1. Financial Instruments
Ind AS 109
Financial Instruments
EY refers to the global organization, and/or one or more of the independent member firms of Ernst & Young Global Limited

2. Classification of financial assets

3. Classification of financial assets – an overview
Three categories as per Ind AS 109:
Key criteria to decide classification:
Entity’s business model for managing the financial assets and
Contractual cash flow characteristics (SPPI test)
Classification requirements are applied to a financial asset in its entirety – No separation of embedded derivatives
Financial Assets
Amortised Cost
Fair Value through other comprehensive income (FVTOCI)
Fair Value through profit or loss (FVTPL)

4. Synopsis of key aspects of the new model for financial assets
Debt (including hybrid contracts)
Derivatives
Equity
‘Contractual cash flow characteristics’ test (at instrument level)
Pass
Fail
Fail
Fail
‘Business model’ assessment (at an aggregate level)
Held for trading? 1
Hold-to-collect contractual cash flows 2
BM with objective that results in collecting contractual cash flows and selling FA
Neither (1) nor (2)
Yes No 3
Additional Information
A debt instrument is normally measured at amortised cost if both of the following conditions are met:
The asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows
The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding
A debt instrument is normally measured at FVTOCI if both of the following conditions are met:
The asset is held within a business model in which assets are managed to achieve a particular objective by both collecting contractual cash flows and selling financial assets
The above requirements should be applied to an entire financial asset, even if it contains an embedded derivative. That is, in contrast with the requirements of IAS 39, a derivative embedded within a hybrid (combined) contract containing a financial asset host is not accounted for separately.
A debt instrument that is not measured at amortised cost or at FVTOCI must be measured at FVTPL.
An entity may irrevocably designate a debt instrument as measured at FVTPL at initial recognition. This is allowed if doing so eliminates or significantly reduces an 'accounting mismatch‘. Such mismatches would otherwise arise from measuring assets or liabilities, or recognising the gains and losses on them, on different bases.
Equity instruments and derivatives are normally measured at FVTPL. However, on initial recognition, an entity may make an irrevocable election (on an instrument-by-instrument basis) to present in OCI subsequent changes in the fair value of an investment in an equity instrument within the scope of IFRS 9, provided it is neither held for trading nor contingent consideration recognised by an acquirer in a business combination to which IFRS 3 applies. For the purpose of this election, ‘equity instrument’ is used as defined in IAS 32 Financial Instruments: Presentation. No
FVTOCI option elected ?
Conditional fair value option (FVO) elected?
Yes
Yes No No
Amortised cost
FVTOCI (with recycling)
FVTPL
FVTOCI (no recycling)

5. Classification of debt instruments (including loans) – outcomes
Contractual cash flow characteristics:
Contractual cash flows are solely payments of principal and interest on the principal amount outstanding
Business model
yes no
Held within a business model whose objective is to hold financial assets in order to collect contractual cash flows
Amortised cost
FVTPL
Held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets
FVTOCI
Financial assets which are neither held at amortised cost nor at fair value through other comprehensive income (FVTOCI)
Additional Information
This table summarises the outcome of the flow chart presented on the previous slide.
The application of the requirements of IFRS 9 to debt instruments means that, apart from the limited exceptions, only relatively simple ‘plain vanilla’ debt instruments qualify to be measured at amortised cost or at FVTOCI.

