Source document: https://docs-lawep.s3.us-east-2.amazonaws.com/1697807618766.pdf (India)
COVER STORY Ind AS 32 & Disclosure of DFIs CMA Dr. Gautam Mitra Professor University of Burdwan Arjun Gope Assistant Professor Iswar Chandra Vidyasagar College, Tripura Banks are widely acknowledged to become large-scale users of DFIs.

The findings of this study suggest that the level of disclosures of derivative financial instruments in accordance with AS 32 will increase in the coming years Accounting is the language of business and financial reporting is its medium.
Financial reporting plays a major role towards the economic growth of a nation.

Although the key objective of the reporting is to pres- ent the financial status of the business in a prudent and transparent manner, the management often tries to exploit the discretion in accounting standards to influence investor interpretation.

Disclosure of derivative financial instruments (DFIs) is at the core of financial reporting practice.
DFI ac- counting has remained a vital issue for long because of its non-balance sheet nature.

There’s no specific accounting standard for derivatives transactions.

The accounting treatment of derivatives is explained and guided by the financial instruments accounting standard.

Of late, three accounting standards on financial in- struments have been framed and approved to deal with the issues of measuring, presenting and disclosing financial instruments, including derivatives.
All Indian companies need to disclose their derivative financial instruments according to the provisions of Ind AS 32, Financial Instruments: Disclosures.

This paper aims to assess the level/quality of DFI disclosures of Indian banks in this regard.

Review of literature Ernst & Young (2006) revealed that majority of the investors identified transparency as the most impor- tant issue while considering an investment.
According to Rawat (2012), the users of financial statements need information about a firm’s exposure to risks and how they can be managed.

Buvaneswari (2007) stud- ied that derivatives are a very important tool of risk management.

The use of this technique, however, is not much known.

The findings of the study (Gope, 2014) disclosed that use of financial derivatives as a risk management was on the rise in the country.
According to Strouhal, Bonaci and Matis (2010), the low level of information provided for derivatives oper- ations can turn DFIs into a potential source of private information and abnormal returns because all market participants do not have access to the information they need.

According to Mitra and Gope (2013), the management is required to disclose how efficiently it uses DFIs to tackle risks.
Woods and Marginson 36 www.icmai.inSEPTEMBER 2015 THE MANAGEMENT ACCOUNTANT Ind AS 32 OF LATE, THREE ACCOUNTING STANDARDS ON FINANCIAL INSTRUMENTS HAVE BEEN FRAMED AND APPROVED TO DEAL WITH THE ISSUES OF MEASURING, PRESENTING AND DISCLOSING FINANCIAL INSTRUMENTS,INCLUDING DERIVATIVES (2004) reported that financial reporting practices are of limited help to users who want to assess the scale of an institution’s financial risk exposure.
Improved and better disclosures reduce information asymmetry and leads to a greater liquidity of the stock.

It also raises the demand from big investors and decreases a company’s cost of capital (Welker, 1995; Leuz and Verrecchia, 2000).

Verrecchia (2001) extensively reviewed and categorised accounting literature on disclosure to develop a firms’ disclosure theory.
He concluded that information asymmetry between stake- holders and management reduction, is the starting point of a comprehensive theory of disclosure.

Lopes and Rodrigues (2007) concluded that the disclosure degree is significantly related to size, type of auditor, listing status and economic sector.

No literature has been found till date that highlights the issues of rela- tion between the ‘level of disclosures’ and the ‘volume of derivatives’ transacted.
General requirements Accounting and financial reporting of a company is regulated by generally accepted accounting prin- ciples (GAAP) comprising of accounting standards, company law, stock market regulations, and others issues.

These keep changing over time to cope with the changing business environment.
Finance minister Arun Jaitley, while presenting the Union Budget for 2014-15, said: “There is an urgent need to converge the current Indian accounting standards with the International Financial Reporting Standards (IFRS).

I propose for adoption of the new Indian Accounting Standards (Ind AS) by the Indian companies from the financial year 2015-16 voluntarily, and from the financial year 2016-17 on a mandatory basis.
Based on the international consensus, the regulators will separately notify the date of implementation of Ind AS for banks, insurance companies etc.” It is expected that Ind AS 30, 31 and 32, on financial instruments which are already approved by the Accounting Stand- ard Board (ASB), will be notified soon.

Ind AS 32 is applicable to all commercial and indus- trial organisations except small and medium sized enterprises (SMEs).

It is applicable for banks as well.


The standard lays down detailed requirements on both qualitative and quantitative disclosures in the financial statements.

The disclosure will help the public to evaluate: a).

The significance of financial instruments for the organisation’s financial position and performance b).

