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  • 1. Accounting for financial asset – Recognition When to recognize? On balance sheet date and When the entity becomes party to the contractual provisions of the instrument For example: an entity becomes party to contractual provisions when it commits to purchase securities or to write derivative option. Planned but not committed future transactions, no matter how likely they may be, are not financial assets or liabilities. For example: an entity’s estimated but uncommitted sales do not qualify as financial assets or liabilities. Timing of recognition of financial asset It depends on whether the accounting is done by •Trade date •Settlement date.
  • 2. Trade date accounting: Financial asset purchased is recognized on the trade date along with simultaneous recognition of related liability to pay for it. Financial asset sold is derecognized on trade date along with recognition of gain/loss on sale of that asset and related receivables. If the financial asset is interest bearing instrument like debt or bond, interest does not accrue on and from trade date. Settlement date accounting: Financial asset purchased is recognized on settlement date along with simultaneous recognition of liability to pay for it Financial asset sold is derecognized on settlement date along with recognition of gain/loss on sale of that asset and related receivables.
  • 3. An important issue is the accounting treatment of fair value change between the trade date and settlement date. Example: A ltd purchases a financial asset as on 29th March 2012 for Rs 100 lakh. The fair value of the asset on 31st March 2012 (year end) and 2nd April 2012 (settlement date) are Rs 105 lakh and Rs 103 lakh respectively. Accounting treatment of the transaction would depend upon classification of the financial asset.
  • 4. Trade date accounting: Date 29th March 2012 Financial Asset Dr to Financial liability HTM investment carried at amortized cost AVS asset remeasured at fair value with changes in equity Assets at FVTPL remeasured at fair value with changes in P&L 100 100 100 100 100 100 31st March 2012 Financial Asset Dr to P&L A/c 5 5 Financial Asset Dr To fair value reserve A/c 5 5 2nd April 2012 P&L A/c Dr To financial asset 2 2 Fair value reserve Dr To financial asset Financial liability Dr To cash 2 2 100 100 100 100 100 100
  • 5. Settlement date accounting: Date HTM investment carried at amortized cost AVS asset remeasured at fair value with changes in equity Assets at FVTPL remeasured at fair value with changes in P&L 29th March 2012 No entry on trade date No entry on trade date No entry on trade date 31st March 2012 Receivables Dr to P&L A/c 5 5 Receivables Dr To fair value reserve A/c 2nd April 2012 Financial Asset Dr To Financial liability/cash 5 5 100 100
  • 6. Financial Asset Dr Fair value reserve A/c Dr To financial liability/cash To Receivable Financial Asset Dr Fair value reserve A/c Dr To financial liability/cash To Receivable 103 2 100 5 103 2 100 5
  • 7. Initial and subsequent recognition and measurement of financial assets: A financial asset or financial liability at FVTPL should be measured at fair value on the date of acquisition or issue. Short-term receivables and payable with no stated interest rate should be measured at invoice amount if the effect of discounting is immaterial. Other financial asset or financial liability should be measured at fair value plus/minus transaction costs that are directly attributable to the acquisition or issue of financial asset or liability. Fair value: It is the amount at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. Fair value hierarchy can be followed as under: Active market- quoted price No active market- valuation techniques- DCF, option pricing model No Active market- equity investment less impairment loss Fair value concept presumes that the entity is a going concern. Therefore fair value is not an amount that an entity would receive or pay in a forced transaction, involuntary liquidation or distress sale.
  • 8. Transaction cost: Transaction costs are the incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. The various transaction costs that an entity incurs in issuing financial instrument might include: Registration and other regulatory fees Printing costs Stamp duty Transaction cost of an equity transaction which are directly attributable to it and are incremental will be deducted from equity.
