Financial Instruments Madhu Sudan Kankani June 2017 KPMG.com/in 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved
Agenda 1 Introduction 2 Classification and subsequent measurements 3 Derivative and embedded derivative 4 Hedge accounting 5 De-recognition of financial liabilities 6 Impairment of financial assets 7 Ind AS 107 overview 8 Key impact areas and challenges 9 Practical perspectives 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved
Introduction 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 3
Financial instruments A financial instrument is a contract that gives rise to both: a financial asset of one entity & a financial liability or equity instrument of another entity Financial asset Financial liability Cash Equity instrum ent of another entity Contractual right to receive cash or another financial asset or to exchange financial assets or financial liabilities under potentially favourable conditions Certain contracts settled in the entity s own equity Contractual obligation to deliver cash or another financial asset or to exchange instruments under potentially unfavourable conditions Certain contracts settled in the entity s own equity 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 4
Financial instruments: Scope Exclusions Certain financial instruments are excluded from the scope of Ind AS 109 Examples include: Interests in subsidiaries, associates and joint ventures (Ind AS 110, Ind AS 27, 28, 31) Employer s rights and obligations under employee benefit plans (Ind AS 19) Financial instruments under share-based payment transactions (Ind AS 102) Rights and obligations under insurance contracts (Ind AS 104) Lease rights and obligations except for: Lease receivables of a lessor which are subject to derecognition and impairment requirements of Ind AS 109 Finance lease payables of a lessee which are subject to the derecognition requirements of Ind AS 109 and Derivatives embedded in leases 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 5
Measurement at initial recognition At initial recognition a financial instrument is measured at fair value Transaction price is normally the best evidence of fair value on initial recognition Transaction costs included in initial measurement of financial instruments not classified as at FVTPL 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 6
Classification and subsequent measurement 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 7
Classification & subsequent measurement of financial assets Debt instruments Derivatives Equity instruments Is objective of the entity s business model to hold the financial to collect the contractual cash flows? yes no Is the financial assets held to achieve an objective by both collecting contractual cash flows and selling financial assets? Do contractual cash flows represent solely payments of principal and interest (SPPI)? yes yes yes no no yes no Is the equity instrument held for trading? no Has the company taken the election to present changes in fair value in OCI for equity instruments that are not held for trading? Does the company apply the fair value option to eliminate an accounting mismatch? yes yes no no Amortised cost FV-OCI (Fair value through OCI) (with- recycling) FVTPL (Fair value through PL) FV-OCI (no- recycling) 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 8
Compound instruments Financial liability component & Equity component Financial Liability Equity Split accounting: Issuer of compound instruments classifies the liability and equity components of the compound instrument separately as financial liability and equity 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 9
Allocation of initial carrying amount of a compound instrument Fair value of entire compound instrument (e.g. convertible bond $ 100) 1. Determine fair value of liability component including any embedded derivatives (e.g. $ 60) Financial Liability 2. Residual equity instrument (e.g. conversion option $ 40) Equity 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 10
Distributions and transaction costs Financial Liability Equity Distributions Transaction costs Recognise in profit or loss Recognise directly in equity Classification of a financial instrument issued determines treatment of distributions and transaction costs related to the instrument 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 11
Classification of financial liabilities Is the instrument a derivative of financial liability that is held for trading? Yes Measure at fair value All FV changes no Is it designated under the fair value (FV) option? no Does it contain a separable embedded derivative? yes Yes Would split presentation of changes due to credit risk create or enlarge an accounting mismatch in P/L? Yes All FV changes Fair value changes not due to credit risk No Fair value changes due to credit risk P&L OCI No Host Separate the host and the embedded derivatives Derivative (s) All fair value changes Measure at amortised cost 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 12
Accounting of financial instruments All financial instruments are initially recognized at fair value adjusted for transaction cost Categories Measurement Value changes Financial assets at fair value through profit or loss Financial assets at fair value through comprehensive income Fair value Fair value P&L OCI Financial assets at amortised cost Amortised cost Not relevant Financial liabilities at fair value through profit or loss Fair value P&L Financial liabilities at amortised cost Amortised cost Not relevant Derivatives Fair value P&L 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 13
Derivative and embedded derivative 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 14
Derivative Three characteristics Fair value changes in response to changes in one or more underlying variables No or little initial net investment Settled at a future date Accounting for derivative Fair value through profit and loss account Option to follow hedge accounting (stringent rules for hedge accounting) 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 15
Examples of derivatives and underlying Type of contract Main variable Interest rate swap Interest rate FX forward Foreign exchange rate Commodity option Commodity price Credit default swap Credit risk Purchased or written stock call or put option Equity price 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 16
Accounting for derivatives Purpose For Hedging Other than Hedging Hedge Accounting Applied Hedge Accounting Not Applied As per Hedge Accounting Principles To be measured at FVTPL To be measured at FVTPL 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 17
