Accounting for Financial Instruments: Valuation and Reporting
K.V. Siva Prasad and*
The valuation and Reporting of financial instruments receive special attention in the course of Financial Reporting. The paper discusses the initial measurement, subsequent recognition of gain and losses on the financial instruments and their balance sheet presentation as prescribed by Accounting Standards of The institute of chartered Accountants of India (AS 30, 31 and 32), UK’s reporting standard and the International Reporting Standards.
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An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
One additional important definition is the finance cost which is defined by FRS as the difference between the net proceeds of an instrument and the total amount of the payments (or other transfers of economic benefits) that the issuer may be required to make in respect of the instrument.
THE VALUATION OF FINANCIAL INSTRUMENTS:
It seems that there is a lack of consensus on the appropriate accounting treatment of financial instruments. The conventional financial accounting and reporting imply the use of cost method for these financial instruments too. However with some exceptions, standard setters seem to be moving towards the market value approach, especially in respect of derivatives. For instance the Institute of Chartered Accountants of India asserts that financial assets and liabilities should initially be recognized at their fair value. The current fair value of a financial instrument on initial recognition is normally the transaction price (i.e., the fair value of the consideration given or received). However, if part of the consideration given or received is for something other than the financial instrument, the fair value of the financial instrument is estimated, using a valuation technique. For example, the fair value of a long-term loan or receivable that carries no interest can be estimated as the present value of all future cash receipts discounted using the prevailing market rate(s) of interest for a similar instrument (similar as to currency, term, type of interest rate and other factors) with a similar credit rating. Any additional amount lent is an expense or a reduction of income unless it qualifies for recognition as some other type of asset.
In the view of Financial Instruments Joint Working Group (JWG) published in 2000, it was expressed that virtually all financial instruments should be measured at fair value and that virtually all gains and losses arising from changes in fair value should be recognized in the profit and loss account. The US Financial Accounting Standards Board require derivatives to be shown at market value while the IAS 39, Financial Instruments: Recognition and Measurement would require all derivatives and other financial instruments held for trading, together with any financial assets that are available for sale, to be measured at fair value.
Underlying the definition of fair value is a presumption that an entity is a going concern without any intention or need to liquidate, to curtail materially the scale of its operations or to undertake a transaction on adverse terms. Fair value is not, therefore, the amount that an entity would receive or pay in a forced transaction, involuntary liquidation or distress sale. However, fair value reflects the credit quality of the instrument.
Those who advocate the use...