expiry of a certain period, for example retention money, which
is common in the construction industry. The customers usually withhold a
percentage of the total contract price for a pre-defined period of time to ensure
all defects have been corrected by the contractor within that period of time.
In this scenario, companies should assess if they may be required to impute
interest and the expected cash receipts might need to be discounted to
measure the fair value of the amount receivable.
• Interest is required to be imputed when the impact of discounting would be
significant. However, an entity is permitted to measure short-term receivables and
payables with no stated interest rate at their invoiced amounts without discounting,
if the effect of discounting is immaterial. Therefore, receivables and payables with
maturities of up to six months are not generally discounted.
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Derecognition of trade receivables under a factoring
arrangement
Ind AS 109, Financial Instruments,
provides specific guidance on
derecognition of financial instruments
that is relevant in analysing transactions
such as an assignment of receivables,
factoring and bill discounting
arrangements, repurchase transactions
and securitisations.
It requires a financial asset to be
derecognised when:
•
the rights to receive cash flows
expire,
•
the entity has transferred substantially
all risks and rewards pertaining to the
asset, and
•
the entity has not retained control
over the asset.
In this case study we illustrate the
application of derecognition principles
to trade receivables under a factoring
arrangement with the help of the
following example.
Key terms of the transaction
Scenario 1
Company S (the company) has entered
into an arrangement on 1 April 2016 with
bank P (the bank) to transfer its shortterm trade receivables to the bank on
an ongoing basis during the year ending
31 March 2017. The aggregate amount
of receivables that may be transferred
under this arrangement during the year is
INR200 million and the maximum tenor
of each receivable is specified as 120
days.
discounts approximating 6 per cent of
the outstanding amount of receivables.
In case of default by the debtor, the
bank has the right to demand payment
from company S, i.e. the factoring
arrangement is ‘with recourse’.
Accounting issue
Company S is required to evaluate
whether Ind AS 109 permits it to
derecognise the trade receivables that
are transferred to the bank under the
arrangement described above.
On 30 June 2016, company S has legally
transferred trade receivables aggregating
to INR100 million to bank P. Company
S receives an initial advance amount of
INR80 million from the bank. The debtors
of the company have also been notified
of the transfer and are required to make
payments directly to the bank on the due
date. On collection, the bank will pay the
balance amount of the receivables to
the company after deducting fees and
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35
Financial Instruments: Application issues under Ind AS
Accounting guidance
Figure 1 illustrates the guidance provided in Ind AS 109 on derecognition of financial assets.
Figure 1: Derecognition of financial assets under Ind AS 109
Perform assessment on consolidated financial statements
Derecognition principles applied to a part or all of the asset
Yes
Have the rights to cash flows from the asset expired?
No
Yes
Are the rights to receive cash flows from the asset transferred?
No
Is an obligation to pay cash flows from the asset assumed?
No
Yes
Yes
Have substantially all risks and rewards been transferred?
No
Derecognise the asset
No
Is control over the asset
retained?
Yes
Do not derecognise the
asset
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition September 2016
The company would first be required
to assess if it has transferred the rights
to the cash flows. Such rights are
considered to be transferred if, and only
if, the company transfers the contractual
rights to receive the cash flows from the
financial asset or enters into a qualifying
‘pass-through arrangement’.
For transactions that meet the transfer
requirements, the company should
evaluate whether it has transferred the
risks and rewards of ownership of the
financial asset. The company would be
permitted to derecognise a transferred
financial asset if it has transferred
substantially all of the risks and rewards
of ownership of that asset. Conversely,
it continues to recognise a transferred
financial asset if it has retained
substantially all of the risks and rewards
of ownership of that asset.
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Financial Instruments: Application issues under Ind AS
36
Analysis
The following is an analysis of the transaction (transfer of trade receivables) based on the guidance above.
Derecognition criteria under Ind AS 109
(Refer Figure 1)
Applicability to factoring transaction
Is the transferee entity required to be
consolidated?
No, since company S does not control bank P, the derecognition criteria are
applied on a consolidated basis for company S.
Are the derecognition principles applied to
a part or all of the asset?
The derecognition principles should be applied to all of the asset, i.e. the
trade receivables in their entirety. (This assessment is relevant only if a part
of the cash flows are transferred, e.g. only principal cash flows in an interest
bearing bond).
Have the rights from the cash flows to the
asset expired?
No, the rights to collect cash flows from the customers (relating to the trade
receivables) have not expired.
Has the company transferred the rights to
receive the cash flows from the asset?
Yes, the rights to receive the cash flows have been legally transferred to
bank P. In addition, the customers have been notified of the transfer and are
required to discharge their obligation by making payments directly to bank
P. This indicates that the company has transferred the contractual rights to
the cash flows from its customers on account of the trade receivables to the
bank.
Has the entity assumed an obligation to pay
cash flows from the asset?
This is relevant to the derecognition assessment only when the company (i.e.
the transferor) retains the contractual rights to the cash flows and assumes
an obligation pass these cash flows through to the purchaser on collection,
i.e. a ‘pass through arrangement’ has been established. In this illustration,
the company has transferred the rights to the cash flows and has not set up
a pass through arrangement.
Has the entity transferred substantially all
risks and rewards?
The receivables have been transferred to the bank ‘with recourse’ to the
company. This means that the company is obliged to repay the bank on
default, if any, by the customers relating to the outstanding receivables.
The bank pays only 80 per cent of the outstanding amount to the company
on transfer of the receivables and the balance (after deduction of fees and
discount) is paid only on collection from the customers. These factors
indicate that the company remains exposed to the same level of credit risk
on the trade receivables as it was, prior to the transfer.
Since the receivables are short-term in nature, credit risk is the most
significant risk arising from these financial assets. This indicates that the
company has retained substantially all risks and rewards relating to the
receivables and would not be permitted to derecognise these financial
assets under Ind AS 109.
Assessment
The transfer of receivables to bank P would not meet the derecognition
criteria and the company should continue to recognise the receivables as its
financial assets. In addition, the advance received from the bank should be
recognised by the company as a borrowing (financial liability).
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37
Financial Instruments: Application issues under Ind AS
Consider this….
• A transfer of trade receivables ‘without recourse’ to the transferor may meet the
derecognition requirements of Ind AS 109 if substantially all risks and rewards have
been transferred to the purchaser. However, ‘without recourse’ transactions are less
common in India and detailed analysis may be required to determine if the transferor
retains substantial risks in the form of exposure to any residual interests.
• Companies may enter into factoring or bill discounting transactions where they
continue to collect cash flows from the underlying receivables and the details
of the transfer or assignment are not disclosed to the debtors/customers. The
company would then be required to pass through these cash flows to the purchaser
(transferee). In this scenario, before analysing whether there has been a transfer of
substantially all risks and rewards, the company should determine if the transaction
qualifies as a transfer under Ind AS 109, i.e. it meets the following criteria:
–– The company has no obligation to pay amounts to the transferee unless it
collects equivalent amounts from the receivables
–– The company is prohibited from selling or pledging the receivables other than as
security to the transferee for the obligation to pay the cash flows, and
–– The company has an obligation to remit any cash flows it collects on behalf of
the transferee without material delay.
The criteria above may not be met in certain situations, for e.g., where the company
first remits cash flows to the purchaser (generally a bank) to the extent of any
advance received (i.e. the consideration) and then retains the residual amount of
cash flows. Such transactions would not qualify as a transfer under Ind AS 109 and
would therefore not be eligible for derecognition from the financial statements of
the transferor company.
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Financial Instruments: Application issues under Ind AS
38
Derecognition of a financial liability
Ind AS 109, Financial Instruments requires a financial liability to be derecognised when it is extinguished, i.e. when the obligation
is discharged, cancelled or expires. This may occur when:
•
The borrower makes a payment to the lender towards the redemption or repurchase of a debt instrument,
•
The borrower is legally released from primary responsibility for the financial liability (this condition can be satisfied even if the
borrower has given a guarantee), or
•
There is an exchange between an existing lender and borrower of debt instruments with substantially different terms or a
substantial modification of the terms of an existing debt instrument.
In this case study we illustrate the application of derecognition principles with an example of a restructuring or refinancing of two
debt instruments issued by an entity.
Key terms of the financial liabilities
S Limited (the entity or the company) had the following term loans outstanding in its financial statements as on 1 April 2016.
Table 1: Key terms of original financial liabilities (term loans)
Particulars
Loan 1 from Bank A
Loan 2 from Bank B
Original loan amount
INR200,000,000
INR500,000,000
Transaction costs/fees
INR4,000,000
INR10,000,000
Amortised cost as on 1 April 2016
INR198,319,853
INR495,895,153
Interest rate
11 per cent per annum
12 per cent per annum
Remaining term to maturity
3 years
2 years
Effective interest rate (EIR)
11.34 per cent per annum
12.49 per cent per annum
Other terms of the instrument
Repayable at maturity. The company
has an option to prepay anytime during
the three years immediately preceding
the maturity date, without any penalty.
Repayable at maturity only.
Prepayment penalty of 1 per cent
would be levied if prepaid.
The company experienced an improvement in its credit rating based on its financial performance for the year ended 31 March
2016. Accordingly, on 1 April 2016 the company decided to refinance its loans as follows:
•
Loan 1 was repaid in full in accordance with the original terms of the loan that permitted prepayment without penalty in the
three years immediately preceding the maturity date. The company then obtained a new loan from bank A on more favourable
terms, in accordance with the market rate applicable to the company based on its improved credit rating.
•
The company had entered into renegotiations with bank B for modification to the terms of Loan 2. On 1 April 2016, the
company finalised an agreement with bank B modifying the terms of this loan with a reduction in interest rate and an extension
in the term of the loan. As part of the restructured arrangement, the company is required to pay a fee of INR2 million to bank B.
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39
Financial Instruments: Application issues under Ind AS
The following table summarises the new terms for both loans:
Table 2: Modified terms of the financial liabilities
Particulars
Loan 1 (new)
Loan 2 (modified)
Borrowings
INR200,000,000
INR500,000,000
Interest rate
9 per cent per annum
9 per cent per annum
Period of the loan
5 years
7 years
Other terms of the instrument
Repayable in 2 equal annual
instalments commencing from 31
March 2020
Repayable in 5 equal annual
instalments commencing from 1 April
2019
Fees for modification
Nil
INR2,000,000
Loan processing fees
INR1,000,000
INR5,000,000
Accounting issue
S Limited is required to determine
the appropriate accounting treatment
under Ind AS 109 for the prepayment/
modification of terms of the loans.
This includes determining whether the
existing loans should be derecognised
from the company’s financial
statements.
Accounting guidance
As mentioned above, Ind AS 109
requires a financial liability to be
derecognised when it is extinguished,
i.e. when the obligation is discharged,
cancelled or expires. An exchange
between an existing borrower and
lender of debt instruments with
substantially different terms or a
substantial modification of the terms
of an existing financial liability or
part thereof is accounted for as an
extinguishment of the original financial
liability and the recognition of a new
financial liability.
Figure 1 illustrates the considerations
under Ind AS 109 to determine whether
a modification is ‘substantial’ and the
consequent accounting treatment
required.
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Financial Instruments: Application issues under Ind AS
40
Figure 1: Analysis to determine if modification of terms is substantial
Quantitative
assessment
(Does the NPV of the
cash flows under the
new terms discounted
using the original EIR,
differ 10 per cent or
more from the NPV of
the remaining original
cash flows?)
Yes
Recognise:
• Gain/loss based on
difference between
carrying amount and
consideration paid
No
Qualitative assessment
(Are there substantial
differences in terms
that are not captured
by the quantitative
assessment?)
Derecognise the liability
•
Yes
Modification costs
or fees incurred
included in the gain/
loss
No
Recognise new liability measured at its fair value
Continue to recognise the
existing financial liability (amortise
costs/fees incurred over the
remaining term)
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition September 2016
Analysis
The following is an analysis of each of
the financial instruments mentioned in
the tables above.
Loan 1
The company has prepaid this loan in
full, in accordance with the original
terms of the loan, which permitted
prepayment without penalty in the three
years immediately preceding maturity.
This loan has been replaced by a new
loan from the same lender, i.e. bank
A. The company is required to assess
whether the repayment and refinancing
of this loan constitutes a substantial
modification of terms or an exchange
of debt instruments with substantially
different terms.
Since this loan was prepaid in
accordance with its original terms, the
repayment/settlement of the loan would
not constitute a modification of terms
and would result in the extinguishment
of the original loan liability.
relating to the original loan. The new
loan is initially recognised at its fair value
(considered as equal to the transaction
price since the loan is at market rates),
minus directly attributable transaction
costs.
Therefore, the company should consider
the original loan as extinguished and
derecognise this liability. A gain or
loss should be recognised based on
the difference between the amortised
cost/carrying amount of the original
loan and the consideration paid. In
this illustration, this represents the
unamortised transaction costs/fees
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41
Financial Instruments: Application issues under Ind AS
The company recognises the following accounting entries:
Date
Accounting entry
Amount in INR
1 April 2016
Term loan 1 (original financial liability)
Dr
198,319,853
Profit or loss
Dr
1,680,147
Bank
Cr
200,000,000
Bank
Dr
199,000,000
Borrowing - Term loan (new financial liability)
Cr
199,000,000
(Prepayment and extinguishment of original loan)
1 April 2016
(Recognition of new loan at initial fair value minus transaction costs)
Source: KPMG in India’s analysis, 2017
Loan 2
The company has renegotiated the
terms of this loan to obtain a reduced
interest rate as well as an extension
in the term of the loan. Further, there
has been a change in the principal
repayment schedule of the loan. Ind AS
109 requires the company to assess
the modified terms of the liability to
determine whether the modification is
substantial in nature.
Ind AS 109 states that ‘terms are
substantially different if the discounted
present value of the cash flows under
the new terms, including any fees paid
net of any fees received and discounted
using the original effective interest
rate, is at least 10 per cent different
from the discounted present value of
the remaining cash flows of the original
financial liability.’ This is a quantitative
assessment of the modification in
terms. The company should also
perform a qualitative assessment
to determine if the modification is
substantial, if the difference in the
present values of the cash flows is less
than 10 per cent.
The company has performed a
quantitative assessment. In accordance
with the guidance above, the present
value of the remaining cash flows of
the original loan (i.e. its amortised cost)
on 1 April 2016 is INR495,895,153 and
the present value of the cash flows
(including modification fees) under the
modified terms, discounted using the
original EIR (12.49 per cent per annum),
is INR440,945,889. This amounts to
a difference of approximately 11 per
cent in the present values of cash
flows under the original loan and the
modified terms and would result in
the extinguishment of the original loan
liability.
The difference between the carrying
amount/amortised cost of the original
loan and the consideration paid is
recognised in profit or loss. In this
illustration, the consideration paid by
the company is the assumption of the
new financial liability (i.e. modified loan).
The new financial liability is initially
measured at its fair value. The fair value
of the new loan is estimated as INR500
million in this illustration, based on the
assumption that this loan has been
provided by bank B at market rates
(being 9 per cent per annum excluding
any adjustment for transaction costs or
fees) as applicable to the company on
the date of modification. Consequently,
the loss on derecognition of the loan
amounts to INR4,104,847.
Ind AS 109 also requires any costs or
fees incurred related to the modification
to be recognised as part of the gain or
loss on extinguishment. These are not
adjusted in the initial recognition amount
of the new financial liability unless it can
be demonstrated that they relate solely
to the new liability. In this illustration,
the company would be required to
include the modification fees of INR2
million and the transaction costs of INR5
million in the gain/loss on derecognition.
This would bring the total loss on
derecognition to INR11,104,847.
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Financial Instruments: Application issues under Ind AS
42
The company should recognise the following accounting entry on derecognition.
Date
Accounting entry
Amount in INR
1 April 2016
Term loan 2 (original financial liability)
Dr
495,895,153
Profit or loss
Dr
11,104,847
Bank
Cr
7,000,000
Borrowing – term loan (modified financial liability)
Cr
500,000,000
(Substantial modification and extinguishment of original loan and
recognition of a new financial liability)
Source: KPMG in India’s analysis, 2017
Consider this….
• A qualitative analysis of a modification in the terms of a financial liability, in order
to determine if the modification is substantial, should exclude those differences
in terms that have been captured by the quantitative assessment. For example,
changes in interest rates, principal amounts, extension of maturities, etc. would
generally be captured in a quantitative assessment. Hence, these modifications
by themselves would not indicate a qualitative modification in terms that is
substantial. Examples of qualitative modifications generally include changes relating
to substantial equity conversion features, security pledged by the borrower, or the
currency in which the liability is denominated. Entities may be required to exercise
judgement to assess if such modifications are substantial in nature.
• A modification in terms that is not substantial in nature would not result in the
derecognition of the financial liability. In this scenario, any fees or costs incurred
on modification are adjusted in the carrying amount of the financial liability and
amortised over its remaining term.
• In a debt restructuring arrangement involving financial difficulty of the borrower,
a lender may agree to modify the terms of a loan to accept a reduced rate of
interest, or to provide a new loan to the company at a lower rate of interest. Such
arrangements may require further consideration to assess whether the new loan
has been provided at fair value and to determine the amount at which the financial
liability should be recognised.
• A lender may accept a reduced rate of interest or forgive repayment of a portion of
a loan under a debt restructuring arrangement on the condition that the company
would continue to be liable to repay this amount from future profits, if any (a
recompense arrangement). In this scenario, further analysis may be required to
determine whether there is a contractual obligation to pay this amount in the future
that would result in the recognition of a financial liability.
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43
Financial Instruments: Application issues under Ind AS
Extinguishment of a financial liability with an equity
instrument
The terms of a financial liability may be renegotiated such that an issuer either settles the liability by issuing its own equity
instruments or amends the contractual terms resulting in its reclassification as an equity instrument.
Ind AS 32, Financial Instruments: Presentation requires an issuer (borrower) to reclassify a financial liability as equity from the date
the instrument has all the features of an ‘equity’ instrument or vice versa. Accordingly, when an entity amends the contractual
terms of a financial instrument (being a financial liability or equity instrument), the entity should assess the requirement for
reclassification of such a financial instrument as a financial liability or an equity instrument.
Appendix D (Extinguishing Financial Liabilities with Equity Instruments) to Ind AS 109, Financial Instruments specifies the
accounting treatment when an entity issues equity instruments to a creditor of the entity to extinguish all or part of a financial
liability. This transaction is referred to as a ‘debt for equity swap’.
In this case study we illustrate the accounting treatment on renegotiation/restructuring of two financial liabilities.
Key terms of the financial instruments
X Limited (the company) is an Indian company operating in the construction sector. Due to recent losses that have been
incurred and reduced forecasts of cash inflows, the company has entered into renegotiations with its lenders and investors for
restructuring certain financial instruments. The company has reached an agreement with its lenders/investor to restructure a term
loan and preference shares as on 31 March 2017. The following is a summary of the original and modified terms of two financial
instruments.
Table 1: Key terms of the financial liabilities on 31 March 2017
Particulars
Term loan
100,000 10.5% Cumulative
Redeemable Preference shares
Carrying amount of loan/
preference shares
INR60,000,000
INR9,892,640
Interest rate
11 per cent per annum (effective interest rate)
10.5 per cent per annum cumulative
distribution
Original maturity date
31 March 2021
31 March 2020
Fair value of the loan/
preference shares
INR55,000,000
INR9,076,353
Restructured terms
The lenders have agreed to accept 3,200,000 equity
shares (face value of INR10 per share) as payment
towards extinguishment of 60 per cent of the term
loan. For the balance 40 per cent, the lender has
extended the term of the loan by two years at a
lower interest rate of 6.5 per cent per annum. The
remaining loan is now repayable on 31 March 2023.
Conversion of the cumulative preference
shares into 6% Non-Cumulative,
Compulsorily Convertible Preference
Shares. The dividends are payable at
the discretion of the company. Each
preference share will be converted into
10 equity shares on maturity.
