There is a uniform accounting standard practised all across India. The foundation for the need of a common Indian standard was laid down with the formulation of the Indian Companies Act 1956. The corporate affairs ministry revised the rules in 2015 and introduced a standard accounting format that includes the Indian Accounting Standard. The Indian Accounting standard (Ind-As) 109 is exclusively for financial instruments. This standard covers recognition, classification and procedures of measurement of all financial assets and liabilities. Care has been taken to keep the Indian Accounting Standard (Ind-AS) compatible with the IFRS for international financing reporting standards.
The objective of having a uniform standard for accounting is to have fair and uniform financial statements in a common format. The standard provides recognition to financial events and quantifies all types of financial transactions. Another objective is to provide financial clarity about prospective companies, individuals or property to creditors and investors. The clarity includes providing and settling loans and also holding, buying or selling equity and any other debt instruments. The financial information provided by these standards provides a tool for boards to make crucial decisions about the use of any economic resource.
There are two sets of accounting standards presently being followed in the country. The first is the accounting standard 2006 and the second is the Indian accounting standard (Ind-As). There was an overwhelming need to have an accounting standard that could be read, understood and followed by a large number of multinational companies in India as well as Foreign Direct Investors (FDI) and Foreign Institutional Investors (FII). The Government took cognizance of this genuine requirement and introduced the Indian accounting standards (Ind-As) to closely match the International Financial reporting standards (IFRS).
There are 40 different Ind-AS standards of which Ind-AS 109 is for financial instruments. Other related standards are Ind-AS 107 for financial disclosures, Ind-AS 32 and Ind-AS 110 for consolidated financial statements. Ind-AS 32 is the standard for definitions of financial instruments and Ind-AS 109 uses many of these definitions in its own standard.
The Indian accounting standards (Ind-AS) are drafted and prepared by the Institute of chartered accountants of India (ICAI). The ministry of corporate affairs acts on the recommended details for the standards given by the National Financial Reporting Authority (NFRA). There is even a supervising body within the ICAI known as the Accounting Standards Board (ASB).
Adoption of the Indian account standards are mandatory for listed companies as well as outside India, unlisted companies that have a net worth of over ₹250 crores and unlisted non-banking financial companies (NBFC) with a net worth between ₹250 to 500 crores.
The Indian accounting standards are also compulsory for subsidiaries, holding companies and joint ventures of NBFCs (Non-banking financial companies) with a net worth above ₹500 crores.
The Ind-AS standards are formulated with the objective of making foreign investment in India attractive as well as for multinational companies to set up factories in India. This is part of the strategy of the government of India in its ‘Make in India’ strategy. The best part of the Indian accounting standards (Ind-AS) is that there are provisions for adverse economic conditions including recession. For instance, the Ind-AS standard 29 is exclusively for preparing financial statements in a hyperinflationary environment.
The 2015 ruling for companies by the ministry of corporate affairs, will bring about a reconsideration of the difference between equities and liabilities and many financial instruments will get reclassified from equity to financial liabilities.
Financial Instruments are themselves classified into 3 categories. They are derivatives, equity instruments and debt instruments.
A derivative is a name given to a contract that derives value from market values or any other valuation technique. Forward contracts, swipes and future contracts use the derivative method.
Debentures, bonds, treasury certificates and redeemable capital are common examples of debt instruments where the company issues these instruments with the ledge of repaying the value along with interest on redemption. The interesting part is that the company selling these instruments will record them in its financial statement as a liability whereas the company or entity buying them will interpret them as financial assets.
The equity form of financial instrument has different connotations on the basis of the percentage of equity that a company owns in another company. If the percentage is more than 50, the company has a controlling authority in the investee company and the owner of the stock will need to consider the investee company as its associate or subsidiary. It will need to issue a financial statement including the performance of both companies. If company A owns 20% to 50% of the equity of company B, company B becomes an associate of A. In this case, company A will need to use the equity accounting method to include the performance of its associate in its financial statement. If, however, company A owns less than 20% of the stock of Company B, the calculation of earnings from its investment in company B will be by the fair value through profit and loss or fair value through other comprehensive income (FVTCI) depending on the specific mode.
What are financial assets?
A financial asset is that part of a contract that assures the flow of cash to an individual or a company or body. A financial instrument is a contract that guarantees or generates a financial asset to one of the parties in a contract. The Ind-AS standard 109 is specifically about such financial instruments.
