Derivative Meaning & Accounting

The word Derivative in common parlance means anything which has no identity or value of its own. Its value is based on the movement in value of another. In the context of financial instruments the term Derivative indicates an instrument which is contractually settled based on certain external factors such as a price or interest rate movement etc. Thus a derivative does not exist devoid of the main instrument or contract.


IAS 39 (Financial Instruments: Measurement and Recognition)

A Derivative contract is generally short-lived for say 3 months or 6months etc. The Indian GAAP with its completely revamped standards (converged to IFRS) proposes to clearly demarcate a short term item from a long term one. Derivatives are to be accounted on ‘Fair Value’ basis as per IAS-39. Fair value prescription is laid wherever a short term is associated. By the way, short term attribute arises when realization of the instrument happens within the entity’s normal operating cycle.


For e.g. In a forward contract in respect of an import of service where the invoice is payable after 1 year, let us  also assume that the seller realizes cash from his customer only after 1 year, it means that his operating cycle extends beyond 1 year. In this context the trade payable is still a short term item though it crosses the one year mark. Applying this logic, an associated derivative (i.e. Forward contract) also becomes a short term balance sheet item. If an item is held on a short term basis the investor will be interested of its realization value at any item. Hence there is a rationale behind Fair value basis which is nothing but the current market value in an arm’s length transaction.

Posted 4 years, 5 months ago by Mukesh Jain CA

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