Fair value of the new
liability
INR17,150,000
NA
Fair value of the equity
instruments issued
INR40,000,000 (INR12.5 per share)
INR11,000,000*
* In this illustration, as part of the restructuring, the company has agreed to exchange the redeemable preference shares held
by investors with equity instruments that have a higher fair value on the date of modification. This is intended to compensate the
investors for giving up their right to return of capital in exchange for a greater equity stake. However, in other scenarios, borrowers
that are in financial distress may be unable to provide equity instruments with an equivalent fair value in exchange for their
financial liability to lenders/investors.
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Financial Instruments: Application issues under Ind AS
44
Accounting issue
The company is required to determine the appropriate accounting treatment under Ind AS for the following:
•
Partial extinguishment of the term loan by issuance of equity shares and modification of the terms of the remaining loan, and
•
Change in the contractual terms of the preference shares issued by the company to its investors.
Accounting guidance
Figure 1 illustrates the accounting guidance provided in Ind AS 109 (including in Appendix D of Ind AS 109) on accounting for
extinguishment of a financial liability by issuance of equity instruments:
Figure 1: Extinguishment of financial liability with equity instruments under Ind AS 109
Yes
Are equity instruments issued to fully
extinguish a financial liability?
No
No
Has the balance amount of the loan
been modified?
Yes
Allocate the consideration paid
between
Can the fair value of the
equity instruments be
measured reliably?
Yes
Derecognise extinguished
loan and recognise
difference between the fair
value of equity shares and
the carrying amount of the
loan as gain/loss
Part of the loan
which has been
extinguished
No
Part of the loan
which has been
modified
Yes
Do the change
in terms result
in a substantial
modification
Derecognise extinguished
loan and recognise
difference between the fair
value of the financial liability
derecognised and the
carrying amount of the loan
as gain/loss
No
Extinguish original
liability and recognise
a new liability at fair
value
Adjust carrying
amount of the
original financial
liability
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG’s IFRG Ltd’s publication, 13th edition, September 2016
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45
Financial Instruments: Application issues under Ind AS
Analysis
Term loan
As mentioned above, 60 per cent of the term loan liability has been extinguished and the remaining 40 per cent has been modified
by extending the term by two years and reducing the interest rate for the remaining term to 6.5 per cent per annum. The company
has issued 3.2 million equity shares (fair value of INR12.5 per share, i.e INR40 million) to the lender for restructuring the liability.
The equity shares are issued towards extinguishment of 60 per cent of the loan as well as modification of the terms for the
remaining 40 per cent. While the aggregate fair value of the equity shares issued to the lender is INR40 million, the company
is required to estimate the shares issued towards the portion of the loan that has been extinguished and the shares issued as
consideration for modifying the terms of the remaining loan. This is determined with reference to the fair value of the portion of
the loan that has been extinguished. The fair value of entire loan on the date of restructuring was INR55 million. Therefore, the
fair value of the extinguished portion of the loan is INR33 million (INR55 million *60%). The carrying amount of the extinguished
portion of the loan is INR36 million (INR60 million *60%). The company should recognise the following accounting impact on
extinguishment of the loan as on 31 March 2017.
Date
Accounting entry
Amount in INR
31 March 2017
On extinguishment of 60 per cent of the loan
Term loan liability
Equity
Gain on extinguishment of loan (P&L)
Dr 36,000,000
Cr 33,000,000
Cr 3,000,000
Source: KPMG in India’s analysis, 2017
The balance equity shares, with a fair value of INR7 million (INR40 million – 33 million) are considered to have been issued as
consideration towards modification of the remaining loan (carrying amount of INR24 million). The company is required to assess
if the modification of terms of the remaining loan is substantial in order to determine if this portion should also be derecognised.
This is determined by comparing the carrying amount of the remaining loan with the net present value of the modified cash
flows (discounted at the original effective interest rate). This difference amounts to 19 per cent of the original carrying amount or
amortised cost indicating that the modification is substantial.
The company should therefore derecognise this portion of the original loan liability and recognise a new financial liability at its fair
value, i.e. INR17.15 million as mentioned above. The difference between the carrying amount and the consideration paid (fair value
of equity shares issued and new loan liability) should be recognised in the statement of profit and loss as a modification gain or
loss. The following is the accounting entry to be recognised on modification.
Date
Accounting entry
Amount in INR
31 March 2017
On modification of the remaining 40 per cent of the loan
Term loan liability
Loss on modification
Equity
New term loan liability
Dr 24,000,000
Dr
150,000
Cr 7,000,000
Cr 17,150,000
Source: KPMG in India’s analysis, 2017
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Financial Instruments: Application issues under Ind AS
46
Preference shares
In accordance with the original terms, the preference shares were cumulative and redeemable in nature and were therefore
classified as a financial liability. Based on the revised terms the preference shares are non-redeemable with a discretionary
dividend component and are mandatorily convertible into a fixed number of equity shares of the company. This indicates that the
preference shares would be classified as an equity instrument of the company after the change in contractual terms.
The change in classification of the preference shares from a financial liability to an equity instrument due to a change in
contractual terms is, in substance, an extinguishment of the financial liability by issue of equity instruments. Therefore, this should
be accounted for on the basis of the guidance in Appendix D of Ind AS 109. The financial liability should be derecognised and
the resulting gain or loss, being the difference between the carrying amount of the financial liability and the fair value of equity
instruments issued should be recognised in profit or loss.
The carrying amount of the preference shares (financial liability) on the date of modification in terms is INR9,892,640 and the
fair value of the preference shares (equity instruments) based on the amended contractual terms is INR11 million. The company
should therefore recognise the following accounting entry.
Date
Accounting entry
Amount in INR
31 March 2017
On amendment of the contractual terms of the preference shares
Preference share liability
Loss on derecognition
Equity (preference shares)
Dr 9,892,640
Dr 1,107,360
Cr 11,000,000
Source: KPMG in India’s analysis, 2017
Consider this….
• In a debt for equity swap, identifying the part of the liability extinguished and
the part that remains outstanding (as well as allocation of consideration received
to both) requires judgement. While a simple allocation method based on the
change in the nominal amount of the financial liability may be appropriate in some
circumstances, it could also lead to unreasonable results, particularly if the interest
payable on the remaining portion of the loan has been increased.
• The guidance on derecognition of a financial liability, including the guidance on
accounting for a debt for equity swap, would not apply to issuance of equity
instruments to settle a financial liability in accordance with its original contractual
terms. For example, conversion of a convertible bond into equity shares in
accordance with the original conversion terms results in derecognition of the liability
and recognition of the equity instrument at the carrying amount of the liability, with
no gain or loss being recognised.
• Apart from a change in the contractual terms, reclassification between equity and
financial liability may also arise on a change in the effective terms of an issued
instrument. This may occur when certain contractual provisions become effective
or cease to be effective due to factors such as the passage of time, occurrence
of contingent events, change in the group structure of an entity, etc. The
reclassification of an instrument from financial liability to equity due to a change
in effective terms may be recognised by analogy to Appendix D of Ind AS 109
(similar to the accounting treatment of a debt for equity swap). Alternatively, the
reclassification may be accounted in a manner similar to that of conversion of a
convertible instrument in accordance with its original terms.
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47
Financial Instruments: Application issues under Ind AS
Accounting for low interest and interest-free loans
Ind AS 109, Financial Instruments requires all financial instruments to be recognised initially at their fair value, which is normally
the transaction price. However, an entity may sometimes receive or give interest-free or low interest loans, e.g. inter-company
loans received from parent/group entities, government loans or tax deferral schemes, subsidised loans to staff, etc.
To determine the fair value of such low-interest or interest-free loans, an entity should first assess whether the interest charged
on the loan is at a below-market rate based on the terms and conditions of the loan, local industry practice and local market
circumstances. The fair value of such loans is then determined in accordance with Ind AS 113, Fair Value Measurement.
In this case study, we analyse four types of financial instruments to determine if these are in the nature of low-interest or interestfree loans and analyse the appropriate recognition and measurement requirements under Ind AS.
Key characteristics of the financial instruments
M Private Limited (the entity/company), operates in the industrial manufacturing sector and has entered into the following types
of transactions during the quarter ended 30 September 2016.
Table 1: Key characteristics of the financial instruments
Particulars
Amount (in INR)
Additional information
Deferred sales tax liability (unsecured)
90,000,000
This represents the sales tax liability of the company for
sales made during the quarter ended 30 September 2016.
The company is covered under a sales tax deferral scheme
which permits the company to pay its quarterly sales
tax liability after a period of 10 years from the end of the
quarter, with no interest being charged to the company
during this term. The company is eligible for this scheme
due to the nature of capital investment made by the
company. The company would be able to borrow funds
for a similar amount and term at an interest rate of 15 per
cent per annum.
Unsecured, interest free loan received
from ABC Private Limited on 1 August
2016 (immediate holding company
of M Private Limited). There are no
stated terms of repayment. However,
M Private Limited is expected to repay
the loan from funds generated from its
business.
200,000,000
Market rate for a short-term loan, repayable on demand, is
11.5 per cent per annum.
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Financial Instruments: Application issues under Ind AS
48
Table 1: Key characteristics of the financial instruments (continued)
Particulars
Amount (in INR)
The company has extended an
unsecured loan on 1 July 2016 (under
its staff policies) to an employee at
a nominal interest rate of 2 per cent
per annum. This loan will be repayable
over a period of 3 years (in equal
instalments) or when the employee
leaves the organisation, whichever is
earlier.
600,000
The company has extended a loan to
its subsidiary, XYZ Private Limited on
30 September 2016 at an interest rate
of 5 per cent per annum. The loan is
repayable after 5 years.
100,000,000
Additional information
The employee would be able to obtain a similar loan at a
market rate of 14 per cent per annum.
Unsecured loan of the same denomination, for the same
period and at same terms would be extended by banks to
XYZ Private Limited at an interest rate of 13 per cent per
annum.
Accounting issue
Ind AS 109 requires all financial instruments to be initially recognised at their fair value. As mentioned earlier, this is normally
evidenced by the transaction price. However, M Private Limited is required to identify loans that may be interest-free or low
interest in nature and determine their fair value in accordance with Ind AS 113 on initial recognition.
The company is also required to determine if the difference between the amount lent/borrowed and the fair value qualifies for
recognition as an asset or liability or whether it should be recognised as a gain or loss.
Accounting guidance
Figure 1 illustrates the applicable guidance in Ind AS 109 for measuring financial instruments at fair value on initial recognition.
Does the transaction price
represent fair value, i.e. is the
interest charged at market
rates?
Yes
Recognise loan at the
transaction price
No
Bifurcate the transaction price
into two components
Fair value of the loan
(within scope of Ind AS
109)
Determine fair value under Ind
AS 113
‘Other component’ (gain
or loss unless it qualifies
for recognition as an
asset or liability)
‘Other component’ recognised
under relevant standard (based
on relationship between
borrower and lender)
Classification and
subsequent measurement
under Ind AS 109
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition September 2016
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49
Financial Instruments: Application issues under Ind AS
In determining whether a loan is offered
at a below-market rate, the company
should consider the following aspects:
•
All the terms and conditions of the
loan
•
Local market circumstances and the
industry practice
•
Interest rates currently charged by
or offered to the entity for loans with
similar risks and characteristics.
Ind AS 113 defines fair value as ‘the
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’.
In determining fair value, Ind AS 113
requires an entity to maximise the
use of quoted prices or other relevant
observable inputs. However, if these
are not available, a valuation technique
may also be used, such as a present
value technique with inputs that include
future cash flows and discount rates
that reflect assumptions that market
participants would apply in pricing the
financial instrument.
Ind AS 109 requires the difference
between the transaction price and the
fair value of a low-interest or interestfree loan to be recognised as a gain
or loss (if the fair value is based on
observable inputs), unless it qualifies for
recognition as an asset or liability. This
normally depends on the relationship
between the lender and borrower or the
reason for providing the loan.
Analysis
The loans received and given by M
Private Limited in the illustration above
would be considered as below market
since they are not at market rates that
would apply to a normal commercial
arrangement between market
participants.
Table 2 below summarises the
accounting and measurement
requirements for the low-interest/
interest-free loans borrowed and lent
by the company, based on the guidance
above.
Table 2: Summarised analysis of the loans given and received
Borrowings
Particulars
Deferred sales tax
liability
Loans given
Loan taken from
holding company
Employee loans
Loan extended to
subsidiary
Face amount of the loan
(in INR)
90,000,000
200,000,000
600,000
100,000,000
Approximate fair value
of the loan initially
recognised as per Ind
AS 109 (in INR)
22,229,593
200,000,000
483,708
71,842,044
The ‘other than market
terms’ element of the
loan (in INR)
67,770,407
NIL
116,292
28,157,956
Government grant
N.A.
Employee benefit
expense
Investment in
subsidiary
Nature of the ‘other than
market terms’ element
of the loan recognised
by the company
Source: KPMG in India’s analysis, 2017
The following is an analysis of each of
the financial instruments mentioned in
the table above.
The deferred sales tax liability is an
incentive received by the company
from the government under a sales
tax deferral scheme. Since the loan is
interest-free in nature, its face value or
the transaction price is not considered
to represent fair value. Therefore, the
company is required to determine the
fair value based on the guidance in Ind
AS 113.
scheme is an appropriate method
of determining fair value. In order to
determine the discount rate to be used,
the company is required to assess the
interest rate based on assumptions
that market participants would use to
price a liability with similar terms, risk
exposures and characteristics as this
loan. For the purpose of this illustration,
this rate is determined on the basis of
the company’s incremental borrowing
rate (i.e. the rate at which the company
would be able to borrow funds on similar
terms from market participants in an
arms’ length transaction) as 15 per cent
per annum.
The company considers that the use
of a present value technique based
on the cash flows payable under the
Using this rate to discount the cash
flows payable by the company under
the sales tax deferral scheme, the fair
Deferred sales tax liability
value of the liability on 30 September
2016 is determined as INR22,229,593.
The difference between the fair value
of the loan and the amount payable
is INR67,770,407. This represents the
‘other component’ which is considered
to be in the nature of a government grant
since it represents an incentive received
by the company from the government.
This should be accounted for in
accordance with Ind AS 20, Accounting
for Government Grants based on the
terms of the scheme applicable to the
company, and may be either deferred
and amortised to the statement of profit
and loss over the period of the sales tax
deferral loan or recognised up front, as
appropriate.
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Financial Instruments: Application issues under Ind AS
The company would have to accrue
interest expense on the loan liability at
the effective interest rate (being the
discount rate used to determine initial
fair value) over the term of the sales tax
deferral loan.
Loan from parent
The unsecured loan received by
the company from its parent, ABC
Private Limited, is also in the nature
of an interest-free loan and should be
recognised initially at its fair value. This
loan has no fixed contractual cash flows
or stated repayment terms. In order to
determine the appropriate recognition
and measurement requirements for this
loan, the company may consider various
factors, including whether:
•
Classification as a liability is
appropriate, i.e. whether there is a
contractual obligation,
•
There is any agreed means of
repayment specified in the loan
agreement or in a side agreement, or
•
It is possible to estimate the timing of
the loan repayments.
For the purpose of this illustration,
the company is expected to repay
this loan from available funds that are
internally generated from its business.
This indicates that the company has an
obligation to repay this loan even though
there is no specific repayment date, and
it may be appropriately classified as a
financial liability.
Since it is not practicable to estimate
the timing of repayment of this loan
(although the company is expected to
have sufficient funds for repayment),
this liability could be considered as
repayable on demand by the lender, i.e.
the parent company. In this scenario,
Ind AS 113 states that ‘the fair value
of a financial liability with a demand
feature is not less than the amount
payable on demand, discounted from
the first date that the amount could
be required to be paid.’ Assuming that
this loan is considered as repayable on
demand at any time, no discounting
would be required on initial recognition.
Accordingly, the loan from the parent
company would be measured by M
Private Limited at its face value, which is
also its fair value.
However, a detailed analysis would
be required on initial recognition to
ascertain all the facts and circumstances
related to this type of a loan to
determine the expected repayment
terms and the appropriate accounting
treatment, including the need for
discounting, if any. For example, if the
loan has no fixed maturity date and
is available in perpetuity, then its fair
value would be measured by applying
a present value/discounting technique
that considered these terms.
Unsecured loan to employee
The staff loan provided to an employee
under the company’s policies is a lowinterest loan that should be measured
at its fair value on initial recognition.
The use of a present value technique is
considered as an appropriate method for
determining fair value by the company.
As mentioned above, the discount rate
is determined based on the guidance
in Ind AS 113 using assumptions that
market participants would use to price
a financial asset with similar terms and
characteristics. In this illustration, the
discount rate is determined as 14 per
cent per annum on the basis of the rate
at which the employee would be able to
obtain a similar loan from independent
market participants.
Using this rate to discount the cash
flows receivable by the company, the
fair value of the loan asset on 1 July 2016
(date of initial recognition) is determined
as INR483,708. The difference between
the fair value of the loan and the amount
lent, i.e. the ‘other component’ is
INR116,292. This would be considered
as an employee benefit provided by
the company and should be generally
recognised as an expense over the term
of the loan.
50
Loan to subsidiary
The 5 per cent, unsecured loan given by
the company to its subsidiary is a lowinterest loan that should be measured at
fair value on initial recognition. The fair
value is determined in a manner similar
to that described above, using a present
value technique. The appropriate
discount rate is estimated as 13 per
cent per annum, being the incremental
borrowing rate of the subsidiary, XYZ
Private Limited, i.e. the rate at which
market participants would price a
financial asset with similar terms and
risk characteristics.
Using this discount rate, the fair value of
the loan to the subsidiary is determined
as INR71,842,044 on initial recognition
as on 30 September 2016. The loan was
provided by the company in its capacity
as the major shareholder of XYZ Private
Limited. Therefore, the difference of
INR28,157,956 between the fair value
and the amount lent, may be considered
as an additional equity contribution
by the company to its subsidiary.
Accordingly, this amount would be
recognised as an additional investment
in the subsidiary in the separate financial
statements of the company at the time
of initial recognition of the loan.
The loan asset would generally be
classified into the amortised cost
category and the company would be
required to subsequently accrue interest
income at the effective interest rate (i.e.
unwind the discount) over the five-year
term of the loan.
The loan asset would generally be
classified as measured at amortised cost
and the company would be required to
accrue interest income at the effective
interest rate (i.e. the discount rate used
to determine fair value) over the term of
the loan.
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51
Financial Instruments: Application issues under Ind AS
Consider this….
•
•
•
The measurement of fair value of a loan repayable on demand by the lender would
be based on the perspective of an independent market participant acting in its
economic best interest. Accordingly, the lender may also measure such a loan at its
face value, being the amount repayable on demand.
In the absence of stated repayment terms for an interest-free/low-interest loan
between group companies, entities are required to apply judgement to determine if
a loan may be classified as a financial liability or an equity instrument of the borrower.
For example, a loan that is not repayable in perpetuity, where the borrower does not
have access to any means of repayment, or repayment is at the discretion of the
borrower, may not qualify for classification as a financial liability. A detailed analysis
of the facts and circumstances surrounding the grant of the loan would be required
in this scenario to determine the appropriate classification as well as measurement
for the loan.
On fair valuation of an interest-free loan from a parent to a subsidiary, the ‘other component’ being the difference between the fair value and the face value
of the loan may be considered as an equity infusion by the parent. Conversely, the
difference between fair value and face value of an interest-free loan provided by
a subsidiary to its parent, could be considered as a distribution/return of capital
by the subsidiary to the parent entity, based on an analysis of relevant facts and
circumstances.
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Financial Instruments: Application issues under Ind AS
52
© 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Classification and
measurement
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Financial Instruments: Application issues under Ind AS
54
Classification of investments in preference shares
Ind AS 109, Financial Instruments establishes principles for the classification of financial assets into various categories and their
subsequent measurement on this basis.
Ind AS 109 broadly requires all financial assets to be categorised based on the business model in which they are held and their
contractual characteristics into those measured at:
•
Amortised cost
•
Fair Value through Profit or Loss (FVTPL), or
•
Fair Value through Other Comprehensive Income (FVOCI)
In this case study, we analyse three types of preference shares to determine the appropriate measurement category for
classification by their holder under Ind AS 109.
