Accounting of Financial Instruments: formula sheet

Key formulas

Financial instrument

Financial instrument = contract → financial asset (one entity) + financial liability or equity instrument (another entity)

No contract, no financial instrument. Statutory dues fail this test.

Financial asset test

Cash | equity instrument of another entity | contractual right to receive cash or another financial asset | contractual right to exchange on favourable terms

Prepayments for goods or services are not financial assets.

Financial liability test

Contractual obligation to deliver cash or another financial asset, or to exchange on unfavourable terms

Obligations settled by delivering goods or services are not financial liabilities.

Equity instrument test

Residual interest = assets − all liabilities

Ind AS 32 decides liability versus equity. Ind AS 109 does not apply to the issuer's own equity.

Equity issued to extinguish a liability

Gain or loss in profit or loss = carrying amount of liability extinguished − consideration paid (equity instruments measured at the extinguishment date)

If the fair value of equity cannot be reliably measured, measure the equity to reflect the fair value of the liability extinguished. This does not apply where the creditor acts as an existing shareholder, where creditor and entity are under common control and the substance is a distribution or contribution, or where the original terms provide for settlement in equity shares.

Role of each standard

Ind AS 32 = presentation | Ind AS 109 = recognition and measurement | Ind AS 107 = disclosure

Name the correct standard in your answer.

Liability test

Contractual obligation to deliver cash or another financial asset → financial liability; no such obligation → equity

Apply it to the contract terms, not to the name of the instrument.

Liability component

Liability = present value of interest and principal at the market rate for similar non-convertible debt

Includes any embedded non-equity derivative features, as per Ind AS 32 paragraph 32.

Equity component (residual)

Equity = Fair value of whole instrument (issue proceeds) − Fair value of liability component

Fixed once at issue and not remeasured later.

Effective interest on liability

Finance cost = Opening liability × effective interest rate; Closing liability = Opening + Finance cost − Cash interest paid

The effective rate is the market rate used to discount at issue.

Debt for equity swap (Ind AS 109 Appendix D)

Gain or loss in P&L = Carrying amount of liability extinguished − Fair value of equity instruments issued

Equity is measured at the date of extinguishment. If its fair value cannot be reliably measured, use the fair value of the liability extinguished.

Amortised cost conditions (para 4.1.2)

Business model = hold to collect contractual cash flows AND cash flows are solely payments of principal and interest (SPPI)

Both conditions must be met. Result: amortised cost.

FVOCI conditions (para 4.1.2A)

Business model = achieved by both collecting contractual cash flows and selling AND cash flows are SPPI

Both conditions must be met. Result: FVOCI for debt-type assets.

Residual category

Not amortised cost and not FVOCI → FVTPL

Includes assets in a trading or other model, and assets failing SPPI.

Level of business model assessment

Portfolio level, not instrument by instrument

One entity can have several business models (para B4.1.2).

Reclassification (para B5.6.1)

Reclassification is applied prospectively from the reclassification date

No restatement of previously recognised gains, losses or interest.

FVOCI to amortised cost (para 5.6.5)

Reclassify at fair value on that date; remove cumulative OCI gain or loss from equity and adjust against the asset's fair value

Asset is measured as if always at amortised cost. Profit or loss is not affected. EIR and ECL are not adjusted.

Initial measurement (not at FVTPL)

Financial asset = Fair value + transaction costs; Financial liability = Fair value − transaction costs

Para 5.1.1 of Ind AS 109 adds or deducts transaction costs only for items not at FVTPL. For items at FVTPL, expense transaction costs in profit or loss immediately.

Interest under the effective interest method

Interest = Opening gross carrying amount × EIR (credit-impaired assets: Opening amortised cost × EIR)

Use the gross carrying amount normally (para 5.4.1). For an asset that became credit-impaired after initial recognition, use amortised cost, net of the loss allowance, in subsequent periods (para 5.4.1(b)). Revert to gross carrying amount if the asset is no longer credit-impaired (para 5.4.2).

Closing carrying amount

Closing = Opening + Interest (EIR) − Cash received or paid (coupon, principal)

Repeat each year. The final closing balance should equal the redemption amount.

Effective interest rate (definition)

Σ [Cash flow ÷ (1 + EIR)^t] = Initial carrying amount

Cash flows include integral fees and transaction costs but ignore expected credit losses. Solve by trial and interpolation if not given.

Amortisation of discount or premium

Amortisation = EIR interest − coupon paid

A positive difference increases the carrying amount (discount); a negative difference reduces it (premium).

FVOCI debt instrument at year end

OCI = Fair value − Amortised cost (after interest accrual)

For a performing asset, interest = EIR × gross carrying amount (amortised cost before any loss allowance), worked out without regard to fair value, and goes to profit or loss. Only the fair value adjustment goes to OCI. Cumulative OCI is reclassified to profit or loss on derecognition.

