Question 1

What is the core principle behind distinguishing financial liabilities from equity instruments?

Accepted Answer

The core principle behind distinguishing financial liabilities from equity instruments lies in the obligation to deliver cash or another financial asset to another entity. Financial liabilities involve a contractual obligation to pay, while equity instruments represent ownership interests in a company. If the instrument does not impose an obligation to transfer cash or assets, it is classified as equity.

Question 2

How do you classify a compound financial instrument such as a convertible bond into its liability and equity components?

Accepted Answer

A compound financial instrument like a convertible bond is classified into liability and equity components based on its terms. The liability component represents the present value of future cash flows (interest and principal), while the equity component reflects the conversion option into shares. This classification follows the guidance of International Financial Reporting Standards (IFRS) and relevant accounting standards, ensuring accurate financial reporting.

Question 3

Under what conditions can an instrument that meets the debt criteria still be classified as equity under Ind AS 32?

Accepted Answer

An instrument that meets the debt criteria can still be classified as equity under Ind AS 32 if it has characteristics such as no obligation to deliver cash or another financial asset, or if it can be settled in the issuer's own equity instruments. Additionally, instruments that are convertible into equity or have a fixed return contingent on the issuer's profits may also qualify as equity.

Question 4

What conditions must be met to offset financial assets and financial liabilities in the balance sheet?

Accepted Answer

To offset financial assets and liabilities, there must be a legally enforceable right to set off the recognized amounts, an intention to settle on a net basis, and the ability to settle the transactions simultaneously. These conditions ensure that the balance sheet presents a true and fair view of the entity's financial position.

Question 5

How should treasury shares held in cost by a company be presented under Ind AS 32?

Accepted Answer

Under Ind AS 32, treasury shares are presented as a deduction from equity in the balance sheet. The cost of treasury shares is subtracted from total equity, as they represent shares that are not outstanding and do not confer voting rights or dividends.

Question 6

When is a financial asset or liability recognized under Ind AS 109?

Accepted Answer

Under Ind AS 109, a financial asset or liability is recognized when the entity becomes a party to the contractual provisions of the instrument. This typically occurs at the point of transaction, provided that the contractual rights or obligations exist.

Question 7

How are embedded derivatives identified and accounted for separately from the host contract?

Accepted Answer

Embedded derivatives are identified when a financial instrument contains features that affect cash flows based on underlying variables. They are accounted for separately from the host contract if their economic characteristics and risks are not closely related to those of the host. This requires a thorough analysis of the contract's terms and adherence to IFRS or GAAP guidelines.

Question 8

Explain the three main classification categories for financial assets: amortized cost, FVTOCI, and FVTPL, with examples.

Accepted Answer

Financial assets are classified into three categories: Amortized Cost, where assets are held for collection of contractual cash flows (e.g., loans); Fair Value Through Other Comprehensive Income (FVTOCI), where assets are held for both collection of cash flows and selling (e.g., equity instruments); and Fair Value Through Profit or Loss (FVTPL), where assets are held for trading (e.g., derivatives).

Question 9

What criteria determine whether a financial asset qualifies to be measured at amortized cost?

Accepted Answer

A financial asset qualifies for amortized cost measurement if it is held within a business model whose objective is to collect contractual cash flows and if its cash flows consist solely of principal and interest on the outstanding balance.

Question 10

Under what circumstances can a financial liability be measured at FVTPL instead of amortized cost?

Accepted Answer

A financial liability can be measured at FVTPL if it is designated as such upon initial recognition, particularly for trading liabilities or derivatives, allowing for changes in fair value to be recognized in profit or loss, which can provide more relevant information for decision-making.

Question 11

How are transaction costs treated during initial recognition of financial instruments?

Accepted Answer

Transaction costs are added to the cost of the financial instrument during initial recognition. For financial assets measured at amortized cost, these costs are included in the calculation of the effective interest rate, impacting the amortized cost over the life of the instrument.

Question 12

Describe the Effective Interest Rate (EIR) method and how it applies to measurement of financial instruments.

Accepted Answer

The Effective Interest Rate (EIR) method is used to calculate the amortized cost of a financial instrument and the interest income or expense recognized over time. It reflects the true economic cost of a financial asset or liability by considering the timing of cash flows and any fees or premiums. This method ensures that interest income or expense is recognized in a manner that reflects the effective yield over the life of the instrument, providing a more accurate picture of financial performance.

Question 13

When should a financial asset or liability be derecognized under Ind AS 109?

