Financial Reporting · Derivatives and Embedded Derivatives

Reassessment of Embedded Derivatives under Ind AS 109

Updated 5 October 2026 · Fact-checked

Under Ind AS 109, an entity assesses whether an embedded derivative must be separated when it first becomes a party to the contract. It reassesses later only if the contract terms change so that the cash flows otherwise required are significantly modified. Market price changes do not trigger it. Otherwise, the original conclusion stands.

Understand Reassessment of Embedded Derivatives

A hybrid contract has a host and an embedded derivative. The embedded derivative makes some cash flows of the hybrid vary like a stand-alone derivative would. Ind AS 109 asks whether it must be separated from the host and measured at fair value through profit or loss (FVTPL).

If the host is a financial asset within the scope of Ind AS 109, there is no separation. The whole hybrid is classified using the business model and contractual cash flow (SPPI) tests. Separation applies only when the host is a financial liability, or a contract outside Ind AS 109 such as a non-financial host, and the derivative is not closely related to the host.

The timing rule is the key point here. The assessment is made when the entity first becomes a party to the contract. Later changes in market prices, credit spreads or circumstances do not trigger a fresh look. This stops entities from moving items in and out of FVTPL as conditions change.

Paragraph B4.3.11 is the reassessment paragraph. It prohibits later reassessment unless there is a change in the contract terms that significantly modifies the cash flows that would otherwise be required under the contract. Only then is reassessment required. This is the trigger you will meet in almost every question. In case questions, look first for a change in terms and then test whether the cash flows are significantly modified.

For a financial liability, check one more thing first. If the change in terms is a substantial modification, it is treated as extinguishment of the old liability and recognition of a new one (paragraph 3.3.2). It is not a reassessment. The new liability is assessed afresh as at that date, as if the entity had just become a party to it.

If a contract contains one or more embedded derivatives and the host is not an asset within the scope of Ind AS 109, the entity may designate the entire hybrid contract as at FVTPL (paragraph 4.3.5). A financial liability host is the main case for this option. It is not available if the embedded derivative does not significantly modify the cash flows, or if it is clear with little analysis that separation is prohibited. An example of the latter is a prepayment option in a loan whose exercise price is approximately equal to the amortised cost at each exercise date.

Key rules to remember

Timing of assessment: Assess at the date the entity first becomes a party to the contract; Do not assess again because of market price, rate or credit changes.
Reassessment trigger (para B4.3.11): Reassessment is prohibited unless the contract terms change and the cash flows that would otherwise be required are significantly modified. Then it is required.; Both parts are needed. The test compares the cash flows required under the contract before and after the change. A change in market conditions alone is never a trigger. For a financial liability, a substantial modification is treated as extinguishment and a new liability (para 3.3.2), not as a reassessment.
Separation conditions (all three): Separate if: (1) economic characteristics and risks are not closely related to the host, (2) a separate instrument with the same terms meets the definition of a derivative, (3) the hybrid is not measured at FVTPL; If the host is a financial asset within Ind AS 109, skip this test and apply SPPI to the whole asset.
Whole-contract FVTPL option (para 4.3.5): Contract with one or more embedded derivatives and a host that is not an asset within the scope of Ind AS 109: may designate the whole contract at FVTPL; Not available if the embedded derivative does not significantly modify the cash flows, or if it is clear with little analysis that separation is prohibited.
Accounting after separation: Derivative at FVTPL; host by applicable Ind AS; At initial recognition, the host's carrying amount is the hybrid's amount minus the derivative's fair value. On a later reassessment, Ind AS 109 gives no separate host-carrying-amount rule. Account for the host and the derivative from the reassessment date, with the derivative at fair value and the residual amount treated as the host.

How to solve Reassessment of Embedded Derivatives questions

Use this order for any question on reassessment of an embedded derivative. Read the dates and the nature of any change carefully.

