4th April, 2025
Derivative Accounting under Ind AS 109
CA. Chintan N. Patel
Agenda
Introduction to derivatives
Applicability of Ind AS 109 to derivative contracts
Hedge accounting and its impact on financial statements
Ind AS 109 vs. AS framework
IndusInd Bank accounting discrepancy
CA. Chintan N. Patel
Derivative?
All 3 Characteristics
Its value changes in response to the change in underlying Requires no/very less initial net investment
CA. Chintan N. Patel
Settled at a future date
DerivativeAccounting
Initial Recognition and Measurement
Subsequent Measurement
Measure at Fair value
Classified and measured at FVTPL unless qualify for hedge accounting
CA. Chintan N. Patel
DerivativeAccounting
Economic characteristics and risks not closely related
Embedded Derivatives
Host not FA, separate if and only if
Otherwise
Designate entire contract at FVTPL
Separate instrument will meet definition of derivative
CA. Chintan N. Patel
Hybrid contract not measured at FVTPL
Hedgeaccounting
‘Hedging’ and ‘hedge accounting’ are two different things
Hedging- Managing risks by using financial instrument (‘hedging instrument’) purposely to offset the variability in FV or cash flows of a recognised asset or liability, firm commitment, or future cash flows (‘hedged item’)
Hedged Item
Hedging Instrument
Hedging Effectiveness
HedgeAccounting
Formal Designation and documentation
Only eligible hedging instruments and hedged items
Meets the hedge effectiveness requirements
Economic relationship between hedged item and hedging instrument gives rise to offset Effect of credit risk does not dominate the value changes
Hedge ratio results from the quantity of item hedged and hedging item used to hedge
Effectiveness – Rebalancing
Change in economic relationship between underlyings
Change in risk management hedge ratio
Changes result in an imbalance that would create hedge ineffectiveness (inconsistent with the purpose of hedge accounting)
CA. Chintan N. Patel
ACCOUNTING FOR QUALIFIYNG HEDGING RELATIONSHIPS
Fair Value Hedge
Cash Flow Hedge Hedges of a net investment Hedge of an entity’s interest in the net assets of a foreign operation.
Hedge of exposure to cash flow variability in cash attributable to a particular risk associated with an asset, liability, or highly probable forecast transaction (or part thereof i.e. component).
Hedge of exposure to fair value variability in an asset, liability, or unrecognised firm commitment (or part thereof i.e. component), attributable to a risk that could affect profit or loss.
All derivatives to be classified and measured at FVTPL unless hedge relationship meets qualifying criteria.
In case of cash flow hedge, fair value of hedging instrument is recognised in cash flow hedge reserve in OCI. Hedge ineffectiveness if any to be recognised in profit or loss statement.
CA. Chintan N. Patel
CaseStudy
On 1 January 20X1, Entity A issues Rs. 10,00,000 of fixed-rate bonds with a coupon rate of 5% per annum, paid annually in arrears on 31 December. The prevailing market interest rate for similar bonds rises, and by 30 June 20X1, the fair value of the bonds has decreased to Rs. 980,000 due to this interest rate increase. On 30 June 20X1, Entity A enters into an interest rate swap to hedge the fair value exposure. The swap has a notional principal of Rs. 10,00,000, matures on the same date as the bonds, and involves Entity A receiving a fixed rate of 5% and paying a floating rate. The fair value of the interest rate swap on 30 June 20X1 is Rs. 20,000 (an asset).
Solution:
• Fair value hedge
• Hedged item – Recognition of FV changes in PL – Rs. 20,000
• Derivative instrument – Recognition of change in FV in PL – Rs. 20,000
CA. Chintan N. Patel
CaseStudy
On 1 January 20X1, Entity B borrows Rs. 500,000 at a floating interest rate of LIBOR + 1%, with interest payments due annually in arrears on 31 December. On 1 April 20X1, Entity B enters into an interest rate swap to hedge the variability in future interest payments. The swap has a notional principal of Rs. 500,000, matures on the same date as the loan, and involves Entity B paying a fixed rate of 4% and receiving floating interest (LIBOR). By 31 December 20X1, due to changes in expected future interest rates, the fair value of the interest rate swap has increased to Rs. 15,000 (an asset), and the cumulative change in the present value of the expected future cash flows of the hedged item (the floating interest payments) is a decrease of Rs. 14,000.
Solution:
• Cash flow hedge • Recognition of Interest expense • Derivative instrument – Recognition of change in FV – effective portion in OCI – Rs. 14,000 and ineffective portion in PL – Rs. 1,000
CA. Chintan N. Patel
IndusIndBank
10-March:
An internal review of its derivative portfolio had revealed a potential 2.35% adverse impact on its net worth, which would have an impact of approximately Rs 2,100 crore on the bank.
As per directives on investments issued by the RBI in September 2023, banks are prohibited from conducting internal trades/ hedging and, accordingly, IndusInd Bank ceased internal trades from April 1 2024.
Internal trades having low liquidity instruments (3 to 6 years yen borrowings and 8 to 10 years dollar borrowings) – hedging through internal trading desk instead of external counterparties
Derivatives are used by the treasury department to convert forex deposits/ borrowings into rupees
Divergent Valuation:
External Trade valued at MTM
Internal Trade valued on Swap valuation
Two sides of the transactions could diverge throughout the contract period and only align at maturity
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Feature AS 11 & ICAI GN
Scope AS 11 - forward exchange contracts
relating to foreign currency existing assets/liabilities
GN covers other derivatives
Comprehensive coverage of all financial instruments
Treatment of Premium/Discount on Forward Contracts (AS 11)
Forward contracts relating to foreign exchange- amortisation of premium or discount over the life of the contract, in certain situations.
Forward contracts measured at fair value and also allows for separating the forward element.
Cash Flow Hedge Accounting Treatment (ICAI GN)
Cash Flow Hedging Reserve (CFHR) in Equity.
CFHR in OCI and as a component of equity
Embedded Derivatives
Disclosure
Not part of its scope due to potential conflicts with other AS
Limited Disclosures
Provides guidance on identifying and separating
Extensive disclosure requirements
CA. Chintan N. Patel