Accepted Answer

A financial asset should be derecognized when the contractual rights to the cash flows expire or are transferred, and the entity has transferred substantially all risks and rewards. A financial liability is derecognized when it is extinguished, meaning the obligation is discharged or canceled.

Question 14

How are modifications to financial liabilities assessed for derecognition or adjustment?

Accepted Answer

Modifications to financial liabilities are assessed based on whether the modification results in a substantial change in the cash flows. If the present value of the cash flows under the modified terms differs significantly from the original terms, the original liability is derecognized, and a new liability is recognized. Otherwise, adjustments are made to the carrying amount.

Question 15

What is the impairment model under Ind AS 109, and how does the Expected Credit Loss (ECL) approach work?

Accepted Answer

The impairment model under Ind AS 109 requires entities to recognize expected credit losses on financial assets. The ECL approach involves classifying assets into three stages based on credit risk: Stage 1 for low risk, Stage 2 for significant increase in credit risk, and Stage 3 for credit-impaired assets. This model ensures timely recognition of losses and more accurate financial reporting.

Question 16

Outline the accounting treatment for fair value hedges and cash flow hedges under Ind AS 109.

Accepted Answer

Under Ind AS 109, fair value hedges are accounted for by recognizing both the hedged item and the hedging instrument at fair value, with gains or losses affecting profit or loss. Cash flow hedges, on the other hand, require that the effective portion of the hedge's gain or loss be recognized in other comprehensive income, while any ineffective portion is recognized immediately in profit or loss. This treatment helps to manage the volatility in financial statements due to fluctuations in market conditions.

Question 17

What is the primary objective of Ind AS 107 in relation to financial instrument disclosures?

Accepted Answer

The primary objective of Ind AS 107 is to enhance transparency regarding the significance of financial instruments for an entity's financial position and performance, as well as to provide information about the nature and extent of risks arising from those instruments and how they are managed.

Question 18

What qualitative disclosures are required regarding financial instruments and risk exposures?

Accepted Answer

Qualitative disclosures regarding financial instruments and risk exposures should include the nature of risks, the objectives and policies for managing those risks, and how they affect the entity's financial position, including any significant concentrations of risk.

Question 19

What quantitative disclosures are required for each financial instrument class?

Accepted Answer

Quantitative disclosures for each financial instrument class typically include the carrying amount, fair value, and the nature and extent of risks associated with those instruments. This includes credit risk, liquidity risk, and market risk, as mandated by IFRS 7 or similar standards.

Question 20

What income, expense, gains, and losses must be disclosed for financial instruments?

Accepted Answer

Disclosures for financial instruments include interest income, dividend income, and any realized gains or losses from sales. Unrealized gains or losses from changes in fair value must also be disclosed, depending on the classification of the instruments, which affects how they are reported in the financial statements.

Question 21

What are the disclosure requirements for credit risk management practices?

Accepted Answer

Disclosure requirements for credit risk management practices include providing detailed information on risk exposure, methodologies used for risk assessment, and the strategies in place for mitigating risks. Compliance with regulations such as IFRS 9 or Basel III is essential, as these frameworks outline the necessary disclosures to ensure transparency and inform stakeholders about the institution's credit risk profile.

Question 22

How must liquidity risk be disclosed, including contractual maturity analysis?

Accepted Answer

Liquidity risk must be disclosed by providing a detailed analysis of contractual maturities of financial liabilities, highlighting the timing and amounts due. This includes a breakdown of cash flows over various time frames and a discussion of the company's strategies to manage liquidity risk.

Question 23

What disclosures are required for market risks like interest rate risk or foreign exchange risk?

Accepted Answer

Disclosures for market risks such as interest rate risk or foreign exchange risk typically include qualitative information about the risks, quantitative data on exposure, and the methods used to manage those risks, in accordance with IFRS 7.

Question 24

What hedge accounting-related disclosures are required under Ind AS 107?

Accepted Answer

Under Ind AS 107, entities must disclose information about the hedging instruments, the nature of the risks being hedged, and the effectiveness of the hedge. This includes details on the fair value of hedging instruments, the amount recognized in the statement of profit and loss, and the overall risk management strategy employed.

Question 25

How do Ind AS 32, 107, and 109 interact to create a comprehensive accounting framework for financial instruments?