6. SPPI test

7. Solely payments of principal and interest cash flows – the SPPI test
Contractual cash flows that are solely payments of principal and interest (SPPI)
Consistent with a basic lending arrangement which includes consideration for:
Do not introduce exposure to risks or volatility unrelated to a basic lending arrangement
Time value of money
Elements inconsistent with a basic lending arrangement include:
Exposure to changes in equity or commodity prices
Leverage
Credit risk
Other basic lending risks and costs:
Liquidity risk
Admin costs
Profit margin
Additional information
The assessment of the characteristics of the contractual cash flows aims to identify whether the contractual cash flows are ‘solely payments of principal and interest on the principal amount outstanding’. Hence, the assessment is colloquially referred to as the ‘SPPI test’.
The SPPI test is designed to screen out financial assets on which the application of the effective interest method (EIM) either is not viable from a pure mechanical standpoint or does not provide useful information about the uncertainty, timing and amount of the financial asset’s contractual cash flows. Because the EIM is essentially an allocation mechanism that spreads interest revenue or expense over time, amortised cost or FVTOCI measurement is only appropriate for simple cash flows that have low variability such as those of ‘plain vanilla’ loans and receivables and debt securities. Accordingly, the SPPI test is based on the premise that it is only when the variability in the contractual cash flows arises to maintain the holder’s return in line with a ‘basic lending arrangement’ that the application of the EIM provides useful information.
In this context, the term ‘basic lending arrangement’ is used broadly to capture both originated and acquired financial assets, the lender or the holder of which is looking to earn a return that compensates primarily for the time value of money and credit risk. However, such an arrangement can also include other elements that provide consideration for other basic lending risks such as liquidity risks, costs associated with holding the financial asset for a period of time (e.g., servicing or administrative costs) and can also include a profit margin.
In contrast, contractual terms that introduce a more than de minimis exposure to risks or volatility in the contractual cash flows that is unrelated to a basic lending arrangement, such as exposure to changes in equity prices or commodity prices, do not give rise to contractual cash flows that are solely payments of principal and interest on the principal amount outstanding.

8. SPPI test – SPPI and non-SPPI cash flows
Examples that will pass:
Bond with interest or principal linked to an inflation index in the currency of issue
Variable rate instrument where rate is capped
Loan secured by collateral
Perpetual rate loan
Examples that will fail:
Instruments with leverage
Stand-alone derivatives
Inverse floaters
Leveraged interest rates
Instruments with a link to a price index
Bonds convertible into equity
Additional information
A contractual cash flow characteristic does not affect the classification of the financial asset if it can have only a de minimis effect on the contractual cash flows of the financial asset. To make this determination, an entity must consider the possible effect of the contractual cash flow characteristic in each reporting period and cumulatively over the life of the financial instrument.
A dictionary defines de minimis as “too trivial or too minor to merit consideration”. Implicit in this definition is that if the entity has to consider whether an impact is de minimis, whether quantitatively or qualitatively, it is almost certainly not.
In addition, if a contractual cash flow characteristic could have an effect on the contractual cash flows that is more than de minimis (either in a single reporting period or cumulatively) but that cash flow characteristic is not genuine, it does not affect the classification of a financial asset. A cash flow characteristic is not genuine if it affects the instrument’s contractual cash flows only on the occurrence of an event that is extremely rare, highly abnormal and very unlikely to occur.
In our view, terms are included in a contract for an economic purpose and therefore are, in general, genuine. The threshold 'non- genuine' is possibly intended to deal with clauses inserted into the terms of financial instruments for legal or tax reasons, or to achieve an accounting outcome, but having no real economic purpose or consequence.
Although the de minimis and non-genuine thresholds are high hurdles, allowing entities to disregard such features will result in more debt instruments qualifying for the amortised cost or FVTOCI measurement categories than in previous versions of IFRS 9. The terms will need to be interpreted by preparers in analysing the impact of the clarified SPPI test on the debt instruments they hold.

