Accounting for Investments - Vol 1

Resources for the book Accounting for Investments - Vol 1

Fixed Income Securities – FVPL

• Fixed income security refers to any type of investment that yields a regular or fixed return. It is an investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. In a variable income security, payments change based on some underlying benchmark measure such as short-term interest rates. However, in this and subsequent chapters, by fixed income securities we mean debt securities that yield a regular return in the form of interest. The terms “debt securities” and “fixed income securities” are used here interchangeably.
• A debt security is defined as “any security representing a creditor relationship with an enterprise.”
• The term “debt security” includes, among other items, U.S. Treasury securities, U.S. government agency securities, municipal securities, corporate bonds, convertible debt, commercial paper, all securitized debt instruments, such as collateralized mortgage obligations (CMOs) and real estate mortgage investment conduits (REMICs), and interest-only and principal-only strips.
• A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. Investments in equity shares are a form of financial asset.
• Investments in debt securities are classified as either fair value through profit and loss or as available-for-sale securities or held-to-maturity investments.
• IFRS 9 is the first part of Phase 1 of the IASB’s project to replace IAS 39. Financial Instruments: Classification and Measurement, which is Phase 1, was published in July 2009 and contained proposals for both assets and liabilities within the scope of IAS 39. An entity shall apply IFRS 9 for annual periods beginning on or after 1 January 2013.
• An entity shall classify financial assets as subsequently measured at either amortized cost or fair value on the basis of both:
• The entity’s business model for managing the financial assets; and
• The contractual cash flow characteristics of the financial asset. (IFRS 9 Para 4.1)
• As per US GAAP, an entity shall classify debt securities into “trading” if it is acquired with the intent of selling it within hours or days. However, at acquisition an entity is not precluded from classifying as “trading” a security it plans to hold for a longer period. Classification of a security as trading shall not be precluded simply because the entity does not intend to sell it in the near term. Investments that are classified as “trading” securities are classified under “fair value through profit or loss” category.
• Bonds are either subscribed at the initial off er through the primary market route or purchased through the secondary market. In a secondary market the buy order is placed through a broker known as a counter party. Most corporate bonds are traded over-the-counter.
• Interest on bonds is payable by the issuer on the coupon date. Investors should account for the interest on the coupon date. However, the interest accrues on the bond on a daily basis even though it is paid periodically as per the terms of the bond, usually on a semi-annual basis.
• Corporate action is, as the name implies, an action taken by the issuer of the bonds that impact the investments or earnings from such investments. Typical examples of corporate actions include interest payment by the company, calls or the issuance of new debt by the issuer that result in change of the name, or number of bonds held by the investor, and so on.
• One of the key activities during the trade life cycle of fixed income securities is the corporate action in the form of interest as stated on the face of the bond. The accounting event for coupon accrual is recorded on the date on which the interest becomes payable by the company.
• The accrued interest purchased on the date of purchase of the bond is reversed on the first date on which interest is payable by the company. This effectively reduces the interest income during the first period during which the bond is held by the investor.
• The bonds should be carried in the books at fair market value for bonds that are held as trading securities. However, interest should be accounted for as though the bond is required to be shown on the basis of amortized cost. The premium paid or discount realized on purchase of the bond should be amortized over the remaining life of the bond on a yield-to-maturity basis. Such an amortized premium or discount is added with the interest on the one hand and held separately in a mark-to-market account on the other.
• The effective interest is calculated based on an iterative process in such a way that the carrying cost is increased to the extent of the effective interest for the period the bond is held. The carrying cost at the end of the tenure of the bond should be equal to the face value of the bond.
• Since interest accrues on a day-to-day basis, the interest on bonds held by the investor from the date of the previous coupon date until the valuation date should be recorded in the books of accounts as “Interest Income” for the period.
• At the end of every valuation date the fair value of the bond is ascertained and the bonds are mark-to-market. This process is known as “portfolio valuation.” The market rate at the end of the period is determined from the primary stock exchange where the bonds are traded. If there is an increase in the market rate over and above the purchase rate then such an increase is recognized as an unrealized gain and the corresponding amount is shown in the MTM—Bonds—FVPL (Asset/Liability) account.
• Interest accrues on the bond on a daily basis even though it is paid periodically, as per the terms of the bond usually on a semiannual basis. Hence, when the bond is sold, the investor actually should get not merely the value of the bond but also the interest element from the previous coupon date until the date of settlement of the trade.
• The profit or loss on liquidation of the bonds is ascertained by deducting the cost of sales from the net sale consideration. Cost of sales is arrived at by following FIFO, LIFO or the weighted average method.
• Certain debt instruments have a call provision which grants the issuer an option to retire all or part of the issue prior to the maturity date as mentioned in the document, even though most of the new bond issues usually have some restrictions against certain types of early redemption.
• Functional is the currency of the primary economic environment in which the entity operates. All other currencies other than the functional currency are known as foreign currencies for the entity. Presentation currency is the currency in which the financial statements are presented to the investors. The entity is free to choose any currency as its presentation currency.
• A foreign currency transaction is a transaction that is denominated in a currency other than the entity’s functional currency or requires settlement in a foreign currency. “Denominated” means that the balance is fixed in terms of the number of units of a foreign currency regardless of changes in the exchange rate.
• An entity must convert foreign currency items into its functional currency for recording in its book of accounts. On initial recognition foreign currency transactions are recorded in the functional currency by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction.
• Under the relevant accounting standards foreign currency monetary items are treated differently from foreign currency non-monetary items during subsequent recognition of those items on any valuation date. The essential feature of a monetary item is the right to receive or an obligation to deliver a fixed or determinable amount of units of currency.
• When an asset is non-monetary and is measured in a foreign currency, the carrying amount is determined by comparing the cost or carrying amount, as appropriate, translated at the exchange rate at the date when that amount was determined (i.e., the rate at the date of the transaction for an item measured in terms of historical cost); and the net realizable value or recoverable amount, as appropriate, translated at the exchange rate at the date when that value was determined (e.g., the closing rate at the end of the valuation date). The effect of this comparison may be that an impairment loss is recognized in the foreign currency but would not be recognized in the functional currency, or vice versa.
• Exchange differences arise from the settlement of monetary items at a subsequent date to initial recognition, and re-measuring an entity’s monetary items at rates different from those at which they were initially recorded (either during the valuation date or at the previous valuation dates). Such exchange differences must be recognized as income or expenses in the period in which they arise.
• When a gain or loss on a non-monetary item is recognized in profit or loss, any exchange component of that gain or loss is also recognized in profit or loss. When a gain or loss on a non-monetary item is recognized directly in other comprehensive income, any exchange component of that gain or loss is recognized directly in other comprehensive income.
• For every transaction denominated and recorded in a foreign currency, a corresponding journal entry is recorded and accounted for in its functional currency, based on the foreign exchange rate on the date on which such a transaction is recognized. This process is known as FX revaluation.
• FX translation is required to be performed by the investor to adjust the FX rate differential between the transaction date and the valuation date in respect of all assets and liabilities, which can either be monetary items or non-monetary items.
• When an entity trades in foreign currency (i.e., where the trade currency is different from the functional currency), then the total unrealized gain or loss consists of two components—capital gain and currency gain.