Accepted Answer

Ind AS 32 provides the definition and classification of financial instruments, ensuring clarity on what constitutes a financial asset or liability. Ind AS 107 complements this by specifying the disclosure requirements, which enhance transparency regarding risks and performance. Ind AS 109 then focuses on the measurement and classification of these instruments, detailing how they should be reported in financial statements, thus creating a cohesive framework for comprehensive financial reporting.

Question 26

How are interest income, impairment losses, and gains or losses presented when using the FVTOCI model for debt instruments?

Accepted Answer

Under the FVTOCI model, interest income is recognized in profit or loss, while impairment losses and gains or losses on disposal of debt instruments are recognized in other comprehensive income. This allows for a clearer view of the performance of the instrument while keeping the volatility of fair value adjustments out of the profit or loss statement.

Question 27

How are equity instruments designated at FVTOCI treated in terms of gains, losses, and dividend recognition?

Accepted Answer

Equity instruments designated at FVTOCI are recorded at fair value, with changes in fair value recognized in other comprehensive income. Importantly, these gains and losses are not recycled to profit or loss upon disposal. However, dividends received from these instruments are recognized in profit or loss.

Question 28

What presentation and classification impact arises when using the cost exemption for certain compound instruments?

Accepted Answer

Using the cost exemption for certain compound instruments affects their presentation on the balance sheet, as these instruments may not be split into their equity and liability components, leading to a simpler classification as liabilities.

Question 29

How should a listed equity investment held for trading be classified and presented over time?

Accepted Answer

A listed equity investment held for trading should be classified as a current asset and presented at fair value on the balance sheet. Changes in fair value are recognized in profit or loss, reflecting their trading nature and ensuring that the financial statements provide a true and fair view.

Question 30

How would you classify a government incentive receivable contingent on specific conditions?

Accepted Answer

A government incentive receivable contingent on specific conditions would be classified as a contingent asset. It is recognized only when it is virtually certain that the conditions will be met, following relevant accounting standards such as IAS 37.

Question 31

If a financial guarantee is issued without receiving any premium, how should it be accounted for?

Accepted Answer

A financial guarantee issued without a premium should be recognized as a liability at its fair value at inception. If the fair value cannot be reliably measured, it should be disclosed in the notes to the financial statements. Over time, the liability is adjusted for any changes in the estimated cash outflows.

Question 32

What documentation should be maintained when judgment is involved in classifying financial instruments?

Accepted Answer

When judgment is involved in classifying financial instruments, it is essential to maintain documentation that includes the criteria used for classification, the rationale behind the judgments made, and any supporting evidence such as market data or valuation techniques. Additionally, it's important to keep records of any revisions to ensure transparency and compliance with accounting standards.

Question 33

What ethical concerns may arise if financial instruments are classified as equity to improve leverage ratios?

Accepted Answer

Classifying financial instruments as equity to improve leverage ratios raises ethical concerns regarding transparency and the potential for misleading stakeholders. It can distort the true financial health of the organization, leading to misinformed investment decisions and regulatory scrutiny.

Question 34

How are intragroup loans accounted for differently in separate vs consolidated financial statements?

Accepted Answer

In separate financial statements, intragroup loans are recorded as financial assets and liabilities. In consolidated financial statements, these loans are eliminated to avoid double counting, reflecting only the net position of the group.

Question 35

How do you apply the ECL model to trade receivables when historical data is limited?

Accepted Answer

In cases of limited historical data, I apply the ECL model by incorporating forward-looking information and macroeconomic factors, while also relying on expert judgment to estimate potential credit losses.

Question 36

How would you account for structured financial products with embedded derivatives?

Accepted Answer

To account for structured financial products with embedded derivatives, I would first analyze the terms of the product to identify the derivative features. I would then apply the relevant accounting standards, such as IFRS 9, to determine whether the embedded derivative should be separated from the host contract. If separation is required, I would measure both components at fair value, recognizing any changes in the income statement, while ensuring proper disclosures are made.

Question 37

How would you present a hedge relationship where only part of the exposure is designated as hedged?

Accepted Answer

In presenting a hedge relationship with partial exposure designated as hedged, I would clearly delineate the hedged portion from the total exposure. I would utilize a detailed schedule showing the specific amounts hedged, the nature of the hedging instrument, and the remaining unhedged exposure. This approach ensures transparency and clarity in financial reporting.

Question 38

How do you test compliance with the business model test when classifying instruments?