9. Business model assessment

10. Overall business model assessment – defining factors
Business model assessment refers to how an entity manages its financial assets in order to generate cash flows
Business model is a matter of fact and not merely an assertion
Assessment based on reasonable expectations and not on worst or stress case scenarios
Typically observable through particular activities that are undertaken to achieve the objectives of that business model
Performance measurement
Risks and risk management
Compensation
The expected frequency and value of sales are important elements of the assessment. However, information about past sales should not be considered in isolation
Additional information
An entity’s business model reflects how it manages its financial assets in order to generate cash flows; its business model determines whether cash flows will result from collecting contractual cash flows, selling the financial assets, or both. This assessment is not performed on the basis of scenarios that the entity does not reasonably expect to occur, such as so-called ‘worst case’ or ‘stress case’ scenarios. For example, if an entity expects that it will sell a particular portfolio of financial assets only in a stress case scenario, that scenario would not affect the entity’s assessment of the business model for those assets if the entity does not reasonably expect that such a scenario will occur.
If cash flows are realised in a way that is different from the entity’s expectations at the date that the entity assessed the business model (for example, if the entity sells more or fewer financial assets), this does not give rise to a prior period error in the entity’s financial statements (as defined in IAS 8) nor does it change the classification of the remaining financial assets held in that business model (i.e., those assets that the entity recognised in prior periods and still holds), as long as the entity has considered all relevant information that was available at the time that it made the business model assessment. There is no ‘tainting’ concept, as in the treatment of held–to-maturity financial assets under IAS 39, but if there is a change in the way that cash flows are realised, then this will affect the classification of new assets recognised in the future.
An entity’s business model for managing financial assets is a matter of fact and it is typically observable through particular activities that the entity undertakes to achieve its stated objectives. An entity will need to use judgement to assess its business model for managing financial assets and that assessment is not determined by a single factor or activity. Rather, the entity must consider all relevant evidence that is available at the date of the assessment. Such relevant evidence includes, but is not limited to:
How the performance of the business model and the financial assets held within it are evaluated and reported to the entity’s key management personnel
The risks that affect the performance of the business model and the way those risks are managed
How managers of the business are compensated (e.g., whether the compensation is based on the fair value of the assets managed or the contractual cash flows collected)
In addition to these three types of evidence, in most circumstances, the expected frequency and value of sales are important elements of the assessment.

11. Amortised cost business model (hold to collect)
Objective of the business model
Hold assets to collect contractual cash flows
Considerations for sales
Frequency, value and timing of past sales
Expectations for future sales
Sales should be considered even if imposed by a regulator
Examples of sales consistent with a hold to collect BM
Due to deterioration in credit quality (asset no longer meets documented investment strategy)
Infrequent sales even if significant (e.g., stress case scenario)
Insignificant sales, even if frequent
Sales made close to maturity
Additional information
Financial assets that are held within a business model, the objective of which is to hold assets in order to collect contractual cash flows is measured at amortised cost, (provided the asset also meets the contractual cash flow test). Financial assets that are held within a business model whose objective is to hold assets in order to collect contractual cash flows are managed to realise cash flows by collecting contractual payments over the life of the instrument.
Although the standard states that sales in themselves do not determine the business model, in most circumstances, the expected frequency, value and timing of sales, as well as the reasons for past sales, are important aspects of the business model assessment.
In determining whether cash flows are going to be realised by collecting the financial assets’ contractual cash flows, it is necessary to consider the frequency and value of sales in prior periods, whether the sales were of assets close to maturity, the reasons for those sales, and expectations about future sales activity. However, the standard states that sales, in themselves, do not determine the business model and cannot be considered in isolation. It goes on to say that, instead, information about past sales and expectations about future sales provide evidence related to how the entity’s stated objective for managing the financial assets is achieved and, specifically, how cash flows are realised. An entity must consider information about past sales in terms of the reasons for the sales and the conditions that existed at that time compared to current conditions.
Based on these considerations, an entity needs to determine the predictive value of the past sales for the expectations of future sales. When performing this assessment, the standard makes it clear that it is irrelevant whether a third party (such as a banking regulator in the case of some liquidity portfolios held by banks) imposes the requirement to sell the financial assets, or whether that activity is at the entity’s discretion.
IFRS 9 is slightly cryptic concerning the role of sales, when it says that ‘sales in themselves do not determine the business model’, the emphasis seems to be on past sales. Given the guidance in the standard, the magnitude and frequency of sales is certainly important evidence in determining an entity’s business models. However, the key point is that the standard requires the consideration of expected future sales and past sales are of relevance only as a source of evidence. Unlike the held- to-maturity classification under IAS 39, there is no concept of ‘tainting’.