Sri T.N. Manoharan conferred with Padma Shri award by Government of India

Sri T.N. Manoharan

Sri T.N. Manoharan

The Government of India named Sri T.N. Manoharan the first accountancy professional from Tamil Nadu to be conferred with the Padma Shri award. Manoharan is based out of Chennai, India and was recently appointed as a board member of the scam-hit Satyam Computer Services and later made as its chairman before the company was taken over by the Mahindra group. He is a distinguished professional and has several acheivements to his credit. Son of T.L. Narayana Chowdhry, a 93-year-old a freedom fighter, Manoharan, 52, is a partner in Manoharan Chowdhry Associates. He is also the past president of the Institute of Chartered Accountants of India (ICAI).

Padma Shri is an award given by the Government of India generally to Indian citizens to recognize their distinguished contribution in various spheres of activity including the Arts, Education, Industry, Literature, Science, Sports, Medicine, Social Service and public life. It stands fourth in the hierarchy of civilian awards after the Bharat Ratna, the Padma Vibhushan and the Padma Bhushan. On its obverse, the words “Padma”, meaning lotus in Sanskrit and “Shri”, in Devanagari script, appear above and below the lotus flower. The geometrical pattern on either side is in burnished bronze. All embossing is in white gold.

‘Accounting for Investments’ blog congratulates Sri T. N. Manoharan on being conferred with the Padma Shri award.