Amortisation period for floating rate items

Period = Time to next repricing date

Applies if the premium or discount relates to market rate changes. If it arises from a credit spread change, amortise over the expected life (para B5.4.4).

Expected credit loss (single exposure)

ECL = Exposure at default × Probability of default × Loss given default

A common working form. Discount to the reporting date at the effective interest rate if cash-flow timing is given. For 12-month ECL use the probability of default within 12 months; for lifetime ECL use the probability over the remaining life.

Cash-shortfall form of ECL

ECL = Σ (probability of each scenario × PV of cash shortfall in that scenario)

ECL is a probability-weighted amount. Cash shortfall = contractual cash flows − cash flows expected to be received.

Provision matrix

Loss allowance = Σ (gross receivables in each ageing bucket × loss rate for that bucket)

Para B5.5.35 allows this as a practical expedient. Rates come from historical experience, adjusted for current and forward-looking information.

Stage rule (general approach)

Stage 1: 12-month ECL | Stage 2 and Stage 3: lifetime ECL

Stage 2 is triggered by a significant increase in credit risk since initial recognition. Stage 3 means credit-impaired.

Simplified approach rule

Trade receivables/contract assets without significant financing component: always lifetime ECL (para 5.5.15)

With a significant financing component, and for lease receivables, lifetime ECL applies if the entity chooses it as an accounting policy.

Income statement effect

Impairment loss/gain = Closing loss allowance − Opening loss allowance (before write-offs)

The change is recognised in profit or loss at each reporting date as an impairment gain or loss. Para 5.5.14 states this specifically for purchased or originated credit-impaired assets, where even favourable changes in lifetime ECL are recognised as an impairment gain. Allowance is a deduction from gross carrying amount for assets at amortised cost.

When to derecognise a financial asset (para 3.2.3)

Derecognise only when (a) cash flow rights expire, or (b) the asset is transferred and the transfer qualifies under 3.2.6

Both limbs are 'when, and only when'. A transfer that fails 3.2.6 gives no derecognition.

Risks and rewards test (para 3.2.6)

Substantially all transferred → derecognise | Substantially all retained → continue to recognise | Neither → test control

Control test: control not retained → derecognise; control retained → recognise to extent of continuing involvement.

Transfer not qualifying (para 3.2.15)

Continue to recognise the asset in full + recognise a financial liability for consideration received

Later, show income on the asset and expense on the liability separately. Do not net them.

Continuing involvement: guarantee (para 3.2.16(a))

Extent = lower of (asset amount, maximum consideration received that could be required to be repaid)

The second amount is the guarantee amount.

Continuing involvement: options (para 3.2.16(b))

Extent = amount of the transferred asset that the entity may repurchase

For a written put on an asset measured at fair value, extent is limited to the lower of fair value of the asset and option exercise price.

Part-asset continuing involvement (para 3.2.20)

Gain/loss = Consideration received for part no longer recognised − carrying amount allocated to that part

Allocate the previous carrying amount between the parts on the basis of relative fair values at the transfer date. The difference goes to profit or loss.

Liability settled with equity (Appendix D, para 9)

P&L = Carrying amount of liability extinguished − fair value of equity instruments issued (consideration paid)

Equity is measured at the date the liability is extinguished. A positive result is a gain.

Option moneyness (B3.2.16)

Deeply in the money → keep asset | Deeply out of the money → derecognise | Fair value exercise price → derecognise

Applies to deeply in-the-money call or put options. Readily obtainable asset with an option neither deep in nor out: derecognise.

Fair value hedge entry

Dr/Cr Hedging instrument (derivative) and Cr/Dr P&L; Dr/Cr Hedged item carrying amount and Cr/Dr P&L

Both changes go to P&L. Net P&L effect is the ineffectiveness.

Cash flow hedge reserve

OCI = lower of (cumulative gain/loss on hedging instrument) and (cumulative change in PV of expected future cash flows of hedged item), in absolute amounts

Any excess on the hedging instrument is ineffectiveness, recognised in P&L.

Hedge ineffectiveness

Ineffectiveness = change in hedging instrument value − change in hedged item value (on the hedged risk)

Para 24C(a)(i) of Ind AS 107 describes it as the difference between the hedging gains or losses of the instrument and the hedged item.

Net position hedge

Net position = FC120 purchase commitments − FC100 sale commitments = FC20 net purchase position, hedged by a forward exchange contract for FC20

Para B6.6.5: compare (a) the forward's fair value change together with the foreign currency risk related changes in the FC100 sale commitments, against (b) the foreign currency risk related changes in the FC120 purchase commitments. For a cash flow hedge of highly probable forecast items, para B6.6.9 uses the same comparison. The changes in the forecast sales are recognised only once the sales are recognised; until then only amounts related to the forward are recognised.