12. FVTOCI business model (hold to collect and sell)
Positively defined measurement category and neither a free choice nor a residual (unlike AFS)
Managing financial assets, both to collect contractual cash flows and for sale, is the outcome of the way in which financial assets are managed to achieve a particular objective, rather than the objective itself
Examples of such objectives include:
Manage every day liquidity needs
Replication portfolios
Liquidity portfolio where regulator requires ‘churning’
Sales are integral to the FVTOCI business model and there is no threshold for the frequency or amount of sales
Additional information
The FVTOCI measurement category is mandatory for portfolios of financial assets that are held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets (provided the asset also meets the contractual cash flow test).
In this type of business model, the entity’s key management personnel has made a decision that both collecting contractual cash flows and selling are fundamental to achieving the objective of the business model. There are various objectives that may be consistent with this type of business model. For example, the objective of the business model may be to manage everyday liquidity needs, to achieve a particular interest yield profile or to match the duration of financial assets to the duration of the liabilities that those assets are funding. To achieve these objectives, the entity will both collect contractual cash flows and sell the financial assets.
Compared to the business model with an objective to hold financial assets to collect contractual cash flows, this business model will typically involve greater frequency and value of sales. This is because selling financial assets is integral to achieving the business model's objective rather than only incidental to it. There is no threshold for the frequency or value of sales that can or must occur in this business model.

13. FVTOCI business model – Example 1
A non-financial entity anticipates incurring capital expenditure in a few years’ time. The entity invests its excess cash in financial assets in order to fund the expenditure when the need arises
The entity’s objective for managing the financial assets is to maximise the return on those financial assets
Accordingly, the entity will sell financial assets and re-invest the cash in financial assets with a higher yield when an opportunity arises
The managers responsible for the portfolio are remunerated based on the return generated by the financial assets

14. FVTPL business model (other business model objectives)
FVTPL is the measurement category for all financial assets neither measured at amortised cost nor measured at FVTOCI
Characteristics or FVTPL business model:
Management of financial assets with the objective to realise cash flows through sales
Decisions based on fair value information
Objectives result in active buying and selling
Collecting contractual cashflows is only incidential and not integral to that business model
Portfolios of assets held for trading fall under a FVTPL business model
Additional information
IFRS 9 requires financial assets to be measured at FVTPL if they are not held within either a business model whose objective is to hold assets to collect contractual cash flows or within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. A business model that results in measurement at FVTPL is where the financial assets are held for trading. Another is where the assets are managed on a fair value basis. In each case, the entity manages the financial assets with the objective of realising cash flows through the sale of the assets. The entity makes decisions based on the assets’ fair values and manages the assets to realise those fair values. As consequence, the entity’s objective will typically result in active buying and selling.
As set out in IFRS 9, FVTOCI is a defined category and is neither a residual nor an election. However, in practice, entities may identify those debt instruments that are held to collect contractual cash flows, those that are held for trading, those managed on a fair value basis and those for which the entity applies the fair value option to avoid a measurement mismatch, and then measure the remaining debt instruments at FVTOCI. As a consequence, the FVTOCI category might, in effect, be used as a residual, just because it is far easier to articulate business models that would be classified at amortised cost or at FVTPL.

15. Classification of Financial Liabilities

16. Classification of financial liabilities
Financial liabilities has been classified into two categories:
Category
Main use
Fair value through profit or loss
Financial liabilities that are held for trading (including derivatives)
Financial liabilities that are designated as FVTPL on initial recognition
Contingent consideration recognised by an acquirer in a business combination
Amortised Cost
All liabilities not in the above category

17. Initial recognition and measurement

18. Initial recognition
An entity must recognise a financial asset or liability on its balance sheet when and only when it becomes a party to the contractual provisions of the instrument
Examples of applying the principle:
Unconditional receivables – recognise when become party to the contract
Forward contract – recognise derivative on commitment date
Options – recognise derivative when written or purchased
Planned future transactions – not recognised
Firm commitments – not recognised until performance under the agreement