Accounting for Investments – Equities, Futures & Options – Part-1 Video

Accounting for Investments – Equities, Futures & Options –  is the first volume in this series published by John Wiley & Sons. This video gives an overview of the contents of this book. This is the first part of a series of videos that would cover the contents all the chapters in great detail.

I would appreciate if you could leave your feedback.

R. Venkata Subramani

Interview in Financial Express Newspaper dated 26th September 2009

INTERVIEW R VENKATA SUBRAMANI, FINANCE EXPERT

‘We need innovative financial products that are devoid of gambling elements’

Saikat Neogi
Posted: Saturday, Sep 26, 2009 at 2126 hrs IST

The global financial crisis has underlined the need for responsible corporate governance. Many of the nuances are explained in R Venkata Subramani’s latest book Accounting For Investments: Equities, Futures and Options published by John Wiley and Sons. A chartered accountant by profession, Subramani is the chief operations officer of Chennai-based Variman Capital Markets Services and is responsible for valuation and accounting, partnership allocation and accounting for companies. He has also taught at the Institute of Chartered Accountants of India and the University of Madras. Subramani in an interview to FE’s Saikat Neogi explains the changes in the accounting process after the global slowdown, credit default swaps and peer review of accounts. Excerpts:

How has the financial crisis underscored the need for greater responsible corporate governance within financial institutions?

It is now a known fact that some large financial institutions did push under the carpet certain losses in some innovative products either to dress up the periodical results or to protect employee bonuses. When the already inflated and heated up markets developed cracks, these unhealthy practices came to the limelight as these could no longer be covered up. The losses snowballed with domino effect, resulting in all round lack of trust amongst the financial institutions per se, which aggravated the situation calling for bailout measures from the government. Though this originated in the US, some of these events replicated in other parts of the world. Perhaps, a lot of these could have been minimised if there were a greater responsible corporate governance within financial institutions.

What are the accounting lessons that one can learn from the global economic crisis?

Accounting is based on common sense. If something defies common sense, it obviously cannot stand the test of time. Accounting standards are designed to provide uniformity in accounting and reporting and to ensure adequate disclosures are made about all aspects of material transactions. The lesson that one needs to learn from this crisis is that the regulatory compliance and reporting and disclosure requirements set forth in accounting standards should be followed in spirit for their own welfare in the long run or else it will boomerang on the entire financial community sooner than later. If there is a trouble, it’s better to bring it to limelight soon and never resort to cover up by applying ‘accounting skills’.

What kind of innovations are called for in the global financial institutions in the near future?

The Street is known for its creative and innovative financial instruments to cater to the risk appetite of every type of investor. Some financial instruments like the credit default swap (CDS), which have become extremely popular since 2000, have been suffering from certain serious flaws. Some economists and financial experts have been harping about the dangers of these products and unfortunately the whole world has been forced to learn a lesson in a very hard way. These inputs will undoubtedly force the global financial institutions to think and come up with innovative products that are devoid of gambling elements.

How can the government reform the financial sector? What kind of checks and balances are needed?

OTC products should be regulated. The financial sector has created several innovative products to take care of the requirements of different types of investors on the one hand and the issuers on the other. In all these, the government has to ensure that unchecked and over ambitious greed on the part of investors does not affect other investors. In other words, while investors with risk appetite should be fed with products that suit their requirements, the loss if any suffered by those investors should be protected by being adequately funded—not causing any domino effect on other investors. The exchange traded products usually ensure this. The government should ensure the same level of safety through appropriate means to both the counter parties of even OTC products. This will go a long way in ensuring financial stability and effectively acting as a shock absorber against any financial crisis.

Will the credit derivatives market regain investors’ confidence?

Not immediately in the present form. Credit derivatives in the present form may not regain investors’ confidence. There is a proposal to ban credit default swap in its present form. India has been very wise in staying away from this devastating product by the good efforts of RBI. In fact, CDS has been one of the main reasons for the present global financial crisis. CDS in the present form suffers from some serious flaws. There is no requirement of insurable interest for this product, turning it into a convenient form of gambling. Look at the numbers — the notional amount of CDS outstanding at the end of 2007 was around $62 trillion as compared to around $25 trillion of the total fixed income securities issued in the US, indicating the gambling element. Unless these flaws are eliminated, credit derivatives are unlikely to regain investors’ confidence.