The nature and extent of risks arising from financial instruments to which the organisation is exposed during the period and at the reporting date c).

How the entity manages those risks.


The principles in this accounting standard comple- ments the principles for recognising, measuring and presenting financial assets and financial liabilities in AS 30, Financial Instruments: Recognition and Measure- ment; and AS 31, Financial Instruments: Presentation.
Before the implementation of the proposed AS 32 we would like to find out whether there is any relation between the ordinary disclosures and the notional principal amount of derivatives; and the disclosures according to AS 32 and notional principal amount of derivatives in respect of Indian banks.

Methodology The study was restricted to the Indian banking sec- tor because it is acknowledged as large-scale users of derivative financial instruments.
We collected data and qualitative information from secondary sources.

The 2013-14 annual reports of all Indian banks listed on the National Stock Exchange (NSE) were consid- ered in this regard.

We have applied content analysis technique to the annual reports of selected compa- nies.

We have applied content analysis techniques to the annual reports of selected companies to identify accounting practices for DFIs.
According to the US General Accounting Office (1989), content analysis is a set of procedures for collecting and organizing information in a standardised format that allows an- alysts to infer about the characteristics and meaning 37 www.icmai.inSEPTEMBER 2015 THE MANAGEMENT ACCOUNTANT COVER STORY of written and other recorded material.
Jones and Shoemaker (1994) stated that content analysis has been widely used in accounting research, applied to annual reports in order to analyze several issues, such as social, environmental, and research and develop- ment disclosures.

We have used the content analysis at two levels: one, a computer-based word count has been done to measure the level of disclosures; and two, a score card was prepared for each company where the scores were allocated according to the level of disclosures.
Findings Evans and Taylor (1982) studied the impact of Inter- national Accounting Standard (IAS) on the financial reporting and found low compliance rates among member countries.

This means that the IAS, back then, had little influence over the accounting practices of its member countries.

Our study finds that all the banking companies have disclosed information on derivative transactions in their annual reports.
They provided both qualitative and quantitative information that was collated in two main places in the annual report: the financial re- view (significant accounting policies/notes and similar things), and the core financial statements (profit and loss account/balance sheet/cash flow statement and others).

It was observed that most banks provided a description of their risk profile.
Besides, they disclosed their main financial risks (interest, liquidity), risk man- agement policies, and classification of a variety of derivatives.

The banks disclosed their annual reports (table 1) and the particular financial risk appears large- ly from the rate of interest and currency exchange.

All the companies used derivative as a risk management instrument.

Though the banks chose derivatives main- ly for hedging but majority of the companies utilised derivatives for trading purposes as well.
Here it can be inferred that almost all the companies used interest rate swaps and currency rate swaps either for hedging or for trading.

The derivatives utilised, and the risks encountered, were common to all banking institutions.
Table 1: Narrative disclosures of DFIs from annual reports of 2013-14 Banks Financial risks Purpose of using DFIs Derivative contracts Axis Bank Interest, foreign currency, liquidity and credit Hedging and trading Interest rate futures, interest rate swaps, currency future, currency swaps, currency options Bank of Baroda Interest rates, foreign currency, liquidity and credit Hedging and trading Interest rate futures, interest rate swaps, currency swaps, credit default swap HDFC Bank Ltd. Interest rate risk, foreign currency and credit risk Hedging and trading Interest rate futures, interest rate swaps, currency future, currency swaps, Currency options HDFC Ltd Interest, foreign currency and liquidity risk Hedging only Interest rate swaps, currency swaps, currency options ICICI Bank Ltd Interest rate, foreign currency, liquidity and credit risk Hedging and trading Interest rate futures and swaps, Currency future, currency swaps, currency options, credit default swaps IDFC Ltd. IndusInd Bank Ltd. Kotak Mahindra Bank Interest rate and foreign currency risk Hedging only Interest rate swaps, currency Interest rate swaps Interest, foreign currency, liquidity and credit Hedging and trading only Interest rate futures, interest rate swaps currency future, currency swaps, Interest rate, foreign currency, liquidity and credit Hedging and trading Interest rate swaps, currency swaps, currency options equity futures, equity options Punjab National Bank Interest rate, Foreign currency, liquidity risk and credit risk Hedging and trading Interest rate futures, interest rate swaps, currency swaps credit default swaps State Bank of India Interest rate, foreign currency risk and credit risk Hedging and trading Interest rate futures, interest rate swaps, currency future, currency swaps, currency options, credit default swaps 38 www.icmai.inSEPTEMBER 2015 THE MANAGEMENT ACCOUNTANT Table 2 shows a wide range of word count from the annual report of banks.
Words include ‘risk’, ‘hedge’/’hedging’, ‘fair value’ and ‘derivative’.