Key terms of the preference shares
Company A holds certain investments in preference shares (as described in table below). The objective of the business model
within which these instruments are held is to hold these preference shares until maturity in order to collect their contractual cash
flows.
Contractual
features
Cumulative Redeemable
Preference Share (CPS)
Non-cumulative
Redeemable Preference
Share (NCPS)
Optionally Convertible Preference Share
(OCPS)
Term
5 years
5 years
5 years
Face value
INR1,000 each
INR1,000 each
INR1,000 each
Redemption
Redeemable at the end of
its term
Redeemable at the end of
its term
Redeemable at the end of its term
Dividend
Mandatory dividend of
10 per cent per annum,
cumulative in nature
Non-cumulative dividend
of 11 per cent per annum,
payable if dividends are to
be paid on ordinary shares
Mandatory dividend of 5 per cent per
annum, cumulative in nature
Conversion
Non-convertible
Non-convertible
Each OCPS is convertible at the option of
the holder into 5 ordinary shares of the
issuer at any time prior to maturity
Company A is required to classify each of these investments on initial recognition in accordance with the guidance in Ind AS 109.
Accounting issue
Ind AS 109 requires company A to classify its financial assets as subsequently measured at amortised cost, FVOCI or FVTPL on
the basis of both:
•
Its business model for managing the financial assets, and
•
The contractual cash flow characteristics of the financial asset.
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55
Financial Instruments: Application issues under Ind AS
Accounting guidance
The following is an illustration of the relevant guidance in Ind AS 109 for classification of the preference shares.
Figure 1: Classification of financial assets in accordance with Ind AS 109
No
Does the preference share (in its
entirety) meet the definition of an equity
instrument (Ind AS 32)?
No
Are the preference share’s contractual
cash flows solely payments of principal
and interest (SPPI)?
Yes
Yes
Is the preference share held for trading?
Are the preference shares held in a
business model whose objective is ‘hold
to collect contractual cash flows’?
Yes
No
Yes
No
Has the preference share been
irrevocably categorised as FVOCI?
No
No
Are the preference shares held in a
business model whose objective is
achieved by both collecting contractual
cash flows and selling financial assets?
Yes
Yes
FVOCI Equity
FVTPL
FVOCI Debt
Amortised cost
Source: Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition, September 2016
Our analysis
The preference shares held by company are analysed on the basis of the guidance above for classification under Ind AS 109 in
Table 1 below.
Table 1: Classification of preference shares under Ind AS 109
Criteria
CPS
NCPS
OCPS
Does the instrument meet
the definition of an ‘equity’
instrument under Ind AS 32?
No
(Redeemable with
mandatory distributions)
No
(Redeemable principal
amount)
No
(Redeemable if holder does
not opt to convert)
Are the contractual cash
flows SPPI?
Yes
(Principal repayment and
cumulative distributions
representative of interest
cash flows)
No
(Non-cumulative,
discretionary nature of
distributions is inconsistent
with SPPI)
No
(Option to convert into
equity shares is inconsistent
with SPPI)
Are the preference shares
‘held to collect’?
Yes
NA
(Since SPPI is not met)
NA
(Since SPPI is not met)
Classification under Ind AS
109
Amortised cost
FVTPL
FVTPL
Source: KPMG in India’s analysis, 2017
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Financial Instruments: Application issues under Ind AS
CPS
The CPS are debt instruments and are
analysed on the basis of the SPPI and
‘business model’ criteria in order to
determine their classification under Ind
AS 109.
•
•
The contractual cash flows of the
CPS are the repayment of principal
and mandatory dividends which are
cumulative in nature. The dividends
represent an ‘interest’ element
as they are consideration for the
time value of money payable by the
issuer of the CPS. The CPS is also
redeemable on maturity, which
represents a payment of principal.
There are no other contractual
cash flows or features that require
consideration for classification of this
instrument. This indicates that the
CPS meets the SPPI criteria.
As stated in the illustration above,
company A holds the CPS within a
business model whose objective is to
collect contractual cash flows arising
from investments over their term.
Therefore, the ‘business model test’
is also met.
In accordance with the guidance in Ind
AS 109, the CPS qualify for classification
into the amortised cost category as
the conditions specified for such
classification are met.
NCPS
The NCPS does not meet the definition
of an equity instrument since the
principal amount is mandatorily
redeemable on maturity. Hence, it
cannot be classified as FVOCI (equity).
It can be classified as measured at
amortised cost or FVOCI (debt) only if it
meets the relevant SPPI and business
model criteria, or else is classified as
measured at FVTPL.
•
•
The NCPS is mandatorily redeemable
at maturity, indicating that one of its
contractual cash flows is payment
of principal. However, the dividend
payments are discretionary as well
non-cumulative in nature. This
indicates that they do not represent
consideration for time value of money
for the holder. Hence, the SPPI
criterion is not met.
The NCPS are held within a business
model whose objective is to hold
the investments to collect their
contractual cash flows.
56
Since the NCPS do not meet the SPPI
criterion, they do not qualify for being
subsequently measured at amortised
cost. Hence, the NCPS should be
classified as and subsequently
measured at FVTPL.
OCPS
The OCPS does not meet the definition
of an equity instrument since the
principal amount is redeemable in the
event that company A does not exercise
the option to convert the OCPS into a
fixed number of shares. Therefore it
cannot be classified as FVOCI (equity).
The mandatory redemption at maturity is
a contractual cash flow that represents
a payment of principal. However, the
conversion feature is in the nature of an
equity return that may flow to company
A, and does not represent either a
payment of principal or interest. This
indicates that the SPPI criterion is not
met.
While the OCPS may be held within
a business model that has a ‘hold to
collect’ objective, they do not qualify for
classification into the amortised cost
category as they do not meet the SPPI
criterion. Therefore, the OCPS should
be classified as and subsequently
measured at FVTPL.
Consider this….
• An instrument that is mandatorily redeemable in cash and that does not meet the
definition of an equity instrument may still be classified and measured at fair value
through profit or loss if it does not meet either of the criteria for amortised cost
measurement.
• Any feature that results in an interest cash flow that is inconsistent with a basic
lending arrangement (representing payment for time value of money) may result
in an investment in a debt instrument being ineligible for classification into the
amortised cost category. For example, leveraged interest payments, interest
payments linked to an inflation index of a currency other than that in which the
instrument is issued, or interest payments linked to an equity index.
• Financial assets that are hybrid or compound in nature are assessed for
classification in their entirety and are not split into their components. Accordingly,
such instruments generally may not qualify for classification into the amortised cost
category.
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57
Financial Instruments: Application issues under Ind AS
Classification of investments in mutual funds
In the previous case study, we described the guidance in Ind AS 109, Financial Instruments, relevant to classification of
investments in preference shares. While the same guidance applies to classification of investments in mutual funds, there are
additional application issues to consider. In this case study, we analyse these issues for investments in three types of mutual
funds to determine their classification under Ind AS 109.
Key terms of investments in mutual funds
Company A provides IT services to clients and invests its surplus funds in the following instruments.
Diversified equity mutual fund
Liquid fund
Fixed Maturity Plan (FMP)
Objective
Long-term investment of
surplus funds
Short-term investment to
manage liquidity needs
Medium term investment to
generate fixed returns
Redemption
Open-ended scheme,
redemption permitted at any
time
Open-ended debt scheme,
redemption permitted at any
time
Close-ended debt scheme with a
fixed maturity date at the end of 3
years (redemption not permitted
prior to maturity). Can be traded on
an exchange
Dividends
None - The mutual fund is a
growth fund and is expected to
generate returns through capital
appreciation
Dividends are paid by the fund
based on its performance
The FMP expects to generate a
yield of 9 per cent per annum
Business
model
Not ‘held to collect’
Held to collect dividends and for
sale
Held to collect until maturity
Underlying
investments
of the fund
Equity shares – these may be
traded frequently by the fund
house to generate returns
Short-term money market
instruments (commercial paper,
certificate of deposit, treasury
bills) – may be traded to
generate returns
Fixed income instruments
(corporate bonds, government
securities, commercial paper) with
matching maturities – these are all
held until maturity
Company A is required to classify each of these investments on initial recognition in accordance with the guidance in Ind AS 109.
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Financial Instruments: Application issues under Ind AS
58
Accounting issue
Ind AS 109 requires company A to classify its financial assets as subsequently measured at amortised cost, FVOCI or FVTPL on
the basis of both:
•
Its business model for managing the financial assets, and
•
The contractual cash flow characteristics of the financial asset.
Accounting guidance
Figure 1 is an illustration of the relevant guidance in Ind AS 109 for classification of investments.
No
Does the instrument (in its entirety) meet the
definition of an equity instrument (Ind AS 32)?
No
Are the instrument’s contractual cash flows Solely
Payments of Principal and Interest (SPPI)?
Yes
Yes
Yes
Are the instruments held in a business model
whose objective is - hold to collect contractual
cash flows?
Is the instrument held for trading?
No
No
Has the instrument been irrevocably categorised as
FVOCI?
No
Yes
FVOCI Equity
Yes
No
Are the instruments held in a business model
whose objective is achieved by both collecting contractual cash flows and selling financial assets?
Yes
FVTPL
FVOCI Debt
Amortised cost
Source: Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition, September 2016
Analysis
Does the mutual fund meet the
definition of an equity instrument?
Ind AS 109 permits an entity to make an
irrevocable choice to present changes
in the fair value of an investment
in an equity instrument in Other
Comprehensive Income (OCI). However,
this option is available only if the equity
investment is neither ‘held for trading’
nor is in the nature of contingent
consideration recognised by an acquirer
in a business combination to which Ind
AS 103, Business Combinations applies.
Accordingly, company A would be
permitted to select this measurement
option if its investments in mutual fund
units are in the nature of qualifying
equity instruments.
The term ‘equity instrument’ is defined
from the perspective of the issuer
in Ind AS 32, Financial Instruments:
Presentation as ‘any contract that
evidences a residual interest in the
assets of an entity after deducting
all of its liabilities’. Further, a financial
liability is defined as ‘any liability that is
a contractual obligation to deliver cash
or another financial asset to another
entity’. Based on these, a unit issued
by a mutual fund or an FMP would
not meet the definition of an equity
instrument since the issuer (the fund)
has a contractual obligation to redeem
the instrument either at the option of
the holder (for open-ended schemes)
or at maturity (for close-ended plans).
While Ind AS 32 has a specific exception
for classifying puttable instruments
(those that give the holder the right to
put the instrument back to the issuer
for cash or another financial asset) as
equity in certain circumstances, these
instruments still are not considered
to meet the definition of an equity
instrument for the purpose of the
FVOCI election. This interpretation
is consistent with the Basis for
Conclusions to International Financial
Reporting Standard (IFRS) 9, Financial
Instruments which is applicable
internationally.
Consequently, these investments
cannot be designated as FVOCI and are
to be classified based on the relevant
guidance illustrated in Figure 1.
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59
Financial Instruments: Application issues under Ind AS
Classification of investments – analysis
Our analysis for classification of the investments in funds is summarised in the table below.
Table 1: Classification of financial assets in accordance with Ind AS 109
Criteria
Diversified equity mutual
fund
Liquid fund
FMP
Does the instrument meet
the definition of an ‘equity’
instrument under Ind AS 32
No
(Redeemable at the option
of the holder)
No
(Redeemable at the option
of the holder)
No
(Redeemable at maturity)
Are the contractual cash
flows SPPI?
No
(Redemption amount
represents capital
appreciation in investment
based on return generated
by underlying equity
investments)
No
(Redemption amount
represents composite
return earned on underlying
investments which may
include gains/losses on sale)
Yes
(FMP pays a return that is
based on contractual cash
flows of its underlying debt
investments, that meet
SPPI)
Are the instruments held
within a ‘held to collect’
business model?
No
No
Yes
Are the instruments held
within a business model
that has a dual objective of
holding to collect and for
sale?
No
Yes
No
Classification under Ind AS
109
FVTPL
FVTPL
Amortised cost
Source: KPMG in India’s analysis, 2017
Diversified equity mutual fund
This investment is classified as FVTPL
since there are no contractually
specified cash flows and hence the
SPPI criterion is not met. The amount
receivable by the holder on redemption
or sale shall be based on the fair value of
the underlying investments held by the
fund in equity instruments.
Liquid fund
While the investment held in the liquid
fund yields returns in the form of
dividends and is also redeemable by
the holder for cash, further analysis is
required to determine its classification.
In addition to assessing the cash flows
generated by the instrument, Ind AS
109 requires the holder to ‘look through’
to the underlying investments that
ultimately generate the cash flows in
a scenario where the returns on an
investment are contractually linked
to underlying assets. In this case, the
investments held by the liquid fund are
all debt instruments which generate
cash flows that represent payments
of principal and interest. However, the
liquid fund has the discretion to sell
its investments in order to optimise
returns. Therefore, the cash flows paid
by the fund to the unit holder comprise
gains/losses on the debt instruments
held by the fund, in addition to interest
and principal cash flows from those
instruments. Consequently, the SPPI
criterion is not met.
While the investment in the liquid fund
is held by company A within a business
model whose objective is achieved
by both collecting contractual cash
flows and selling financial assets, the
investment cannot be classified as
FVOCI since the SPPI criterion is not
met. Hence, company A should classify
this investment as FVTPL.
FMP
In the illustration above, the FMP that
company A has invested in is a closeended scheme with no redemptions
permitted until maturity. Further, the
underlying instruments that the FMP
invests in are all debt instruments that
give rise to contractual cash flows that
are in the nature of solely principal and
interest payments. The FMP invests
in debt instruments with maturities
that match the payments to be made
by the FMP to its unit holders, and also
generally holds these investments until
their maturity. This indicates that the
SPPI criterion is met for this investment.
Further, the investment in the FMP is
held by company A within a business
model whose objective is to hold
investments to collect their contractual
cash flows.
These factors indicate that company
A’s investment in the FMP could qualify
for classification into the ‘amortised
cost’ category. This classification is
based on a detailed analysis of facts
and circumstances, including ‘looking
through’ to the underlying investments
made by the FMP and a restriction
on the fund’s ability to buy/sell/trade
investments. In the absence of such
restriction FVTPL treatment would be
required.
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Financial Instruments: Application issues under Ind AS
60
Consider this….
• Although a puttable financial instrument such as a unit issued by a fund may qualify for
classification as ‘equity’ from the perspective of the issuer under the exception provided
in Ind AS 32, it does not meet the definition of an equity instrument since the issuer has
a contractual obligation to pay the holder. Consequently, the irrevocable option to classify
and measure equity investments at FVOCI would not be available to such investments,
which would therefore be classified and measured at FVTPL.
• Investments in a debt mutual fund do not necessarily meet the SPPI criterion even though
the fund invests in debt instruments with contractual cash flows that are solely payments
of principal and interest. The fund may periodically churn its investment portfolio and
hence the return paid by the fund to its unit holders is also based on gains or losses on
sale of investments. Therefore, the units in the fund held by the investor may not give rise
to contractual cash flows that meet the SPPI criterion.
• While the investment in the FMP in the illustration above may qualify for classification
and measurement at amortised cost, each investment should be assessed based on its
specific facts and circumstances. This may include ‘looking through’ to the underlying
investments when the cash flows are contractually linked to such instruments and
restrictions on the fund manager’s ability to buy/sell/trade such investments.
• On transition to Ind AS, companies that have significant investments in mutual funds
that are classified as FVTPL, are required to recognise the cumulative fair value change,
if any, as an adjustment to equity (retained earnings). This amount represents the fair
value change in the investments up to the transition date and would not be subsequently
reclassified into the statement of profit or loss or reflected in the earnings per share (EPS),
even on disposal of the investments.
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61
Financial Instruments: Application issues under Ind AS
Analysis of business model to determine
classification of financial assets
Entities are required to consider the business model within which they hold financial assets in order to determine their
classification, i.e. amortised cost, Fair Value through Other Comprehensive Income (FVOCI), or Fair Value through Profit or Loss
(FVTPL), on initial recognition.
Indian Accounting Standard (Ind AS) 109, Financial Instruments permits financial assets to be classified as measured at ‘amortised
cost’ only if:
•
Their contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the
principal amount outstanding (SPPI), and
•
They are held within a business model whose objective is to hold assets to collect contractual cash flows (held to collect).
In this case study, we illustrate some of the considerations relating to analysing the business model within which an entity holds a
portfolio of investments.
Key characteristics of investments
R Limited (the company or the entity), a large engineering and construction company, is required to invest funds in multiple
ongoing projects. The company has prepared an expenditure budget for a period of five years (which approximates the operating
cycle of its projects) and revises it on an annual basis to determine the funds required for its projects. The company has a treasury
department which invests surplus funds and manages its funding/liquidity requirements by investing in a suitable portfolio of
investments. As on 1 January 2017, the company acquired the following investments:
•
7 per cent 10 year government securities for INR10 million
•
9 per cent three year bonds issued by X Limited for INR5 million.
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Financial Instruments: Application issues under Ind AS
62
The company also held the following investments in government securities and corporate bonds as on 1 January 2017.
Investments
Government securities
Corporate bonds
Carrying amount of
investments
INR300 million
INR200 million
Period for which the
company intends to
hold the investment
The management intends to hold its
investments in government securities until
maturity
The company intends to hold the corporate bonds
to maximise yield but may also sell to profit from a
fall in interest rates
Objective of the
business model
The treasury department invests in
government bonds with long-term
maturities that match its liquidity needs (in
accordance with its expenditure budgets).
The company invests in corporate bonds in order to
benefit from higher yields and also earn profits from
sales of corporate bonds in a falling interest rate
scenario. Bonds may be sold based on the medium
term funding requirements of the company as well
as to earn profits based on changes in bond prices.
Current assessment
of business model
Held to collect
Dual objective – held to collect and for sale
Past trend
The company generally holds government
securities until maturity and has negligible
instances of sales from this portfolio.
However, in the previous quarter, the
company secured two new infrastructure
projects that were not originally part of
its expenditure budget. In order to obtain
the funds required to commence these
projects, the company sold government
securities of INR25 million before maturity.
The entity has aligned its subsequent
investments to the liquidity needs of
the new projects and has revised its
expenditure budget.
In the past, the entity invested in high-yield
corporate bonds in order to maximise its investment
returns. The maturities of the corporate bonds were
generally longer than the company’s medium-term
funding requirements. Therefore, the company sold
a portion of its corporate bond portfolio to fund
expenditure on capital projects.
The investments in government securities
meet SPPI criteria
The investments in corporate bonds meet SPPI
criteria
SPPI criteria
Over the past six months, the company has
also sold over 50 per cent of its corporate bonds
portfolio in order to benefit from increasing bond
prices. The company now intends to actively
maximise profits by trading in corporate bonds to
benefit from volatility in bond prices.
The employees in the treasury department receive variable incentive payments on the basis of the yield generated on government
securities and corporate bonds as well as the profits earned on sale of corporate bonds.
Accounting issue
The company is required to determine the objective of the business model within which the investments acquired as on 1 January
2017 would be held. Accordingly, the company is required to classify the acquired investments on initial recognition into one of the
following three categories:
•
Fair Value Through Profit or Loss (FVTPL) – investments that are not held within a ‘held to collect’ business model or those that
do not meet SPPI
•
Fair Value Through Other Comprehensive Income (FVOCI) – investments held within a business model that has a dual objective
(held to collect and for sale) and that meet SPPI
•
Amortised cost – investments that are held within a ‘held to collect’ business model and that meet SPPI.
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63
Financial Instruments: Application issues under Ind AS
Accounting guidance
Financial assets, such as the government and corporate bonds above, that meet the SPPI criteria (debt investments) may be
classified into one of three categories on the basis of the business model within which they are held. Figure 1 illustrates the
effect of the business model on classification of bonds:
Figure 1: Impact of business model on classification of financial assets
No
Are the bonds’ contractual cash flows solely payments of principal and interest (SPPI)?
Yes
Are the bonds held in a business model whose objective is ‘hold to collect contractual cash flows’?
Yes
No
No
Are the bonds held in a business model whose objective is achieved by both collecting contractual cash
flows and selling financial assets?