Book review in Business Line (The Hindu Group)

Life-cycle of financial instruments

In the case of an equity instrument investment, impairment; according to IFRS (International Financial Reporting Standards) means a significant or prolonged decline in the fair value of that investment below its cost. And as per the US GAAP (generally accepted accounting principles), impairment is when an entity considers a decline in fair value to be other than temporary.
Indicators of impairment include the financial health of the counterparty, intention of the investor to hold the asset for a reasonable length of time to permit recovery in value, the duration and extent that the market value has been blow cost, and the prospects of a market price recovery, explains R. Venkata Subramani in the first volume of Accounting for Investments: Equities, futures and options ( www.wiley.com).  Among the other differences that he highlights, in this regard, are reclassification, trading securities, and available-for-sale securities.

While in IFRS, the IAS (International Accounting Standard) 32, IAS 39, and IFRS 7 deal with the principles involved in recognition, measurement, disclosure, and presentation of financial instruments, the Indian pronouncements from the Institute of Chartered Accountants of India (ICAI) are AS 30 on the recognition and measurement of financial instruments and AS 32 on the disclosures. In sum and substance, the Indian Accounting Standards are the same as the corresponding IFRS, informs T. N. Manoharan in the foreword. Even though investment banking institutions suffered a serious setback due to the financial crisis that began in 2008, banks, hedge funds, and several other financial institutions do trade and invest in several financial instruments, the author observes in the preface.

“The need for comprehensively understanding these financial instruments, including the accounting aspects involved, assumes great importance. Even before the beginning of a trading day, the front office should know the positions of the various financial instruments held by the entity and have the flexibility to obtain a detail breakdown of cost, and so on.”

The book should be a handy reference for accountants because it deals with `the entire life-cycle’ of the different financial assets, and is replete with examples that drill down to details such as journal entries, general ledger accounts, trial balance, income statement, and balance sheet. More importantly, the book aspires to fill `the knowledge gap’ between the technology people and the finance professionals, in projects concerning the specialised field of investment accounting.

Recommended addition to the CAs’ shelf.

D. MURALI

Foreword by Mr. T. N. Manoharan

Foreword by Mr. T. N. Manoharan Former President of The Institute of Chartered Accountants of India

Accounting for Financial Instruments is a complex exercise in view of the varied kind of instruments that are emerging in the market in the recent past. The flow of funds across the borders in the form of financial instruments is ever increasing in the global scenario. Equity, Futures and Options have trade life cycle and accounting treatment on such life cycle from the front office and back office perspectives call for detailed elucidation. Hardly there is any book that provides guidance on these matters. This book is a commendable effort to fill the knowledge gap that exists in the accounting of financial instruments.

International Financial Reporting Standards (IFRS) encompassing IAS 32, IAS 39 and IFRS 7 deals with the principles involved in recognition, measurement, disclosures and presentation of financial instruments. The Institute of Chartered Accountants of India (ICAI) has come out with corresponding Accounting Standards (AS) viz., AS 30 on ‘Financial Instruments – recognition and measurement’; AS 31 on ‘Financial Instruments – Presentation’ and AS 32 on ‘Financial instruments – disclosures”. In sum and substance, the Indian Accounting Standards are the same as that of the relevant IFRS. This book deals with the principles laid down in the IFRS and in relevant places deals with similarities and differences between US GAAP and IFRS. In that sense, one can say without fear of contradiction, that this book is a comprehensive treatise of the title.

Mr. R. Venkata Subramani is a learned person, having immense knowledge and expertise on the matters dealt with in this book. The benefit of his hands on experience and in depth practical exposure is reflected in the illustrations given in the various chapters of this book. With the tremendous growth witnessed in the Investment Banking Institutions, Hedge funds and several other financial institutions, this book will become handy for understanding and capturing the entire trading process of the financial instruments. The author, Mr.R.Venkata Subramani, is also known as a ‘Technology wizard’. Consequently, the lucid exposition that he has adopted would help automating the system of proper accounting of the entire trade cycle of each of the financial instruments.

Investment bankers, financial institutions, dealers, brokers, professionals and other investors would find this book immensely useful in the day-to-day operations, as various concepts unique to the financial instruments are explained in this book besides laying down the accounting treatment in a detailed manner. This book will be a useful addition to any library, which serves as a source of knowledge and information with reference to various financial products dealt with in the market. Mr.R.Venkata Subramani has done a splendid job in authoring this book in order to share wealth of information and knowledge on the subject.