19. Initial measurement – financial assets
Transaction costs
At fair value through profit or loss
Fair value
Expense
At fair value through OCI
Capitalize
At amortized cost
Capitalise
Financial liability
Initial measurement
Transaction costs
At fair value through profit or loss
Fair value
Expense
Other financial liabilities*
Deduct from the amount originally recognized

20. Subsequent measurement: Financial assets
Recognition of fair value changes
FVTPL
Fair value
Profit or loss
FVTOCI - Equity
OCI except for dividend
Dividends in income statement
No recycling from OCI to P&L
Amortised cost
Amortised cost
Not relevant

21. The FVTOCI measurement category for debt instruments
Classification
Measurement
Business model whose objective results in collecting contractual cash flows and selling financial assets
Need to pass the ‘contractual cash flow characteristics’ test
Positively defined measurement category and neither a free choice nor a residual (unlike AFS)
Sales are integral to the FVTOCI business model and there is no threshold for the frequency or amount of sales
Expected credit losses
Derived as for amortised cost instruments
Recorded in profit or loss
Interest income
Calculated using the effective interest method
Foreign currency gains and losses
Calculated based on the amortised cost
Other fair value gains and losses
Recognised in OCI
Derecognition
Recycling of cumulative gains or losses
Additional information
The IASB noted that the FVTOCI measurement category is intended for debt instruments for which both amortised cost information and fair value information are relevant and useful. This will be the case if their performance is affected by both the collection of contractual cash flows and the realisation of fair values through sales.
The FVTOCI measurement category may help some insurers achieve a greater level of consistency of measurement for assets held to back insurance liabilities under the new IFRS 4 insurance contracts model. It should also help to address concerns raised by preparers who expect to sell financial assets in greater volume than would be consistent with a business model whose objective is to hold financial assets to collect contractual cash flows and would, without this category, have to record such assets at FVTPL.
The FVTOCI category differs from the available-for-sale (AFS) category in IAS 39 Financial Instruments: Recognition and Measurement in several aspects. First, the AFS category was essentially a residual classification and an unrestricted election. In contract to that, the FVTOCI classification under IFRS 9 reflects a business model evidenced by the way a group of financial assets is managed and its performance is reported and is neither a residual nor an election. Second, financial assets measured at FVTOCI will be subject to the same impairment model as those measured at amortised cost. Accordingly, although recorded at fair value, the profit or loss treatment will be the same as for an amortised cost asset, with the difference between amortised cost and fair value recorded in OCI until the asset is derecognised. Third, only relatively simple debt instruments will qualify for measurement at FVTOCI.

22. Subsequent measurement: Financial liabilities
Fair value
FV change attributable to own credit risk in OCI except if this creates or enlarges an accounting mismatch
Remainder in profit or loss
Amortised cost
Not relevant
FVTPL
Recognition of fair value changes
Financial liabilities
Measurement

23. Investment measurement – summary
Nature
Current Indian GAAP
Ind AS 109
Equity shares of subsidiaries/ associates/JV
Cost less other than temporary decline in value
Option to use either cost or Ind AS 109
Other strategic equity investment: long term
Option to use either FVTPL or FVTOCI
Non strategic equity investments: long-term
Traded equity instruments
Lower of cost and market value
FVTPL
Mutual funds

24. Financial guarantee contracts
Generally covered under Ind AS 109
Initial recognition: At fair value
Subsequent measurement: At the higher of the following
Amount determined in accordance with Ind AS 37
Amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with Ind AS 115

25. Example – Financial guarantees
P Limited (the parent) has a stronger credit rating than its wholly owned subsidiary - S Limited.
S Limited is looking to borrow INR100 million, repayable in five years.
A bank has indicated it will charge 7.5% per annum.
However, the bank has offered to lend S 7.0% per annum if P Limited provides a guarantee to the bank.
S Ltd chooses to borrow at 7% pa by obtaining P Limited’s guarantee.
No charge was made by P Limited to S Limited for the guarantee.
Issue
How should P Ltd. account for the financial guarantee?

