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CA Final · Financial Reporting · Derivatives and Embedded Derivatives

Kaveri Industries holds a hybrid contract whose host is not an asset within Ind AS 109. The contract has an embedded forward whose substantive terms are stated, and a separate embedded put option feature. On separating the embedded forward from the host, how must the forward be set up at initial recognition?

An embedded non-option derivative like a forward is separated using its stated or implied substantive terms so that it has a fair value of zero at initial recognition, and the host instrument carries the residual amount.

  1. ASeparated on its stated or implied substantive terms so that its fair value at initial recognition is zeroCorrect
  2. BSeparated so that it carries a fair value equal to the premium implied by the option feature
  3. CSeparated at the entire contract price, leaving the host at nil
  4. DSeparated at an amount that makes the host equal to its face value

Explanation

An embedded non-option derivative such as a forward or swap is separated on its stated or implied substantive terms so that its fair value at initial recognition is zero. The host takes the residual amount. Choosing a non-zero value for the forward would misstate the host's residual carrying amount.

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