Yes
FVTPL
FVOCI Debt
Amortised cost
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition, September 2016
The assessment of the business model
is generally at an aggregated or portfolio
level. Although it requires judgement,
the analysis is based on fact and not
management intent (expressed at a
security level), and should consider all
relevant information, including:
•
•
•
The way in which the performance
of the portfolio is evaluated and
information is reported to key
management personnel
How managers of the business/
portfolio are compensated, i.e. on
the basis of contractual cash flows or
fair value of assets managed
The frequency, volume and timing
of sales in prior periods, including
the reasons for such sales and
expectations about future sales
activity. Sales may be consistent with
a ‘held to collect’ business model
in certain scenarios. For example, if
sales occur due to an increase in the
credit risk or close to the maturity
of the financial asset. Additionally,
sales that are either infrequent or
insignificant (individually and in
aggregate) in nature may also be
consistent with a ‘held to collect’
business model.
Analysis
Government securities
The company has invested in
government securities to meet
its long-term liquidity needs. The
maturities of the investments are
aligned to the company’s budgeted
expenditure on its projects. Further,
the company has infrequent instances
of sales that have occurred from its
portfolio of government securities in
the past. These factors indicate that the
government securities are held within a
business model whose objective is met
by holding the investments to collect
their contractual cash flows.
However, an instance of a significant
sale in the past quarter may require
further analysis. The company has sold
securities worth INR25 million to meet
an unexpected capital expenditure on
new projects won in the previous year.
Although the sale is not individually
insignificant (relative to the aggregate
portfolio of INR325 million, including
the investments sold), it appears to
be infrequent in nature. Similar sales
are not expected to occur in the future
since investments have been aligned to
the revised budget.
Therefore, the business model for the
portfolio of government securities may
continue to be assessed as ‘held to
collect’. The company should classify
the government securities acquired as
on 1 January 2017 into the amortised
cost category since they meet both the
SPPI and business model criteria.
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Financial Instruments: Application issues under Ind AS
64
Corporate bonds
The company invests in corporate bonds
to improve its returns on investments
by generating higher yields on corporate
bonds to offset the low interest rates
earned on investments in government
securities. Since the maturities of the
corporate bonds were sometimes
longer than the timing of the funds
required, the company had several
instances of sales in the past to meet
the funding requirements for incurring
capital expenditure. The company
also sold bonds to earn profits by
taking advantage of increasing bond
prices. Based on these factors, the
company had previously assessed
that the corporate bonds were held
within a business model that had a dual
objective, i.e. collecting contractual cash
flows as well as for sale.
The company should now assess the
impact of increasing sales over the past
six months from the corporate bond
portfolio. The sale of approximately
50 per cent of the bonds portfolio in
several transactions over six months
may be considered as both frequent as
well as significant in aggregate. Further,
the company now intends to maximise
gains by actively trading in corporate
bonds in the future due to increasing
volatility in bond prices. While this
would not affect the classification of
the existing investments in the portfolio,
it may require a reassessment of the
business model for new investments.
Figure 2 below illustrates the relevant
considerations in Ind AS 109:
Figure 2: Reassessment of business model
Are cash flows realised in a way
different from the entity’s expectation?
No
No reassessment
required
Yes
Remaining financial assets held in
that business model
Newly orginated/purchased
financial assets
No change in classification
Reassess business model
Source: KPMG in India’s analysis, 2017
As explained in Figure 2, the entity should not change the business model under which it manages its existing investments.
However, while classifying the new investment in corporate bonds of X Ltd, acquired on 1 January 2017, it should reassess the
business model if it considers that the investments are no longer managed in a manner consistent with a dual objective (held-tocollect and for sale). Given that the company expects to actively trade in the corporate bonds going forward, the new investment
may require to be classified as at FVTPL.
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65
Financial Instruments: Application issues under Ind AS
Consider this….
• If, in the case study above, the company sold the corporate bonds due to an increase
in their credit risk based on the credit policy of the company, then, the company may
have been able to conclude that the sales were consistent with a ‘held to collect’
business model. This is because the credit quality of financial assets is considered
relevant to the company’s ability to collect contractual cash flows.
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Financial Instruments: Application issues under Ind AS
66
Application of effective interest method
Financial assets and liabilities that are classified as ‘amortised cost’ are subsequently measured using the effective interest rate
method under Indian Accounting Standard (Ind AS) 109, Financial Instruments. In addition, financial assets (excluding equity
instruments) that are classified into the ‘Fair Value through Other Comprehensive Income (FVOCI)’ category may also require the
application of the Effective Interest Rate (EIR) method for recognition of interest income.
Ind AS 109 defines the EIR method as the rate that exactly discounts estimated future cash payments or receipts through the
expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or to the amortised cost of a
financial liability.
In this case study, we aim to illustrate the application of the EIR method to a financial liability measured at amortised cost and a
financial asset classified as FVOCI.
Key terms of financial instruments
Z Limited (the company), currently in the process of building a port in India, has entered into the following transactions on 1 April
2016:
Preference shares issued
Corporate bonds acquired
Description
1,000,000, 5 per cent cumulative preference shares of INR100
each, issued at par (INR100,000,000)
5,000 10 per cent corporate
bonds acquired for INR1,000 each
(INR5,000,000)
Transaction
costs
INR1,000,000 on legal and professional fees
N.A.
Redemption
Redeemable by the company at the end of 3 years at
a premium of 20 per cent (i.e. redemption amount is
INR120,000,000)
Redeemable by the issuer at the end
of 5 years at face value being INR1,200
per bond (i.e. redemption amount is
INR6,000,000)
Dividends/
interest
5 per cent per annum
10 per cent per annum
Business
model
N.A.
Held to collect and for sale (the company
has acquired these investments for
temporarily investing surplus funds.
These bonds may be sold to fund capital
expenditure in the future)
Ind AS 109
classification
Financial liability at amortised cost
Financial asset at FVOCI
Fair value at 31
March 2017
N.A.
INR1,100 per bond
This illustration does not include the impact of expected loss assessment on the investment in corporate bonds.
Accounting issue
Ind AS 109 requires the company to recognise interest expenses/income in accordance with the EIR method. The financial
liability (preference shares) is subsequently measured at amortised cost and the financial asset (investment in corporate bonds)
is subsequently measured at FVOCI. The analysis in this case study illustrates the computation of the EIR and its application in
accounting for these financial instruments.
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67
Financial Instruments: Application issues under Ind AS
Accounting guidance
Figure 1 illustrates the guidance in Ind AS 109 on the elements forming part of the calculation of amortised cost:
Financial liabilities
Financial assets
Amount initially recognised
Minus
Principal repayments
Plus or minus
Cumulative amortisation, using the EIR of any difference
between the initial amount and the maturity amount
Equals
Gross carrying amount
Minus
Loss allowance
Equals
Amortised cost
Amortised cost (no adjustment for loss allowance)
Source: Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition, September 2016
Analysis
Preference shares - financial liability
On initial recognition, a financial asset
or financial liability that is not classified
as FVTPL is measured at its fair value
plus or minus directly attributable and
incremental transaction costs. The fair
value on initial recognition is generally
equal to the transaction price, i.e. the fair
value of consideration given or received
for the financial instrument. Therefore,
the preference share liability is initially
recognised at INR99 million (INR100
million – INR1 million).
In the case of the preference share
liability, its amortised cost on initial
recognition is equal to its fair value,
adjusted for transaction costs, i.e. INR99
million. The expected cash payments
include the annual interest payments
at 5 per cent per annum (INR5 million
payable annually) and the redemption
amount including the redemption
premium (INR120 million).
The preference share liability is classified
as measured at amortised cost, which
is calculated on the basis of the EIR
method. This method is used for
amortising premiums, discounts and
transaction costs. The EIR is calculated
on initial recognition and is the rate
that exactly discounts estimated future
cash payments or receipts through the
expected life of the financial instrument,
to the gross carrying amount of a
financial asset or the amortised cost of a
financial liability.
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Financial Instruments: Application issues under Ind AS
68
Based on these, the EIR for this liability is computed as 11.37 per cent per annum. The following table illustrates the computation
of interest expense and amortised cost based on the EIR.
Date
Interest expense (in INR)
Cash inflows/(outflows)
(Amortised cost*11.37% p.a.)
(in INR)
1 April 2016
Amortised cost (in INR)
(Opening amortised cost+Interest
expense-Cash outflows)
99,000,000
99,000,000
31 March 2017
11,260,852
(5,000,000)
105,260,852
31 March 2018
11,972,998
(5,000,000)
112,233,850
31 March 2019
12,766,150
(125,000,000)
Nil
Source: KPMG in India’s analysis, 2017
The difference between the accrued interest expense and the dividend paid represents the amortisation of the transaction costs
and the redemption premium on the preference share liability. The following are the accounting entries that should be recognised
by Z Limited for the preference share liability for the year ended 31 March 2017.
Date
Accounting entry
1 April 2016
On initial recognition of the financial liability, net of
transaction costs
Bank
Preference share liability
31 March 2017
Amount in INR
Dr 99,000,000
Cr 99,000,000
Accrual of interest expense and payment of dividend
Interest expense
Preference share liability
Bank
Dr
Cr
Cr
11,260,852
6,260,852
5,000,000
Source: KPMG in India’s analysis, 2017
Corporate bonds – financial asset
The investment in corporate bonds
is in the nature of a debt instrument,
which is classified as FVOCI by Z
Limited. Therefore, gains or losses
are recognised in OCI, except for
the following items, which are to be
recognised in the statement of profit
and loss (similar to the recognition
requirements for financial assets
measured at amortised cost):
•
Interest revenue measured using the
EIR method,
•
Expected credit losses or reversals,
and
•
Foreign exchange gains or losses, if
any.
On derecognition of the financial asset,
the cumulative gain or loss recognised in
OCI is reclassified to profit or loss.
In determining the EIR for a financial
asset, all contractual terms of the
instrument are considered other than
expected credit losses. This is since
the interest revenue is measured on
the basis of contractual terms and is
independent of the expected credit loss
estimates.
The corporate bonds are initially
recognised at their fair value (equal
to the transaction price), being INR5
million. The expected cash receipts
include the annual interest coupon of
10 per cent per annum (INR600,000 per
annum) and the redemption proceeds
of INR6 million at the end of five years.
Based on these, the EIR for this financial
asset is computed as 14.92 per cent per
annum.
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69
Financial Instruments: Application issues under Ind AS
The following table illustrates the accounting impact for the first year, including the computation of amortised cost and the
amounts recognised in profit or loss/OCI. The impact of expected credit losses has been ignored for the purpose of this
illustration.
Particulars
Amount in INR
Initial carrying amount of the corporate bonds at 1 April 2016
5,000,000
Add: Interest income accrued in the profit or loss at the EIR of 14.92 per cent
746,166
Less: Interest coupon received by the entity
(600,000)
Amortised cost of the corporate bonds as at 31 March 2017
5,146,166
Fair value of the corporate bonds at 31 March 2017 (INR1,100 per bond)
5,500,000
Amortised cost of the bonds
5,146,166
Cumulative fair value change (gain) recognised in OCI
353,834
Source: KPMG in India’s analysis, 2017
The interest income accrued in profit or loss includes the amortisation of the difference between the amount initially recognised
and the redemption amount.
The following are the accounting entries that should be recorded by Z Limited in respect of the corporate bonds for the year
ended 31 March 2017.
Date
Accounting entry
1 April 2016
On initial recognition of the investment
Investment in corporate bonds (FVOCI debt)
Bank
31 March 2017
Amount in INR
Dr 5,000,000
Cr 5,000,000
Accrual of interest income, receipt of interest coupon and
recognition of fair value changes
Bank
Investment in corporate bonds
Interest income (profit or loss)
Fair value gain on corporate bonds (OCI)
Dr
Dr
Cr
Cr
600,000
500,000
746,166
353,834
Source: KPMG in India’s analysis, 2017
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Financial Instruments: Application issues under Ind AS
70
Consider this….
• A financial liability that has been issued at a low or nil interest rate but carried a
substantial redemption premium will affect the statement of profit and loss as the
redemption premium will be accrued over the life of the instrument at the EIR.
Companies that have such financial liabilities outstanding at the date of transition
to Ind AS are required to retrospectively compute the amortised cost of the liability
and recognise the unamortised premium in the form of interest expense over the
remaining term.
• A financial asset, being a debt instrument, classified as FVOCI will still have an impact
on the statement of profit and loss for accrual of interest income on the basis of the
EIR, recognition of expected losses and foreign exchange differences, if any. Further,
the fair value change recognised in OCI is reclassified into the profit or loss on
derecognition of such financial asset unlike fair value gains or losses on investments in
equity instruments that are irrevocably classified as FVOCI.
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Impairment of financial
assets
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Financial Instruments: Application issues under Ind AS
72
Impairment assessment for trade receivables
Indian Accounting Standard (Ind AS)
109, Financial Instruments requires
the recognition of an impairment loss
allowance for expected credit losses on a
financial asset (being a debt instrument)
that is measured at amortised cost or
fair value through other comprehensive
income (FVOCI).
The general approach to impairment
assessment under Ind AS 109 requires
the loss allowance to be measured at
an amount equal to 12-month expected
credit losses for financial instruments
where the credit risk has not increased
significantly since initial recognition. For
those financial instruments where the
credit risk has increased significantly, the
loss allowance is measured at an amount
equal to lifetime expected credit losses.
However, Ind AS 109 also provides
a simplified approach to measure
impairment losses on trade receivables,
lease receivables and specific
contractual rights to receive cash/
another financial asset. This case study
illustrates a method that may be used by
an entity to apply the simplified approach
to measure impairment losses on trade
receivables.
Key characteristics of the trade
receivables
equipment nationally to a large number
of small clients. Its past experience
indicates that loss patterns on its trade
receivables differ based on the region in
which its customers are located. Further,
receivables that have been outstanding
for more than one year have historically
been uncollectable and result in a loss
being incurred, irrespective of the region
in which they originate. The outstanding
amount of trade receivables for each
region is as follows:
An Indian company, M Limited,
manufactures office equipment and has
a portfolio of trade receivables of INR461
million at its half-yearly reporting date,
30 September 2016. M Ltd supplies
Region
Trade receivables at 30 September
2016 (in INR million)
Impairment allowance as at 30 June
2016 (in INR million)
North
137
2.85
South
98
1.80
East
74
1.50
West
152
3.00
Total
461
9.15
M Limited monitors the current and
expected economic scenario on an
ongoing basis and categorises it as
stable, improving or worsening in nature.
When preparing its business forecasts
for the next financial year, M Limited has
obtained information that suggests that
the domestic economic environment
is likely to worsen, specifically for
businesses operating in the western
region.
Accounting issue
Ind AS 109 requires an entity, at
each reporting date, to measure and
recognise a loss allowance for expected
credit losses on all financial assets. The
assessment of expected credit losses
should be based on reasonable and
supportable forward-looking information
that is available without any undue cost
or effort. M Limited is preparing its
interim financial statements for the halfyear ended 30 September 2016 and is
therefore required to assess impairment
on its portfolio of trade receivables under
Ind AS 109.
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73
Financial Instruments: Application issues under Ind AS
Accounting guidance
Figure 1 illustrates the guidance on impairment in Ind AS 109.
Is the asset credit impaired at initial recognition?
Yes
Recognise changes in lifetime expected
credit losses
No
Is the asset a trade receivable or a contractual right to receive
cash or another financial asset (arising under Ind AS 11 or 18)?
Yes
No
Is the asset a lease receivable for which the entity has elected
to measure impairment based on lifetime expected credit
losses?
Yes
Recognise lifetime expected credit losses
No
Has there been a significant increase in credit risk since initial
recognition?
Yes
No
Recognise 12-month expected credit losses
Source: KPMG in India’s analysis, 2017 read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition September 2016
Ind AS 109 permits the use of practical
expedients for measurement of
expected credit losses if they are in
compliance with the general principles,
i.e. result in measurement of expected
credit losses in a way that reflects:
•
An unbiased and probabilityweighted 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.
Ind AS 109 provides an example of a
practical expedient – a provision matrix
– for calculation of expected credit
losses on trade receivables. A provision
matrix may generally have the following
features:
•
It is based on historical credit loss
experience, adjusted as appropriate
to reflect current conditions and
reasonable and supportable forecasts
of future economic conditions,
•
It might specify provision rates based
on the number of days that a trade
receivable is past due, and
•
Appropriate grouping or segmentation
may be used if the historical
experience shows different loss
patterns for different customer
segments, e.g., geographical region,
customer rating, product type, etc.
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Financial Instruments: Application issues under Ind AS
74
Analysis
M Limited uses the provision matrix as a practical expedient to measure expected credit losses on its portfolio of trade
receivables as at 30 September 2016. Based on its historical experience, it segments its receivables based on the geographical
region to which its customers belong.
Table 1 provides the ageing of M Limited’s trade receivables for the western region, at 30 September 2016 and as at the past 10
quarterly interim reporting dates. Receivables that are more than one year old are considered uncollectable. This illustration is
based on the assumption that the trade receivables have a short duration and do not carry a contractual interest rate. Therefore,
the effective interest rate of these receivables is considered to be zero and discounting of expected cash shortfalls has not been
performed.
Table 1: Historical ageing of trade receivables held by M Limited (in INR million)
Reporting
date
Balance
Not due
0-90 days
90-180 days
180-270
days
270-360
days
More than
360 days
September-16
152.00
86.00
42.00
18.50
3.00
2.00
0.50
June-16
144.00
81.00
48.00
9.00
4.00
1.00
1.00
March-16
116.00
69.00
29.00
10.60
4.00
2.00
0.40
December-15
117.00
60.00
35.00
15.30
5.00
1.00
0.70
September-15
96.00
44.00
32.00
15.30
3.00
1.50
0.20
June-15
136.00
76.00
40.00
13.00
4.60
2.00
0.40
March-15
164.00
91.00
53.00
12.30
5.00
2.00
0.70
December-14
160.00
94.00
48.00
12.00
3.50
1.50
1.00
September-14
151.00
79.00
56.00
9.00
4.50
2.20
0.30
June-14
147.00
72.00
59.00
9.00
5.70
1.00
0.30
March-14
150.00
85.00
47.00
11.00
4.50
2.00
0.50
Source: KPMG in India’s analysis, 2017
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75
Financial Instruments: Application issues under Ind AS
A provision matrix is developed by M Limited to compute the historical observed default rates. These are determined by
computing the historical ‘flow rate’ of trade receivables, based on their ageing and arriving at an average loss rate. This is
demonstrated in Table 2 below:
Table 2: Computation of ‘flow rate’ based on historical ageing of trade receivable
Not due
0-90 days
90-180 days
180-270 days
270-360 days
More than
360 days
September-16
56.58%
51.85%
38.54%
33.33%
50.00%
50.00%
June-16
56.25%
69.57%
31.03%
37.74%
25.00%
50.00%
March-16
59.48%
48.33%
30.29%
26.14%
40.00%
40.00%
December-15
51.28%
79.55%
47.81%
32.68%
33.33%
46.67%
September-15
45.83%
42.11%
38.25%
23.08%
32.61%
10.00%
June-15
55.88%
43.96%
24.53%
37.40%
40.00%
20.00%
March-15
55.49%
56.38%
25.63%
41.67%
57.14%
46.67%
December-14
58.75%
60.76%
21.43%
38.89%
33.33%
45.45%
September-14
52.32%
77.78%
15.25%
50.00%
38.60%
30.00%
June-14
48.98%
69.41%
19.15%
51.82%
22.22%
15.00%
54.08%
59.97%
29.19%
37.27%
37.22%
35.38%
Reporting
date
March-14
Average
Source: KPMG in India’s analysis, 2017
The flow rate indicates the percentage
of trade receivables in an ageing bracket
that have not been collected during the
quarter and have therefore moved into
the next ageing bracket. For example,
INR85 million of trade receivables were
not due as at 31 March 2014. Of these,
INR59 million were not collected during
the following quarter and moved into
the 0-90 days ageing bracket as at 30
June 2014. Therefore, the flow rate for
the 0-90 days ageing bracket at 30 June
2014 is 69.41 per cent (59/85*100). The
flow rate for all ageing brackets has been
computed in this manner. Accordingly,
M Limited has determined the historical
average flow rates for all ageing
brackets.
