Valuation of financial instruments as per Ind AS 109 – Valuation services

Ind AS 109 mandates financial instruments that are classified as fair value through profit or loss account to be fair valued whenever the financial statements are prepared. This ipso facto means that for all the listed entities, fair valuation of such financial instruments should be performed on a quarterly basis due to the listing requirements. Below is the partial list of financial instruments that should be valued on a fair value basis at every reporting period.

  1. Equity investments
  2. Debt securities (other than the ones classified as amortised cost)
  3. All derivative contracts including equity derivatives, interest rate derivatives, commodity derivatives, foreign exchange derivatives and credit derivatives
  4. Financial guarantee contracts
  5. Loan commitments
  6. Pre-payment features affecting the fair value of long term loans payable
  7. Interest in subsidiaries, associates and joint ventures which are not valued at cost
  8. Preference shares – convertible preference shares, cumulative preference shares, non-cumulative preference shares, compulsorily convertible cumulative preference shares, compulsorily convertible non-cumulative preference shares, preference shares with a put option and call option
  9. Long term security deposits – interest bearing security deposits, interest free security de-posits, interest bearing security deposits having fixed maturity, interest free security de-posits having fixed maturity
  10. Long term loans to subsidiaries, joint ventures and associates which are given at a con-cessional rate of interest or zero percentage
  11. Debentures – redeemable convertible debentures, redeemable non-convertible debentures, either with or without put and call options
  12. Term loans from banks where the transaction costs are written off in an earlier period

Contact: rvsbell@gmail.com; Mobile: +919444025255

Training course on Financial Instruments – Ind AS 109

Three day training course on Financial Instruments as per Ind AS requirements

Day 1

Session

Topics covered

Session 1
10 am to 1 pm
Basic concepts of derivative instruments
  – What are derivatives and why we need them

  – Meaning of Forward, Futures and options
  – Pricing futures
  – Hedging, speculation & gambling
  – Option basics: ITM, ATM, OTM, Exercise, Lapse
Session 2
2 pm to 5 pm
Advanced concepts on derivative instruments
  – Greeks in options pricing
  – Black-Scholes model / Binomial model   
  – Put-call parity
Features of equity and equity derivatives
– Exercise with practical problems

Features of Interest Rate Derivatives
  – Interest Rate Swaps
  – Interest Rate CAPs / Floors
  – Interest Rate Collars / Reverse Collars
  – Cross Currency Swaps
Fixed Income Securities
FX Derivatives
Credit Default Swaps
Total Return Swaps

Day 2

Session

Topics covered

Session 1
10 am to 1 pm
Accounting Standard Ind AS 32
  – Financial asset and financial liabilities
  – Compound instruments
  – Liability Vs. Equity
Session 2
2 pm to 5 pm
Accounting Standard  Ind AS 109
  – Recognition, measurement, subsequent measurement

  – Amortized cost
  – Classification, reclassification & derecognition
  – Impairment
  – Embedded derivatives
Ind AS 107 Disclosures
 – Live examples from published accounts

Report of the working group on implementation of Ind AS by Banks
 – Discussion of the report and practical implications thereof

Day 3

Session

Topics covered

Session 1
10 am to 11.15 pm
Accounting for financial instruments
  – Interest rate derivatives
  – Fixed income securities
Effect of changes in foreign exchange rates Ind AS 21
  – Impact on financial instruments / hedge accounting
Session 2
11.30 am to 1 pm
Hedge Accounting
  – Fair Value Hedge

  – Cash Flow Hedge
Session 2
2 pm to 5 pm
Hedge Accounting
  – Case studies on Hedge Accounting

Financial instruments nuances in First time adoption

For details please send email to rvsbell@gmail.com or contact +919444025255

Classification of financial assets

As per Ind AS 109, financial assets should be classified as one of the following:

  1. Amortised cost
  2. Fair value through other comprehensive income or
  3. Fair value through profit or loss

Classification is based on the analysis of the following two key factors:

  1. The entity’s business model for managing the financial assets and
  2. Contractual cash flow characteristics of the financial assets.

For an instrument that does not have a defined maturity period, the financial asset should be classified as either fair value through profit or loss or fair value through other comprehensive income.

For a debt security (since it has a pre-defined maturity period), all the three types of classification as mentioned above is possible viz., Amortised cost, Fair value through other comprehensive income or Fair value through profit or loss.
Key criteria to be examined for the purpose of classification of financial assets:

1) The entity’s business model: The business model of the entity should be analysed to find out if the financial asset is held with the objective to collect contractual cash flows that are solely payment of principal and interest or to collect such contractual cash flows as well as to buy or sell such financial asset. The business model objective should be analysed at the portfolio or sub-portfolio level and not on instrument-by- instrument basis. Such analysis should not be conducted at the entity level either, as the entity may have multiple business models to achieve different objectives for different sets of portfolios.

2) SPPI Criterion: The next key test to be performed is the test to find out if the contractual cash flows represent solely payment of principal and interest only. To understand the significance of this test, one need to have a very thorough knowledge of what is meant by both principal as well as interest. The standard specifies that principal is the fair value of the financial asset on initial recognition. Interest is primarily a consideration for the time value of money and includes the consideration for the credit risk associated with the financial asset. Interest also includes consideration for the other basic lending risks and costs including the profit margin.

If the financial asset is held with the business model objective to collect contractual cash flows that represent solely payment of principal and interest, then such a financial asset should be measured at amortised cost.

If the business model objective is to collect both the contractual cash flows as well as to buy and sell such financial assets, the financial asset should be classified as fair value through other comprehensive income, provided the contractual cash flows represent solely payment of principal and interest.

If the contractual cash flows do not represent solely payment of principal or interest or if the financial asset is held with the business model objective, i.e. neither to collect the contractual cash flows nor to buy or sell such financial assets, then the classification should be fair value through profit and loss account.

Derivative Instruments

Derivative Instrument

  • Derivatives are financial instruments
  • They derive their value from an underlying asset price or index
  • Their primary purpose is to create rights and obligations to facilitate the transfer of risks between the party wanting to transfer and the party with the risk appetite willing to take on the risk
  • Usually used as a hedging instrument for managing risks

Definition of a derivative

  • A derivative is a financial instrument or other contract with all three of the following characteristics:
  1. its value changes in response to the change in a ‘underlying’;
  2. it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts; and
  3. it is settled at a future date

Examples of certain underlying

  • The following are some examples of underlying

– Interest Rate
– Security price
– Commodity price
– Index like Dow Jones, Sensex, Nifty
– FX rate
– Credit rating provided by an agency
– Non-financial variable like weather

Key features of derivative

  • Where the underlying is a non-financial variable, then it should not be specific to a party to be a derivative – else it would become an insurance contract
  • A derivative can have more than one underlying – for example a cross currency interest rate swap has a FX rate as one variable and interest rate as another variable

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