1Identify the host contract and the feature that may be an embedded derivative. Note the date the entity became a party.
2Check the host. If it is a financial asset within Ind AS 109, do not separate. Apply the SPPI test to the whole asset.
3If the host is a financial liability or a non-financial contract, test the three separation conditions as at the date of becoming a party.
4Decide the original treatment: separated, not separated, or whole hybrid at FVTPL by choice.
5Identify what changed later. Ask whether it is a change in contract terms or only a change in market conditions.
6If only market conditions changed, conclude that no reassessment is allowed. The original treatment continues.
7If terms changed, first ask whether the change is so significant that it is a substantial modification of a financial liability (para 3.3.2). If so, the old liability is extinguished and a new one is recognised and assessed afresh.
8If it is not an extinguishment, compare the cash flows required before and after. Reassess only if the change significantly modifies them.
9State the accounting result: derivative at FVTPL, host at the applicable measurement, and the effect on profit or loss.

Quickest way: Two-question filter

When to use it: Use when the question gives a change after inception and asks if reassessment is needed.

Question 1: Did the contract terms change? If no, answer 'no reassessment' and stop. A change in market conditions alone never triggers it.
Question 2: Did the change significantly modify the cash flows required under the contract? If no, no reassessment.
If both answers are yes, check for extinguishment of a financial liability first. If there is none, reassess using the original three conditions, but at the date of the change.
Write one line with the paragraph logic: assessed at inception; reassessed only on a significant cash flow change.

Common mistakes in Reassessment of Embedded Derivatives

Reassessing every year-end because interest rates or prices moved.
Students link embedded derivatives with fair value and assume fresh testing at each reporting date.
Fix: Remember that the assessment is once, at inception. Market movements change the fair value of a separated derivative but never trigger a new separation test.
Saying any amendment to the contract triggers reassessment.
The word 'change in terms' is read without the cash flow condition.
Fix: Both parts are needed: a change in terms and a significant modification of cash flows. A minor administrative amendment does not qualify.
Separating an embedded derivative from a financial asset host.
Students apply the liability approach to every hybrid.
Fix: For a hybrid with a financial asset host in the scope of Ind AS 109, classify the whole asset using the business model and SPPI tests. No separation.
Forgetting the whole-contract FVTPL option.
Students think separation is compulsory once the derivative is not closely related.
Fix: Mention the option under para 4.3.5 to designate the whole hybrid at FVTPL when the host is not an asset within the scope of Ind AS 109, with its two limits.
Carrying the derivative at its inception fair value after separation.
Students confuse the initial split with subsequent measurement.
Fix: Measure the separated derivative at FVTPL at each reporting date. The host is measured under its own standard, for example at amortised cost.
Treating a significant amendment of a loan only as a reassessment event.
Students jump to the embedded derivative rule and skip the modification rules.
Fix: For a financial liability, first test the amendment for substantial modification under para 3.3.2. A substantial modification is extinguishment and a new liability, not a reassessment. Reassess the embedded derivative only if the original liability continues.

Worked examples

Example 1

Entity A issued a 5-year debenture on 1 April 2026 with interest linked to the price of gold. The gold-linked return was judged to be an embedded derivative not closely related to the debt host, and it was separated. On 31 March 2027, gold prices rose sharply and the finance head proposes to treat the whole debenture as an ordinary liability at amortised cost. The contract terms have not changed. Advise.

Show the solution

The host is a financial liability, so the separation test applies. It was done at 1 April 2026, the date A became a party to the contract.
The only event since then is a rise in gold prices. This is a change in market conditions, not in contract terms.
Reassessment is allowed only if contract terms change and cash flows are significantly modified. Neither has happened.
So the original conclusion stands. The derivative remains separated.

Answer: The proposal is not acceptable. The embedded derivative continues to be measured at FVTPL, with the fair value change shown in profit or loss at each reporting date. The host is carried at amortised cost.

