FINANCIAL INSTRUMENTS: RECOGNITION AND

MEASUREMENT (AS-30)PART- II

Accounting for financial asset – Recognition

When to recognize?

On balance sheet date andWhen the entity becomes party to the contractual provisions of the instrumentFor example: an entity becomes party to contractual provisions when it commits to purchase securities or to write derivative option.

Planned but not committed future transactions, no matter how likely they may be, are not financial assets or liabilities.For example: an entity’s estimated but uncommitted sales do not qualify as financial assets or liabilities.

Timing of recognition of financial assetIt depends on whether the accounting is done by• Trade date• Settlement date.

Trade date accounting:

Financial asset purchased is recognized on the trade date along with simultaneous recognition of related liability to pay for it.

Financial asset sold is derecognized on trade date along with recognition of gain/loss on sale of that asset and related receivables.

If the financial asset is interest bearing instrument like debt or bond, interest does not accrue on and from trade date.

Settlement date accounting:

Financial asset purchased is recognized on settlement date along with simultaneous recognition of liability to pay for it

Financial asset sold is derecognized on settlement date along with recognition of gain/loss on sale of that asset and related receivables.

An important issue is the accounting treatment of fair value change between the trade date and settlement date.

Example: A ltd purchases a financial asset as on 29th March 2012 for Rs 100 lakh. The fair value of the asset on 31st March 2012 (year end) and 2nd April 2012 (settlement date) are Rs 105 lakh and Rs 103 lakh respectively. Accounting treatment of the transaction would depend upon classification of the financial asset.

Trade date accounting:Date HTM investment

carried at amortized cost

AVS asset re-measured at fair value with changes in equity

Assets at FVTPL re-measured at fair value with changes in P&L

29th March 2012Financial Asset Dr to Financial liability

100100

100100

100100

31st March 2012Financial Asset Dr to P&L A/c

55

Financial Asset DrTo fair value reserve A/c

55

2nd April 2012P&L A/c DrTo financial asset

22

Fair value reserve DrTo financial asset

22

Financial liability DrTo cash

100100

100100

100100

Settlement date accounting:

Date HTM investment carried at amortized cost

AVS asset re-measured at fair value with changes in equity

Assets at FVTPL re-measured at fair value with changes in P&L

29th March 2012 No entry on trade date

No entry on trade date

No entry on trade date

31st March 2012Receivables Dr to P&L A/c

55

Receivables DrTo fair value reserve A/c

55

2nd April 2012Financial Asset DrTo Financial liability/cash

100100

Financial Asset DrFair value reserve A/c Dr To financial liability/cash To Receivable

103 2100 5

Financial Asset DrFair value reserve A/c Dr To financial liability/cash To Receivable

103 2100 5

Initial and subsequent recognition and measurement of financial assets:

A financial asset or financial liability at FVTPL should be measured at fair value on the date of acquisition or issue.

Short-term receivables and payable with no stated interest rate should be measured at invoice amount if the effect of discounting is immaterial.

Other financial asset or financial liability should be measured at fair value plus/minus transaction costs that are directly attributable to the acquisition or issue of financial asset or liability.

Fair value:It is the amount at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.Fair value hierarchy can be followed as under:Active market- quoted priceNo active market- valuation techniques- DCF, option pricing modelNo Active market- equity investment less impairment loss

Fair value concept presumes that the entity is a going concern. Therefore fair value is not an amount that an entity would receive or pay in a forced transaction, involuntary liquidation or distress sale.

Transaction cost:

Transaction costs are the incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability.

The various transaction costs that an entity incurs in issuing financial instrument might include:

Registration and other regulatory fees

Printing costs

Stamp duty

Transaction cost of an equity transaction which are directly attributable to it and are incremental will be deducted from equity.

Accounting and measurement of financial

asset

Category of financial assets

Measurement at initial recognition

Measurement at subsequent reporting date

Impairment test (if objective evidence)

FVTPLAll stand-alone derivatives come here

At fair value, on acquisition date, which is acquisition price.Directly attributable transaction cost is charged to profit and loss A/c separately

At fair valueChange in fair value between two reporting dates is charged/credited to profit and loss A/c directly

No

click here for example

Available for sale At fair value, on acquisition date, which is acquisition price plus transaction costs that are directly attributable to acquisition or issue of financial asset

At fair value Change in fair value between two reporting dates is charged/credited to a separate component of equity, say, investment valuation reserve

Yes

Click here for example

Category of financial assets

Measurement at initial recognition

Measurement at subsequent reporting date

Impairment test (if objective evidence)

Held to maturity At fair value, on acquisition date, which is acquisition price plus transaction costs that are directly attributable to acquisition or issue of financial asset

At amortized cost applying effective interest rate.

Yes

Click here for example

Loans and receivable Short term receivable with no stated interest rate should be measured at original invoice amount if the effect of discounting is immaterial. Other items at fair value, on acquisition date, which is acquisition price plus transaction costs that are directly attributable to acquisition or issue of financial asset

At amortized cost applying effective interest rate.

