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Standards on financial instruments
February, 22nd 2007
One of the major achievements of AS 30 is that it gives detailed guidelines about accounting and recognising hedging instruments.

After a lull, the Institute of Chartered Accountants of India (ICAI) has decided to issue Exposure Drafts and Re-Exposure Drafts on Accounting Standards. This lull can be attributed to the developments on the international front with the attempt to create a one-size-fits-all accounting standards globally.

What we have on the table is AS-30 (Financial Instruments Recognition and Measurement and Re-exposure Draft), AS 31 (Financial Instruments Presentation); and AS 32 (Financial Instruments Disclosures). A standard on insurance contracts is also on the way which would bring our standards almost on a par with the International Financial Reporting Standards (IFRS), save a few, minor differences in presentation and disclosure. Accounting Standards 2, 11, 21, 23, 26, 27, 28 and 29 will also undergo changes once AS 30 and 31 are officially issued.

AS 30 matches IAS 39 (on recognition and measurement of financial instruments) and IFRS 7 (on disclosure of financial instruments). It starts off by noting that an entity should recognise a financial asset or a financial liability on its balance-sheet only when the entity becomes a party to the contractual provisions of the instrument.

Measuring assets, liability

A financial asset or a financial liability should be measured at fair value on the date of acquisition or issue. Short-term receivables and payables with no stated interest rate should be measured at original invoice amount if the effect of the discounting is immaterial. Other financial assets or liabilities should be measured at fair value, plus or minus transaction costs that are directly attributable to the acquisition or issue of the financial asset/liability.

This marks a change from the first version of the standard wherein fair value was optional. Fair value of the asset or liability has also been defined as the amount for which an asset could be exchanged or a liability settled between knowledgeable willing parties in an arm's length transaction. Even after initial recognition, financial instruments are to be measured at fair values; loans and receivables, however, should be measured at amortised cost using the effective interest method.

Held-to-maturity instruments should also be measured at amortised cost. The Standard also states that investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured, including linked derivatives, should be measured at cost. All financial assets, except those measured at fair value through the profit and loss account, are subject to review for impairment.

The AS goes on to state that an entity should not reclassify a financial instrument into or out of the fair value through profit and loss while it is held or issued. In case it is no longer possible to classify an instrument as held-to-maturity, it should be reclassified as available for sale and re-measured at fair value. A gain or a loss on a financial asset or financial liability classified as at fair value through profit or loss should be recognised in the profit and loss statement.

Also, an entity should assess at each balance sheet date whether there is an objective evidence that a financial asset or group of financial assets is impaired. The standard goes on to illustrate how to recognise impairment losses.

Key achievements

One of the major achievements of the Standard is that it gives detailed guidelines about accounting and recognising hedging instruments including those embedded as derivatives. Till date this was only mentioned in AS 11 (on exchange rate fluctuations).

Hedging instruments these days come in various complexities and the Standard does not disappoint when talking about fair value hedges or cash flow hedges. The derivatives market is also assuming huge proportions in India and it is commendable that we have guidance now instead of waiting for an issue to be thrown up in the form of a scam since derivatives are now closely linked to the stock market in India and then respond by issuing a standard.

In all, the ICAI has attempted to ensure that no loose ends are covered in the case of financial instruments. Read with all the standards as of today, it can be stated that we are almost there in terms of merging with international accounting standards.

Mohan R. Lavi
(The author is a Hyderabad-based chartered accountant.)

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