Example 2

Entity B has a 10-year loan received from a bank, with a fixed interest rate. At inception, B concluded that no separable embedded derivative existed. In year 3, B and the bank amend the contract. Interest becomes linked to the price of crude oil, which changes the cash flows significantly. B assesses that the amendment is not a substantial modification under para 3.3.2, so the loan is not extinguished. The crude-oil link is not closely related to the loan host, and a stand-alone contract with that feature would be a derivative. The hybrid is not designated at FVTPL. Discuss the accounting.

Show the solution

B's original conclusion was valid at inception, when it became a party to the contract.
In year 3, the contract terms changed. The crude-oil link significantly modifies the cash flows that would otherwise have been required.
Because the loan is a financial liability, B first tests the amendment under para 3.3.2. B concludes it is not a substantial modification, so the original loan continues. Had it been substantial, the old loan would be treated as extinguished, a new liability would be recognised and assessed afresh as at that date, and there would be no reassessment of the old loan.
As the original loan continues, the change in terms that significantly modifies the cash flows meets the condition in para B4.3.11. B must reassess the embedded derivative as at the date of the amendment.
Test the three conditions: the crude-oil link is not closely related to the loan host, a stand-alone contract with that feature would be a derivative, and the hybrid is not at FVTPL.
All three are met, so the embedded derivative must be separated. It is recognised at its fair value at the amendment date and measured at FVTPL afterwards. Ind AS 109 gives no separate formula for the host's carrying amount on a later reassessment. From the amendment date, B accounts for the derivative at fair value and treats the residual amount as the host.

Answer: B first tests the amendment for substantial modification under para 3.3.2. Here it is not substantial, so the loan continues. B then reassesses at the amendment date, as para B4.3.11 requires, and separates the crude-oil-linked derivative at fair value, measured at FVTPL afterwards. The residual amount is the host loan, which stays under Ind AS 109 for financial liabilities, normally at amortised cost. If the amendment were substantial, the old loan would be extinguished and the new liability assessed afresh instead.

Exam tips

In theory answers, quote the rule in two parts: assessed on becoming a party, reassessed only for a significant cash flow change.
In case scenarios, first underline the host type. A financial asset host closes the question quickly with the SPPI test.
Separate market changes from term changes in your answer. Examiners often hide the key fact in the wording of the change.
Cover the whole-contract FVTPL option in one line, with its two limits, when the question asks for choices open to the entity.
When a liability's terms are amended, mention the para 3.3.2 modification test before the reassessment.
Always give the result: which item goes to FVTPL, which stays at amortised cost.

Practice questions from Derivatives and Embedded Derivatives

Reassessment of Embedded Derivatives: frequently asked questions

When is reassessment of an embedded derivative required under Ind AS 109?

Reassessment is prohibited unless the contract terms change in a way that significantly modifies the cash flows otherwise required under the contract (paragraph B4.3.11). Then it is required. Changes in market rates or prices do not trigger it. For a financial liability, a substantial modification is treated as extinguishment and a new liability (paragraph 3.3.2), not as a reassessment.

Can an entity measure the whole hybrid contract at FVTPL under Ind AS 109?

Yes. Under para 4.3.5, where the contract contains one or more embedded derivatives and the host is not an asset within the scope of Ind AS 109, the entity may designate the whole contract at FVTPL. It is not allowed if the embedded derivative does not significantly modify the cash flows, or if it is clear with little analysis that separation is prohibited. An example is a loan prepayment option with an exercise price approximately equal to amortised cost.

Does a financial asset host get separated?

No. If the host is a financial asset within the scope of Ind AS 109, the whole hybrid is classified using the business model and SPPI tests. Separation applies to financial liability hosts and to hosts outside the standard.

Where is this rule found in Ind AS 109?

It is in the application guidance on embedded derivatives, around paragraphs B4.3.11 and B4.3.12, which sit alongside the main requirement for embedded derivatives in paragraph 4.3.3. The whole-contract FVTPL option is in paragraph 4.3.5. Read them together before the exam.