The second column presents the score obtained by each company in terms of disclosures of DFIs.

The score card is prepared on the basis of the disclosed items guided by Ind AS 32.

The score card consists of 31 items under the subheads of financial risk, market risk, liquidity risk, credit risk, hedging, cash flow-hedge, fair value hedge, and net investment hedge.
In the score card a score of 1 is assigned to the item if it is disclosed anywhere in the bank’s annual report.

Else, Table 2 a score of 0 is assigned.

The total score (T) for a company is T=, where di is 1 if the i is disclosed, and 0 otherwise; n is the maximum number of items (n=31).

The total score is computed as the unweighted sum of the scores of every item.

The implied assumption is that each item is equally important for all user groups.
This assumption may not be realistic, but we think that the resulting bias is smaller than the one that would result from assigning subjective weights to the items (Lopes and Rodrigues, 2007) Banks No of Words used* Score Notional principal amount Total assets (derivatives) [A] (₹ crores) (₹ crores) [B] Ratio [A/B] Axis Bank Bank of Baroda HDFC Bank Ltd. HDFC Ltd. ICICI Bank IDFC Ltd. IndusInd Bank Kotak Mahindra Bank Punjab National Bank State Bank of India *Words include ‘risk’, ‘hedge’/’hedging’, ‘fair value’ and ‘derivative’ Table 3: Descriptive statistics Parameters Words used in the content Mean 414.70 Std.
Deviation 185.108 Notional principal amount of derivatives contracts 185888.9670 224519.19016 Score obtained as per Accounting standard 10.70 3.889 N 10 10 10 ACCOUNTING AND FINANCIAL REPORTING OF A COMPANY IS REGULATED BY GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) COMPRISING OF ACCOUNTING STANDARDS, COMPANY LAW, STOCK MARKET REGULATIONS, AND OTHERS ISSUES.
THESE KEEP CHANGING OVER TIME TO COPE WITH THE CHANGING BUSINESS ENVIRONMENT 39 www.icmai.inSEPTEMBER 2015 THE MANAGEMENT ACCOUNTANT We conducted the Spearman’s rank correlations test.

According to Kornbrot (2005), Spearman’s Rho is a correlation measure of association based on the ranks of scores rather than the raw scores.

It is applicable if either or both variables are direct rankings or only ordinal.
It is also applicable when both variables are metric but not normally distributed, or when the rela- tion between the variables is monotonic but nonlinear.

Although we found constructive correlation between and the number of words disclosed and the notion- al principal amount of derivatives, the correlation wasn’t significant.

This suggests that the disclosed words of derivatives aren’t related with the volume of derivative deals.
At the second stage, we tried to know whether the notional principal amount of derivatives is related to any accounting guidelines.

For this purpose we used the score obtained by each company that helped us to identify the adoption of AS 32, Financial Instruments: Disclosures.

Conclusion Almost all the Indian banking sectors use derivatives for hedging and trading purposes.

The banks give more emphasis on narrative disclosures than the quantita- tive ones regarding the DFIs.
The analysis concludes that although ordinary disclosure level does not have any association with their notional principal amount of derivative, disclosures in accordance with AS 32 have a strong positive association with them.

It can be inferred from the analysis that the adoption and practices of AS 32 will increase in the near future if the volume of derivatives used increases for hedging and trading purposes.
Table 4: Spearman’s Rank Correlations Parameters Words used in the content Notional principal amount of derivatives contracts Spearman’s Rho Words used in the content Sig.

(2-tailed) Correlation coefficient Notional principal amount of derivatives contracts N Correlation coefficient Si123/*96 g. (2-tailed) N/ 1.000 .

10 0.467 0.174 10 0.467 0.174 10 1.000 .


10 Table 5:Spearman’s rank correlations Parameters Notional principal amount of derivatives contracts Score obtained as per Accounting standard Correlation Coefficient Sig.

(2-tailed) N Correlation Coefficient Sig.

(2-tailed) N Notional principal amount of derivatives contracts Score obtained as per Accounting standard 1.000 .

10 .915** .000 10 0.915** .000 10 1.000 .

10 Spearman’s rho ** Correlation is significant at the 0.01 level (2-tailed).
From table 5 we can see that Spearman’s rank correlation coefficient is 0.915 which lies in the range of 0.80-1.00 and indicates ‘very strong’ positive correlation between the notional principal amount of derivatives and the score obtained by the banks on DFI disclosures.

Nevertheless the correlation is significant indeed which indicates that there is positive correlation between the AS 32 and the notional principal amount of derivatives.
MA arjungope@rediffmail.com 40 www.icmai.inSEPTEMBER 2015 THE MANAGEMENT ACCOUNTANT