Integrated Business Solutions (Multidisciplinary Case Study with Strategic Management) · Financial Reporting

Financial Instruments (Ind AS 32, 107, 109) for CA Final

Updated 5 October 2026 · Fact-checked

Financial instruments are contracts that create a financial asset for one party and a financial liability or equity for another. Ind AS 32 classifies and presents them, Ind AS 109 recognises, measures and impairs them, and Ind AS 107 requires disclosure. To solve a question, classify first, then measure, then test impairment or hedging.

Understand Financial Instruments (Ind AS 32, 107, 109)

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. Loans, trade receivables, bonds, shares held, derivatives and preference shares are all examples. Physical items, prepaid expenses and most tax balances are not.

Ind AS 32 answers the presentation question: is the instrument you issued a liability or equity? The test is whether you have a contractual obligation to deliver cash or another financial asset, or to exchange on potentially unfavourable terms. If you cannot avoid that obligation, it is a liability. Mandatorily redeemable preference shares are therefore liabilities. A conversion option that will be settled by a fixed amount of cash for a fixed number of own shares is equity (the fixed-for-fixed condition). A conversion option that does not meet the fixed-for-fixed condition is a derivative financial liability, accounted for at FVTPL, separate from the host liability. A compound instrument, such as a convertible debenture, is split: the liability is the present value of the cash flows at the market rate for similar non-convertible debt, and equity is the residual.

Ind AS 109 has three parts. First, classification of financial assets depends on two tests: the entity's business model (collect contractual cash flows, collect and sell, or other) and whether the cash flows are solely payments of principal and interest (SPPI). Collect plus SPPI gives amortised cost. Collect and sell plus SPPI gives FVTOCI. Everything else is FVTPL. Equity investments are FVTPL by default, with an irrevocable election for FVTOCI if not held for trading. Second, impairment uses the expected credit loss (ECL) model: 12-month ECL at stage 1, lifetime ECL when credit risk has increased significantly (stage 2) or the asset is credit-impaired (stage 3). Trade receivables use a simplified lifetime approach, often a provision matrix. Third, hedge accounting is optional. It matches the gain or loss on the hedging instrument with the hedged item, as a fair value hedge, cash flow hedge or net investment hedge.

Ind AS 107 requires disclosures that let users see the significance of instruments and the nature and extent of credit, liquidity and market risks. It includes categories of assets and liabilities, ECL reconciliations, hedge details and sensitivity analysis.

In the case study paper, the skill is to read the facts, pick the right category and carry the effect into profit or loss, OCI and the balance sheet.

Key rules to remember

Financial asset classification: Hold to collect + SPPI → Amortised cost | Hold to collect and sell + SPPI → FVTOCI | Otherwise → FVTPL; Fair value option at initial recognition can remove an accounting mismatch. It is irrevocable.
Amortised cost: Gross carrying amount closing = Opening gross + Interest at EIR − Cash received (interest and principal). Net carrying amount = Gross carrying amount − Loss allowance; Interest income is opening gross carrying amount × effective interest rate (EIR). For credit-impaired assets in stage 3, apply EIR to the net amount (gross less loss allowance).
Initial measurement: Financial assets/liabilities not at FVTPL: fair value plus (assets) or minus (liabilities) directly attributable transaction costs | FVTPL: fair value, with costs expensed to P&L; Trade receivables without a significant financing component start at transaction price.
ECL: ECL = Σ (Probability of default × Loss given default × Exposure at default), discounted at EIR; Stage 1: 12-month ECL. Stages 2 and 3: lifetime ECL. Trade receivables: simplified lifetime ECL.
Compound instrument split: Liability = PV of cash flows at market rate of similar non-convertible debt; Equity = Proceeds − Liability; Equity portion is not remeasured afterwards. Transaction costs are allocated in proportion.
Equity vs liability test (Ind AS 32): Unavoidable contractual obligation to deliver cash/financial asset → Liability. Fixed-for-fixed own-share settlement → Equity; Substance over legal form. Variable number of shares to settle a fixed value gives a liability.
Cash flow hedge: Cash flow hedge reserve (OCI) = Lower of (absolute cumulative gain/loss on hedging instrument, absolute cumulative change in fair value (present value) of hedged item). Remainder = ineffectiveness → P&L; The lower-of test applies in absolute amounts where the instrument and the hedged item move in opposite directions, as in a working hedge. Any remainder of the instrument's gain or loss is recognised in profit or loss as ineffectiveness. The OCI amount is later reclassified when the hedged item affects profit or loss, or included in the cost of a non-financial asset.
Fair value hedge: Gain/loss on hedging instrument → P&L; Gain/loss on hedged item attributable to hedged risk → adjusts carrying amount and P&L; If the hedged item is an FVTOCI equity investment, both effects go to OCI.