Forward element

Transaction-related item: forward element is part of the cost of the transaction. Time-period-related item: forward element is amortised over the hedge period

Applies when the forward element is excluded from designation and its changes go to OCI (paras 6.5.16, B6.5.34).

Effectiveness criteria (para 6.4.1(c))

Economic relationship + credit risk not dominant + hedge ratio matches actual quantities

Plus formal designation and documentation at inception.

Offsetting test (Ind AS 32)

Offset only if: (1) legally enforceable right to set off AND (2) intention to settle net OR realise asset and settle liability simultaneously

Both parts are needed. A right alone, or an intention alone, is not enough (para 46).

Simultaneous settlement

Treated as simultaneous only when transactions occur at the same moment

Para 48. Short delays create credit or liquidity exposure, so net presentation fails.

Scope of offsetting disclosures

Ind AS 107 paras 13B–13E apply to: instruments set off under Ind AS 32 para 42 + instruments under an enforceable master netting arrangement or similar agreement

Master netting instruments are covered even if not set off (paras 13A, B40).

Liquidity risk definition

Risk of difficulty in meeting obligations on financial liabilities settled by delivering cash or another financial asset

From Appendix A of Ind AS 107.

Measurement differences in offsetting disclosure

Show instruments at recognised amounts and describe measurement differences

Para B42. Example: a repo payable at amortised cost against a derivative at fair value.

Quick revision

• Ind AS 32 covers presentation; Ind AS 109 covers recognition and measurement; Ind AS 107 covers disclosure.
• Financial liabilities are measured at amortised cost unless an exception in Ind AS 109 applies.
• Exceptions include FVTPL liabilities, failed-derecognition liabilities, financial guarantees, below-market loan commitments and contingent consideration.
• Contingent consideration in a business combination is at fair value, with changes in profit or loss.
• Interest revenue = effective interest rate × gross carrying amount, except for credit-impaired assets.
• For a credit-impaired asset that was not so at origination, apply the effective interest rate to amortised cost.
• Equity issued to extinguish a liability is consideration paid and is measured at fair value, unless that cannot be reliably measured.
• The gain or loss on extinguishment is the carrying amount of the liability less the consideration paid, taken to profit or loss.
• Multiple embedded derivatives are generally treated as one compound derivative, with exceptions for equity-classified or independent risks.
• Remove a financial liability only when it is extinguished.
• Write the journal entry for every date in hedge and derecognition problems.

Common mistakes

• Treating income tax payable or GST payable as a financial liability. Fix: Check for a contract. Statutory obligations are not contractual, so they fall outside the financial instrument definition.
• Treating advances paid to suppliers or prepaid expenses as financial assets. Fix: The future benefit is goods or services, not cash. These are not financial assets.
• Classifying by name, calling every preference share equity. Fix: Check for a contractual obligation to redeem or pay. Mandatory redemption makes it a liability.
• Discounting at the coupon rate instead of the market rate for similar non-convertible debt. Fix: Use the market rate for debt without the conversion option. The coupon is only used to compute the cash interest.
• Classifying each instrument by management's intention for that one instrument. Fix: The business model is set at a higher level of aggregation. It does not depend on intentions for an individual instrument (para B4.1.2).
• Applying only the business model test and skipping SPPI. Fix: Both tests are required (para 4.1.1). An asset failing SPPI goes to FVTPL even in a hold-to-collect portfolio.
• Calculating interest at the coupon rate instead of the EIR Fix: Interest in P&L is always opening carrying amount × EIR. The coupon is only the cash paid. The difference is amortisation.
• Ignoring transaction costs in the initial amount Fix: For items not at FVTPL, add costs to an asset and deduct them from a liability (para 5.1.1). The EIR is then calculated on that adjusted amount.
• Applying 12-month ECL to trade receivables without a significant financing component. Fix: For these receivables, para 5.5.15 requires lifetime ECL always. Do not assign stages.
• Treating the provision matrix as a mandatory method. Fix: It is a practical expedient allowed if consistent with the ECL principles. Say it is a permitted expedient.

Exam tips

• In MCQs, the trap is usually a non-contractual item (tax, statutory dues) or a prepayment or deferred income. Test for a contract and cash settlement first.
• Memorise the Ind AS 109 exclusion list and its carve-backs, such as lessor receivables and lessee derecognition.
• State the standard by number in written answers. Examiners reward the correct link between topic and standard.
• For equity-for-debt questions, check the scope exclusions before computing the gain or loss.
• Give a one-line reason with every classification. A bare label earns fewer marks.
• In MCQs, look for the words 'must redeem', 'at the option of the holder' or 'discretionary'. They usually decide the answer.
• Always show the working of the liability component first. Marks are given for the discount factors and the residual equity step.
• Use the market rate for the finance cost. Examiners often give the coupon rate as a trap.