Accepted Answer

To test compliance with the business model test for classifying instruments, I analyze the entity's business model for managing financial assets. This involves reviewing how assets are generated—either through collecting contractual cash flows or selling the assets. I assess the cash flow characteristics of the instruments to ensure they align with the model, and I document my findings with evidence to demonstrate that the classification criteria are met according to the relevant accounting standards.

Question 39

How would you audit disclosures related to market risk when hedge instruments are not fully aligned?

Accepted Answer

I would start by reviewing the entity's risk management policies to understand their approach to hedging. Then, I'd assess the alignment of hedge instruments with underlying exposures, ensuring that disclosures accurately reflect any discrepancies. Finally, I would verify the completeness and accuracy of the information presented in the financial statements, focusing on compliance with relevant accounting standards.

Question 40

How is a loan modification due to financial difficulty accounted for when interest is waived?

Accepted Answer

When a loan modification occurs due to financial difficulty, and interest is waived, the lender must assess whether the modification is a troubled debt restructuring. The waived interest is treated as a concession, and the loan is remeasured at its present value using the original effective interest rate, reflecting the new terms in the financial statements.

Question 41

How do you account for a long-term bond issued at deep discount using the EIR method?

Accepted Answer

To account for a long-term bond issued at a deep discount using the EIR method, you first determine the effective interest rate based on the bond's cash flows. The interest expense is then calculated by applying this rate to the carrying amount of the bond at the beginning of each period. The discount is amortized over the life of the bond, increasing the carrying amount until it equals the face value at maturity.

Question 42

What is the accounting treatment when a liability is extinguished using equity instruments?

Accepted Answer

When a liability is extinguished using equity instruments, the liability is derecognized from the balance sheet. The equity instruments issued are recognized at fair value, impacting shareholders' equity by increasing it, while any difference between the liability's carrying amount and the fair value of the equity instruments is recorded in equity.

Question 43

How is a derivative hedge accounted for when it becomes ineffective?

Accepted Answer

When a derivative hedge becomes ineffective, it is necessary to discontinue hedge accounting. The ineffective portion is recognized in profit or loss, while the effective portion remains in equity until the underlying transaction affects profit or loss.

Question 44

How are financial instruments written off under the ECL model?

Accepted Answer

Under the ECL model, financial instruments are written off when there is no reasonable expectation of recovery, typically after assessing the credit risk. This involves recognizing lifetime ECLs, which reflect expected losses over the life of the asset, ensuring accurate financial reporting.

Question 45

How are translation differences and hedge accounting applied in a cross-currency hedge of a foreign investment?

Accepted Answer

Translation differences arise from converting financial statements of foreign operations into the reporting currency, which can be mitigated through hedge accounting. In a cross-currency hedge, the gains or losses from the hedging instrument are recognized in the same period as the translation differences, ensuring that the financial impact is aligned and reducing volatility in reported earnings.

Question 46

How is fair value disclosure reconciled with measurement under Ind AS 109?

Accepted Answer

Fair value disclosure under Ind AS 109 involves reconciling the fair value measurements with the underlying assets and liabilities, ensuring that the measurement reflects the market conditions at the reporting date. This includes providing insights into the valuation techniques used and the assumptions made, which enhances transparency and aids users in understanding the financial statements.

Question 47

How should fair value measurement policies be disclosed in financial statements?

Accepted Answer

Fair value measurement policies should be disclosed in the financial statements by providing clear information on the valuation techniques used, inputs applied, and the level of the fair value hierarchy as per Ind AS 113. This enhances transparency and allows users to understand the basis for the fair values reported, thus assisting in the assessment of the financial position and performance of the entity.

Question 48

What are the disclosure requirements when financial instruments are pledged as collateral?

Accepted Answer

When financial instruments are pledged as collateral, disclosure requirements include detailing the nature of the collateral, its fair value measurement, and any risks associated with it. This ensures transparency and provides stakeholders with a clear understanding of the financial position.

Question 49

What factors influence the materiality threshold for disclosing categories of financial instruments?

Accepted Answer

Materiality thresholds for disclosing financial instruments are influenced by factors such as the size and nature of the financial instruments, their impact on the financial statements, and regulatory guidelines like IFRS and GAAP. Additionally, qualitative aspects, such as the potential for influencing economic decisions of users, play a crucial role in determining what is considered material.

Question 50

How should financial instruments be presented when they are under litigation or their recoverability is uncertain?

Accepted Answer

Financial instruments under litigation or with uncertain recoverability should be disclosed in the notes to the financial statements, detailing the nature of the uncertainty and any potential impacts on the financial position. They should not be recognized as assets until their recoverability is virtually certain.