How to solve Financial Instruments (Ind AS 32, 107, 109) questions

Use this order for any financial instrument question. It stops you from jumping to measurement before the classification is settled.

1Identify each instrument and whether you are the holder (asset) or the issuer (liability or equity).
2For issued instruments, apply Ind AS 32: look for an unavoidable obligation to pay cash or a variable share settlement. Split compound instruments.
3For assets, apply the business model test and the SPPI test. Check for equity election or fair value option.
4Measure initially at fair value, adding transaction costs unless the item is FVTPL.
5Subsequently measure: build the effective interest table for amortised cost, or apply fair value changes to P&L or OCI as per category.
6Test impairment: determine stage, then compute 12-month or lifetime ECL. Show the allowance and the P&L charge.
7If a hedge is described, check the designation, documentation and effectiveness conditions, then apply fair value or cash flow hedge entries.
8State the disclosure impact in one line where relevant (Ind AS 107), and conclude with the journal entries and balance sheet effect.

Quickest way: Classify-then-ladder approach

When to use it: Use this for MCQs and for the first part of a written case when time is short.

Underline two phrases in the case: what the entity intends to do with the instrument, and what the cash flows are.
Match them to the classification grid: collect and SPPI, collect and sell, or other.
Ask one question for liabilities: can the issuer avoid paying cash? If not, liability.
For ECL, find the stage first. A significant increase in credit risk or being 30 days past due creates a rebuttable presumption of stage 2. Being 90 days past due creates a rebuttable presumption of default.
For hedges, ask what risk varies: fair value (fair value hedge) or future cash flows (cash flow hedge). Then write the entry.

Common mistakes in Financial Instruments (Ind AS 32, 107, 109)

Classifying a debt instrument only by its legal form or by what the entity prefers.
Students recall the categories but skip the business model and SPPI tests.
Fix: Always state both tests. A bond with a leveraged return or equity-linked payoff fails SPPI and goes to FVTPL even if held to collect.
Treating redeemable preference shares as equity because they are called shares.
Company law terminology overrides substance in the student's mind.
Fix: Apply Ind AS 32. If redemption is mandatory or at the holder's option, there is an unavoidable obligation, so it is a financial liability, and dividends are finance cost.
Computing interest on amortised cost using the coupon rate instead of the effective interest rate.
Coupon is given in the question and looks like the obvious rate.
Fix: Use EIR on the opening carrying amount. Coupon is only the cash received.
Using lifetime ECL for every asset, or 12-month ECL for trade receivables.
The staging model and the simplified approach get mixed up.
Fix: The general approach applies staging. The simplified approach is mandatory for trade receivables and contract assets without a significant financing component, and is a policy choice for those with a significant financing component and for lease receivables.
Recycling gains on FVTOCI equity investments to profit or loss on sale.
The rule for FVTOCI debt instruments is applied to equity.
Fix: For elected FVTOCI equity, gains and losses never go to P&L. Only dividends do. The reserve may be moved within equity. For FVTOCI debt, cumulative gains are reclassified on derecognition.
Taking the full gain on a cash flow hedging derivative to OCI.
Students forget the lower-of test.
Fix: Compare the cumulative change in the derivative with the cumulative change in the hedged item's value. OCI gets the lower absolute amount, and the excess is ineffectiveness in P&L.

Worked examples

Example 1

On 1 April 20X1, Veda Ltd issues 1,000 convertible debentures of ₹1,000 each, at par, for ₹10,00,000. They carry 6% interest payable annually and are redeemable at par after 3 years, or convertible into a fixed number of equity shares at the holder's option. The market rate for similar non-convertible debentures is 10%. Present value factors at 10% for years 1 to 3 are 0.9091, 0.8264 and 0.7513. Ignore transaction costs. Show the classification and split.