These average flow rates are then
used to determine the credit loss
rate (determined as a product of the
average flow rates for the applicable
ageing brackets) to be applied to the
trade receivables as at 30 September
2016. This loss rate is adjusted by a
forward-looking estimate that includes
the probability of a worsening domestic
economic environment in the western
region over the next few quarters. The
computation of the credit loss rate and
the expected credit loss amount is
illustrated in table 3.
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Financial Instruments: Application issues under Ind AS
76
Table 3: Credit loss rate and impairment loss computation
Ageing
bracket
Not due
00-90
days
90-180
days
180-270
days
270-360
days
More
than 360
days
Total
Balance
0-90
days
(INR
million)
86.00
59.97%
42.00
90-180
days
More
than
360
days
Adjusted
credit
loss rate
ECL (INR
270-360
days
29.19%
37.27%
37.22%
35.38%
100.00%
0.86%
0.90%
0.77
29.19%
37.27%
37.22%
35.38%
100.00%
1.43%
1.50%
0.63
37.27%
37.22%
35.38%
100.00%
4.91%
5.15%
0.95
37.22%
35.38%
100.00%
13.17%
13.80%
0.42
35.38%
100.00%
35.38%
37.00%
0.74
100.00%
100.00%
100.00%
0.50
18.50
3.00
2.00
0.50
Not
collected
Credit
Loss
Rate
180-270
days
152.00
million)
4.01
Source: KPMG in India’s analysis, 2017
For example, of the INR86 million
receivables that are currently not due,
59.97 per cent is expected to move
into the 0-90 days bracket. 29.19 per
cent of the receivables in the 0-90 days
bracket are expected to move into the
90-180 days ageing bracket, and so on.
The credit loss rate computed in table
3 above is a product of the flow rates
for the applicable ageing brackets. The
adjusted credit loss rate includes the
forward-looking estimate to reflect
the probability of worsening economic
conditions. The adjusted credit loss
rate has been computed by applying an
increase of approximately 5 per cent
to the historical credit loss rate for all
ageing brackets. Using this method, the
total expected credit loss on the portfolio
of trade receivables as at 30 September
2016 is measured as INR4.01 million.
M Limited is required to measure its
total impairment allowance on trade
receivables on 30 September 2016
at INR4.01 million. At 30 June 2016,
the impairment allowance for trade
receivables for the western region was
INR3 million. Therefore, the additional
impairment loss to be recognised in
the statement of profit and loss for the
quarter ended 30 September 2016 is
INR1.01 million.
M Limited should perform a similar
analysis to compute the expected credit
loss for trade receivables for the other
three regions.
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77
Financial Instruments: Application issues under Ind AS
Consider this….
• Trade receivables generally have a short duration and do not carry a contractual
interest rate. Therefore, they are measured on initial recognition at the transaction
price. Accordingly, the effective interest rate for trade receivables is considered to be
zero and discounting of expected cash shortfalls to reflect the time value of money
would not be required when measuring expected credit losses. However, companies
should consider the impact of any financing element in the trade receivables which
may have to be separated at initial recognition, especially once Ind AS 115, Revenue
from Contracts with Customers becomes applicable.
• The use of historical loss experience to determine lifetime expected credit losses
is permitted as a practical expedient under Ind AS 109. However, companies are
required to adjust data based on their credit loss experience on the basis of current
observable data to reflect the effects of current conditions and forecasts of future
conditions. Further, information about historical credit loss rates should be applied
to groups of receivables that are consistent with groups for which the historical loss
rates were observed.
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Financial Instruments: Application issues under Ind AS
78
`
© 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Hedge accounting
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Financial Instruments: Application issues under Ind AS
80
Hedging foreign currency risk on forecast
transactions
Ind AS 109, Financial Instruments
permits an entity to apply hedge
accounting in order to represent the
effect of its risk management activities
in its financial statements. Hedge
accounting is voluntary and may be
applied to individual transactions or a
group of similar transactions if they meet
the qualifying criteria specified in the
standard.
Ind AS 109 envisages the following three
types of hedging relationships:
•
•
Fair value hedge: A hedge of the
exposure to changes in the 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 or
other comprehensive income (OCI)
(for a hedge of an equity investment
measured at fair value through OCI).
Cash flow hedge: A hedge of the
exposure to variability in cash flows
that is attributable to a particular risk
associated with all of, or a component
of, a recognised asset or liability or a
highly probable forecast transaction,
and could affect profit or loss.
•
Net investment hedge: A hedge of
the foreign currency exposure arising
from a net investment in a foreign
operation, as defined in Ind AS 21,
The effects of changes in foreign
exchange rates, when the net assets
of that foreign operation are translated
for inclusion in the consolidated
financial statements.
This case study highlights the qualifying
criteria for hedge accounting as
prescribed by Ind AS 109.It analyses
its applicability to a hedge of foreign
currency risk and determines the
accounting treatment for such
transaction.
Key terms of the financial
instruments
Company A (the entity/company) is a
manufacturer of fragrances and imports
certain essential raw materials that
are used in manufacturing its finished
products. Approximately 95 per cent of
the imports of the company are made
in US Dollars (USD). Considering the
volume of foreign exchange transactions
and the fluctuation in the USD-INR
exchange rates, the entity has identified
foreign currency risk as a key financial
risk. In accordance with its documented
risk management policies, the company
hedges its foreign currency exposure
using USD-INR forward contracts. A
hedge is considered to be effective
under the policy if it offsets the variability
in the cash flows on the imports within a
range of 90-110 per cent.
On 1 March 2017, the company has
hedged a highly probable forecast
foreign currency purchase of USD
4,280,000, expected to be delivered
on 15 May 2017, by entering into a
forward contract to buy USD 4,280,000
on 31 May 2017 at a forward rate of
INR67.53. The forward contract has
been transacted with a reputed banking
institution. Further, company A is itself
a highly-rated, investment grade entity.
The following are the forward rates
applicable during the period of the
transaction:
Date
USD/INR spot rate
USD/INR forward
rate for 31 May 2017
maturity
USD/INR forward
rate 15 May 2017
maturity
MTM ((gain)/loss)
on forward contract
(INR)
1 March 2017
66.58
67.53
67.22
-
31 March 2017
66.90
67.70
67.35
(727,600)
15 May 2017
67.44
67.82
67.44
(1,241,200)
31 May 2017
68.21
68.21
NA
(1,669,200)
(Note: Time value of money has been ignored for the purpose of this illustration)
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81
Financial Instruments: Application issues under Ind AS
Accounting issue
Ind AS 109 requires the entity to classify
and measure the forward contract
(derivative instrument) at fair value
through profit or loss (FVTPL). This gives
rise to an accounting mismatch and
creates volatility in the statement of
profit and loss since the corresponding
hedged transactions are not recognised
until the company receives delivery of
the raw materials.
While hedge accounting is not
mandatory under Ind AS 109, it may
be applied to mitigate the accounting
mismatch if the hedge relationship
meets the qualifying criteria. The
company is required to analyse the
underlying transaction, including the
relationship between the hedged item
(forecast imports in USD) and the
hedging instrument (forward contract)
to evaluate if hedge accounting may be
applied.
Accounting guidance
The forward contract has been acquired
to mitigate the variability in cash flows
arising from exposure to foreign currency
risk on the forecast import transaction.
The company is required to evaluate if it
can designate and account for this hedge
relationship as a cash flow hedge under
Ind AS 109. Figure 1 below illustrates the
qualifying criteria to be met in order to
apply hedge accounting to this hedging
relationship.
Figure 1: Qualifying criteria for applying hedge accounting under Ind AS 109
Is there a qualifying hedged item and hedging instrument?
No
Yes
Is the hedging relationship consistent with the entity’s risk
management obective?
No
Yes
Is there an economic relationship between the hedged item
and the hedging instrument?
No
Hedge accounting cannot be applied
• Measure the hedging instrument at
FVTPL
• Measure the hedged item based on
applicable Ind AS
Yes
Does the effect of the credit risk dominate the fair value
changes?
Yes
No
Does the hedge ratio (based on actual quantities used for risk
management) reflect an imbalance that would create hedge
ineffectiveness?
Yes
No
The entity is permitted to apply hedge accounting
(Ensure formal designation and documentation)
Source: KPMG in India’s analysis, 2017, read with Ind AS 109
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Financial Instruments: Application issues under Ind AS
Analysis
Ind AS 109 requires all derivatives to be
classified as and measured at FVTPL,
giving rise to volatility in profit and loss
on each reporting date until maturity
of the forward contract. Since the
underlying hedged item is a forecast
purchase in foreign currency, it does not
affect the statement of profit and loss
until the transaction occurs, i.e. until
the material is delivered. If company A
elects to not apply the hedge accounting
principles in Ind AS 109, the accounting
mismatch in the timing of the impact
on the statement of profit and loss will
remain.
hedging instrument. However, the
maturity date of the forward contract
is 31 May 2017 and the forecast
purchase is expected to occur on 15
May 2017, indicating that the critical
terms of the transactions are closely
aligned but do not completely match
(as there would be a difference
in the forward rates for the two
maturity dates). The company would
therefore need to use a quantitative
method to establish that this hedging
relationship is expected to be highly
effective over the hedging period.
•
The company may also consider
excluding the forward element of the
derivative contract from the hedging
relationship and designate only the
spot element (i.e. changes in spot
rates as the hedged risk) in order to
prevent the forward element from
affecting hedge effectiveness. Under
this approach, the forward element
may be separately accounted for
as a ‘cost of hedging’ based on the
guidance in Ind AS 109.
•
The forward contract has been
transacted with a highly rated banking
institution. Company A is itself also
an investment grade entity based on
external credit ratings. Hence, it may
be expected that the effect of credit
risk would not dominate the fair value
changes.
Qualifying criteria
The company may therefore apply hedge
accounting to mitigate this accounting
mismatch provided the transactions
meet the qualifying criteria under Ind AS
109, as indicated below:
•
•
•
•
The USD/INR forward contract is a
derivative transacted with an external
party. Therefore, this is a qualifying
hedging instrument.
As mentioned above, the hedged
item is a ‘highly probably’ forecast
purchase in USD that gives rise to
foreign currency risk. The transaction
may be considered as ‘highly
probable’ based on an analysis of
facts and circumstances that includes
consideration of the extent and
frequency of similar transactions
in the past (past trends), quality of
the budgeting process (for planned
purchases and production), availability
of adequate resources to complete
the transaction, etc. Therefore, this
would be considered to be a qualifying
hedged item.
The entity has identified foreign
currency risk as a key financial risk and
has documented risk management
policies relating to the use of forward
contracts to hedge this risk.
The forward contract to buy USD
offsets the foreign currency risk
arising from the USD obligation on
the forecast purchase contract, thus
indicating an economic relationship
between the hedged item and
•
The notional amounts of the forward
contract and the forecast purchase
transaction are identical indicating
a hedge ratio of 1:1. Therefore, the
hedge ratio does not reflect an
imbalance that would give rise to
hedge ineffectiveness.
and the current spot price (on the
date of entering into the contract) of
the underlying exposure. The forward
element would therefore be separately
accounted for as a cost of hedging. This
is illustrated separately in this case study.
The company may measure hedge
effectiveness using the hypothetical
derivative method. Under this method,
the hedged item is defined as a
hypothetical derivate with critical terms
that exactly match the forecast purchase
transaction, i.e. the hedged item would
be a forward contract to purchase
USD, maturing on 15 May 2017. Since
the notional amounts of the forecast
purchase transaction and the forward
contract are the same, the hedge ratio
is 1:1. The change in the fair value of the
forward contract would exactly offset the
change in the fair value of the hedged
item, based on changes in spot rates
(being the designated risk). Therefore,
the hedge relationship is expected to
be highly effective in nature and the
company may apply cash flow hedge
accounting.
Cost of hedging
When the forward element of a forward
contract is separated and excluded from
the designated hedging instrument, Ind
AS 109 requires the change in fair value
of such excluded portion to be either
recognised at FVTPL or accounted for
as a cost of hedging. The company has
elected to apply the ‘cost of hedging’
approach when recognising the excluded
forward element. Ind AS 109 requires
this element to be divided into two parts:
•
Aligned component – the component
of the forward element that relates
to the hedged item based on critical
terms that exactly match the hedged
item. This would be the forward
premium for a maturity date of 15 May
2017 in the illustration above.
•
Remaining component – this is the
remaining portion of the forward
element that does not relate to the
hedged item, i.e. the difference
between the forward premium for a
31 May 2017 maturity date and a 15
May 2017 maturity date.
The analysis above indicates that
this hedging relationship meets the
qualifying criteria.
Hedge designation and effectiveness
The company has elected to exclude the
forward element and designate only the
change in spot element of the forward
contract as the hedging instrument in
a cash flow hedge of foreign currency
risk on the forecast purchase. The
forward element represents the
difference between the forward price
82
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83
Financial Instruments: Application issues under Ind AS
Cash flow hedge accounting
The company would apply the cash flow hedge accounting model to this hedge relationship. Accordingly, the designated portion
(i.e. spot element) and the excluded portion (i.e. forward element) of the forward contract would be accounted as illustrated in
figure 2 below:
Figure 2: Application of hedge accounting
Effective component in Cash
flow hedge reserve (OCI)
Change in fair value of spot
element of forward contract
Transfer to initial cost of nonfinancial asset (inventory)
Ineffective component in
profit or loss
Total change in fair value
of forward contract
Aligned component (based
on critical terms match) in
cost of hedging reserve (OCI)
Change in fair value of forward
element of forward contract
Transfer to initial cost of nonfinancial asset (inventory)
Remaining component of
excluded portion in profit or
loss
Source: KPMG in India’s analysis, 2017
•
•
•
The effective portion of the change in
fair value of the hedging instrument
due to a change in spot rates (100 per
cent in this illustration) is recognised
in a cash flow hedging reserve,
which is a component of other
comprehensive income (OCI).
Hedge ineffectiveness, being the
portion of change in the fair value of
the hedging instrument that does not
offset changes in the hedged item
(nil, in this illustration) is recognised in
the statement of profit and loss.
Since the hedged forecast purchase
results in the recognition of a nonfinancial asset, i.e. inventory, the
accumulated effective component is
removed from the cash flow hedging
reserve and included in the initial cost
of the inventory, when the purchase is
recognised.
•
The aligned component of the cost
of hedging is accumulated in a
separate component of equity (cost
of hedging reserve) and the remaining
component is recognised in profit or
loss.
•
The accumulated cost of hedging
is recognised in the initial cost of
inventory since the hedged item is a
transaction that results in recognition
of a non-financial asset.
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Financial Instruments: Application issues under Ind AS
84
The following table indicates the accounting impact for each component (the effect of time value has been ignored for the
purpose of this illustration).
Date
FV of forward
contract
FV change in
spot element
FV change in
excluded element
FV change in
aligned component
FV change
in remaining
component
(A)
(B)
(C)#
(D)##
(E)
(change in forward
rates*notional)
(change in spot
rates*notional)
(change in forward
premium*notional)
(change in forward
premium*notional)
(C-D)
01-March-17
-
-
-
-
-
31-March-17
727,600
(1,369,600)
642,000
813,200
(171,200)
15-May-17
513,600
(2,311,200)
1,797,600
1,926,000
(128,400)
31-May-17
**1,669,200
-
-
-
-
**Hedge accounting would cease on occurrence of the forecast purchase transaction on 15 May 2017
# Forward premium of the forward contracts maturing on 31 May 2017 has been considered.
## Forward premium of the hypothetical derivative maturing on 15 May 2017 has been considered.
Source: KPMG in India’s analysis, 2017
Accounting entries
The following are the illustrative accounting entries for the example above (the effect of time value has been ignored for the
purpose of this illustration).
Date
Accounting entry
1 March 2017
No entry for entering into forward contract as the fair value of the forward contract
is nil.
No entry for payables/purchases since the procurement/payment will be made in
the future.
31 March 2017
Hedge accounting impact at reporting date
Derivative account
Cost of hedging reserve- OCI (aligned forward component)
Cash flow hedge reserve- OCI (spot element)
Profit and loss (remaining forward component)
(Recognised change in spot element in the cash flow hedge reserve in accordance
with cash flow hedge accounting and change in fair value of the aligned forward
element in a separate component of equity)
15 May 2017
Hedge accounting impact on date of purchase
Derivative account
Cost of hedging reserve- OCI (aligned forward component)
Cash flow hedge reserve- OCI (spot element)
Profit and loss (remaining forward component)
(Recognised incremental change in spot element in the cash flow hedge reserve in
accordance with cash flow hedge accounting and incremental change in fair value
of the aligned forward element in a separate component of equity)
15 May 2017
Actual purchases
Purchases/inventory
Trade payables
(Recognition of purchases at spot rate as on 15 May 2017.)
Amount in INR
Dr
Dr
Cr
Cr
727,600
813,200
1,369,600
171,200
Dr
Dr
Cr
Cr
513,600
1,926,000
2,311,200
128,400
Dr 288,643,200
Cr 288,643,200
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85
Financial Instruments: Application issues under Ind AS
Date
Accounting entry
Amount in INR
15 May 2017
Recycling cumulative gain/loss to cost of inventory on termination of hedge
accounting
Cash flow hedge reserve
Cost of hedging reserve
Inventory
(Hedge accounting is terminated on occurrence of the hedged item, i.e. the
purchase)
Dr
Cr
Cr
3,680,800
2,739,200
941,600
Dr
Cr
1,669,200
1,669,200
Dr
Cr
2,910,400
2,910,400
31 May 2017
Fair valuation of forward contract
Derivative account
Profit and loss
(Incremental change in fair value of the forward contract recognised in profit and
loss.)
Settlement of derivative contract
Bank
Derivative account
(Net settlement of the forward contract on maturity)
Source: KPMG in India’s analysis, 2017
Consider this….
• The effectiveness of a hedging relationship should be determined at the inception
of the hedging relationship as well as on an ongoing basis. At a minimum, this
assessment is required at each reporting date, or on a significant change in the
critical terms, or in circumstances affecting the hedge effectiveness requirements.
Where any of the criteria for hedge accounting is no longer met, hedge accounting
must be discontinued prospectively.
• If the company had elected to designate the entire forward contract (including
forward element) as the hedging instrument, the hedge relationship may have been
ineffective based on the effectiveness range of 90 to 110 per cent required as per
the entity’s risk management policy. The exclusion of the forward element enables
the company to improve the hedge effectiveness ratio and designate this as a
qualifying hedging relationship.
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Financial Instruments: Application issues under Ind AS
86
Hedge accounting using cross currency interest rate
swaps
Entities that borrow funds at floating
rates in foreign currency are exposed
to market risks arising from changes
in interest and foreign exchange rates.
Companies in India often mitigate these
risks by entering into a fixed to floating
cross currency interest rate swap
(CCIRS).
A fixed to floating CCIRS (as typically
used in India) is in effect a combination
of two swaps:
•
A principal only swap- in which
principal cash flows in two different
currencies are exchanged to hedge
against adverse movements in
exchange rates
•
A coupon only swap- to exchange a
series of floating rate coupons in a
foreign currency for a series of fixed
rate coupons in the entity’s desired
currency to hedge changes in interest
rates and exchange rates.
By entering into a CCIRS agreement, two
parties undertake to exchange nominal
and interest payments in two currencies
periodically.
In this case study, we analyse how
a CCIRS may qualify as a hedging
instrument and illustrate the applicable
accounting treatment.
