AS-30 has a whole set of rules on hedge accounting.

The rules are pretty stringent and in many cases it may be impossible to apply hedge accounting because the rules cannot be complied with. This may be so, even if there was a perfect economic hedge.

MR DOLPHY D¶SOUZA, PARTNER, E&Y.

AS-30? Derivatives? MTM? If you are a keen reader of business news, a lot of these accounting hieroglyphics have been appearing in the past few weeks. There has been so much noise about accounting policies, but none of it has been music to either companies or investors in listed entities. Business Line attempted to get in touch with tax and accounting giant Ernst and Young (E& amp;Y) to present facts as they are. Mr Dolphy D¶Souza, Partner, E&Y, gives us a few important answers taking help from the firm¶s knowledge repository. What is AS-30? AS-30 (Accounting Standard 30 titled µFinancial Instruments: Recognition and Measurement¶) of the ICAI (Institute of Chartered Accountants of India) is excruciatingly complex, and is pretty much rule driven. Essentially the rules relate to classification of financial instruments in one of the four prescribed categories to which different valuation rules apply. The other important aspect of the standard is the application of hedge accounting. What types of financial instruments are we talking about here? The four categories of financial assets are Fair value through Profit and Loss Account (FVTP), Available for Sale (AFS) instruments, Held to Maturity (HTM) instruments and Loans and Receivables (L&R). The FVTP classification is used in case of financial assets that are traded or managed as a portfolio or a derivative. In the FVTP classification, the fair value changes in each reporting period are taken to the income statement.

A breach of the intention subjects an entity to a tainting provision that precludes any further HTM classification for a period of two years. advances. hedge instrument. recognition and de-recognition of financial instruments. etc. if the payments to be received from a debtor are scheduled and are not on demand. even if there was a perfect economic hedge. The HTM classification can be only used for assets that have a maturity period and there is intention to hold the asset to its maturity. L&R classification would be applicable for debtors. etc in AS-30. and would apply to instruments that do no fall in any of the other three categories. for example. These rules relate to the hedged item. deposits. hedge effectiveness. is it easy to do both accounting and hedging? AS-30 has a whole set of rules on hedge accounting. and recognised in the profit and loss (P&L) account only when they are sold. In the case of debtors that are receivable on demand. AFS category is a residual category. for which fair value cannot be reliably measured. These instruments would be valued at cost with a provision made for impairment. the rules require hedge effectiveness in the bounds of 80-125 per cent. etc. There are various other detailed rules. on impairment. classification of financial liabilities. The fair value changes in the AFS-categorised financial instruments are taken to the retained earnings. Give us an example of hedging effectiveness« To give an example. restructuring of loans. .The FVTP classification is not used for unquoted equity investments. The accounting is done to reflect the inherent IRR (internal rate of return) in the instrument. there is no discounting. which is not held with the intention of trading. This may be so. an equity investment in a listed company. With such instruments. The rules are pretty stringent and in many cases it may be impossible to apply hedge accounting because the rules cannot be complied with. hedging documentation. However there would be discounting. for example. securitisation. Airline companies may have a need to protect themselves from future fuel price increases.

and the effect would depend on a case-by-case basis. The ineffectiveness could be beyond the 80-125 per cent bound and therefore consequently the airline company may not be successful in applying hedge accounting. What happens in case the hedging activity fails? When hedging fails. even if the FCCBs are presumably zero coupon bonds. NBFCs or non-banking financial companies) would be severely affected by the standard. Off-balance-sheet items such as various types of derivatives will now have to be fully accounted for. the hedge instrument (in the above case it is the forward purchase of oil) is marked to market at each reporting period and the effect is taken to the income statement. no generalisation can be made.Since there is no futures market in jet fuel. Any severe negative effect could cause capital adequacy problems. What about the effect on companies? Companies that have issued FCCBs (foreign currency convertible bonds) will have to take an interest charge to the income statement. Banks and other financial institutions (example. In fact. Almost everything contained in the standard will impact these entities. Coming back to the standard. they may hedge themselves for oil price changes. It is however too early or difficult to say whether those impacts would be positive or negative to the net worth. generally the oil prices changes should move in tandem with the jet fuel. FCCBs will also be subjected to split accounting. What would be the problems in implementation? . some ineffectiveness could creep in because oil needs considerable processing before it can be converted to jet fuel. Now. However. tell us what impact it could have on different parties. which could cause considerable volatility in the income statement. which requires splitting of a debt component and the option derivative at fair value.

there are no strict hedge rules. and for hedging to be applied it is enough to demonstrate that the forward was not for speculation purposes. and hence the underlying hedge instrument (example. a derivative such as a forward foreign exchange contract) would have to be marked to market (MTM) at each reporting period with the effect being taken to the income statement. As far as auditing is concerned. particularly NACAS (National Advisory Committee on Accounting Standards) and the RBI (Reserve Bank of India). debt markets). MURALI KUMAR SHANKAR ROY . under AS-11 (on the effects of changes in foreign exchange rates). Given that Indian markets are not deep enough. Many valuation experts would be required for arriving at a fair value for financial instruments. The standard would also need to be aligned with the Companies Act. determining fair valuation could be a challenge (example. considerable amount of training would be required before the standard is implemented. What are the challenges? The standard would need to be aligned and approved by the regulators. D. particularly relating to treatment of preference capital and the use of securities premium (Section 78).Generally hedge accounting would be difficult to apply. Right now.

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