Show the solution

Classification: the debentures must be repaid in cash or converted into a fixed number of shares. This is a compound instrument under Ind AS 32 with a liability component and an equity component.
Annual interest = 6% × ₹10,00,000 = ₹60,000.
PV of interest = ₹60,000 × (0.9091 + 0.8264 + 0.7513) = ₹60,000 × 2.4868 = ₹1,49,208.
PV of principal = ₹10,00,000 × 0.7513 = ₹7,51,300.
Liability component = ₹1,49,208 + ₹7,51,300 = ₹9,00,508.
Equity component = ₹10,00,000 − ₹9,00,508 = ₹99,492.
Finance cost for year 1 = 10% × ₹9,00,508 = ₹90,051. Cash interest paid is ₹60,000, so carrying amount at the end of year 1 = ₹9,00,508 + ₹90,051 − ₹60,000 = ₹9,30,559.

Answer: Liability component ₹9,00,508 and equity component ₹99,492 at issue. Year 1 finance cost is ₹90,051 and the closing liability is ₹9,30,559. The equity component is not remeasured.

Example 2

Rao Ltd holds a 5-year bond with a gross carrying amount of ₹50,00,000 in a hold-to-collect business model. Cash flows are solely principal and interest. At the reporting date the issuer's credit rating has fallen sharply, and Rao concludes credit risk has increased significantly since initial recognition, but the bond is not credit-impaired. Estimated lifetime ECL is ₹4,00,000 and 12-month ECL is ₹1,20,000. The opening loss allowance was ₹1,20,000. Show the classification, the stage and the entry.

Show the solution

Classification: hold to collect and SPPI are both met, so the bond is measured at amortised cost.
Stage: credit risk has increased significantly but there is no credit impairment, so this is stage 2. The loss allowance must be lifetime ECL.
Required allowance = ₹4,00,000. Opening allowance = ₹1,20,000.
Additional charge to profit or loss = ₹4,00,000 − ₹1,20,000 = ₹2,80,000.
Entry: Impairment loss (P&L) Dr ₹2,80,000 to Loss allowance Cr ₹2,80,000.
Interest income continues on the gross carrying amount of ₹50,00,000 at the EIR, because the asset is not credit-impaired. Net carrying amount on the balance sheet = ₹50,00,000 − ₹4,00,000 = ₹46,00,000.

Answer: Amortised cost, stage 2. Recognise an additional impairment loss of ₹2,80,000 so the allowance is ₹4,00,000. The net carrying amount is ₹46,00,000, and interest income is still computed on the gross amount.

Exam tips

In case-scenario MCQs, the trap is usually a single phrase such as 'may sell if liquidity is needed' or 'redeemable at the option of the holder'. Read the sentence carefully before choosing.
For written answers, write the provision first (the test), then the facts, then the conclusion. Ind AS 32, 107 and 109 answers are scored this way.
Always show the working for compound instruments and the EIR table. Method marks are given even if a discount factor is misread.
In the integrated paper, link the classification to its effect on reported profit, ratios and covenants. Examiners reward the cross-link to Financial Reporting and Advanced Financial Management.
Do not forget Ind AS 107 in a long case. One line on credit risk disclosures, ECL reconciliation or hedge disclosures can earn a mark.

Practice questions from Financial Reporting

Financial Instruments (Ind AS 32, 107, 109) in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Financial Instruments (Ind AS 32, 107, 109): frequently asked questions

What is the difference between Ind AS 32, 107 and 109?

Ind AS 32 deals with presentation, mainly equity versus liability classification and offsetting. Ind AS 109 covers recognition, classification, measurement, impairment and hedge accounting. Ind AS 107 covers the disclosures about instruments and their risks.

How does the ECL model work in Ind AS 109?

You estimate expected credit losses on financial assets measured at amortised cost or FVTOCI (debt). Stage 1 uses 12-month ECL, and stages 2 and 3 use lifetime ECL. For trade receivables, you can use the simplified approach with lifetime ECL, commonly through a provision matrix.

When is an instrument equity under Ind AS 32?

It is equity when the issuer has no unavoidable contractual obligation to deliver cash or another financial asset. Settlement of a fixed amount through a fixed number of own shares also supports equity. Substance, not legal form, decides.

Is hedge accounting mandatory under Ind AS 109?

No, it is optional. To use it, you must designate and document the hedging relationship and meet the effectiveness requirements. Otherwise, derivatives are measured at FVTPL.