26. Response – Example
The fair value of the guarantee is arrived at INR 2 million, i.e., difference between the present value of the contractual payments discounted at 7.0% and 7.5%.
The financial guarantee liability should be recognized in the financial statements of parent at fair value:
The following entry shall be recorded by the parent:
Investment in subsidiary Dr. 2million
Financial guarantee obligation Cr. 2million
In the CFS, no financial guarantee obligation shall be recognized as the transaction is eliminated.
If a subsidiary gives financial guarantee on behalf of the parent, its fair value shall be treated as distribution to owners.

27. Impairment of financial assets

28. Scope and variation of the expected credit loss model
21 September 2018
Scope and variation of the expected credit loss model
Scope of ECL requirements
General approach
Simplified approach
Ind AS 109
Trade receivables that do not contain a significant financing component 
Trade receivables that contain a significant financing component
Policy election at entity level
Other debt financial assets measured at AC or at FVTOCI
Loan commitments and financial guarantee contracts not accounted for at FVTPL
Ind AS 115
Contract assets that do not contain a significant financing component
Contract assets that contain a significant financing component
Ind AS 17
Lease receivables
Additional information
Contract assets are defined in Appendix A of IFRS 15.
Paragraphs of IFRS 15 provide the requirements for determining the existence of a significant financing component in the contract.

29. Expected credit loss model – general approach
21 September 2018
Expected credit loss model – general approach
Stage 2
Stage 3
Stage 1
Loss allowance updated at each reporting date
12-month ECL
Lifetime ECL
(credit losses that result from default events that are possible within the next 12-months)
Lifetime ECL criterion
Credit risk has increased significantly since initial recognition
(whether on an individual or collective basis) +
Credit-impaired
Interest revenue recognised
Effective Interest Rate (EIR) on gross carrying amount
EIR on gross carrying amount
EIR on amortised cost
(gross carrying amount less loss allowance)
Change in credit risk since initial recognition
Improvement Deterioration
Additional information
Under the general approach, entities must recognise ECL in two stages. For credit exposures where there has not been a significant increase in credit risk since initial recognition (i.e., ‘good’ exposures), entities are required to provide for credit losses that result from default events ‘that are possible’ within the next 12-months (a 12-month ECL – Stage 1 in the illustration below). For those credit exposures where there has been a significant increase in credit risk since initial recognition, a loss allowance is required for credit losses expected over the remaining life of the exposure irrespective of the timing of the default (a lifetime ECL – Stages 2 and 3 in the illustration below).
If the financial assets become credit-impaired (Stage 3 in the illustration below), interest revenue would be calculated by applying the effective interest rate (EIR) to the amortised cost (net of loss allowance) rather than the gross carrying amount.
Financial assets are assessed as credit-impaired using the same criteria as for the individual asset assessment of impairment under IAS 39 .
(The examples of events to assess whether a financial asset is credit-impaired are provided in paragraph 59 of IAS 39 and Appendix A of IFRS 9. )
IFRS 9 Financial Instruments

30. Simplified approach: Provision matrix
According to the simplified approach, for trade receivables and contract assets that do not contain a significant financing component, an entity shall always measure loss allowance at an amount equal to lifetime expected credit losses.
A provision matrix could be used to estimate ECL for these financial instruments.
For example, an entity may set up the following provision matrix based on its historical observed default rates, which is adjusted for forward-looking estimates:
non-past due: 0.3% of carrying value
30 days past due: 1.6% of carrying value
31-60 days past due: 3.6% of carrying value
61-90 days past due: 6.6% of carrying value
more than 90 days past due: 10.6% of carrying value

31. Derivatives and embedded derivatives

32. Derivative definition
Three characteristics
Fair value changes in response to changes in one or more underlying variables
No or little initial net investment
Settled at a future date
Instruments with a non-financial underlying variable that is specific to a party to the contract are NOT derivatives
Example-Non-financial variables that are not specific to one party to the contract may include an index of earthquake losses in a particular region or an index of temperatures in a particular city.
Example-Non-financial variables that are specific to one party to the contract- Linked to credit rating

