Contracts to deal with non-financial asset in foreign currency

Where an entity is in the practice of entering into a derivative contract to either buy or sell a non-financial item in foreign currency, such contracts will also not be regarded as financial instruments.  The entity should not be in the practice of dealing with such non-financial item merely with the intention to buy or sell in the short term with a view to making profits.

At the time of entering into contract to either buy or sell a non-financial item in foreign currency, there is also a foreign exchange component that is involved in such contracts.  The question arises as to whether the FX component should be segregated and treated as an embedded derivative to be valued on a fair value basis.

The answer is provided in the accounting standard whereby it clearly mentions that the embedded portions in such contracts need not be segregated.

An embedded foreign currency derivative in a host contract that is an insurance contract or not a financial instrument (such as a contract for the purchase or sale of a non-financial item where the price is denominated in a foreign currency) is closely related to the host contract provided it is not leveraged, does not contain an option feature, and requires payments denominated in one of the following currencies:

  1. the functional currency of any substantial party to that contract;
  2. the currency in which the price of the related good or service that is acquired or delivered is routinely denominated in commercial transactions around the world (such as the US dollar for crude oil transactions); or
  • a currency that is commonly used in contracts to purchase or sell non-financial items in the economic environment in which the transaction takes place (eg a relatively stable and liquid currency that is commonly used in local business transactions or external trade).

Hence, the forward contract dealing with a non-financial item in a foreign currency need not be fair valued.

Treatment of contracts dealing with non-financial assets

A contract to deal with a non-financial asset is not a financial instrument. Commodity contracts normally result in either taking delivery or giving delivery of a non-financial item. Such contracts are not regarded as a financial instrument as per financial instruments accounting standard viz., Ind AS 109.  However, if the contract is capable of being settled net in cash or any other financial asset, then such contract would be treated as though it is a financial instrument.

Exception to this principle

Contracts entered into with the sole purpose of either taking delivery or giving delivery of a non-financial item is not regarded as a financial instrument and is covered under the own-use exemption. However, there could be some derivative contracts dealing with non-financial items that may result in either delivery or providing delivery. If delivery or receipt of a non-financial item happens on account of a third party exercising an option (say put option), then the entity cannot claim exemption provided in ‘own-use exemption’. This happens especially when an entity enters into a written option contract to deal with a non-financial instrument. For example, if an entity writes a put option (sells a put option), then if the price of such non-financial asset drops below the put option strike price, then the buyer of such put option will exercise the option resulting in delivery of the non-financial item for the entity. In this case, even though the entity receives the non-financial item, it is not because of the entity’s choice to buy such a non-financial item but due to the third party exercising the put option resulting in delivery to the entity. Such contracts will be regarded as financial instruments and the entity should value such contracts on a mark to market basis.

If the entity avails ‘own-use exemption’ in respect of contracts that deal with non-financial items, such contracts need not be fair valued, as ultimately such contracts would result in either receipt or delivery of the non-financial item thereby directly impacting the cost of goods sold or consumed, as the case may be.

Message by CA P.B. Sampath, Director & Secretary, Tractors and Farm Equipments Limited

I have knownPB Sampath R. Venkata Subramani for more than two decades now and he is known for his penchant for topics on financial instruments. He has dumped down the complex topic on the treatment of financial instruments as per Ind AS which I am sure is completely new for most of the professional accountants both in India and elsewhere. The timing of the release of the book coincides with the standards on financial instruments becoming applicable for the top corporate India including Banks and finance companies as per the road map issued by the MCA. I am sure this publication would be found quite useful for all professionals in their regular day-to-day official work, be it in practice or in Industry. My best wishes for the success of this publication.

CA P.B. Sampath
Director & Secretary
Tractors and Farm Equipments Limited

Message / Review from CA P. R. Ramesh, Chairman, Deloitte Haskins & Sells LLP

CA P R RameshFinancial Instruments is by far the most complex and difficult subject in the field of accounting. The varied nature of such instruments with a wide range of derivatives and associated risk makes the task of measuring and reporting extremely challenging even for experts in the subject. A number of books have been written on IFRS and more recently on Ind AS but very few books have dwelt at length on the subject of financial instruments.

This book by CA R. Venkata Subramani demystifies the subject of accounting for Financial Instruments and is extremely useful for practitioners, preparers, finance professionals and even for any person with basic knowledge of this subject. Written in a lucid manner with practical examples and screen shots of real data, it enables readers to very quickly grasp the principles and facilitates easy application of these principles. The inclusion of extracts from Annual Reports and FAQs enhances the utility of this book.

A book of this nature is very useful at a time when India has transitioned to Ind AS for certain large ‘public interest’ entities effective April 1, 2016 and the financial services sector too following soon.

I have no doubt this book will be a treasure for every professional and my compliments and best wishes to CA R. Venkata Subramani.

CA P. R. Ramesh,
Deloitte Haskins & Sells LLP,
Mumbai.Book cover

Foreword by Padma Shri T.N. Manoharan, Chairman, Canara Bank

T N ManoharanMr R. Venkata Subramani, known for his expertise in the field of Financial Instruments accounting, has come up with a new edition of his book on Accounting for Financial Instruments as per Ind AS, incorporating all the relevant aspects in various chapters. The book lucidly deals with the various dimensions of presentation, classification, recognition, measurement and derecognition of Financial instruments in the initial chapters which would empower any reader with a conceptual understanding of the subject matter. The Book further explains in a lucid manner the impairment methodology in addition to elucidating on embedded derivatives and its reclassification.

The book adequately deals with Hedge accounting both in terms of Fair value dimension as well as cash flow dimension. Comprehensive coverage on Fair value measurement of financial instruments and effects of changes in forex rates should be immensely useful to those who refer to this book. Guidance is also provided on first time adoption of the accounting standards for financial instruments. There is cross reference provided to the guidance note on accounting for derivatives. The guidance note on accounting for derivatives and extracts from annual reports incorporated in the last two chapters should serve as ready reference to the users of book.

Mr.R.Venkata Subramani is a Chartered Accountant having immense knowledge and expertise on the matters dealt with in this book. The benefit of his hands-on experience and in depth practical exposure is reflected in the illustrations given in the various chapters of this book. Accounting standards notified as IND AS are Indian version of the IFRS with appropriate modifications. All the business organizations are expected to comply with the IND AS within the timelines prescribed. Considering the complex nature of accounting for financial instruments and in the light of compliance requirement of new set of standards notified by the Government as IND AS, the significance of this book cannot be undermined.

Banks, financial institutions, Insurance companies, Investment bankers, dealers, brokers, professionals and other investors would find this book quite useful in the day-to-day operations, as various concepts unique to the financial instruments are explained besides laying down the accounting treatment in a detailed manner. This book will be a useful addition to any library, which serves as a source of knowledge and information to all those associated with financial instruments accounting.

Sri T.N. Manoharan
Chairman, Canara Bank
Padma Shri Awardee
Former President of ICAI

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