Third currency involvement Ind AS 109 Provides specific guidance for an embedded foreign currency derivative in a host contract that is not a financial instrument (such as a contract for the purchase or sale of a non-financial item where the price is denominated in a foreign currency). The embedded foreign currency derivative is closely related to the host contract provided it is not leveraged, does not contain an option feature and requires payments denominated in one of the following currencies: The functional currency of any substantial party to that contract. The currency in which the price of the related goods or service that is acquired or delivered is routinely denominated in commercial transactions around the world (such as the US dollar for crude oil transactions). A currency that is commonly used in contracts to purchase or sell non-financial items in the economic environment in which the transaction takes place (for example, a relatively stable and liquid currency that is commonly used in local business transactions or external trade). 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 18
Embedded Derivatives Hybrid Instrument Embedded Derivative Host Contract Significant accounting impact on third currency contracts 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 19
Hedge Accounting 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 20
Three hedge accounting models Ind AS 109 contains 3 hedge accounting models Fair value hedges of fair value exposures Cash flow hedges of cash flow exposures Net investment hedges of currency exposure on a net investment in a foreign operation 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 21
De-recognition of financial liabilities 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 22
De-recognition of financial liabilities Is the obligation in the contract discharged, cancelled or expired? yes Financial liability is extinguished Evaluate the modification terms (quantitative and qualitative test) Yes Derecognise 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 23
Modification of terms of financial liabilities Quantitative 10% assessment: Does net present value of the cash flows under the new terms (including any fees paid / received), discounted using original effective interest rate, differ at least 10% from the present value of the remaining cash flows under the original terms? yes no Substantial modification of terms Derecognise yes Qualitative assessment: Are there substantial differences in terms that by their nature are not captured by the quantitative assessment? no Continue to recognise 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 24
Impairment of financial assets 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 25
Impairment of financial asset Expected credit losses Ind AS 109 changes accounting for impairment - impairment losses recognised for all amortised cost and FVOCI assets, not only those where credit loss has been incurred. The model also applies to certain financial guarantees and loan commitments, but not to equity investments or instruments measured at FVTPL. Larger provisions with more volatility Under the general principle, one of two measurement bases will apply: 12-month expected credit losses; or lifetime expected credit losses. The measurement basis would depend on whether there has been a significant increase in credit risk since initial recognition. 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 26
Ind AS 107 Overview 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 27
Ind AS 107 - Overview Classes of financial instruments and level of disclosure Level 1, 2 and 3 Nature and extent of risks arising from financial instruments Qualitative Quantitative Significance of financial instruments for financial position and performance Appendices Statement of financial position Statement of comprehensive income and other comprehensive income Other like fair value, hedge accounting, etc Application guidance Defined terms 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 28
Key impact areas and challenges 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 29
Key impact areas & challenges (1/2) Equity vs liability classification (Preference shares redeemable/convertible mandatory/optional) Fair value of investments (mutual funds, investment in unlisted securities) EIR accounting of transaction costs for borrowings (corresponding impact on fixed assets) Fair value accounting of derivatives (stringent rules around hedge accounting) Fair value accounting of interest free/off market financial instruments (group funding, security deposits, employee loan etc) Specific guidance on loan refinancing/restructuring De-recognition of trade receivables under factoring arrangement 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 30
Key impact areas & challenges (2/2) Expected credit loss model (significant impact for financial service sector) Accounting for financial guarantee contracts Sales tax deferral loan (corresponding government grant) Embedded derivative accounting (third currency contracts) 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 31
Practical perspectives 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 32
Practical perspectives sector wise impact Sector Companies covered Sector Companies covered Automotive and ancillaries (AA) 10 Other manufacturing (OM) 7 Cement and cement products (CC) 1 Packaged food (PF) 1 Energy (EN) 11 Personal products (PP) 6 Infrastructure (IN 7 Pharmaceuticals (PH) 8 IT Consulting and software 5 Telecom and telecom services (TT) 4 Metals (ME) 7 Others (OT) 5 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 33
Practical perspectives nature of adjustments Provisions on receivables (ECL) Recognition of compound financial instruments Impact of EIR on borrowings Transaction cost, step up interest rates etc. MTM of derivatives Financial guarantees contracts Fair valuation of interest free/off market financial instruments Fair valuation of investment in equity instruments Fair valuation of investment in mutual funds Fair valuation of investment in group companies (transition date option) Modification of borrowings arrangement (loan restructuring) Classification of debentures and preference shares issued between debt and equity (mandatory convertible, optionally convertible, mandatory redeemable) Embedded derivative accounting (third currency contracts) 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 34
Thank You Madhu Sudan Kankani Partner Accounting Advisory Services KPMG in India Mobile: 98453 20711 E-mail: mkankani@kpmg.com The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International. 2017 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 35