33. Example – non financial underlying variable
Non-financial variables that are not specific to one party to the contract may include an index of earthquake losses in a particular region or an index of temperatures in a particular city.
Non-financial variables that are specific to one party to the contract- Linked to credit rating of the party to the contract

34. Examples of derivatives and underlyings
Type of contract
Main variable
Interest rate swap
Interest rate
FX forward
Foreign exchange rate
Commodity option
Commodity price
Credit default swap
Credit risk
A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a loan default or other credit event. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults.
Purchased or written stock call or put option
Equity price

35. Commodity contracts – normal purchase/ sale exemption
A derivative may have an underlying which non-financial variable not specific to party to the contract.
Whether all forward contracts for purchase/ sale of non-financial items need to be accounted as derivative?
Consider the following examples whether the same needs to be accounted as derivatives under Ind AS 109
Forward for purchase of land
Option to buy raw material at future date
Agreement to supply goods after one month

36. Scope: Non-financial item contracts
Forward contracts to buy or sell a non-financial item (e.g. commodity contracts)
Within scope
Not within scope
Continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale and usage requirements
Establish practice of net settling similar contracts or taking delivery of the underlying and selling it within a short period after delivery
Derivative Vs Executory Contracts 36

37. Example – normal purchase/ sale exemption
Company XYZ enters into a fixed-price forward contract to purchase 1,000 kg of copper in accordance with its expected usage requirements.
The contract permits XYZ to take physical delivery of the copper at the end of twelve months, or to pay or receive a net settlement in cash, based on the change in fair value of copper.
Whether the contract is entitled to normal sale/ purchase exemption?

38. Response – example
Contract has all characteristics of a derivative instrument
There Is No Initial Net Investment,
It Is Based On The Price Of Copper, And
It Is To Be Settled At A Future Date.
However, it is entitled to normal sale/ purchase exemption if XYZ:
Intends to settle the contract by taking delivery;
Has no history for similar contracts of settling net in cash, or of taking delivery and selling it within a short period after delivery for the purpose of generating a profit from short-term fluctuations in price or dealer’s margin.
In such a case, contract would be accounted for as an executory contract rather than as a derivative.

39. Embedded derivatives
An embedded derivative is a component of a hybrid (combined) instrument that also includes a non-derivative host contract
An embedded derivative causes some of the cash flows of the combined instrument to vary in a similar way to a stand-alone derivative
Requirements on separation of embedded derivatives retained from Ind AS 109 in relation to Financial Liability
An embedded derivative is attached to a financial instrument and is not contractually transferable independently of that instrument and has the same counterparty

40. Examples of embedded derivatives
Type of contract
Embedded derivative
Bond with interest payments linked to an equity index
Equity-indexed payments
Inflation-indexed lease contract
Inflation-indexed payments
Bond with a call option
Call option
Sales contract in third currency
FX forward

41. Separation of embedded derivatives
Is the hybrid instrument classified as FVTPL?
Separation prohibited
Yes No
Would a separate instrument with the same terms as the embedded derivative meet the definition of a derivative? No
Yes
Are the economic characteristics and risks of the embedded derivative closely related to those of the host contract?
Under IFRS 9, Embedded derivative concept is retained for FL.
Yes No
Separation required ; or
FVTPL classification of entire combined contract in certain circumstances

42. Separation prohibited
Separation of foreign currency embedded derivatives from non-financial instrument contract
Is the embedded foreign currency derivative leveraged or does the hybrid contract contain an option feature? No
Separation prohibited
Are payments denominated in the functional currency of one of the substantial parties to the contract?
Are payments denominated in currency commonly used in contracts to purchase / sell non-financial items in economic environment in which transaction takes place?
Are payments denominated in the currency in which the price of related goods/services are routinely denominated around the world?
Yes No
Yes
Yes No
Yes No
Separation required

43. Accounting for separable embedded derivatives
Is fair value of embedded derivative reliably measurable?
Yes No
Designate the entire hybrid (combined) contract as FVTPL
Determine fair value of embedded derivative directly
Carrying value of host contract is difference between fair value of hybrid contract and embedded derivative
Is fair value of host contract reliably measurable? No
Yes
Determine fair value of embedded derivative indirectly based on difference between fair value of hybrid contract and host contract
The initial bifurcation of an embedded derivative does not result in recognition of a gain or loss