Yes

Click here for example

Category of financial assets

Measurement at initial recognition

Measurement at subsequent reporting date

Impairment test (if objective evidence)

Financial assets, fair value of which can not be reliably measured

At cost At cost Yes

Click here to go to next slide

Example: Held for trading securities (FVTPL)A ltd began operations on January 1, 2012. during the year A ltd purchased various marketable equity securities. The cost and fair value of these securities at the end of 2012 were as follows:

Face value cost Marketloss gain

P ltd Rs. 10 2000 2500 500Q ltd Rs. 10 3000 2600 400R ltd Rs. 10 1000 1200 200S ltd Rs. 10 1500 1350 150

7500 7650 550 700

Unrealised

Solution:Adjusting entry Valuation Allowance Dr 150 (7650-7500) To Profit and Loss A/c 150 Debit balance in Valuation Allowance A/c indicates fair value is larger than cost and credit balance indicates fair value is less than cost.

Dr. (Cr.)Trading securities A/c (cost) 7500Valuation Allowance 150Trading securities at fair value 7650

A ltd’s securities would be reported on its December 31, 2012 balance sheet in the Current asset section at their fair value of Rs 7650.

Click here to go back

Example: Available for saleAssume same information as given in previous example except that the securities qualify as available for sale.

Solution: Adjusting entry Valuation Allowance Dr 150 (7650-7500) To Investment valuation reserve A/c 150

Investment valuation reserve account is included in the stockholder’s equity section of the balance sheet.

A ltd’s available for sale securities would be reported on it’s December 31, 2012 balance sheet at their fair value of Rs 7650. Each security would be evaluated to determine whether it should be classified in current asset or in non-current assets. Those that are expected to be sold within the next year should be included in current assets. The others should be included in non-current assets.

Click here to go back

Example: Held to MaturityOn January 1, year 1, A ltd purchased Rs 100000 face value , 3 year, 8% bonds of B ltd for Rs 94924 which provides an effective interest rate of 10%. The bonds pay interest semi-annually on June 30 and December 31.Solution:

Cash interest is to be calculated on face value and effective interest is to be calculated on previous amortized cost.

date cash interest effective interest Discount Carrying value of bonds (4% semi annually) (5% semi annually) Amortization or amortized cost

01/01 Yr 1 9492430/06 Yr 1 4000 4746 746 9567031/12 Yr 1 4000 4784 784 9645430/06 Yr2 4000 4823 823 9727631/12 Yr 2 4000 4864 864 9814030/06 Yr 3 4000 4907 907 9904731/12 Yr 3 4000 4952 952 100000

Amortized schedule -effective interest method

Entries for the first year and maturity date:

01/01/yr 1Investment in bonds Dr 94924 To Cash 94924(initial recording at fair value)

30/06/Yr 1Cash Dr 4000Investment in bonds Dr 746 To Interest income 4746

31/12/Yr 1 Cash Dr 4000Investment in bonds Dr 784 To Interest income 4784

31/12/Yr 3Cash Dr 4000Investment in bonds Dr 952 To Interest income 4952

Cash Dr 100000 To Investment in binds 100000

Click here to go back

Example: Loans and receivable

A ltd grants Rs 10 lakhs loan to its employees on January 1, 2012 at a concessional interest rate of 4% p.a. Loan is to be repaid in five equal annual installments along with interest. Market rate of interest for such loan is 10% p.a. At what value loan should be recognized initially and also calculate the amortized cost for all the subsequent five years.

Solution:(a) Calculation of initial recognition amount of loan that will be discounted present value

of future cash flows from re-payment of the loan

Year end Total Discount factor Discounted Principal Interest At 10% value

2012 200000 40000 240000 0.9090 2181602013 200000 32000 232000 0.8263 1917022014 200000 24000 224000 0.7512 1682692015 200000 16000 216000 0.6829 1475062016 200000 8000 208000 0.6208 129126

854763

Cash in flows

Present value or Fair value

Entries 1/1/2012Staff loan A/c Dr 1000000 To Bank 1000000

Staff cost A/c Dr 145267 (1000000-854763) To staff loan 145267 (loan will be initially recognized at its fair value i.e. Rs 854763 and balance amount will be debited to staff cost)

(b) Calculation of amortized cost at the end of each year

Year Balance Interest to be Re-payment Amortized costrecognized (10%) (including interets)

2012 854763 85476 240000 7002392013 700239 70024 232000 5382632014 538263 53826 224000 3680902015 368090 36809 216000 1888992016 188899 18890 208000 NIL

Entry for 2012

Staff loan A/c Dr 85476 To Interest on staff loan 85476

Bank A/c Dr 240000 To staff loan 240000

Interest on staff loan Dr 85476 To Profit & Loss A/c 85476

Click here to go back

IF YOU HAVE ANY SUGGESTION, OPINION OR FEEDBACK PLEASE FEEL FREE TO WRITE US AT roshankumar.2007@rediffmail.com

ROSHANKUMAR

Roshankumar S Pimpalkar