Ind AS 32, 107 & 109 – Financial Instruments Interview Q&A

A. Classification & Presentation (Ind AS 32)

Q1: What is the core principle behind distinguishing financial liabilities from equity instruments?

Q2: How do you classify a compound financial instrument such as a convertible bond into its liability and equity components?

Q3: Under what conditions can an instrument that meets the debt criteria still be classified as equity under Ind AS 32?

Q4: What conditions must be met to offset financial assets and financial liabilities in the balance sheet?

Q5: How should treasury shares held in cost by a company be presented under Ind AS 32?

B. Recognition, Measurement & Hedge Accounting (Ind AS 109)

Q6: When is a financial asset or liability recognized under Ind AS 109?

Q7: How are embedded derivatives identified and accounted for separately from the host contract?

Q8: Explain the three main classification categories for financial assets: amortized cost, FVTOCI, and FVTPL, with examples.

Q9: What criteria determine whether a financial asset qualifies to be measured at amortized cost?

Q10: Under what circumstances can a financial liability be measured at FVTPL instead of amortized cost?

Q11: How are transaction costs treated during initial recognition of financial instruments?

Q12: Describe the Effective Interest Rate (EIR) method and how it applies to measurement of financial instruments.

Q13: When should a financial asset or liability be derecognized under Ind AS 109?

Q14: How are modifications to financial liabilities assessed for derecognition or adjustment?

Q15: What is the impairment model under Ind AS 109, and how does the Expected Credit Loss (ECL) approach work?

Q16: Outline the accounting treatment for fair value hedges and cash flow hedges under Ind AS 109.

C. Disclosures (Ind AS 107)

Q17: What is the primary objective of Ind AS 107 in relation to financial instrument disclosures?

Q18: What qualitative disclosures are required regarding financial instruments and risk exposures?

Q19: What quantitative disclosures are required for each financial instrument class?

Q20: What income, expense, gains, and losses must be disclosed for financial instruments?

Q21: What are the disclosure requirements for credit risk management practices?

Q22: How must liquidity risk be disclosed, including contractual maturity analysis?

Q23: What disclosures are required for market risks like interest rate risk or foreign exchange risk?

Q24: What hedge accounting-related disclosures are required under Ind AS 107?

D. Presentation Interaction & Policy Choices

Q25: How do Ind AS 32, 107, and 109 interact to create a comprehensive accounting framework for financial instruments?

Q26: How are interest income, impairment losses, and gains or losses presented when using the FVTOCI model for debt instruments?

Q27: How are equity instruments designated at FVTOCI treated in terms of gains, losses, and dividend recognition?

Q28: What presentation and classification impact arises when using the cost exemption for certain compound instruments?

Q29: How should a listed equity investment held for trading be classified and presented over time?

E. Ethical Judgement, Complex Scenarios & Practical Cases

Q30: How would you classify a government incentive receivable contingent on specific conditions?

Q31: If a financial guarantee is issued without receiving any premium, how should it be accounted for?

Q32: What documentation should be maintained when judgment is involved in classifying financial instruments?

Q33: What ethical concerns may arise if financial instruments are classified as equity to improve leverage ratios?

Q34: How are intragroup loans accounted for differently in separate vs consolidated financial statements?

Q35: How do you apply the ECL model to trade receivables when historical data is limited?

Q36: How would you account for structured financial products with embedded derivatives?

Q37: How would you present a hedge relationship where only part of the exposure is designated as hedged?

Q38: How do you test compliance with the business model test when classifying instruments?

Q39: How would you audit disclosures related to market risk when hedge instruments are not fully aligned?

Q40: How is a loan modification due to financial difficulty accounted for when interest is waived?

Q41: How do you account for a long-term bond issued at deep discount using the EIR method?

Q42: What is the accounting treatment when a liability is extinguished using equity instruments?

Q43: How is a derivative hedge accounted for when it becomes ineffective?

Q44: How are financial instruments written off under the ECL model?

Q45: How are translation differences and hedge accounting applied in a cross-currency hedge of a foreign investment?

Q46: How is fair value disclosure reconciled with measurement under Ind AS 109?

Q47: How should fair value measurement policies be disclosed in financial statements?

Q48: What are the disclosure requirements when financial instruments are pledged as collateral?

Q49: What factors influence the materiality threshold for disclosing categories of financial instruments?

Q50: How should financial instruments be presented when they are under litigation or their recoverability is uncertain?