  • 9. Category of financial assets Measurement at initial recognition Measurement at subsequent reporting date Impairment test (if objective evidence) FVTPL All stand-alone derivatives come here At fair value, on acquisition date, which is acquisition price. Directly attributable transaction cost is charged to profit and loss A/c separately At fair value Change in fair value between two reporting dates is charged/credited to profit and loss A/c directly No Available for sale At fair value, on acquisition date, which is acquisition price plus transaction costs that are directly attributable to acquisition or issue of financial asset At fair value Change in fair value between two reporting dates is charged/credited to a separate component of equity, say, investment valuation reserve Yes click here for example Click here for example
  • 10. Category of financial assets Measurement at initial recognition Measurement at subsequent reporting date Impairment test (if objective evidence) Held to maturity At fair value, on acquisition date, which is acquisition price plus transaction costs that are directly attributable to acquisition or issue of financial asset At amortized cost applying effective interest rate. Yes Short term receivable with no stated interest rate should be measured at original invoice amount if the effect of discounting is immaterial. Other items at fair value, on acquisition date, which is acquisition price plus transaction costs that are directly attributable to acquisition or issue of financial asset At amortized cost applying effective interest rate. Loans and receivable Click here for example Yes Click here for example
  • 11. Category of financial assets Measurement at initial recognition Financial assets, fair At cost value of which can not be reliably measured Measurement at subsequent reporting date Impairment test (if objective evidence) At cost Yes Click here to go to next slide
  • 12. Example: Held for trading securities (FVTPL) A ltd began operations on January 1, 2012. during the year A ltd purchased various marketable equity securities. The cost and fair value of these securities at the end of 2012 were as follows: P ltd Q ltd R ltd S ltd Face value cost Market Unrealised loss gain Rs. 10 2000 2500 500 Rs. 10 3000 2600 400 Rs. 10 1000 1200 200 Rs. 10 1500 1350 150 7500 7650 550 700
  • 13. Solution: Adjusting entry Valuation Allowance To Profit and Loss A/c Dr 150 (7650-7500) 150 Debit balance in Valuation Allowance A/c indicates fair value is larger than cost and credit balance indicates fair value is less than cost. Dr. (Cr.) 7500 150 7650 Trading securities A/c (cost) Valuation Allowance Trading securities at fair value A ltd’s securities would be reported on its December 31, 2012 balance sheet in the Current asset section at their fair value of Rs 7650. Click here to go back
  • 14. Example: Available for sale Assume same information as given in previous example except that the securities qualify as available for sale. Solution: Adjusting entry Valuation Allowance To Investment valuation reserve A/c Dr 150 (7650-7500) 150 Investment valuation reserve account is included in the stockholder’s equity section of the balance sheet. A ltd’s available for sale securities would be reported on it’s December 31, 2012 balance sheet at their fair value of Rs 7650. Each security would be evaluated to determine whether it should be classified in current asset or in non-current assets. Those that are expected to be sold within the next year should be included in current assets. The others should be included in non-current assets. Click here to go back
  • 15. Example: Held to Maturity On January 1, year 1, A ltd purchased Rs 100000 face value , 3 year, 8% bonds of B ltd for Rs 94924 which provides an effective interest rate of 10%. The bonds pay interest semi-annually on June 30 and December 31. Solution: date 01/01 Yr 1 30/06 Yr 1 31/12 Yr 1 30/06 Yr2 31/12 Yr 2 30/06 Yr 3 31/12 Yr 3 Amortized schedule -effective interest method cash interest effective interest Discount Carrying value of bonds (4% semi annually) (5% semi annually) Amortization or amortized cost 94924 4000 4746 746 95670 4000 4784 784 96454 4000 4823 823 97276 4000 4864 864 98140 4000 4907 907 99047 4000 4952 952 100000 Cash interest is to be calculated on face value and effective interest is to be calculated on previous amortized cost.
  • 16. Entries for the first year and maturity date: 01/01/yr 1 Investment in bonds Dr To Cash (initial recording at fair value) 94924 94924 30/06/Yr 1 Cash Dr Investment in bonds Dr To Interest income 4000 746 4746 31/12/Yr 1 Cash Dr Investment in bonds Dr To Interest income 4000 784 4784 31/12/Yr 3 Cash Dr Investment in bonds Dr To Interest income 4000 952 4952 Cash Dr To Investment in binds 100000 100000 Click here to go back
  • 17. Example: Loans and receivable A ltd grants Rs 10 lakhs loan to its employees on January 1, 2012 at a concessional interest rate of 4% p.a. Loan is to be repaid in five equal annual installments along with interest. Market rate of interest for such loan is 10% p.a. At what value loan should be recognized initially and also calculate the amortized cost for all the subsequent five years. Solution: (a) Calculation of initial recognition amount of loan that will be discounted present value of future cash flows from re-payment of the loan Year end 2012 2013 2014 2015 2016 Cash in flows Total Discount factor Principal Interest At 10% 200000 40000 240000 0.9090 200000 32000 232000 0.8263 200000 24000 224000 0.7512 200000 16000 216000 0.6829 200000 8000 208000 0.6208 Present value or Fair value Discounted value 218160 191702 168269 147506 129126 854763
  • 18. Entries 1/1/2012 Staff loan A/c To Bank Dr 1000000 1000000 Staff cost A/c Dr 145267 (1000000-854763) To staff loan 145267 (loan will be initially recognized at its fair value i.e. Rs 854763 and balance amount will be debited to staff cost) (b) Calculation of amortized cost at the end of each year Year 2012 2013 2014 2015 2016 Balance 854763 700239 538263 368090 188899 Interest to be Re-payment recognized (10%) (including interets) 85476 240000 70024 232000 53826 224000 36809 216000 18890 208000 Amortized cost 700239 538263 368090 188899 NIL
  • 19. Entry for 2012 Staff loan A/c To Interest on staff loan Dr 85476 85476 Bank A/c To staff loan Dr 240000 240000 Interest on staff loan To Profit & Loss A/c Dr 85476 85476 Click here to go back
  • 20. IF YOU HAVE ANY SUGGESTION, OPINION OR FEEDBACK PLEASE FEEL FREE TO WRITE US AT roshankumar.2007@rediffmail.com
  • 21. Roshankumar S Pimpalkar