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CA Final · Financial Reporting · Derivatives and Embedded Derivatives

Arya Ltd's hybrid contract contains an embedded forward, which is a non-option derivative, and it must be separated. The whole hybrid was acquired for ₹50,00,000. Based on the substantive terms of the contract, a forward rate is implied. Which treatment is correct at initial recognition?

The embedded forward is separated using its stated or implied substantive terms so that it has a fair value of zero at initial recognition. Consequently the host's initial carrying amount is the full ₹50,00,000, as no value is carved out for the derivative.

  1. ASet the forward's terms so that its fair value is zero at initial recognition; the host is then carried at ₹50,00,000Correct
  2. BRecognise the forward at its fair value determined from the option-style stated terms, with the host as residual
  3. CRecognise the forward at the transaction price, with the host reduced by that amount
  4. DDo not separate it, as embedded forwards are always closely related to the host

Explanation

Under B4.3.3 an embedded non-option derivative is separated on the basis of its stated or implied substantive terms so that its fair value at initial recognition is zero. No amount is carved out, so the host residual equals the full ₹50,00,000. Option B applies to option-based derivatives, not forwards.

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