44. Substantial modification of terms Qualitative assessment:
Quantitative 10% assessment: Does net present value of the cash flows under the new terms (including any fees paid / received), discounted using original effective interest rate, differ at least 10% from the present value of the remaining cash flows under the original terms?
yes no
Substantial modification of terms
yes
Qualitative assessment:
Are there substantial differences in terms that by their nature are not captured by the quantitative assessment? no
Continue to recognise
Derecognise

45. Accounting for an extinguishment
A gain or loss is recognised based on the difference between the carrying amount of the financial liability extinguished and the consideration paid
The consideration paid includes non-financial assets transferred and the assumption of liabilities, including the new modified financial liability
Any new financial liability recognised is measured initially at fair value
Any costs or fees incurred are recognised as part of the gain or loss on extinguishment

46. Financial Instruments – Update December 2012
Hedge accounting

47. Hedge accounting
Special accounting used to reflect hedge relationship in the financial statements
Objective is to manage/ smoothen profit of loss
Matches earnings recognition of hedging instruments with that of hedged item
Normal derivative accounting does not apply
At the sacrifice of balance sheet
Designated hedging relationship between hedging instrument and hedged item is required
Ind AS 109 also lays down conditions for documentation and hedge effectiveness

48. Commonly used types of hedging relationship
Fair value hedge
Cash flow hedge
Net investment hedge
Some assets and liabilities have fair value exposures arising from more than one type of risk, e.g. interest rate, credit, foreign currency risk, etc.

49. Examples of fair value hedges
Fixed-rate debt issued by the entity and hedged using a ‘receive fixed/pay floating’ interest rate swap. This protects the fair value of the debt against changes in interest rates.
Equity security hedged with a purchased put option. This protects against a decline in fair value of the security below a pre-determined level (the strike price of the option).
Oil held in inventory and hedged using a six-month oil forward. This protects the fair value of the inventory against changes in the oil price during the six-month period.
(Note all exposures are on balance sheet)
Entities are given an option to treat hedges of the foreign currency exposure of a firm commitment as either a fair value or a cash flow hedge.
Fair value hedges, e.g.
Fixed rate liabilities like loan,
Fixed rate assets like investments in bonds
Investment in equity securities, and
Firm commitments to buy/sell non financial items at a fixed price
Hedges of firm commitment are generally treated as FV hedges. However F/x risk in a firm commitment may be accounted for as FV hedges or cash flow hedges

50. Cash flow hedges
Hedging the exposure to changes in the cash flows attributable to a particular risk associated with a recognised asset, liability, or highly probable forecasted transaction and could affect reported profit or loss
Aims to provide protection from the variability of cash flows arising from market price movements

51. Examples of cash flow hedges
Floating-rate debt issued by the entity and hedged using a "receive floating/pay fixed" interest rate swap. This protects the future interest cash flows to be paid on the debt against changes in interest rates
Forecasted USD foreign currency sales of airline seats in September hedged by a USD/euro forward contract. This protects the euro cash flows to be received from the sales against changes in exchange rates
A firm commitment to buy a machine in six months' time for a fixed USD foreign currency amount hedged by a USD/euro forward contract. This protects the future euro cash flows to be paid against changes in exchange rate
Cash flow hedges
Variable rate liabilities like loans
Variable rate assets like investments in bonds
Highly probable forecast purchase and sale
Hedge of a variable rate debt with a floating to fixed interest rate swap
A hedged forecast transaction must be identified and documented with sufficient specificity so that when the transaction occurs, it is clear whether the transaction is the designated hedged transaction. Hence a forecast transaction may be identified as the sale of the first 15,000 units of a particular product for a particular period. But it could not be identified as the last 15,000 units of that product during that period because the last 15,000 units cannot be identified with sufficient specificity, it could be units 20,001-35,000 or 120, ,000