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CA Final · Financial Reporting · Derivatives and Embedded Derivatives

Bharat Polymers Ltd holds a host contract with an embedded option-based derivative, a purchased cap, that must be separated. At initial recognition, the whole hybrid contract has a fair value of ₹10,00,000, and the cap, valued on its stated terms, has a fair value of ₹1,80,000. How is the initial carrying amount of the host determined, and what is it?

The host's initial carrying amount is ₹8,20,000. An embedded option such as a cap is separated on the basis of its stated terms at fair value of ₹1,80,000, and the host is the residual amount: ₹10,00,000 less ₹1,80,000.

  1. A₹10,00,000, since the host retains the full contract price
  2. B₹8,20,000, being the residual after separating the embedded derivative at its fair valueCorrect
  3. C₹11,80,000, by adding the cap's fair value to the contract price
  4. D₹8,20,000, but only after setting the cap's fair value at zero

Explanation

For an embedded option-based derivative, separation is based on the stated terms of the option, so it is initially measured at fair value (₹1,80,000). The host carrying amount is the residual: 10,00,000 - 1,80,000 = ₹8,20,000. Setting the value at zero applies to non-option derivatives, so D is wrong.

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