Key terms of the financial
instruments
On 1 July 2016, A Limited (the company
or the entity) obtained a three-year,
USD10,000,000 loan from bank X that
is repayable on 30 June 2019. The
interest rate on the loan is variable at
6-month LIBOR plus 2.75 per cent per
annum, payable on a half yearly basis
(on 31 December and 30 June each
year). Concerned that interest and
foreign exchange rates may increase, A
Limited simultaneously (on 1 July 2016)
enters into a three year cross currency
principal cum interest rate swap (CCIRS
or the swap) with bank Y. Details of the
transaction are as follows:
Key terms of the financial instruments
Swap start date
1 July 2016
Underlying exposure
ECB from bank X
Notional amount
USD10,000,000
Maturity date
30 June 2019
Fixed exchange of principal at maturity
A Limited receives USD10,000,000 and pays
INR660,000,000 to bank Y on maturity
Interest payment frequency
Half-yearly
Interest hedge
USD floating rate payer
Bank Y pays:
USD 6-month LIBOR + 2.75% p.a. on outstanding
notional amount
INR fixed rate payer
A Limited pays:
10.5% p.a. on outstanding INR notional on a half
yearly basis (on 31 December and 30 June each year)
This includes a currency basis spread* of 0.5%p.a.
Settlement
Net settlement
* The currency basis spread represents the liquidity premium/discount that an entity is exposed to when borrowing/transacting in foreign currencies that is not explained by a theoretical interest
rate parity computation.
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87
Financial Instruments: Application issues under Ind AS
The 6-month LIBOR rates and foreign exchange rates prevailing during the period are as follows:
Dates
Total variable rate of interest (i)
Spot exchange rate(ii)
1 July 2016
1.24%
66.00
31 December 2016
1.31%
68.20
31 March 2017
1.33%
67.00
The fair value of the interest rate swap at the end of each reporting period is as follows (the changes in fair value have been
assumed for the purpose of this illustration):
Fair value of hypothetical derivative (Amount
Dates
Fair value of CCIRS (Amount in INR)
1 July 2016
Nil
n/a
31 December 2016
84,858,895
78,206,573
31 March 2017
88,421,515
81,336,554
in INR)
Accounting issue
The company needs to evaluate whether the CCIRS qualifies as a hedging instrument and whether the transaction meets the
qualifying criteria to apply hedge accounting. The company also needs to determine the appropriate accounting treatment for the
swap for the year ended 31 March 2017.
Accounting guidance and analysis
Qualifying criteria
Although CCIRS are complex instruments, they may qualify for hedge accounting if they meet the qualifying criteria and the
company has ensured that it appropriately identifies and documents the hedge relationship at inception. Figure 1 below analyses
the CCIRS based on the qualifying criteria for applying hedge accounting. The analysis indicates that the hedge relationship would
meet the qualifying criteria in Ind AS 109 and is therefore eligible for hedge accounting.
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Financial Instruments: Application issues under Ind AS
88
Figure 1: Qualifying criteria for applying hedge accounting under Ind AS 109
Guidance
Is there a qualifying hedged item and
hedging instrument?
Analysis
No
Yes
Is the hedging relationship consistent with
the entity’s risk management obective?
No
Yes
Is there an economic relationship between
the hedged item and the hedging
instrument?
No
Yes
Does the effect of the credit risk dominate
the fair value changes?
Yes - the swap is with an external
counterparty and the hedged risks affect
profit or loss
Yes - hedging of currency and
interest rate risk is based on company’s
risk management policies
Yes - the critical terms of the swap
are closely aligned to the foreign currency
loan and offset the risks
Yes
No - bank Y and the company are highly
rated entities (investment grade)*
No
Does the hedge ratio (based on actual
quantities used for risk management)
reflect an imbalance that would create
hedge ineffectiveness?
Yes
No - the hedge ratio is 1:1 as the
notional amounts of the swap and the loan
match
No
The entity is permitted to apply hedge
accounting
(Ensure formal designation and
documentation)
Hedge accounting cannot be applied
(Measure derivative hedging instrument at
FVTPL)
Source: KPMG in India’s analysis, 2017, read with Ind AS 109
* The effect of credit risk on the fair value of the hedged loan as well as the fair value of the swap should be considered to measure hedge effectiveness, although it has been assumed as
immaterial for the purpose of this illustration.
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89
Financial Instruments: Application issues under Ind AS
Hedge designation
The company may elect to designate the
entire CCIRS as a hedge of the variability
in cash flows relating to interest
payments on and principal repayment
of the foreign currency borrowing (the
hedged item), arising from fluctuation
in the floating interest rates and foreign
exchange rates.
Considering that the CCIRS involves
exchange of a stream of cash flows in
two different currencies, it generally
includes a foreign currency basis spread.
Since there is no similar spread in the
hedged item (i.e. the foreign currency
loan), the basis spread is expected to
give rise to some ineffectiveness. Ind AS
109 permits the company to exclude the
currency basis spread from the hedge
relationship and recognise it separately
as a ‘cost of hedging’. However, the
company has not elected to do so and
has designated the entire swap as the
hedging instrument.
The hedged item would be represented
by a hypothetical derivative in order to
measure effectiveness and compute
ineffectiveness using the hypothetical
derivative method. The hypothetical
derivative is defined so that it matches
the critical terms of the hedged item.
analyse the prospective effectiveness
of the hedge relationship and expects
the changes in the fair value of the
swap to offset the changes in the fair
value of the loan (represented by the
hypothetical derivative) in the range of 90
to 110 per cent. This is within the desired
effectiveness range specified in the
company’s financial risk management
policies.
In this case study, the critical terms of
the hypothetical derivative would be
similar to the actual CCIRS, however,
the swap rate (interest rate payable)
on the hypothetical derivative would
exclude the currency basis spread of 0.5
per cent. This is expected to give rise
to some ineffectiveness. The company
has used a quantitative method to
For foreign currency loans received prior to the beginning of its first Ind AS reporting period, i.e.
outstanding as on 1 April 2016, the company might have availed of the provisions in paragraph 46
or 46A of AS 11, The effects of changes in foreign exchange rates. These provisions permitted
capitalisation of the exchange differences on translation of the loan into the cost of a related asset,
or accumulation in a Foreign Currency Monetary Item Translation Difference Account (FCMITDA).
The company may then elect to continue this accounting treatment for the existing loans under
Ind AS, as permitted by Ind AS 101, First-time adoption of Ind AS. Consequently, under Ind AS, the
translation differences on the existing loans would then continue to be capitalised into the related
asset, or accumulated in FCMITDA and subsequently amortised over the life of the loan.
The principles of Ind AS 109 seem to permit designating these loans as a hedged item in a
hedge of foreign currency risk, since the translation differences ultimately affect profit or loss in
the form of depreciation or amortisation of FCMITDA. This is supported by guidance in Ind AS
109 that considers a scenario where cash flow hedge accounting is applied to a hedge of the
foreign currency risk arising from a highly probable forecast transaction to acquire a non-financial
asset (e.g., plant and equipment). If the hedged forecast transaction subsequently results in the
recognition of a non-financial asset, then Ind AS 109 states that the entity should remove the
accumulated amount from cash flow hedge reserve and include it directly in the initial cost or
carrying amount of the asset.
However, this issue was considered by the Ind AS Transition Facilitation Group (ITFG). In its third
bulletin, the ITFG opined that an entity that avails of the option available under Ind AS 101, and
continues to capitalise (to the cost of the related asset) the foreign exchange differences arising
from a long-term foreign currency loan, has no corresponding foreign currency exposure (arising
from that loan) that affects profit or loss. Accordingly, hedge accounting under Ind AS 109 will not
be applicable for foreign currency swaps transacted to hedge the foreign currency risk of such
foreign currency loans. Companies should therefore carefully evaluate these transactions on firsttime adoption of Ind AS and monitor further developments in this area.
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Financial Instruments: Application issues under Ind AS
90
Cash flow hedge accounting
The company has hedged the variability in the cash flows of the loan due to changes in currency and interest rates. Therefore,
it should apply the cash flow hedge accounting model to this hedge relationship. The accounting treatment for the transaction
would be as illustrated in Figure 2 below:
Figure 2: Cash flow hedge accounting for the swap
Hedging instrument
Critical terms matching with the
hedged item
Basis spread
Effective portion of the hedging
instrument
Ineffective portion of the hedging
instrument
Change in fair value transferred
to OCI
Change in fair value charged to
profit or loss
Reclassify amount corresponding
to translation differences to profit
or loss
Reclassify amount corresponding
to net settlement (interest) to
profit or loss
Source: KPMG in India’s analysis, 2017, read with Ind AS 109
The effective portion of changes in fair value of the hedging instrument is recognised in a separate component of equity ‘the cash
flow hedging reserve’. The ineffective portion of the gain or loss on the hedging instrument (to the extent of movement in the
currency basis spread, computed as the difference between the change in fair value of the CCIRS and the change in fair value of
the hypothetical derivative) would be recognised in the statement of profit and loss.
The following table indicates the accounting impact for the swap (the changes in fair value have been assumed and the effect of
time value has been ignored for the purpose of this illustration):
Amounts in INR
Variable
interest
rate
Swap
rate
1 July 16
3.99%
10.5%
66
31 December 16
4.06%
10.5%
31 March 17
4.08%
10.5%
Date
Spot
exchange
rate
Gross payment
made/accrued as
per the swap
(10,000,000*fixed
exchange
rate*swap rate)
Gross amount
received/accrued
as per the swap
(10,000,000*spot
rate*floating interest
rate)
Net pay/accrual as
per the swap
(Gross pay - Gross
received)
–
–
Nil
68.2
34,650,000
13,844,600
20,805,400
67
17,325,000
6,834,000
10,491,000
Source: KPMG in India’s analysis, 2017
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91
Financial Instruments: Application issues under Ind AS
Accounting entries
The following are the illustrative accounting entries for the example above (the effect of time value has been ignored for the
purpose of this illustration).
Date
Accounting entry
Amount in INR
1 July 2016
Bank
External commercial borrowing
(ECB of USD 10,000,000 at a floating interest rate of 6-month LIBOR + 2.75%
taken from bank X. The spot rate on that date is INR66 per USD, hence the loan has
been translated at the spot rate.)
Dr 660,000,000
Cr 660,000,000
No entry for entering into CCIRS as the fair value of the swap is Nil.
31 December
2016
31 March 2017
Interest expense on borrowing
Bank
(Record floating interest rate on foreign currency borrowing)
Dr
Cr
13,844,600
13,844,600
Cash flow hedge reserve (OCI)
Net finance cost (ineffective portion of the cash flow hedge)
CCIRS (Balance sheet)
(To recognise incremental change in fair value of CCIRS: INR84,858,895 – Nil. The
effective portion is accumulated in OCI and the ineffective portion is recognised in
the statement of profit and loss.)
Dr
Dr
Cr
78,206,573
6,652,322
84,858,895
CCIRS (Balance sheet)
Bank
(Net settlement of CCIRS interest exchange)
Dr
Cr
20,805,400
20,805,400
Interest expense on borrowing
Cash flow hedge reserve (OCI)
(Reclassified from hedging reserve to reflect that interest expense has been fixed)
Dr
Cr
20,805,400
20,805,400
Foreign exchange loss on borrowing (profit or loss)
External commercial borrowing
(Recognise foreign exchange loss on borrowing: USD 10,000,000*(68.2-66))
Dr
Cr
22,000,000
22,000,000
Cash flow hedge reserve (OCI)
Foreign exchange gain (profit or loss)
(Since the currency risk on principal repayment is hedged, an amount equal to the
translation loss on the loan is reclassified from the hedging reserve to offset spot
re-measurement of the borrowing)
Dr
Cr
22,000,000
22,000,000
Cash flow hedge reserve (OCI)
Net finance cost (ineffective portion of the cash flow hedge)
CCIRS (Balance sheet)
(To recognise change in fair value of CCIRS: INR88,421,515 – 84,858,895- the
effective portion is accumulated in OCI and the ineffective portion is recognised in
the statement of profit and loss.)
Dr
Dr
Cr
3,129,981
432,639
3,562,620
Dr
Cr
12,000,000
12,000,000
Dr
Cr
12,000,000
12,000,000
Dr
Cr
6,834,000
6,834,000
Dr
Cr
10,491,000
10,491,000
External commercial borrowing
Foreign exchange gain on borrowing (profit or loss)
(Recognise foreign exchange gain on borrowing: USD 10,000,000*(67-68.2))
Foreign exchange loss (profit or loss)
Cash flow hedge reserve (OCI)
(Since the currency risk on principal repayment is hedged, an amount equal to the
translation loss on the loan is reclassified from the hedging reserve to offset spot
re-measurement of the borrowing)
Interest expense on borrowing
Accrued interest payable on borrowing
(Accrue the interest on foreign currency loan for 3 months ended 31 March 2017)
Interest expense on borrowing
Cash flow hedge reserve (OCI)
(Reclassified from hedging reserve to reflect that interest expense has been fixed)
Source: KPMG in India’s analysis, 2017
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Financial Instruments: Application issues under Ind AS
92
Consider this….
• The ineffectiveness arising as a result of the currency basis spread may be mitigated
by excluding this element from the hedging relationship. The company may then
recognise this as a cost of hedging and accumulate the amount in a separate
component of reserves. This cost of hedging, on a time-period related item is
amortised into the statement of profit or loss over the period of the swap.
• A receive-fixed pay-floating interest rate swap may be designated as a fair value
hedge of a fixed interest liability or as a cash flow hedge of a variable interest asset.
An interest rate swap cannot be designated as a cash flow hedge of a fixed interest
liability because it converts known (fixed) interest cash outflows, for which there
is no exposure to variability in cash flows, into unknown (variable) interest cash
outflows. Similarly, the swap cannot be designated as a fair value hedge of a variable
interest asset because a variable interest instrument is not generally exposed to
changes in fair value arising from changes in market interest rates.
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Financial Instruments:
Disclosures
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Financial Instruments: Application issues under Ind AS
94
Frequently Asked Questions (FAQs) on disclosure of
financial instruments
Ind AS 107, Financial Instruments: Disclosures prescribes disclosures to be presented by an entity in its financial statements. Such
disclosures enable users to evaluate the significance of financial instruments to the entity’s financial position and performance,
the nature and extent of risks arising therefrom during the period and at the end of the reporting period, and how it manages those
risks.
In these FAQs, we highlight some of the methods and techniques that may be used in preparing the disclosures on financial
instruments. The disclosures illustrated in this article are only representative in nature and additional disclosures may have to be
presented to comply with the requirements of Ind AS 107.
Fair value
Q 1. Company A has the following financial instruments outstanding as on 31 March 2017:
•
A working capital loan from XYZ bank of INR50 million which is repayable in December 2017, the interest rate is reset on a
monthly basis.
•
Trade receivables amounting to INR1.5 million; and
•
Trade payables of INR0.9 million.
What are the fair value disclosure requirements for these instruments?
A. Ind AS 113, Fair Value Measurement requires company A to measure and disclose the fair value of the financial instruments
held at the reporting date. In addition, the company is required to categorise and disclose the fair value in accordance with the fair
value hierarchy on the basis of the inputs used to measure fair value.
The working capital loan is classified and subsequently measured in the financial statements at amortised cost. Considering that
the interest rate on the loan is reset on a monthly basis, the carrying amount of the loan would be a reasonable approximation of
its fair value.
Similarly, the carrying amount of trade receivables and trade payables, which are classified and subsequently measured at
amortised cost, approximate the fair values of these instruments due to their short-term nature.
Ind AS 107 provides relief to entities from disclosing the fair value of an instrument whose carrying amount is a reasonable
approximation of its fair value. Accordingly, company A is not required to separately disclose the fair values of the working capital
loan, the trade receivables and trade payables. Company A may provide a note as part of its fair value disclosure, stating that the
carrying amounts of the instruments approximate their fair value.
Q 2. On 1 April 2016, company A borrowed USD 10.4 million (INR690 million) at a floating interest rate of 6-month LIBOR + 3
per cent per annum repayable on 31 March 2019. The LIBOR is reset on a half yearly basis on 31 March and 30 September each
year. The financial performance of company A has improved in the previous year, which is reflected in a better credit rating. As
on 31 March 2017, floating foreign currency loans, with a similar remaining term to maturity were available from other financial
institutions at the rate of 6-month LIBOR + 2.5 per cent per annum to entities with an equivalent credit rating. The 6-month LIBOR
as on 31 March 2017 is 1.3 per cent per annum and the carrying amount of the loan is INR685 million. What are the considerations
for the fair value disclosures relating to the loan and at what level would it be categorised in the fair value hierarchy?
A. The fair value of a floating rate loan may be considered to approximate its carrying amount, assuming credit spread remains
constant. However, as a result of an improvement in its credit rating, the company would be able to borrow funds with similar
contractual characteristics at a lower rate of interest (based on a lower credit spread). Therefore, the discount rate to be used
in computing the fair value of the loan should be the applicable market rate, based on the revised credit spread. The future cash
flows payable on the loan may be estimated using the 6-month LIBOR forward curve and the forward exchange rates applicable
on the contractual payment dates. The fair value of the foreign currency loan would be determined by discounting the estimated
future cash flows at the market rate of return (i.e. 6-month LIBOR + 2.5 per cent). The computation is given below:
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95
Financial Instruments: Application issues under Ind AS
Date
6-month
LIBOR*
Interest
rate (per
annum)
Forward (USDINR) exchange
rate*
Cash outflow
(INR in millions)
Discounting
factor (6-month
LIBOR + 2.5%)
30 September 2017
1.33%
4.33%
69.60
15.67
0.982
15.39
31 March 2018
1.58%
4.58%
69.81
15.83
0.964
16.03
30 September 2018
1.83%
4.83%
70.10
15.97
0.947
16.67
31 March 2019
2.08%
5.08%
71.22
756.98
0.929
706.27
Fair value
Net present
value (INR in
millions)
754.36
* For the purpose of this illustration, the 6-month LIBOR forward curve and the forward exchange rates have been assumed.
As per Ind AS 113, company A should disclose the valuation technique and inputs used to compute the fair value, and may
consider providing a note as follows:
‘The valuation model adopted for computing the fair value of the borrowing is the discounted cash flow model, where the present
value of expected payments is discounted using a market interest rate.’
Considering that the forward rates and the discount rate used for measuring fair value are market observable inputs, the foreign
currency loan may be categorised as Level 2 in the fair value hierarchy disclosure.
Q 3. On 1 April 2016, company X fully acquired ABC Ltd by issuing its own shares to the vendor. The company also agreed to pay
additional contingent consideration, being 5 per cent of the EBITDA exceeding INR50 million earned by ABC Ltd in the next two
years of its operation, as a lump sum in the second year. The fair value of the liability for contingent consideration was INR30
million on initial recognition and INR36 million as on the reporting date.
•
How should the contingent consideration liability be categorised within the fair value hierarchy disclosure; and
•
What are the other fair value related disclosures applicable to this instrument?
A. As per Ind AS 109, the company should recognise and measure the financial liability for contingent consideration at fair value
through profit or loss (FVTPL). The inputs required for computing fair value would include variables such as forecast revenues,
EBITDA and an appropriate discount rate. Some of these inputs are unobservable in nature, being specific to the company.
Therefore, the fair value of the financial liability at reporting date (INR36 million) should be categorised as a Level 3 measurement
in the fair value hierarchy disclosure.
Ind AS 113 prescribes additional disclosures for financial instruments measured at FVTPL and categorised under Level 3 of the fair
value hierarchy. Company X should therefore disclose:
a. A description of the valuation process and technique used to measure the fair value of the liability, including how it decides its
valuation policies and procedures and analyses changes in the fair value measurement from period to period
b. Quantitative information about significant unobservable inputs used for the fair value measurement, where such quantitative
information are significant to the fair value measurement and are reasonably available to the company
c. The amount of unrealised gains or losses earned/incurred during the financial period on the contingent consideration liability
existing as on the reporting date and the line item in the statement of profit and loss in which the entity records, the unrealised
gains or losses on such liability.
d. A reconciliation from the opening balances to the closing balances, disclosing separately changes during the period attributable
to:
––
Total gains or losses for the period recognised in the profit or loss or other comprehensive income (OCI) and the line item in
the profit or loss or the OCI in which it is recognised.
