Measurement and Effective Interest Method under Ind AS 109

Understand Measurement and Effective Interest Method

Key rules to remember

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).

How to solve Measurement and Effective Interest Method questions

1. 1Identify the instrument and its classification: amortised cost, FVOCI or FVTPL. Check whether it is an asset or a liability.
2. 2Compute the initial carrying amount: fair value, plus transaction costs for an asset, less transaction costs for a liability. For FVTPL, expense the costs.
3. 3Write down all contractual cash flows with dates: coupon, principal, premium on redemption. Ignore expected credit losses for the EIR.
4. 4Find the EIR. Use the rate given in the question, or solve by trial so that the PV of cash flows equals the initial carrying amount.
5. 5Build the amortisation table with columns: opening balance, interest at EIR, cash paid or received, closing balance. Check that the last closing balance equals the redemption amount.
6. 6Pass the journal entries: initial recognition, transaction costs, yearly interest accrual, cash receipt or payment, and fair value changes in OCI or P&L as per classification.
7. 7For FVOCI or FVTPL, compare fair value with the carrying amount at year end and take the difference to OCI or profit or loss. State the closing carrying amount clearly.

Quickest way: Table-first method for EIR problems

Common mistakes in Measurement and Effective Interest Method

• Calculating interest at the coupon rate instead of the EIR

  The coupon rate is printed on the instrument and looks like the interest rate.

  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

  Students start from the issue price or the face value.

  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.

• Capitalising transaction costs on an FVTPL asset

  Students apply the general rule without checking the classification.

  Fix: For FVTPL assets, record the asset at fair value and charge the costs to profit or loss immediately.

• Calculating FVOCI interest on fair value

  Students think a fair-valued asset earns interest on fair value.

  Fix: For a performing asset, interest income is the EIR × the gross carrying amount (amortised cost before any loss allowance) and goes to P&L. Fair value moves only affect OCI, measured against amortised cost.

• Deducting the sale commission when measuring fair value at year end

  Students think the net realisable amount is the right value.

  Fix: Measure at fair value without regard to possible commission on sale. The Ind AS 109 illustration (para B5.2.2) for an FVOCI asset bought for Rs.100 plus Rs.2 commission measures it at Rs.100 at year end, recognising a Rs.2 loss in OCI, even though Rs.3 would be paid on sale. If the asset is a debt instrument at FVOCI under para 4.1.2A, the Rs.2 transaction cost is also amortised to profit or loss using the EIR.

• Including expected credit losses in the EIR calculation

  Students confuse EIR with impairment accounting.

  Fix: The EIR uses contractual cash flows, including options such as prepayment, but does not consider expected credit losses. Loss allowances are separate.

Worked examples