Financial assets are measurable and this is done in a balance sheet. Financial assets can be current or noncurrent. It can be used to show the company management’s intent with the financial asset. In a nutshell, this factor is used to measure the value of a financial asset. Market value would be a good yardstick of the measurement of financial assets in the form of equity shares of another company. But the market value of equity would not be a recommended unit of measurement if the company that holds the shares of another company would be more interested in building share capital for voting rights or management control in the other company.
Financial assets include the following:
- A right by contract to receive or even exchange financial assets or cash in the form of loans, trades or bonds from another party.
- Equity documents, shares or stock of another company
- Cash reserves in any financial institution including banks
Classification of Financial assets
Businesses including companies need to categorise all their assets based on the type of model of business that they operate. The categorisation would be measured on the pattern of cash flow as per the contract of business. The classification is thus based on the type of cash flow pattern which is categorised into fair value through other comprehensive income (FVTOCI) and on the basis of amortised cost. The fair value method is used for a future plan to sell the asset and is not for intended ownership.
The measurement at amortised rate is when there is a contractual agreement to collect cash flow on specified dates. The cash flow is the interest on the due principal amount
There is another classification of fair value through fair value in profit and loss accounts. All financial assets that are to be used for selling or trading come under this category.
What are financial liabilities?
A financial liability is an obligation under the contract to deliver, transfer or hand over cash, dividends, bonds or any asset to another party or individual, often at a loss to that individual. An example is of a mortgaged property that is bequeathed to a descendant. The value of the mortgage that is to be paid back is more than the value of the property and becomes a financial liability for the descendant.
Thus any unfavourable exchange of property or assets can be a financial liability. Experts give the example of financial liability as to the use of a credit card. The going is good as long as one uses the credit card company’s money but good times come to an end when it is time to pay up.
Financial liabilities may usually be legally binding to an agreement having been made between 2 parties but they are mostly not legally enforceable.
Financial liabilities mostly include past debts, unpaid rents and even interest on the dues. However, financial liabilities show up on the balance sheet of a company.
Financial liabilities are measured by different ratios which are the debt ratio, the debt to equity ratio, the capitalisation ratio, cash flow to total debt ratio, interest coverage ratio, current ratio and quick ratio.
Classification of financial liabilities
Most financial liabilities are assessed on amortised costs. Other liabilities include the commitment of interest below the market rate, consideration of contingent and contracts of financial guarantee.
Another classification of financial liabilities is long term and short term. Long term liabilities are long term debts. Long term debts are payable for long periods upto a decade. Long term liabilities exist in the form of debentures, loans, pension obligations and deferred tax liabilities.
Short term liabilities include due payment to vendors and monthly payroll dues to employees. It may be noted that any payment that is deferred can become a long term liability.
Financial liabilities are a good subject for analysis by financial and even stock analysts who study how much value can be created from a financial liability and advise investors accordingly.
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Frequently Asked Questions (FAQ’s)
Does the accounting standard board (ASB) have any regulatory power over the Indian chartered accountants of India and reject a standard drafted by the ACAI?
The Accounting Standard Board (ASB) is only a supervisory board that oversees the activities of the ICAI. It does not have regulatory powers over the ICAI and can make a recommendation only. The regulatory power over the ICAI. However, it rests with the National Financial reporting authority (NFRA) of India.
What section of the law makes it mandatory for companies to have a balance sheet and balance of accounts?
The Companies Act of 1956 is the law for organisations registered as companies to operate. Sections 3(a) to 211 of the Companies Act require all companies in India to publish their audited profit and loss account and balance sheet.
Is it compulsory for all companies in India to follow the Indian Accounting standard?
It is mandatory for most companies to follow the Indian accounting standard. There is a provision, however, under section 129 of the Companies Act 2013 for some companies to formulate their own statutes for publishing their own financial reports. It must be kept in mind that if a company chooses to follow the Indian accounting standard once, it cannot change over to another standard at a later stage.
Is there a separate Indian accounting standard for investment property including agricultural property?
The Indian Accounting Standard (Ind-AS) covers both investment property as well as agriculture but there are separate sections. The Ind AS-41 is for agriculture whereas Ind AS-40 is for investment property. There are a total of 40 Ind-AS standards for different activities.
How many kinds of financial instruments are covered in the standard Ind-AS 109?
The Indian standard Ind-AS 109 covers financial instruments. As per this standard, financial Instruments are of the debt, equity and derivative types. The Indian standard Ind-AS 32 has definitions for each of these classifications. Investments in equity shares come under the scope of the equity classification whereas debentures, loans, bonds and redeemable certificates come under the scope of debt type of financial instruments. The third classification is the derivative type which is a kind of future agreement and often requires no initial investment.