T.N. MANOHARAN

Review by Sri M. S. Ray, ED, SEBI

Accounting treatment of financial instruments is a highly complex subject Efficient handing of this subject requires in-depth knowledge of the intricacies of various financial products, accounting  standards and practices relating to such products and tax laws governing these products. Mr R. Venkata Subramani, being a professional Chartered Accountant of long standing, has brought in his expert knowledge of the subject in writing the book ‘Accounting for Investments’.

The book adequately covers the Indian and international accounting standards – both US GAAP and IFRS – in so far as they relate to financial instruments. This is extremely important in view of the ensuing convergence between Indian accounting standards with IFRS.

In this book, the author has attempted to explain the subject in lucid language with ample illustrations and real-life problems with solutions. The book also adequately covers a number of equity products including futures and options etc.

I must congratulate Mr. Subramani for coming out with this invaluable and painstaking work. I am sure, the book will be immensely useful as a ‘hand book’ and ready reference on financial instruments for both students and professionals in the financial world.

(Manas S Ray)

Brief profile of Mr. Manas Ray, Executive Director, SEBI.

Mr. Manas Ray is Executive Director of the Securities and Exchange Board of India (SEBI),  where he is heading the ‘Market Regulation Department’ ‘Market Intermediaries Regulation and Supervision Department’ and ‘Derivatives and New Products Department’.  He is a member of the International Organisation of Securities Commissions (IOSCO)’s  ‘Standing Committee on Secondary Market’ and International Standards Organisation (ISO)’s ‘Association of National Numbering Agencies’ (ANNA).  Mr. Ray has been a member of the ‘Inter-Departmental Committee’ appointed by the Ministry of Finance for examination of India – Mauritius Double Taxation Avoidance Agreement.  He is also SEBI’s co-ordinator for the ‘High Level Consultative Committee on Financial Markets’ and is SEBI’s representative at ‘RBI-SEBI Standing  Technical Committee’. He heads the ‘RBI-SEBI Standing Committee on Exchange – traded Currency Derivatives and Interest Rate Futures’.  He is also a member of the Governing Council of the Indian Institute of Capital Markets, Mumbai.

Mr. Ray holds a post-graduate degree in Political Science from the University of Delhi in addition to a degree in Law  and Post-graduate Diploma in Securities Law.

Mr. Ray belongs to the Indian Revenue Service where he holds the rank of Commissioner of Income-tax.

Review by Yoshio Nakayama, Director, Professional Service, Calypso Technology Inc, Japan

R. Venkata Subramani is a brilliant author with many years of hands-on experience in financial accounting field. Accounting for Investments was created from his efforts to teach future accountants and anyone working in the world connected with investment and financial accounting today on how to see accounting from a new and easy angle. Never has this topic been written in such simple but theoretical, practical and comprehensive form – a total triumph of maverick erudition and publishing.

Yoshio Nakayama, Director, Professional Service, Calypso Technology Inc, Japan

Review by Prof. (retd.) Girish G Yajnik, South Carolina, USA

This handbook provides a basic foundation with deep insight into the current global economic and financial crisis. The author has effectively employed a user-oriented approach to illustrate the complex mechanics of financial accounting for investments in a dynamic, volatile environment. With clear writing and pragmatic yet detailed guidance, this is a good resource for a novice researching accounting for equity investments.  No library, investment advisor or CPA practitioner should be without this handbook in their collection.

Prof. (retd.) Girish G Yajnik : alumni of USC Darla Moore School of Business and a research faculty member of University of South Carolina.

Review by Sri V. Ranganathan, Partner, Ernst & Young

In the current unprecedented and volatile economic environment which owes much of its malaise to the financial and banking sectors’ behavior, a comprehensive   guide to accounting for investment and financial transactions is a very timely addition to the existing literature on this branch of accounting. This book provides a clear understanding of the intricacies of the evolving products of the investment industry, in a very meticulous and illustrative way. A book which would be highly respected by all discerning professionals in this field.

V. Ranganathan, Partner, Ernst & Young, India.

R. Venkata Subramani

Financial Instruments

Hedge Accounting

ECL / CECL

IFRS / US GAAP / Ind AS

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