––
Purchases, sales, issues and settlements (each of these changes disclosed separately)
––
Amount of transfers into or out of Level 3 of the fair value hierarchy, to be disclosed separately along with reasons for those
transfers.
e. A sensitivity analysis of the fair value measurements, by making changes in unobservable inputs, where such a change would
result in a significantly higher or lower fair value measurement.
f. Interrelationships between significant unobservable inputs used in the fair value measurement and how they may (together)
magnify or mitigate changes in fair value of the liability on account of a change in those inputs
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Financial Instruments: Application issues under Ind AS
96
Q 4. On 1 April 2016, company M extended an employee loan of INR4 million, repayable after three years at an interest rate of
2 per cent per annum. The bank interest rate for personal loans offered to salaried individuals for the same amount and with a
similar maturity was 12 per cent per annum at the time of providing the loan, and is 11.75 per cent per annum as on the reporting
date. The carrying amount of the loan at the balance sheet date is INR3 million. What are the fair value disclosure requirements for
this loan and in which level of the fair value hierarchy should it be categorised?
A. The company classifies and subsequently measures the loan extended to an employee at amortised cost. However, it needs to
disclose the fair value of this loan at year end and categorise this in the appropriate level of the fair value hierarchy. For computing
the fair value of the loans, the entity should discount the future cash flows of the loan at the market rate of return applicable to
similar instruments as on the balance sheet date, which is 11.75 per cent per annum. Accordingly the fair value of the loan as on
the reporting date is INR3.3 million.
Ind AS 113 requires company M to disclose the valuation techniques and inputs used to compute the fair value of the loan, the
entity may consider providing the below note as part of its fair value disclosures:
‘The valuation model adopted for computing the fair value of the employee loans is the discounted cash flow model, where the
present value of inflows is discounted using a market interest rate’.
The interest rate used to discount the future cash flows of the loan would be the market rate of return on similar financial
instruments. Since this is generally an observable input, the loan may be categorised within Level 2 of the fair value hierarchy
disclosure.
Q 5. Company D, an unlisted entity, has entered into certain derivative contracts of which the following are outstanding on the
balance sheet date:
Sr.
No.
Particulars
Carrying amount
(INR in millions)
1
3 month futures contract, actively traded on the futures exchange, for sale of 100,000
shares of company ABC at INR100 per share, to be settled net in cash.
1.5
2
Forward contracts to sell USD25 million at INR68 per USD to hedge forecast sales
expected to occur after 6 months.
2.7
3
Written put option to non-controlling shareholders (NCI) to sell 15% of the remaining
shareholding in its subsidiary to the company at INR87 million, exercisable within the
next year.
77.8
What are the fair value disclosure requirements for these instruments and their categorisation in the fair value hierarchy
disclosure?
A. The fair value disclosure requirements for the derivatives listed above are as follows:
•
Futures contract: The three - month futures contract is recognised and measured in the financial statements at FVTPL. Since
this derivative is actively traded on a futures exchange, its price is quoted in an active market. Accordingly, the fair value of the
contract is measured at its quoted price, being the most reliable evidence of fair value. Therefore, the futures contract will be
categorised as Level 1 in the fair value hierarchy disclosure.
•
Forward contracts: The forward contracts are recognised and measured in the financial statements at FVTPL. Since these
contracts are not actively traded, a quoted market price is not available for them. The fair value of these contracts is generally
determined on the basis of the change in forward rates offered by counterparties at the reporting date, discounted using
the market interest rate applicable to the entity. The forward rates and discount rates are not ‘quoted prices’ but would be
considered as observable or market corroborated inputs. Therefore, the forward contracts would generally be categorised
within Level 2 of the fair value hierarchy disclosure.
The company should also disclose the valuation techniques and inputs used to compute the fair value of the forward contracts.
•
Written put option to NCI: The written put options to NCI are recognised and measured as a liability at fair value, being the
present value of the exercise price, in accordance with Ind AS 32, Financial Instruments: Presentation. The company has
elected an accounting policy to recognise changes in the put liability through FVTPL. The fair value of such instruments would
generally be computed using a valuation model with some of the inputs being specific to the company, for example, forecast
revenue growth rate, risk-adjusted discount rate, volatility in share price, etc. Considering that some of the inputs used to
compute the fair value of the put option liability may be unobservable, it would generally be categorised as Level 3 in the fair
value hierarchy disclosure . Similar considerations would apply when computing the fair value of a long term put option liability,
even if the company was listed. Some of the inputs used to compute the fair value of a long term put option liability, such as
volatility in share price, may be unobservable, indicating a Level 3 categorisation.
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97
Financial Instruments: Application issues under Ind AS
Credit risk
Q 6. R Ltd. has measured the expected credit loss (ECL) on its retail trade receivables using the simplified approach permitted
in paragraph 5.5.15 of Ind AS 109. Accordingly, the company recognises lifetime expected credit losses on its trade receivables
based on a provision matrix. The ageing of the receivables and the corresponding ECL as on 31 March 2017 are given below:
Ageing
Debtors (INR in millions)
Expected loss
Not due
86
0.90%
1-90 days
42
1.50%
18.5
5.00%
181-270 days
3
13.50%
271-360 days
2
36.00%
0.5
100.00%
91-180 days
More than 360 days
The expected loss balance in respect of trade receivables as on 31 March 2016 was INR2.5 million. R Ltd. has also written off
debtors of INR0.8 million during the year. What details should be provided by the company in its credit risk disclosures?
A. Ind AS 107 requires an entity to disclose the gross carrying amount of the receivables and its exposure to credit risk. Since
the ECL on the receivables has been computed using a provision matrix R Ltd. should, in accordance with para B5.5.35 of Ind
AS 109, provide the methodology for computing the loss rates and disclose, how these loss rates reflect the management’s
view of economic conditions over the expected lives of the receivables. The company should also provide a reconciliation from
the opening balance to the closing balance of the ECL. The entity may consider adding the following content in its credit risk
disclosures:
Expected credit loss assessment for retail trade receivables
31 December
2016
Gross carrying
amount (INR in
millions)
Expected credit
loss rate
Expected credit
losses (INR in
millions)
Whether
receivable is
credit impaired
Carrying
amount of trade
receivables
Not due
86.0
0.90%
0.8
No
85.2
1-90 days
42.0
1.50%
0.6
No
41.4
91-180 days
18.5
5.00%
0.9
No
17.6
181-270 days
3.0
13.50%
0.4
No
2.6
271-360 days
2.0
36.00%
0.7
No
1.3
More than 360
days
0.5
100.00%
0.5
Yes
-
Total
152
3.9
148.1
Source: KPMG in India’s analysis, 2017
Based on industry practices and the business environment in which the entity operates, the management considers that the trade
receivables are in default (credit impaired) if the payments are more than 360 days past due.
The company uses an allowance matrix to measure the expected credit losses on its retail trade receivables. Loss rates are
calculated based on actual credit loss experience over the last ten quarters. These rates have been adjusted to reflect the
management’s view of the economic conditions over the expected lives of the receivables.
The movement in the expected credit loss allowance during the year was as follows:
Particulars
Amount in INR (millions)
Balance as at 1 April 2016
2.5
Measurement of loss allowance
2.2
Less: Amounts written off
(0.8)
Balance as at 31 March 2017
3.9
Source: KPMG in India’s analysis, 2017
During the year, trade receivables of INR0.8 million were written off.
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Financial Instruments: Application issues under Ind AS
98
Liquidity risk
Q 7. Company L has the following contractual obligations in respect of its financial liabilities as on 31 March 2017:
Sr.
no.
Particulars
Amounts
1
Monthly finance lease obligation (including interest); this will expire on 31 March 2020.
INR1 million per month
2
Quarterly principal repayment of INR loan, payable until 30 September 2019.
(Outstanding loan amount as on 31 March 2017 is INR5 million. The next instalment
is due on 30 June 2017. Interest on such loan is at the rate of 12% per annum on the
outstanding amount, payable quarterly)
INR0.5 million per quarter
3
Annual repayment of principal on a foreign currency loan, payable until 31 December
2019.
USD0.5 million per annum
(Outstanding loan amount as on 31 March 2017 is USD1.5 million, next instalment
is due on 31 December 2017. Interest on such loan is at 4.5% per annum, payable
annually. USD-INR exchange rate as on 31 March 2017 is INR68.15)
4
Trade payables (of which INR0.4 million is payable within 180 days and INR0.4 million
after 180 days but within 360 days)
INR0.8 million
5
Company L also has undrawn credit facilities of INR100 million from its bank at 12.5%
p.a. It intends to draw these funds in FY 2017-18. This loan is repayable in 10 equal
instalments starting from 1 April 2019.
INR100 million
What amounts and time brackets should the entity disclose in respect of its exposure to liquidity risk?
A. Ind AS 107 requires an entity to describe how it manages its liquidity risk, which may include information on its processes
for managing liquidity, including its funding sources and its liquid investments. Ind AS 107 also requires a quantitative maturity
analysis to be provided disclosing the remaining contractual maturities of non-derivative as well as derivative financial liabilities.
The entity should disclose such quantitative data based on the information provided internally to key management personnel.
In order to determine the time brackets that should be used to group its cash flow obligations, the company should exercise
judgement based on the frequency and materiality of the cash flows. Based on the cash flow obligations of company L, half-yearly
time brackets may be considered appropriate for its maturity analysis, as illustrated below:
Amount in INR (millions)
Particulars
0-6 months
6-12 months
12-18 months
18-24 months
More than 24
months
Monthly finance
lease obligation
6
6
6
6
12
Repayment of INR
Loan
1.29
1.23
1.17
1.11
1.05
Repayment of
foreign currency
loan*
-
38.7
-
37.1
35.6
Trade payables
0.4
0.4
-
-
-
Source: KPMG in India’s analysis, 2017
* The INR amounts for cash flows relating to the foreign currency loan are determined on the basis of the spot rate as on 31 March 2017.
The cash outflows should be disclosed at their undiscounted amounts and include contractual interest payments. Hence, the
company may consider adding a note to clarify that the amounts in the maturity analysis table would not match the carrying
amounts of the corresponding financial instruments in the financial statements.
In the current illustration, the company has elected to not disclose the undrawn credit facilities in its quantitative maturity analysis.
It may disclose the details of such facilities in its qualitative disclosures if it considers that these are relevant to an understanding
of the company’s liquidity position.
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99
Financial Instruments: Application issues under Ind AS
Q 8. Company D has entered into the following derivative contracts on 1 January 2017 to hedge its currency and interest rate risks:
Particulars
Method of settlement
Carrying amount
A pay fixed/receive floating interest rate swap
The difference between the pay/receive streams
to hedge cash flow variability on its floating rate
of the swap would be settled net with the bank at
USD loan. The notional amount of the swap is
each interest payment date.
USD5 million. Company D is required to make
semi-annual payments in USD on the swap at
a fixed rate of 2% per annum and receive USD
amounts at a floating rate of 6-month LIBOR per
annum. The interest on the loan and on the swap is
payable on a semi-annual basis on 31 March and 30
September each year, till the entire loan is repaidi.e. until 30 September 2020.
Fair value liability
of INR0.72
million.
A fixed-to-fixed principal cum interest cross
currency swap, to hedge the cash flow variability
arising from repayment of a 4.5% per annum
foreign currency loan of USD1 million. The
company is required to pay interest quarterly in
INR at 6% per annum and receive USD amounts
at 4.5% per annum. The swap also includes an
exchange of principal of USD0.125 million every
quarter for INR8.36 million (at a fixed rate of
INR66.9 per USD) until maturity, being 31 March
2019. The next settlement date for the swap is 30
June 2017.
Every quarter, the entity pays the bank INR8.36
million and interest at 6% per annum on the
outstanding INR amount and receives USD125,000
and interest at 4.5% per annum on the outstanding
USD amount. Hence, the swap is gross settled.
Fair value asset of
INR0.3 million.
Forward exchange contracts to sell EUR at a EUR/
INR rate of 73.5, maturing on 1 August 2017, to
hedge outstanding debtors of EUR800,000.
Difference between spot and forward rate to be
settled net in cash with the bank.
Fair value liability
of INR0.8 million.
As on 31 March 2017, the USD/INR spot rate is 68.31 and the EUR/INR forward rate is 74.62 respectively, and 6-month LIBOR as
on 31 March 2017 is 1.33 per cent. What should the entity disclose in its maturity analysis for exposure to liquidity risk?
A. Ind AS 107 requires an entity to disclose the gross/net cash flows of a transaction based on the manner in which the contract
is settled. Accordingly, the entity should compute the amounts to be disclosed for these derivative instruments in the following
manner:
Contract
Basis of disclosure
Pay fixed/receive
floating interest rate
swap
Since the swap is net-settled, the company should disclose the net undiscounted cash flows
payable on the swap. The net settlement amount payable to/receivable from the bank up to
30 September 2020 should be determined on the basis of the 6-month LIBOR forward curve.
This amount, converted into INR at the spot rate as on 31 March 2017 should be disclosed in
the relevant time brackets as the expected cash outflow/(inflow) for the entity on the derivative
contract.
Principal cum interest
cross currency swap
The swap has a positive fair value, i.e. is a financial asset at 31 March 2017. Therefore, the company
is not required to include the cash flows relating to this swap in its maturity analysis for exposure
to liquidity risk. However, the company may elect a policy of disclosing cash flows relating to all
derivatives since the fair value of a derivative may change from one reporting date to the next.
Since the swap is gross settled, the company would have to disclose the gross cash outflows
relating to the swap in the relevant time brackets. It may be preferable to also disclose the gross
cash inflows in order to provide more meaningful information on liquidity risk.
EUR/INR forward
exchange contracts
Ind AS 107 requires entities to disclose their undiscounted cash outflows based on conditions
existing on the reporting date. Since the fair value of the forward contract on the reporting date
represents the net settlement amount of the contract, company D should disclose the fair value of
the forward contract in its maturity analysis.
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Financial Instruments: Application issues under Ind AS
100
Therefore, the approximate amounts to be included in the disclosure on maturity analysis for the derivatives in the illustration
above are computed as follows . The company should include these amounts in the relevant time brackets applicable to its
liquidity risk disclosure.
Amount in INR (millions)
Particulars
0-3 months
3-6 months
6-9 months
9-12 months
More than 12
months
-
1.14
-
0.37
(0.80)
Inflow
9.12
9.02
8.93
8.83
34.39
Outflow
9.34
9.24
9.11
8.99
34.70
-
0.90
-
-
-
Pay fixed/receive
floating interest
rate swap
Principal cum
interest cross
currency swap:
EUR/INR forward
exchange
contracts
Source: KPMG in India’s analysis, 2017
Q 9. Company X holds 80 per cent of ordinary shares in company XY (an unlisted company). Company X has written a put option in
favour of the non-controlling interest (NCI) shareholder to sell the balance 20 per cent shareholding in company XY to company X
for INR100 million. The option can be exercised at any time until company X controls company XY. The fair value of the put option
as on 31 March 2017 is INR20million.
•
Should company X include the written put option in its liquidity risk disclosure and if yes, at what amount?
•
If the exercise price of the put option is the fair value of the shares on the exercise date (instead of a fixed amount), what would
be the amount disclosed in the liquidity risk analysis?
A. Exercise price of the put option is fixed: Ind AS 107 requires an entity to disclose the remaining contractual maturities of
its derivative financial liabilities, where such contractual maturities are essential for an understanding of the timing of the cash
flows. Company X could be required to pay the exercise price on the option exercise date, i.e. on any date after the reporting
date at the option of the NCI holder as long as company X controls company XY. Therefore, company X should disclose the entire
amount that it could be required to pay to settle its obligation (i.e. INR100 million) in the earliest period in which the option could
be exercised. Such disclosure is essential for the users of the financial statements to understand the timing of the cash flows and
the company’s exposure to liquidity risk.
Company X may consider adding a note that the exercise of put option would result in recognition of additional investment.
Option exercisable at fair value of shares: It is essential for the entity to disclose the probable cash outflow relating to the put
option written by it on NCI. However, where the amount of outflow is not fixed, the entity would be required to estimate the
amount payable based on the fair value of the underlying shares on each reporting date. Considering the complexity involved
in estimating the fair value of equity shares of an unlisted company, the company may consider the involvement of a valuation
expert.
Q 10. Company D has taken a term loan of INR100 million from its bank on 1 April 2016 at an interest rate of 11 per cent per
annum, payable monthly. The principal amount of the loan is repayable on 30 June 2019. Company A, the parent entity of company
D has provided a financial guarantee for the loan to the bank. In accordance with the terms of the guarantee, company A would be
liable to pay the bank if company D fails to make a payment on the loan within 30 days after it is due. Company D has been making
timely interest payments to the bank since the initiation of the loan. What would company A be required to disclose in its liquidity
risk analysis in respect of the guarantee provided?
A. Ind AS 107 requires the entity to disclose the maximum amount of guarantee that could be called for, in the earliest period in
which it could be called, since it is an obligation of the entity in situations which are outside its control. Accordingly, company A
should disclose its possible obligation for payment of monthly interest amounts (in the relevant time bracket as if these amounts
were 30 days past due) as well as the principal amount of the loan (i.e. INR100 million) as payable 30 days after its due date of 30
June 2019 . The company may consider providing additional information to distinguish the financial guarantee from other financial
liabilities in its liquidity risk disclosure to highlight the contingent nature of the amounts payable under the guarantee.
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101
Financial Instruments: Application issues under Ind AS
Foreign currency risk
Q 11. Company G with an INR functional currency holds trade receivables of USD 500,000 and EUR 200,000, and trade payable of
USD400,000 at the reporting date. Its subsidiaries have the following outstanding exposures:
•
Company A, with a functional currency of USD, holds trade receivables of INR3 million and trade payables of USD600,000;
•
Company B with a functional currency of SGD, holds trade receivables of INR1 million and AUD10,000.
Which currencies should be included in the quantitative disclosure for exposure to foreign currency risk in the consolidated
financial statements of company G?
A. Ind AS 107 requires entities holding financial instruments denominated in a currency which is different from the functional
currency of the entity, to disclose these as exposures to foreign currency risk. While preparing consolidated financial statements,
group companies may have functional currencies which are different from that of the parent entity. Hence, such group companies
may have foreign currency exposure in the form of financial instruments denominated in the functional currency of the parent
entity. These should be included in the disclosure for exposure to currency risk in the consolidated financial statements of the
group.
Accordingly, the disclosure relating to foreign currency risk in the consolidated financial statement should include the following
amounts:
31 March 2017
Amount in
INR
Trade receivables
USD
EUR
AUD
4,000,000
500,000
200,000
10,000
Trade payables
-
(400,000)
-
-
Net exposure
4,000,000
100,000
200,000
10,000
Source: KPMG in India’s analysis, 2017
Payables amounting to USD600,000 of company A will be excluded from this disclosure as these payables are denominated in the
functional currency of company A (i.e. USD) and do not represent an exposure to foreign currency risk for company A.
Q 12. Company H, which has INR as its functional currency, holds 100 per cent shares in company S, which has USD as its
functional currency. The entities have the following inter-company balances as on 31 March 2017:
Company S
Particulars
Currency
Amount
Receivable from H
USD
10 million
Payable to H
USD
2 million
Particulars
Currency
Amount
Payable to S
USD
10 million
Receivable from S
USD
2 million
Company H
How should the group disclose its exposure to foreign currency risk as on the reporting date in its consolidated financial
statements?
A. Ind AS 107 requires entities holding financial instruments that are denominated in a currency which is different from the
functional currency of the entity to disclose these as exposures to foreign currency risk. While the intercompany balances would
be eliminated on consolidation, the parent entity, company H, remains exposed to foreign currency risk since the USD balances
are denominated in a currency other than its functional currency (being INR). Therefore, the foreign currency receivable/payable
amounts should be included in the disclosure on foreign currency risk in the consolidated financial statements.
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Financial Instruments: Application issues under Ind AS
102
Q 13. Company M, with INR as its functional currency, imports raw materials and exports finished products to several countries
and has unhedged foreign currency exposures of the following amounts:
Particulars
EUR
GBP
10,000,000
5,000,000
4,000,000
10,000
4,000
3,000
2,000
Payables
3,000,000
100,000
3,750,000
-
-
600
-
Net exposure
7,000,000
4,900,000
250,000
10,000
4,000
2,400
2,000
Receivables
USD
CHF
AUD
SGD
JPY
What foreign currency risk exposures should the company disclose in its financial statements under Ind AS?
