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CA Final · Financial Reporting · Derivatives and Embedded Derivatives

Vishwa Textiles Ltd enters into a hybrid contract whose host is not an asset within the scope of Ind AS 109 and which contains an embedded forward. The forward is to be separated from the host. Under Ind AS 109, how should the embedded non-option derivative be separated at initial recognition?

An embedded forward or swap is separated using its stated or implied substantive terms so that its fair value at initial recognition is zero. The host contract then carries the residual amount. Stated-terms separation with a non-zero value applies to option-based derivatives instead.

  1. AOn the basis of its stated or implied substantive terms, so that it has a fair value of zero at initial recognitionCorrect
  2. BOn the basis of the stated terms so that it has a fair value equal to the premium paid at inception
  3. CAt whatever amount makes the host instrument carry its face value at initial recognition
  4. DAt its intrinsic value on the date the contract is entered into, with the host as the residual

Explanation

Ind AS 109 (B4.3.3) says an embedded non-option derivative such as a forward or swap is separated on the basis of its stated or implied substantive terms so that its fair value is zero at initial recognition. The host takes the residual amount. Separating it on stated terms with a premium is the treatment for option-based derivatives, not forwards.

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