A. Ind AS 107 requires an entity to include currencies to which it has significant exposure as part of its disclosures on foreign
currency risk and its sensitivity analysis. In the example above, the entity’s net exposure to USD and EUR constitutes
approximately 97 per cent of its net foreign currency exposure, indicating that the company’s disclosures on foreign currency
risk should comprise these two currencies. Although an entity may generally determine the currencies to be disclosed on a net
basis, this approach would not be appropriate if it does not suitably represent the entity’s exposure to currency risk. For example,
if an entity has short term payables and long term receivables denominated in USD it may be more appropriate to determine the
currencies to be disclosed on the basis of the gross exposure.
In the illustration above, since the gross receivables and payables in GBP approximate 24 per cent of the total receivables and
59 per cent of the total payables of the entity respectively, it may be relevant to also include the GBP exposure in the company’s
disclosures on foreign currency risk. Accordingly, the company may include the USD, EUR and GBP amounts in its disclosures on
foreign currency risk. The exposures to other foreign currencies may be excluded as they are not likely to be individually significant
from a foreign currency risk disclosure perspective.
Q 14. On 31 March 2017, company S forecasts exports of USD 6 million in September 2017. In order to hedge a portion of
its forecast exports, the company has entered into foreign currency forward contracts with its bank to sell USD5 million at
INR68.9, maturing on 30 September 2017. The forward contracts would be net settled in cash on maturity. While preparing its
foreign currency risk disclosure, should company S disclose the forecast foreign currency transactions along with the derivative
instruments?
A. The forward exchange contracts are financial instruments that represent exposure to foreign currency risk and are required to
be disclosed by company S as part of its disclosure on foreign currency risk.
While the forward exchange contracts have been transacted to hedge the currency risk on the forecast sales, these underlying
transactions do not meet the definition of a financial instrument under Ind AS 32. Therefore, company S is not required to
mandatorily include its forecast USD exports in its disclosure on foreign currency exposure. However, if the company considers
that such a disclosure would be relevant for a complete understanding of its exposure to currency risk, it may be preferable to
provide these details voluntarily and ensure that they are clearly and accurately described.
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103
Financial Instruments: Application issues under Ind AS
Q 15. Company S holds the following GBP receivables and payables as on 31 March 2016 and 31 March 2017, respectively:
Amount in INR (millions)
Particulars
31 March 2017
31 March 2016
Receivables
200,000
75,000
Payables
150,000
100,000
Spot rate
82.00
95.08
When performing a sensitivity analysis to changes in currency rates as on 31 March 2016, the company had considered 3 per cent
as the reasonably possible change in GBP/INR foreign exchange rates. This was based on the observed deviation in the GBP/INR
exchange rates in that financial year. In the financial year ended 31 March 2017, the deviation in GBP/INR rate is approximately
5.6 per cent. What are the considerations for company S when analysing the sensitivity to foreign currency rates as on 31 March
2017?
A. Ind AS 107 requires an entity to provide a sensitivity analysis for exposure to each market risk, including the impact of
changes in the risk variable on profit and loss or equity. Generally, the sensitivity analysis for foreign currency risk is based on the
reasonably possible change in the foreign exchange rates, expressed as a percentage that may be derived from the historical
deviation in the spot rate over the reporting period. The estimated possible change in the variable may therefore differ from one
reporting period to another. The sensitivity analysis of the previous year would not be restated for any changes in the percentage
of deviation in the variable. In the example above, the sensitivity analysis could be presented as follows:
Profit or loss (Amount in INR (millions))
Particulars
Strengthening
Weakening
31 March 2017
GBP (5.6%
movement)
229,600
(229,600)
(71,310)
71,310
31 March 2016
GBP (3%
movement)
Source: KPMG in India’s analysis, 2017
Q 16. Company F has entered into the following forward contracts to hedge its underlying forecast foreign currency transactions:
Particulars
Underlying
Notional
amount
Maturity date
Forward rate
Spot rate
on date of
transaction
Spot rate on
balance sheet
date
Forward
contract 1
Forecast USD
purchases
USD1 million
15 June 2017
INR69.81
INR67.66
INR68.15
Forward
contract 2
Forecast USD
sales
USD10 million
31 December
2017
INR69.95
INR67.15
INR68.15
How should the entity disclose these forward exchange contracts in its sensitivity analysis for exposure to foreign currency risk?
A. For computing the sensitivity analysis for foreign currency risk arising from a forward exchange contract, the company is
required to apply a percentage that represents a reasonably possible change in the foreign exchange rates to the notional amount
of the forward contract. This ‘reasonably possible change’ in foreign currency rates is generally determined on the basis of the
standard deviation in spot exchange rates pertaining to that foreign currency for the past year.
Generally, while analysing the sensitivity to changes in foreign exchange rates for forward contracts, an entity may assume
that the forward premium remains unchanged and only the spot component is subject to sensitivity. Accordingly, the impact of
sensitivity to foreign exchange rates is determined by applying the percentage of change in exchange rates (determined as above)
to the spot exchange rate as on the reporting date, multiplied by the notional amount of the forward exchange contract.
However, in cases where the quantum of exposure to forward exchange contracts is significant, the entity may consider using a
valuation expert to determine the sensitivity to foreign currency risk based on forward rates prevailing on the reporting date.
In the example above, company F should consider the significance of the foreign currency derivative transactions to determine the
approach to be adopted for the sensitivity analysis.
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Financial Instruments: Application issues under Ind AS
Q 17. On the date of transition to Ind AS, company L had an
outstanding loan of USD 7 million, at an interest of 5.5 per cent
per annum, repayable on 31 December 2020. The company
had borrowed these funds to make payments to suppliers for
import of machinery. In its financial statements prepared in
accordance with the previously applicable generally accepted
accounting principles in India (previous IGAAP), the company
had elected to capitalise the foreign exchange differences
arising on the loan in the cost of the machinery, as permitted
by paragraph 46 of Accounting Standard 11, The effects of
changes in foreign exchange rates. On transition to Ind AS, the
entity exercised the option available under para D13AA of Ind
AS 101, First-time adoption of Indian Accounting Standards, to
continue capitalising the foreign exchange differences arising
on this long-term foreign currency loan in the cost of the
machinery. Should the company include the foreign currency
loan in its disclosure on sensitivity analysis under Ind AS 107 for
exposure to foreign currency risk?
A. Ind AS 107 requires entities to disclose their exposure to
foreign exchange risk on financial instruments and provide a
sensitivity analysis indicating the effect of a change in foreign
exchange rates on profit and loss or equity.
In the example above, although the foreign exchange
differences on the long-term foreign currency loan are
capitalised in the cost of the related asset, these amounts
would ultimately affect the statement of profit and loss when
the asset is depreciated over its useful life. Hence, the entity
should include the foreign currency loan in its sensitivity
analysis for exposure to foreign currency risk.
The entity may consider adding a note as follows:
The sensitivity analysis to foreign currency risk includes an
exposure to foreign exchange fluctuations on long term foreign
currency loans of USD7 million that have been capitalised into
the cost of the related asset and are expected to impact profit
or loss over a period of x years in the form of an adjustment to
the depreciation charge.
Market price risk
Q 18. Company I holds long-term investments in the equity
shares of certain entities that are listed on the Bombay Stock
Exchange (BSE) and has elected to measure them at FVOCI.
The carrying amount of the investments as on 31 March
2017 and 31 March 2016 is INR5 million and INR4.8 million
respectively. What should the entity disclose in its sensitivity
analysis for exposure to share price risk relating to these
investments in equity shares?
A. Ind AS 107 requires an entity to disclose its exposure to
market risk and provide a sensitivity analysis for the impact of
changes in the risk variable on the profit and loss or equity of
the entity. Share price risk is a part of the company’s exposure
to market risk and should be considered in the sensitivity
analysis disclosure.
The company should determine the correlation, if any, between
the market price of the equity instruments and the equity index.
The sensitivity analysis may then be disclosed as the impact
on profit and loss or equity arising from exposure to the equity
instruments as a result of a percentage variation in the index.
There may be a scenario where the quantum of investments
104
in equity instruments is large and the level of exposure of the
entity to price risk is high, or it is impracticable to establish a
correlation between the market price of the equity instruments
and the index, for example for mutual fund investments. The
entity may, in that case compute the sensitivity based on a
percentage fluctuation in the market price of the respective
equity instruments.
The entity may consider providing a disclosure as illustrated
below for its exposure to equity price risk:
The entity is exposed to equity price risk, which arises from
investments made in equity securities listed on the Bombay
Stock Exchange. Material investments within the portfolio are
managed on an individual basis and all buy and sell decisions
are approved by the Risk Management Committee.
Sensitivity analysis
The company’s investments in shares of publicly listed
companies amounting to INR5 million (2016: INR4.8 million)
are generally exposed to a risk of fluctuations in fair value. A
10 per cent increase in the BSE market index at the reporting
date would increase equity by INR0.45 million (2016: INR0.43
million). An equal change in the opposite direction would
decrease equity by INR0.45 million (2016: INR0.43 million).
Interest rate risk
Q 19. Company B has invested INR8 million in corporate bonds
of a listed company, carrying a fixed interest rate of 8.5 per cent
per annum. These investments are classified and measured at
amortised cost. The market interest rate as on 31 March 2017
for corporate bonds with similar remaining term to maturity
and credit characteristics is 9 per cent. Does the entity need to
present a sensitivity analysis for the impact on profit and loss or
equity due to a change in the market interest rates?
A. Ind AS 107 requires an entity to disclose exposure to market
risks in its financial statements and perform a sensitivity
analysis that presents the impact of a reasonably possible
change in the variable on the profit and loss or equity of the
company. The corporate bonds held by the entity carry a fixed
rate of interest rate and are measured at amortised cost in the
company’s Ind AS financial statements. A change in the market
rate for instruments with similar terms would impact the fair
value of these bonds. However, there would be no impact on
the carrying amount of the instrument, or the profit and loss or
equity of the company since the bonds are not measured at fair
value. Company B would therefore not be required to present a
sensitivity analysis for its exposure to interest rate risk on these
investments . If the bonds were variable rate instruments (i.e.
carried a floating rate of interest), a change interest rates would
have an impact on the profit or loss of the company due to a
change in interest income. Therefore, the company would be
required to present a sensitivity analysis on such variable rate
instruments.
If the company has hedged the interest rate risk on the fixed
rate corporate bonds using a fixed-to-floating interest rate swap
and designated this as a fair value hedge under Ind AS 109, the
bonds would be measured at FVTPL for changes in the hedged
risk (i.e. changes in market interest rates). In this scenario,
the change in market interest rates would have an impact on
profit and loss and the corporate bonds may be included in the
sensitivity analysis for exposure to interest rate risk.
© 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
105
Financial Instruments: Application issues under Ind AS
Q 20. Company L has the following financial liabilities as on 31 March 2017:
Carrying
amount
in INR
Sr. no.
Particulars
1
Working capital loan at floating rate, interest is reset on a monthly basis. Interest as on 31 March
2017 is 11.5% per annum
12
2
Foreign currency loan of USD15 million, at 6-month LIBOR + 2.3% per annum, repayable on 30
September 2019 (As on 31 March 2017, the 6-month LIBOR was 1.5%)
980
3
USD15 million, pay fixed/receive floating USD interest rate swap to hedge the cash flow variability
arising due to interest rate risk on the foreign currency loan. As per the terms of the swap, the
entity is required to pay a fixed interest rate at 2.3% per annum and receive floating interest at
6-month LIBOR.
12.4
(millions)
How should the entity compute the sensitivity analysis for the above financial instruments?
A. Ind AS 107 requires an entity to compute the sensitivity analysis by estimating a reasonably possible change in the relevant risk
variable; this may be computed on the basis of the economic environment in which the entity operates and the time frame over
which it is making the assessment.
For the purpose of computing interest rate sensitivity on the borrowings above, management has estimated a reasonably possible
change in interest rates as 1 per cent based on current as well as expected economic conditions. The company may consider
adding the following note:
A reasonably possible change of 100 basis points in interest rates across all yield curves at the reporting date would have
increased (decreased) equity and profit or loss by the amounts shown below. This analysis is based on risk exposures outstanding
at the reporting date and assumes that all other variables, in particular foreign currency exchange rates, remain constant. The
period end balances are not necessarily representative of the average amounts outstanding during the period.
Computation of the interest rate sensitivity (Amounts in INR)
Profit or loss
Equity
Particulars
100 bp increase
100 bp decrease
100 bp increase
100 bp decrease
31 March 2017
Working capital
loan
Foreign currency
loan
(120,000)
120,000
-
-
(9,800,000)
9,800,000
-
-
Source: KPMG in India’s analysis, 2017
For the purpose of computing sensitivity on the interest rate swap, the entity may assume a 1 per cent change in the floating rate
of interest (i.e. the LIBOR). Accordingly, the change in the net cash flows on the swap should be disclosed as an additional/lower
charge to the statement of profit and loss.
Such a change in the interest rate would also affect the fair value of the swap. Since the swap is a designated hedging instrument,
the change in fair value of the instrument would be charged/credited to equity. The entity may accordingly, disclose the sensitivity
in its interest rate risk disclosures as follows.
Profit or loss
Particulars
(Amount in INR)
Equity
100 bp increase
100 bp decrease
100 bp increase
100 bp decrease
(10,072,500)
10,072,500
(25,990,840)
25,990,840
31 March 2017
Interest rate swap
Source: KPMG in India’s analysis, 2017
© 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Financial Instruments: Application issues under Ind AS
106
Master netting arrangements
Q 21. On 1 April 2016, company V, a manufacturer of consumer goods, entered into an agreement to provide volume rebates to
its large wholesale customers. As per the agreement, the rebates payable to the customers would be computed at the end of
the financial year, considering the volume of sales made to those customers during the financial year. These rebates would be
reduced from amounts receivable from the customers at the end of the financial year.
The amounts receivable from these customers at 31 March 2017 were as follows:
Customer
Amount receivable (in INR)
Rebate payable (in INR)
Company A
12,000,000
650,000
Company X
15,000,000
700,000
Company P
20,000,000
1,200,000
Total
47,000,000
2,550,000
What are the disclosures to be made by the entity in its financial statements for these transactions?
A. Ind AS 32 requires the presentation of financial assets and financial liabilities on a net basis in the financial statements, when
doing so reflects the entity’s right to receive or pay a single net amount and its intention to do so. As per the volume rebate
agreements entered into by company V with its customers, the company has a legal right to offset the rebate payable to the
customers against amounts receivable from them. This contract also confirms the company’s intention to settle the rebate
payable to the customers on a net basis with the related trade receivable. Accordingly, company V should present in its financial
statements the net amounts receivable from companies A, X and P as trade receivables of INR11,350,000, 14,300,000 and
18,800,000.
Ind AS 107 also requires entities to disclose the following information pertaining to all recognised financial instruments that are set
off in accordance with Ind AS 32:
a. The gross amounts of the recognised financial asset and the recognised financial liabilities
b. The amounts that are set-off in accordance with the criteria prescribed in Ind AS 32
c. The net amounts presented in the balance sheet.
Company V may include the following amounts in its disclosures for the transactions described above:
(Amounts in INR)
Effect of offsetting on the balance sheet
31 March 2017
Gross amounts
Gross amounts set off in
the balance sheet
Net amounts presented in
the balance sheet
47,000,000
(2,550,000)
44,450,000
36,000,000
(2,550,000)
33,450,000
Financial assets
Trade receivables
Financial liabilities
Trade payables
Source: KPMG in India’s analysis, 2017
© 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
107
Financial Instruments: Application issues under Ind AS
Q 22. Company A entered into an International Swaps and Derivatives Association (ISDA) Master Agreement with its bank relating
to the over-the-counter (OTC) derivative contracts purchased from the bank. As per the ISDA agreement, if on any date, amounts
are payable by company A and the bank, in the same currency (regardless of whether they pertain to the same transaction),
the amounts will be considered to be discharged or will be net settled, where the amounts are different. As on 31 March 2017,
company A had the following derivative instruments:
Derivative contracts
Notional amount (INR)
Carrying amount (INR)
Forward contract to sell USD5,000,000
at INR69 on 30 June 2017
34,500,000
2,500,000
A pay fixed/receive floating cross
currency interest rate swap. The
notional amount of the swap is USD10
million. Company A is required to make
semi-annual payments (on 31 March
and 30 September each year until 31
March 2020) in INR on the swap at a
fixed rate of 2% per annum at INR68
per USD and receive USD amounts at
a floating rate of 6-month LIBOR per
annum on the USD notional amount.
680,000,000
(14,000,000)
What are the disclosures to be presented by the entity for the master netting arrangement entered into with the bank in relation to
these derivatives?
A. Ind AS 32 prescribes that where an entity enters into a ‘master netting arrangement’ which provides for a single net settlement
of all financial instruments covered by the agreement in the event of default, or termination of, any one contract, the financial
assets and financial liabilities subject to the master netting agreement should be offset and presented net in the financial
statements. However, where the Ind AS 32 criteria for offset of the financial assets and the financial liabilities subject to the
master netting arrangement is not satisfied, the entity should, in accordance with Ind AS 107 disclose:
a. The net amounts presented in the balance sheet
b. The amounts related to recognised financial instruments that do not meet some or all of the offsetting criteria.
The entity may consider including the amounts below in its disclosure on master netting arrangements:
Amounts not offset (Amount in INR)
31 March 2017
Gross and net amounts of
financial instruments in
the balance sheet
Related financial
instruments that are
not offset
Net amount (*)
Financial assets
Interest rate swaps used for
hedging
(14,000,000)
2,500,000
(11,500,000)
2,500,000
(14,000,000)
-
Financial liabilities
Forward exchange contracts
used for hedging
* The net amount is disclosed as per the requirements of Ind AS 107 and represents the difference between the net amounts presented in the balance sheet (that are subject to an enforceable
master netting arrangement) and the amounts related to these recognised financial instruments that do not meet some or all of the offsetting criteria in Ind AS 32.
Source: KPMG in India’s analysis, 2017
© 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Financial Instruments: Application issues under Ind AS
108
Notes
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Notes
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IFRS Notes
ICAI issues exposure draft of Schedule III for
NBFCs as per Ind AS
Missed an issue of Accounting and Auditing
Update or First Notes?
MCA issued relaxation for
an IFSC company located
in an SEZ
13 February 2017
Companies (NBFCs).
On 6 February 2017, the
Accounting Standards
Board (ASB) of the
Institute of Chartered
Accountants of India
(ICAI) issued the
Exposure Draft (ED) of
the Ind AS compliant
Schedule III to the
Companies Act, 2013 for
Non-Banking Financial
The ED sought comments and the last date to
provide comments is 6 March 2017.
This issue of IFRS Notes provide an overview of the
Ind AS compliant Schedule III for NBFCs.
17 January 2017
On 2 September 2015,
Securities and Exchange
Board of India (SEBI)
notified the SEBI (Listing
Obligations and Disclosure
Requirements) Regulations,
2015 (Listing Regulations).
Clause 34(2)(f) of the
Listing Regulations requires mandatory submission
of Business Responsibility Report (BRR) for top
500 listed entities based on market capitalisation
(calculated as on 31 March of every year). The BRR
should describe the initiatives taken by the companies
from an environmental, social and governance
perspective, in the format as specified by SEBI from
time to time.
New development
The SEBI issued a circular dated 6 February 2017,
advising top 500 listed companies which are required
to prepare BRR to adopt IR on a voluntary basis from
the Financial Year (FY) 2017-18.
This issue of First Notes provide an overview of
the SEBI circular and requiremnets of Integrated
reporting.
Introducing
‘Ask a question’
write to us at
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KPMG in India is pleased to present Voices on
Reporting – a monthly series of knowledge sharing
calls to discuss current and emerging issues
relating to financial reporting.
In our recent call, on 8 February 2017, we provided an
overview and implications of the proposals given in the
Finance Bill, 2017 on the following topics:
• Computation of book profit for Ind AS compliant
companies for the purpose of levy of MAT
• Income Computation and Disclosure Standards
• Change in base of cost inflation index from 1 April
1981 to 1 April 2001
• MAT credit allowed to be carried forward to 15
Assessment Years.
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